Auto dealers may absorb partial VAT cost in their margins
The UAE and GCC automotive industry faced challenging times during 2016. The trend is expected to continue this year across the GCC due to the lack of demand for new vehicles and oversupply of pre-owned vehicles, thereby depressing prices for dealers. Buyers are also reluctant to spend since it’s a discretionary decision in these difficult market conditions.
The presence of several manufacturers and dealers also makes the automobile market highly competitive, depressing margins, especially for the luxury, SUV and mid-size segment. Backed by banks, dealers are trying to lure customers with discounts on new purchases, lower maintenance costs, higher loan values and free insurance for the first year.
Saudi Arabia and the UAE are the two most predominant automotive markets in the GCC. Underlying positive factors continue due to low fuel costs, low customs duty, high per capita disposable income, growing population and favourable tax structures. Additionally, attractive insurance and financing options make it easier to own a car in the UAE.
There are no significant manufacturing activities taking place in the sector, barring a few truck and bus component assembling units. It relies heavily on imports to fulfill demand.
Car dealers in the UAE do not just sell new and second-hand vehicles but have also diversified into more support activities such as provision of finance, insurance, warranties and car accessories, to name a few.
The supply chain and ancillary services feeding the automotive industry is massive, including vehicle manufacturers, importers, distributors, insurance companies, finance providers, after-sales markets in parts, accessories, annual service workshops and second-hand vehicle sales.
Businesses operating in such a vast industry should be more cautious in their actions starting 2018 when the value added tax (VAT) will be effective in the region. The areas of concern may be managing demand, logistics and inventory concerns, alternate market, managing working capital cash flows and pricing.
The increase in price on account of VAT may have some impact on demand for cars as overall the cost of living will marginally go up. Bearing in mind the price elasticity for demand, dealers may absorb partial VAT cost in their margins. Dealers’ margins are not only on the sale price but they also have a back-end margin such as bonuses and rebates granted by manufacturers for meeting sales targets.
The automotive industry is open to tax abuse, attracting the special attention of tax authorities for close examination. The VAT laws for automotive industry have, therefore, become more complex over the years.
Some of the concerns from industry are importation of a vehicle, demonstrator car versus trade-in, hire or leasing of motor vehicles and margin scheme for second-hand vehicles. It is expected that VAT treatment on a second-hand vehicle will be different than a new vehicle. This is because a second-hand car has already incurred non-recoverable VAT at the time of purchasing it.
To avoid ‘tax on tax’ cascading effect, a margin scheme is generally used in most countries and is expected to be introduced in the UAE as well. Under the margin scheme, the VAT is calculated on the profit made in the transaction and not on the full sale value. The scheme is generally optional but if used, there are a number of conditions to meet.
Hence, we await publication of the GCC framework, VAT law and its underlying rules for compliance to seek answers to concerns. But overall, the industry despite challenges will be resilient and is expected to adapt well to the legislative changes by finding innovative solutions to spur demand.