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Is VAT to blame for GCC auto sector running out of gas?

The GCC automotive sector has been experiencing some difficult times over the past two years, and VAT may not make it easier.

New Car sales have been hit hard with the market correction of 2016 and 2017. This coupled with excess inventory has made car dealers’ job tougher.

Now with the Value Added Tax (VAT) coming into effect from January this year in the UAE and Saudi Arabia, how has it impacted the region’s auto sector? Has it been putting more pressure on auto sales?

Even though the VAT rate of 5% is low by comparison to rates of VAT applied in other countries (the average VAT rate around the OECD is 19%), in the GCC region with a penchant for purchasing expensive automobiles, the imposition of VAT has increased the nominal prices of car brands.

For example, a car that had the sales price of AED 100,000 last year has now a new price tag of AED 105,000 from January 1st 2018.

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Impact on auto dealers’ cash flows

Although it’s too early to fully assess the clear impact of VAT on auto sales in the region, since the expected transition period normally ranges between 12 to 15 months, there are some initial signals by analysts that indicate VAT imposition could impact the cash flows of auto dealers in the short term.

Before understanding how, let’s quickly wrap-up how VAT works. VAT is a basically transaction-based tax (it is levied at each stage in the chain of production/distribution). It is charged on supplies/sales (output tax) and deducted on purchases (input VAT)

Auto sales are charged at a standard rate of 5%, the related input tax is deductible. But here’s the catch!

Most, if not all, new vehicles are imported into the GCC having been manufactured in third countries. According to Deloitte, it is likely that the importation of a car will be subject to import VAT at the time the vehicle is removed from customs control and entered into so-called “free circulation”.

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The same goes for other purchases made by dealers; VAT will have to be paid on purchases and the additional amount will need to be pre- financed until a credit for it can be obtained from the tax authority.

“The lag between payment and credit can be substantial, (certainly during the initial phase of operations under the VAT), with the result that working capital headroom may have to be increased in order to allow for it,” Deloitte notes in its report, ‘Value Added Tax in the GCC: Insights by industry, Volume 1’.

“Application of VAT would vary depending on the type of goods. New vehicles, auto parts and repair services would have the VAT rate of 5%. Optional special rules in determining VAT are applicable for second hand car sales. Exports would incur no VAT while import of vehicles would come under VAT. Businesses that pay VAT to procure then it could charge on its suppliers would be affected on their working capital front. Also businesses which incur a mix of VAT exemption and taxable products would incur hassles in VAT recovery, ” MR Raghu, MD Marmore Mena Intelligence, told AMEInfo.

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Positive impact on nearly new used cars

For the second-hand car segment, VAT is chargeable on the profit margin achieved on sale by the registered dealer, to ensure that there is no ‘tax-on-tax’ cascading, the Deloitte report notes.

Overall, VAT is likely to see a significant increase in demand for nearly new used cars, since VAT is calculated significantly different on used cars than it is on new cars.

“VAT will create a high demand on nearly new used cars as the dealer only pays VAT on the profit. A simple example is that a consumer could purchase a used car, 6 months old, low mileage and two trim levels higher than the original new car which is now priced at AED 105,000 due to VAT for AED 90,000. If the dealer operates and a 9% margin the VAT element is only AED 400,” told Ian Batey, General Manager of Autodata Middle East, to GMR (a sister publication of AMEInfo).

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Let’s do some maths here on how VAT is calculated on used cars.

– AED 80,000 (Dealer purchases a used car)

– AED 2,000 (Dealer expenses in preparing the car for sale)

– AED 82,000 (Total cost of the car the dealer, purchase price plus costs)

– AED 90,000 (selling price)

– AED 8,000 Profit margin (90,000 – 82,000)

– VAT AED 400

However, despite all these implications, car dealers in the GCC region are optimistic for the future. In order to offset the impact, they are coming up with various offers to entice potential car buyers.

Axel Dreyer, General Manager, Galadari Automobiles, Dubai comments, “The market has really struggled in 2016 and 2017. However, things are gradually turning around, and hopefully 2018 will be a flat market and the drop in sales will stop.”