When it comes to fiscal policy in the UAE, value-added tax (VAT) and corporate tax are the most significant. Both of these taxes play a vital role in the government’s revenue collection, which is necessary for public spending. However, the collection is fundamentally different under both taxes, with varying impacts on the economy and society. VAT is levied on the consumption of goods and services that affect the end consumer. Corporate tax applies to the profits of corporations, thus influencing corporate behavior and investments. In this blog, we provide a comprehensive yet basic comparison of VAT vs. corporate tax under UAE laws and regulations.
VAT vs. Corporate Tax: Defining Terms
To understand the key differences between the two primary taxes in the UAE, first, we need to define the terms as per the law.
The UAE’s VAT Law defines value-added tax as:
A tax is imposed on the import and supply of goods and services at each stage of production and distribution, including the deemed supply.
The UAE’s tax law defines corporate tax as:
The tax is imposed on legal persons and business income (taxable income).
In simple words, VAT applies to the supply of goods and services at each stage of the supply chain. While corporate tax applies to the business’s taxable income.
VAT vs. Corporate Tax: Key Differences
The definitions of both of these taxes give us a starting point for the key differences between the two. Let’s highlight a few differences between VAT and corporate tax.
Tax Base:
VAT applies to the consumption of goods and services. However, corporate tax is charged on business profits.
Tax Incidence:
VAT is ultimately borne by the end consumer, while corporate tax is borne by the company. Thus, corporate tax affects shareholders, employees, and even customers of a business.
Tax Collection:
VAT is collected at each stage of the supply chain. A business charges VAT on sales and reclaims VAT on purchases. On the other hand, businesses pay corporate tax, usually on an annual basis based on their taxable income.
Impact on Pricing:
A business typically includes VAT on the final price of goods and services. Thus, a low or high VAT can impact the final price of the good or service. On the other hand, corporate tax is chargeable on business income; therefore, it does not impact pricing directly. However, it can impact pricing policy indirectly through cost management and profit margins.
VAT vs. Corporate Tax: Advantages and Disadvantages
Both tax systems have advantages and disadvantages. Let’s discuss it in a detailed fashion.
VAT
Advantages:
There are various advantages of VAT. We are discussing a few of them below.
Broad Tax Base:
As VAT applies to a wide range of goods and services, it ensures a steady source of revenue. Thus, it is a reliable source for raising public funds.
Reduces Tax Evasion:
The collection of VAT at various steps of the supply chain, rather than a single-pint tax, makes it difficult to evade VAT. This clarity in the collection makes it less probable for tax evasion.
Neutral:
VAT is neutral in a way that it taxes based on consumption rather than production. Therefore, it does not affect the business’s activities and operations.
Disadvantages:
There are several disadvantages to the VAT system.
Disproportionate Nature:
VAT impacts all individuals with any income level in the same way. This impacts disproportionately lower-income individuals. Thus, low-income individuals spend a higher percentage of their income on taxed goods and services. Therefore, VAT can intensify economic inequality.
Complex Administration and Cost:
There is a need to calculate and recover VAT at multiple stages of the business. This creates administrative complexity in managing VAT. Consequently, there will be higher compliance costs and a need for sophisticated tax administration systems.
Pricing:
The burden of VAT is directly put on the consumer through the selling price. This, in turn, will reflect in the form of a higher sale price. Therefore, this might impact overall consumer spending, leading to lower sales.
Corporate Tax
Advantages:
There are various benefits to corporate taxation.
Progressive Taxation:
Corporate tax is a direct tax that targets the profits of a company. This enables lower taxation for low-profit businesses and higher taxation for more profitable firms.
Encourages Level Playing Field:
Corporate taxation taxes profits; therefore, it prevents large, profitable companies from gaining too much market power. Thus, this form of taxation enables a level playing field for all businesses.
Flexible Policing:
Governments can adjust their fiscal policy to encourage certain sectors of business, thus promoting the economy. They can adjust corporate tax rates or introduce tax incentives to promote the overall economy of the country.
Disadvantages:
There are various disadvantages of corporate tax. We are discussing a few of them below.
Lower Investments:
Higher tax rates can impact the investment rate badly, as firms may prefer jurisdictions with lower tax rates. This will, in turn, impact overall job creation and economic growth.
Encourages Tax Avoidance:
There are chances that firms are involved in complex tax-minimizing strategies. For instance, businesses may shift profits to low-tax jurisdictions. Thus, there can be significant revenue losses for governments.
Impact on Competitiveness:
Corporate tax rates play a significant role for multinational corporations. These firms prefer to operate in lower tax jurisdictions. Thus, different corporate tax rates in different countries encourage competition among large multinationals in selecting places of operation.
Administrative Costs:
Managing corporate tax can be complex and costly for businesses. This is because it involves various calculations, deductions, and incentives. Plus, there is a need to keep documentation and comply with the ongoing updates in the tax laws.
Conclusion:
In the UAE, both value-added tax (VAT) and corporate tax are pivotal in revenue generation. While VAT is imposed on the consumption of goods and services, ultimately affecting the end consumer, corporate tax is levied on the profits of businesses, influencing corporate behavior and investment decisions. Understanding these two tax systems and their impacts on the economy and society is crucial for businesses and consumers alike. This blog has provided a comprehensive comparison of VAT and corporate tax, highlighting their key differences, advantages, and disadvantages. By examining these aspects, we can better appreciate the role each tax plays in shaping the economic landscape of the UAE.
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