Willy Wonka and the VAT factory

I keep finding myself to be like an omen of bad news in conversations when I mention VAT in the UAE. However, two things strike me as alarming(and somewhat irresponsible) with the coming change announced for Q1 2018.

Firstly, the blasé approach to the implications of this indirect tax; I mean Q1 is gone, budget planning for next year should be in people’s mind, and also the 5-year plans (the 5-year whaat?, yes, I get that response a lot).

Secondly, the lack of understanding and interest about how it works, how to calculate it and the impact to your particular line of business.

First things first, you should adjust your prices 5% up, to maintain your margins.

Accounting basis

Cash-basis: You record the amounts you receive at the time you receive the payment, and record the purchases when you pay them.

Accrual-basis: You record the amounts when they incur (the period they relate to) and the purchases in the same way.

I.e: A customer pays your invoice 2 months late in April, you still record the sale as February, the time it incurred.
I.e.2: You pay your entire year’s rent in one instalment, but you divide it by 12 and associate each portion to a calendar month, as the time each rental period was incurred(related to).

If you are keeping your accounts (and budgets) on a cash-basis, you will need to adjust them by the VAT amount, both on sales and purchases. Also start thinking to move your accounting to accruals, I sense a whole lot of audits are coming!

It is unclear at this stage if services will be included in the new taxation, but the amount mentioned is around is 5% (I would personally leave service expenses out of the forecast).

If you, like the big majority of businesses work on an accrual-basis, then you need to adjust your cash flow forecast, with an amount equal to the sales(revenue) and purchases(expenses) times the VAT (5% tentatively), and your balance sheet for an amount equal to the difference between sales and purchases multiplied by the VAT, recorded as a liability (VAT payable).

Secondly, you need to think about your customer base, would they be sensitive to their new expenses going up 5%, and how much would that affect(negatively) their propensity to consume; or how many things they’lll have to sacrifice after most of their  expenses go up by 5%.

LESS MONEY, LESS HONEY; BUNNY.

A research by the Tulane university in conjunction with the IMF found that roughly; aggregate consumption drops at a 1:1 ratio with indirect taxes in the short term, and more in the long term; meaning every 1% of VAT will result in 1% less sales for you. Obviously this may not be exact, but if you are to adjust your sales by some magical amount, make sure you do it conservatively at least by that amount.

You can read the whole research here

If your business trades in necessity goods (food, fuel, water, etc), then you may even see a spike on sales (don’t plan for that). There is even a theory that predicts such behaviour on necessity goods. The economic equivalent of a unicorn, Giffen goods!. These are goods that respond against a price change, maths aside and long story short they work like this:

You have $12 dollars per week, you buy three steaks ($2) and a bottle of sparkling water ($5), the steaks go up to $3 each, you may now buy 4 steaks and drink tap water, (notice the water price didn’t change); because you can no longer afford your initial basket and you value your steak more than water!

And that is more or less what a Giffen good is, still waiting for someone to prove their unbiased existence in the real world with statistical significance. I was talking to someone who believed in fairies just a couple of days ago, also waiting on proof of that.(This research is the closest I have ever been to be convinced, but the household composition criteria was the equivalent of the fairy lady saying that, “I had to believe to see them”.)

IN SUMMARY; get your 5-year plan together. Adjust it from January 2018 to include 5% tax in sales and purchases, also adjust your cash-flow forecast (which in essence both should match if you are working on cash-basis), also reduce your expected sales. Then adjust the balance sheet liabilities by the difference between the tax of both sales and purchases, and your cash flow forecast.

If you are working on an accrual-basis, adjust your sales(down), your balance sheet liabilities and your cash flow (as per above).

Hope you find this somewhat useful, and hopefully it increases the amount of people starting to plan ahead for the small change.

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