First-Mover Advantage

VAT Implementation

The introduction of VAT has led to a rise in CPI with strong prospects of closing the government's financial deficit and growing the economy.

On January 1, 2018, Saudi Arabia implemented a 5% value-added tax (VAT) on a wide range of goods and services following the country’s ratification of the Common VAT Agreement of the GCC. The introduction of VAT marks a significant change in the region, which has a well-known reputation for being largely tax-free. However, VAT was necessitated by persistently low oil prices resulting in a reduction of hydrocarbon income for the Saudi Arabian government, coupled with a widening fiscal deficit. Other neighboring countries experienced the same fate as the Kingdom, hence the region-wide tax agreement.

The implementation of VAT was one of several fiscal reforms; other reforms included an increase in fuel and utility prices, the introduction of excise taxes, and a new levy on certain temporary foreign workers. The reforms were intended to offer positive support to efforts by the Crown Prince Mohammed Bin Salman to grow the country’s non-oil sectors and reduce reliance on income derived from oil-related activities.
All six GCC member states—Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the UAE—signed the agreement in 2016, though Saudi Arabia and the UAE are the only GCC countries to implement VAT thus far. Though, unlike the UAE, which simultaneously implemented VAT in January 2018, Saudi Arabia had an established government taxation authority, the General Authority on Zakat and Taxation (GAZT). GAZT had previously administered taxes in the country and was well positioned to implement VAT.

In preparation for the introduction of the tax, GAZT had conducted several field visits to assist businesses by advising them on how to prepare. Only businesses with an annual turnover of SAR1 million had to register by December 20, 2017 for filing VAT returns in January 2018, while businesses with an annual turnover of SAR375,000 were given time until December 2018 to register.

Despite efforts to support businesses in filing their first VAT return, GAZT had registered over 3,000 VAT violations within the first two months of implementation. Six months after its implementation, many businesses remained uncertain about aspects of the VAT regime and insecure around issues regarding compliance. A less than smooth rollout of VAT in the GCC’s most sophisticated market, at least in terms of tax infrastructure, does not bode well for other GCC countries. Implementation in the remaining four GCC states remains uncertain.

The immediate economic effect of the fiscal reforms was a sharp rise in consumer price inflation to 3% in January, up from 0.4% in December 2017. Inflation is further expected to rise as demand increases following the initial shock of the tax introduction, while the IMF estimates that it will stabilize at around 2% in the medium-term. Cash-strapped consumers have consequently turned to the banks to finance their purchases, including day-to-day expenses.

Business activity had also slowed to a record low in the wake of the increases, largely because of high output and purchasing in anticipation of the new tax. Despite the temporary economic effects, the IMF is confident that the fiscal reforms, including the introduction of VAT, will achieve the Saudi Arabian government’s stated objectives. The fiscal deficit is expected to narrow from 9.3% of GDP to 1.7% by 2019, although much of this is expected to be financed by asset drawdowns coupled with domestic and international borrowing.
The increase in revenue has led to a rise in business confidence on the back of an expansionary budget set by the Kingdom. GDP growth is expected to rise to 1.9% in 2018, and continued reforms are expected to help the Saudi Arabian government promote growth in the non-oil sector to 2.3% that same year.