Vat – Pain To Gain

A wave of uncertainty is passing through the gems and jewellery industry in Dubai, as the city of gold gears up for a new tax regime. On 1 January 2018, a value added tax (VAT) regime will come into force across the United Arab Emirates (UAE). This 5 per cent tax will apply to nearly all sectors of the economy, including jewellery. Regarding VAT, industry concerns mainly relate to implementation and the impact on business and on the clout of Dubai as the world’s leading jewellery trading hub. Niladri S Nath speaks to industry stakeholders to gain insight into sentiment within the trade.

In a move to diversify revenue sources and reduce their economies’ reliance on oil and gas, the six member states of the Gulf Cooperation Council (GCC) recently signed a Value Added Tax (VAT) Framework Agreement. The United Arab Emirates (UAE) has just published its draft domestic VAT law.

On 1 January 2018, the United Arab Emirates (UAE) and the Kingdom of Saudi Arabia (KSA) will switch to a new tax regime based on value added tax (VAT). Other Gulf Cooperation Council (GCC) states will implement VAT at a later stage. Although intensive and extensive planning underlie the change, it is only to be expected that among residents and businesses the anticipation is paired with nervousness.

“The UAE government is known for providing the highest quality of public services for its residents, and this requires investment,” explains Rihen Mehta, chairman, 7Cs Group, a leading Dubai-based diamond and jewellery trading and retail house. “Catering to the needs of the population requires revenue, which is sourced predominantly from the oil and hydrocarbons industry. Imposition of VAT is an effort to diversify revenue sources and increase revenue.”

Both the International Monetary Fund (IMF) and the World Bank (WB) have, in the past, advised the UAE government to diversify away from oil, a commodity that can experience serious price volatility. In recent years the oil prices have halved on the global market from $100 a barrel to under $50, making the IMF and WB recommendations timely and relevant.

“As the UAE government’s development goals become more ambitious, stable revenues are even more crucial to making long-term plans and attaining results,” says Chetan Karani, secretary, Dubai Gold & Jewellery Group (DGJG), a trade body.

A report by PricewaterhouseCoopers’ on the imposition of VAT provides further support: “VAT will help governments deliver on long-standing plans for economic diversification away from oil, while still being able to deliver social and economic programmes.”

Losing the edge?

The goal of broad-based and secure government revenues for a healthy and well-functioning society is regarded universally as admirable. Most jewellery industry stakeholders, however, continue to be concerned about VAT’s potential impact on profitability and demand, at the trade as well as consumer level. They also flag a possible risk to the dominance of Dubai as a premier jewellery trading hub.

“Among Dubai’s gold and diamond businesses, there is a sincere feeling of uncertainty. We are aware of two gold refineries that want to shift their base from Dubai to Hong Kong. This will send a very negative message if it becomes a reality. Diamonds and gold are critical to Dubai’s trade, jointly accounting for business worth $75 billion annually,” observed Ahmed Bin Sulayem, executive chairman, Dubai Multi Commodities Centre (DMCC), at the recently concluded Dubai Diamond Conference (DDC) 2017. His comments reflected widespread industry sentiment.

In his speech at the same conference, Peter Meeus, chairman, Dubai Diamond Exchange (DDE) said that the imposition of VAT could neutralise the growth Dubai has achieved over the last 15 years.

Sulayem and Meeus both highlighted the value of the strategic edge, from the trade point of view, that Dubai has gained over the years by dint of its excellent infrastructure, superb connectivity and ease of doing business. Dubai is the world’s leading trading hub for gold jewellery, leveraging the ability of its gems and jewellery enterprises to offer consumers purity, competitive pricing and an unlimited variety of designs from all over the world.

What is the special recipe behind Dubai’s success so far? Chandu Siroya, vice-chairman, DGJG, spells it out: a low cost of operations, almost-zero taxation and a high-turnover, low-margins retail approach. These strengths have made Dubai the leading jewellery-sourcing destination, at the trade and consumer level. Karani of DGJG expands the recipe, identifying favourable government policies, low import duties and ready availability of finance.

The results are there for all to see. In his speech at the DDC, Meeus had numbers. Dubai’s diamond trade grew from just $300 million in CY2002 to $26 billion in CY2016. That places Dubai next in line after Antwerp and Mumbai among the largest diamond trade hubs on Earth.

