The Viability Of GCC 'TAX' Regimes

05 April 2002

Last week's news that Saudi Arabia is considering a corporate tax of some 8% was not altogether surprising; although it did cause concern in some quarters as to its possible 'demonstration' effect. It is unclear if the news itself stemmed from valid quarters and as to the pace with which this corporate tax regime will be introduced. Nor is it uncommon within the GCC as Oman for instance, already has a form of corporate tax and in the UAE, the foreign banks pay a levy on their profits to the local authorities. Indeed there are parallels in other parts of GCC. Indirect taxes including customs duty, collected in all the GCC countries, was recently harmonised at 4%, in the main, and at varying rates for some goods. Nevertheless, all Saudi announcements are often viewed as harbingers that other GCC states will follow suit, although this is not always the case. Besides different GCC states are in an altogether more or less comfortable fiscal situations. A few have, in the past, articulated against taxes, even on expatriates, and / or non-national-owned corporate entities. Besides, in the 'cities' and free zones in the UAE, companies have been expressly granted tax immunities for specified periods. Therefore, the so called demonstration effect syndrome may turn out to be limited; except in countries such as Oman and Bahrain, whose fiscal situation, relatively low oil and gas revenues, large domestic population and employment pressures may warrant consideration of such fiscal measures. Usually, the IMF and the World Bank projected as the inspiration behind such moves are thereby the villains in the piece; as their experts often proffer tax advice and draconian fiscal and financial recommendations to remedy economic ailments. Sometimes this takes the form of a sledge hammer to swat a fly!. Their policy prescriptions tend to be universally uniform i.e. privatisation, widening of the tax base, reduction of fiscal deficit etc. i.e. cliched economic approaches that certainly land them in the controversial 'hot spots', particularly after the Asean denouement.

It is the genius of each GCC country that needs to be reflected in their economic growth plans and as to what fiscal regime suit them best. But it is important to consider fiscal strategies not only in the context of the classical economic theories but in terms of their continued relevance. Direct and indirect taxes have always been the subject of university economic discourses; with the former being the most favoured for its egalitarian and equitable dispensation. Again much of this is linked to the debate on democracy as vividly depicted in the U.S. history and the Boston tea party episode when "no taxation without representation" was the popular slogan. Furthermore, there is the widespread and non-focused impact of indirect taxes that is often considered as pernicious. Such adverse effects depend very much on whether or not a particular country has a skewed income distribution. Another harmful fallout of indirect taxes is inflation.

The customs duty currently in place in the GCC, is also an indirect tax and the specific charges for services and utilities represent a good approach with one substantial merit. It is service-specific to the uses of the relevant offerings and thus is not quite an indirect tax, in the literal sense of the term. In fact, the user fees mechanism is a good way of ensuring that there are no 'free-lunch' expectations in the public minds and that like air, water and other freely available commodities, taken for granted. The economics text books would say that taxes ought to be levied only on those who can afford to pay i.e. "charge what the traffic bears"; that can then be used to subsidize those who cannot contribute to the kitty. This should not, however, be a prerequisite; given the GCC's largely welfare state orientation, where the government does support and subsidise many worthwhile social infrastructure activities such as education, health, power and water. Toll roads may be another useful instance of a user charge.

A more important consideration should be the cost of administering and collecting taxes. In many countries, such as India, the implementation of the tax regime and the cost of bureaucracy thus created tend to absorb a significant portion of the revenue raised from the taxes, thus leaving precious little for development spending and making the whole question of personal income taxation suspect from a viability perspective. Indirect taxes are easier to collect and the costs of administration and collection represent only a small fraction of the revenue.

Personal income tax has another important dimension, which is that it puts 'people off'; viewed by the productive as penalties and generally becomes a disincentive with a demoralising effect. If over a third of your hard-earned income is taken away, as is done in many countries, then your incentive to perform and excel is affected, particularly at the higher ends of employment and businesses. Therefore it acts as a 'tax' on talent and will make the more intellectually bright and skilled work force vote with their feet. Now that most of the developed markets are welcoming knowledge workers with open arms, this is a particularly relevant point. In the high productivity segments of any economy, it is prudent to avoid losing the brightest and best by way of brain drain!.

