By Megha S. Anthony
The era of Value Added Tax (VAT) has begun in the GCC with regional facilities management companies – as well as those in several other sectors – seeing 5% VAT added to the cost of their services. Residents of UAE have always been fortunate to enjoy a tax-free living for a long time. However, like most other changes, the introduction of tax has had its effect. ‘FM today’ talks to professionals in the facilities management and cleaning sector to understand the impact VAT has had on them and on the industry at large.
For many, the tax may not increase the cost of operation as such for businesses, as the tax paid on inputs is set off against the tax collected from the sale of products and services. George Thomas, Vice President, Epsco, says that business enterprises in most cases are going to be agents who collect tax on behalf of the government on the value addition done by them and pay the collected amount to the government. “Business will get affected adversely by revenue loss caused by controlled or reduced spending by end users who are living already on a tight budget. For businesses, there is also going to be an additional resource requirement to collect and compile tax, file and keep compliance records. Although the tax is to be paid by the consumer, we are already witnessing a tendency for customers to negotiate a reduction in total price to balance their budget. This could lead to some revenue loss and reduction in the bottom lines,” he adds.
The FM and cleaning industry has been preparing itself for this change. And part of these preparations includes the need for companies to get to grips with their compliance arrangements, work through the cash-flow implications, put in place proper invoicing, and make sure their contracts reflect the new tax. And, most importantly, it involves educating the team about VAT.
In order to prepare Emrill Services for VAT, planning primarily focused on education, review of processes and preparation of systems. “Technical accounting of VAT and the capability of the financial system is the key to ensuring that VAT is accounted for correctly. This is important in order to ultimately avoid fines and penalties. Once this is understood, internal controls and processes are then re-designed around the system to ensure full compliance with the VAT regulations and relevant tax law,” explains Sam Emery, Finance Director, Emrill.
JLL has been active in preparing for the impact of VAT for some time now. Some of the measures they’ve taken include registering the company with the relevant tax authorities in both the UAE and Saudi Arabia, adding the implications of VAT into their financial modeling and valuation programs and updating all their contracts and invoice documentation to make provisions for VAT where appropriate. “The regulations have already been announced in Saudi Arabia, but this is not the case in the UAE. We have therefore been basing our modeling and planning on the basis of various comments from the Federal Taxation Authority. The latest of these suggests that commercial properties will be subject to VAT but that the construction, sale, and leasing of new residential properties will be exempted,” says Craig Plumb, Head of Research, MENA, JLL. Some companies have also provided in-house training to improve awareness. One such company is Al Fajer Facilities Management. “We are currently providing in-house VAT training to improve awareness about VAT within the finance team and operation department. We are also automating the financial processes through ERP systems to properly calculate, raise invoices and successfully to register the VAT Payables,” adds Yogam Ponnambalam, Director – Finance, Al Fajer Facilities Management.
The introduction of VAT will impact the overall real estate sector and specifically the service industries including property and FM. With the cleaning and maintenance services in the taxable category, all residential, commercial and industrial customers are paying 5 per cent more for the services this year. One of the target groups for the industry is the property owners. The FM industry is entirely dependent on manpower and consumables; hence, the cost distributed to end user/occupiers will be higher than the cost of the same level of services. “The present real estate rental market is seeing a downward trend, and where cleaning and maintenance services are offered by the landlord, we expect to see some loss of revenue from both renegotiated lower prices and reduction in the frequency of the services. We also expect this from other target groups,” says Thomas.
According to Raheel Memon, Finance Manager, Property & Asset Management Services, MENA, JLL, in UAE, particularly in Dubai, most of the communities and buildings are operated and serviced by 3rd party FM service providers. In such cases, the occupants may face high distribution of service charges on the units/buildings, which may result in a shortfall in cash flow as most of the occupants will resist the high FM cost and will delay repayment of service charges. FM companies will have to inject the cash to pay VAT to the authorities for all uncollectable invoiced fees. “One will also see a marginal increase in the rent prices. FM companies may lose revenue in short-term as occupiers may look for cheaper service with low standards. It would be interesting to understand whether VAT will also be applicable to the staffing cost. In such cases where the labor cost is exempted from the VAT, FM companies may take a route to create new entities to employ the manpower and split the contract between 2 entities. This will result a significant reduction in the revenue of the original entity, and VAT will be significantly lower if the contracts are designed based on manpower supply instead of KPIs,” says Memon.
Ponnambalam, too, feels that there will be an increased burden on cash flow and working capital till the market experiences a correction in prices. “This year, we are expecting high competition in prices, and this would lead to companies squeezing profits, which would eventually impact the cash flows,” he adds. Emery, on the other hand, says that the implications for businesses will be the lack of knowledge and understanding amongst staff that can stem from insufficient training or investment in education. “If this is not properly addressed by FM companies, it could lead to incomplete VAT returns ultimately resulting in fines and penalties. So, the key is to plan ahead,” she adds.
Any change in the system will always come with its own set of challenges. The 2 main challenges that many foresee are uncertainty and cash flow. “Any new legislation introduces a degree of uncertainty in the marketplace, and this is particularly the case with VAT as there are currently no systems established for the collection of this tax within the region. The fact that the detailed regulations have not yet been published in the UAE is further increasing the sense of uncertainty. Like any uncertainty, this will reduce the level of market activity and transaction volumes as all participants delay decisions while they assess the full impact of the new regulations on the performance of their real estate investments or operations,” says Plumb. He goes on to add, “There are also concerns that while companies will be required to pay the 5% tax on many goods and services from 1st January 2018, it may take some time for them to be able to reclaim the tax that is owed to them by suppliers at different levels in the value chain. This could impact cash flow and therefore the profitability of businesses in the short term.”
Ponnambalam, on the other hand, feels that all FM companies will have an initial adapting period to the new VAT regulations. “In the short run, we can experience problems from lack of understanding of the VAT norms, new processes, finance modules, possible administrative requirements,” he adds. However, some companies will find it easier than others depending on the complexity and volume of transactions, and the competency levels of existing accounting staff. “If companies have not yet commenced their VAT planning and implementation, then in the short term this could lead to significant issues. In addition, problems may arise from the lack of understanding of applicable transactions, additional administrative requirements and the introduction of new modules within the accounting system,” adds Emery.
Another issue that could arise is from the long-term contract that FM and cleaning companies already have. Typically, some contracts are signed for 3-5 years, and if the tax clause is absent, there may be a possibility of some amount of dispute. “VAT implementation will not only impact our current long-term contracts but also our ongoing discussions and new contracts; therefore, we are reviewing all the contracts to plan and ensure smooth cash flow planning and pricing. Since VAT returns to the tax authorities will require supporting documents, we are working with our system for document control solutions to ensure proper registering and filing of the documents so that they can be retrieved efficiently,” adds Ponnambalam.
These short-term negatives are likely to be more than offset by positive impacts on the real estate sector in the longer term. “As well as increasing the level of government revenue available for investing in infrastructure and other measures to stimulate the real estate sector, the improved level of accounting and openness that will result from the introduction of VAT will increase the overall transparency of the market and thereby attract further investment in the longer term,” says Plumb.
Thomas agress, “VAT is expected to be positive in the long run, as the government will have higher income to spend on the infrastructure projects and others, which will boost the core industries of tourism and trade,” he sums up.