With VAT, however, the industry fears that Dubai places at risk one major ingredient of its special recipe, namely the low-tax regime. There is general concern about the impact of VAT on business conditions in this respect.

Imported as well as manufactured jewellery will come under the purview of VAT. The 5 per cent tax will be levied on all transactions across the supply chain. “Traders will pay 5 per cent VAT at the point of import, and then charge their customers while selling, to offset the VAT paid on all their inputs,” says Karani. “This will cascade down the supply chain all the way to the consumer. The final consumer will be the only one who will not be able to claim any VAT credit or refund.”

The implementation uses the reverse charge mechanism. “For locally manufactured jewellery, the manufacturer will levy the VAT at the first point of sale and pay it to the government,” says Siroya.

Dubai is also a transshipment hub. A significant share of the industry’s revenue comes from re-export to other GCC countries. Abdul Salam K P, group executive director, Malabar Group, estimates that 80–85 per cent of the gems and jewellery imported to Dubai are re-exported to other countries. Now the people will start exporting goods from the manufacturing country to the consuming country, says he.

Naturally, margins at the trade level are low. “I think VAT will not be a huge concern for traders dealing in finished diamond jewellery, where the margins are higher,” says Karani. “But in loose diamond and plain gold jewellery trading, the margins are relatively low and a 5 per cent additional tax burden on buyers might be something that one can’t overlook.”

It is worth noting here that only two GCC countries will introduce VAT in January. After VAT kicks in, therefore, a customer from Oman, where the new tax is yet to be implemented, may not be willing to pay VAT on the jewellery she is buying in Dubai. “That scenario creates a possibility that wholesalers from non-VAT GCC countries may source directly from the manufacturing country, if the differential rates works out lower,” says one Dubai trader, on condition of anonymity.

Another impact of VAT will be felt by the small traders who visit Dubai regularly to purchase jewellery in their individual capacity. “It’s an unorganised segment in export,” explains Abdul Salam K P.

While implementing VAT, says Karani, the UAE government should study the trade statistics for the jewellery industry. “I think 85 per cent of the entire wholesale trade and manufacturing in jewellery is subject to export. In the diamond trade, probably 90–95 per cent is re-exported. In such a scenario, the actual collections the government can realise from VAT will be much lower than the headline figures suggest.”

Traders, meanwhile, may try to limit the impact of VAT on their business by shifting to bonded free zones. As per the regulations, any import and export done through these zones is not subject to VAT. The reshipment business will have no option but to move to these zones. Bonded free zones don’t come under the purview of local duties and taxes.

The problem is there are only two bonded free zones — the Dubai Airport Free Zone and the Jebel Ali Free Zone. So, more may have to be created. Certain places, like the DMCC in the Jumeirah Lakes Towers (JLT), where most of the jewellers and diamond dealers are located, are free zones but not bonded. One solution in this case, say industry insiders, is for a portion of the DMCC to be notified as a bonded free zone to facilitate trade.

Siroya of DGJG shares the view that traders will consider moving to other destinations or to customs bonded areas within the UAE. But he adds that it is too early to jump to any conclusions, because the final executive rules are still not released. “If VAT is levied on the full value there will surely be a major shift in the business, and all of us will be required to adapt in order to maintain our industry position,” he says. “We could see business expansion plans being postponed, as companies wait to study the actual impact of VAT after implementation.”

Mehta of 7Cs, on the other hand, does not believe that business will move to other countries. The extremely business-friendly environment of Dubai, in terms of approvals, logistics and the absence of red tape, he says will remain a solid attraction.

What troubles the industry most is the lack of clarity on the mechanisms and likely impact of VAT. To gain the clarity they need, key industry stakeholders have opened channels of discussion and negotiation with the government. And this effort will continue until full details on the VAT mechanism and implementation are released. These procedural details, after all, will closely determine how the gems and jewellery business, which is not like any other industry, functions.

To take an example, the bulk of the jewellery trade in Dubai runs on a “gold-to-gold” basis. In other words, wholesalers often supply the gold as a raw material to the manufacturers to make jewellery, and the manufacturers in turn raise invoices only for the labour charges on manufacturing the jewellery. “How will the tax authorities treat the gold supplied to the manufacturers by the wholesalers?” asks Siroya. “Do the manufacturers have to show full value purchase?”