Corporate tax has a yet different aspect, in that it leads to a spawning and mushrooming of tax planning vocations such as those of accountants and tax consultants, who are geared to 'advise' you as to how to avoid tax legally if not 'evade' the same by way of multiple book entries. In the least it blurs focus and eggs on people towards thoughts on how best to minimise the tax burden. This consultancy mania leads to a vicious cycle where the corporate and commercial segments are forever busy cooking up or juggling with what is tax-efficient or not taking their minds away from businesses of growth. It is almost like the 'recharge' mechanism in some corporations and banks, where endlessly, each individual unit within a group, is trying to palm off its cost to another; with the latter resisting; all leading to considerable unpleasantness. Ultimately all levies end up as taxes on patience, productivity and profitability. If this sounds pedestrian and cliche; then like all cliches, this one also has considerable validity.

A major attraction of doing business in the GCC, has always been its low and / or non-existent tax regimes. Saudi Arabia has recently embarked on an inward investment promotion exercise and has progressively relaxed its business ownership regulations. Its consideration of a corporate tax now, therefore, might act as a serious dis-incentive to the foreign direct investments (FDI); whose flow it seeks so assiduously. Dubai, on the other hand, has always kept the 'investor' right at the fore, and its trump cards include the absence of bureaucracy and the tax-man knocking on (or down) your doors!

It is true that in Dubai there are user fees and specific costs that are escalating, including for instance, what the tenants pay to the municipality on rentable properties year after year. But mercifully, these are not perceived as irritants; in the same way as a full blown personal and corporate tax regime will be.

All governments will try and justify how their increasing expenditure should be recouped from taxes and the IMF and the World Bank will always point out the need for sustainable monetary resources such as corporate and personal income taxes! Ultimately, the proof of the pudding lies in how such taxes are accepted by the citizens of a country. Inflation itself is a creeping, hidden tax on one's income and if inflationary pressures are kept low through specific fees for services, there will be little reluctance on the part of the payer. But if he begins to compare, moan and groan on unjustifiable 'share of the wallet', then he has an exit choice. If he moves his business away to another country, then the tax base will shrink anyway. The governments therefore, need to feel the pulse of the common man and the businesses constantly; in the current competition for investable funds / capital by different countries around the globe.

Another key issue is the concern on the part of the citizens that they may end up paying taxes to support an inefficient government or an overblown bureaucracy and that their money is best spent by themselves; if it is going to be allocated unwisely. This is the classic Republican or Conservative party credo as in the U.S. and the U.K. The welfare states' taxation approach is exemplified by the Scandinavian countries. There are different geo-political models and the socialist mores have clearly been thrown overboard last century. There is now a transparent tone, implying that "lower taxes might actually make the revenue generation more buoyant".

Case studies can be drawn from around the world for the GCC countries and based on the experience and experiment in other parts of the world. Policy prescriptions by outsiders who have a little knowledge of this region, may not always help. Home-brewed medicines and the grandma recipes are more likely to cure and endure and will be regarded positively by the businesses and individuals within a country!

In this context, Singapore's example is instructive. It has been consistently slashing taxes (as announced yesterday yet again); with a view to making that country a good destination for inward capital flow, for high quality global businesses, for creating employment opportunities for its youth and for raising its profile as a well regulated jurisdiction. This is a model that Dubai has been and should be pursuing.

TAILPIECE : Tax will always be considered a three-letter word and to quote a tax-payer "They asked me to pay it with a smile. I tried it; but they wanted cash!". Jokes on taxes are aplenty but ultimately, the 'smile' or simile here is also indicative of the need for 'feel-good' factors for any economy to progress soundly and sensibly.

(The author (sureshk@emiratesbank.ae) is a General Manager in Emirates Bank Group. The views expressed in this article are not necessarily shared by the Bank.)

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