When it comes to a compliance failure, says Mehta, the Federal Tax Authority (FTA) may impose an administrative penalty, which is assessed at a minimum of AED500 and a maximum of three times the tax that would have been payable.

There will also be provision for strict penalties for tax evasion. Tax evasion involves the use of illegal means to either lower tax exposure or not pay the tax due. Obtaining a refund to which one is not entitled under the law also counts as tax evasion. “The penalty can be up to five times the tax payable, and imprisonment,” says Mehta.

Consumer

What about the end-consumer? “I think there will be initial confusion and resistance among consumers to the rising prices of jewellery at the retail end,” says Karani. “If retailers are able to absorb some of the costs for a few months, it may help the consumer to continue spending. Passing on the costs of VAT slowly, over six to nine months, may be one strategy. In the longer term, consumers in the UAE will get used to VAT.”

“Business may take time to adjust to these changes,” says Mehta. “I feel there may be a reduction of 15–20 per cent in business in CY2018, compared to CY2017. Mid-stream businesses will not be able to absorb the cost of VAT, and they will pass it to the end-consumers.” To avoid this, in his own business Mehta is planning to absorb part of the additional cost and pass the benefit to his end-consumers.

The UAE, especially Dubai, is one of the most competitive markets in the world. This is why, say experts, the industry will find it difficult to adjust to a 5 per cent VAT. As the last couple of years have been challenging for the jewellery industry, the expectation is that a lot of retailers will try to absorb some of the costs of VAT rather than lose customers.

A jeweller in the UAE works on a typical margin of 2–4 per cent at the wholesale level and 8 per cent at the retail level, in gold jewellery. The margins are a little higher on diamond jewellery, but overall the 5 per cent VAT is likely not only to reduce the profit margins of jewellers but also affect sales.

The introduction of VAT, says Tawhid Abdullah, chairman, DGJG, “may narrow the price advantage between UAE and the Indian subcontinent. Dubai could likely to become a less attractive shopping destination for jewellery purchasers from that region.”

Karani hopes that the variety and quality of jewellery in Dubai continue to draw buyers. “We also hope that a VAT refund mechanism for tourists will be enabled at a later date,” he says, positively. The big question, he says, is whether Dubai will remain the global jewellery hub it is today.

Accepting the change

Taxation has long been the bane of the jewellery industry. Every successful jewellery hub has extremely minimal or zero taxation. There are examples from history that the UAE’s policymakers can readily refer to. They include the migration of the diamond trade from Amsterdam to Antwerp after the Second World War, and the subsequent exodus from Antwerp to Dubai.

In fact the introduction of tax led to the demise of Europe’s, and potentially the world’s biggest physical gold market. After tax was imposed, market volumes crashed by 90 per cent. The market shifted to Luxembourg. Many years later Germany abolished the tax, but the damage was well and truly done.

Having said that, 160 countries already have a VAT or GST in force. Clearly, there must be some examples of success. Given the worldwide prevalence of these taxes, there is every chance that buyers who come to Dubai to purchase jewellery, at the trade and consumer level, will be used to paying VAT and other taxes. The difficulty is that many buyers come to the UAE expecting tax-free purchases. That mindset will just have to change, say the experts.

Is it possible that just one factor, the imposition of a 5 per cent VAT, will cause Dubai to stumble on its astonishing journey to jewellery success? That success is owed to close cooperation and understanding between the industry and the UAE government. Together they have transformed Dubai, over the last 35 years, from a small local retail market into a world-class gems and jewellery hub. There is no doubt that the industry will not fritter away its great advantage.

“Our industry representative at the DGJG has been constantly consulting and lobbying with various government departments and ministries to make them aware of our concerns, offer our solutions and highlight possible consequences for the industry,” says Karani. The DGJG is urging the government to limit VAT to the making charges (the actual value-add) and not on the gold and diamond value of a piece of jewellery. “If the government accepts this suggestion, VAT will have a minimal impact on the trade, and in fact business will grow more in Dubai and across the UAE,” says Siroya.

Through the storm of doubt and worry, we see all the hard-won and long-protected advantages of Dubai stand unshaken. Certainly the city will not easily be dislodged from its position as the world’s leading gems and jewellery trading hub — even by so consequential a change as the introduction of VAT. Dubai is synonymous with style, variety and success, but also adaptability, especially in this unique and special industry.