Insurance Industry – Are you ready for VAT?
After a little more than a year from the date of signing the Common VAT agreement between the six member states of Gulf Cooperation Council, the Kingdom of Saudi Arabia (KSA) and the United Arab Emirates (UAE) launched the much awaited ‘Value Added Tax’ in their countries from January 1, 2018, with the two countries pushing their limits to ensure VAT hits the business bloodstream without much complications. The Ministry of Finance of Bahrain announced their intention to launch VAT in their country by the end of 2018. Now is not the time to ask ‘when’ but to work towards ‘how’ VAT will impact the businesses in Bahrain in the near future.
However, it is to an extent foreseeable, from the footprint of the forerunner countries, how VAT would impact different industries and in particular the insurance industry. VAT is a consumption based transaction tax which is levied at each stage of value addition. One of the key features of VAT is the free flow of tax credits, which averts the cascading effect of tax on tax. VAT is levied on supply of all goods or services within the country unless a supply is specifically defined to be a zero-rated supply or an exempt supply. Predicaments start to peek in once a business supplies exempt goods or services. This is because VAT paid on purchases or expenses to make such an exempt supply would not be allowed as a tax credit, leading to an increase in the overall cost of such exempt goods or services. For instance, in KSA and UAE life insurance is exempt. However, commission paid to a broker for life insurance policies sold by such broker is still taxable. Hence, insurance companies would need to absorb the five percent VAT on commissions paid to broker for selling life insurance policies.
Insurance services falls within the broader ambit of ‘Financial Services’. Financial services and VAT repel each other to a certain extent. The reason being, certain financial services are categorised as exempt services and certain services as taxable services. Consequently, a financial service provider would need to constantly evaluate what portion of their costs should be directly attributable towards exempt supplies and what portion of their costs should be directly attributable towards taxable services. Further, the common costs which are attributable towards both exempt and taxable supplies would undergo a process to carve out the eligible portion of tax credit. Generally in the insurance industry, life insurance and reinsurance of life insurance are categorized as exempt supply of services. However, other insurance services would normally be taxable, provided the place of supply of such insurance services falls within the member state and such insurance services are not expressly defined as zero-rated supplies.
Several players are involved in the business of insurance such as the insurer, the insured, the insurance broker, third party administrators (TPA’s), reinsurers, reinsurance brokers, retrocessionaires, garages / service centres, medical service providers, etc. Having multiple parties adds to the complexities of exchanging documents and determining the precise times of supply. VAT being a documentation tax, it would warrant the creation of an intricate documentation trail to justify the business transactions between these players. Another key aspect to consider is the customization or integration of existing information technology systems, which may be complex in the case of insurance industry. Systems should be upgraded to incorporate tax efficient modules or tax engines to ensure VAT reporting and compliances are taken care of.
As per BMI Research Report, VAT is expected to add around 2% to the overall inflation rate in Bahrain, but would also bring in $568 million in revenues, according to estimates by the International Monetary Fund (IMF). It is also forecasted that the budget deficit would gradually decrease. However the introduction of VAT might not lead to significant drop in the deficit. Shale oil and natural gas recently discovered in a deposit off the island’s west coast “is understood to dwarf Bahrain’s current reserves,” Bahrain News Agency reported. Oil revenues from the recent finding together with the VAT revenue could provide a great boost to Bahrain’s overall economic condition.
With the VAT wave sweeping across the GCC region, it is imperative for complex industries, such as insurance, to leverage on the recent introduction of VAT in the neighbouring countries and organise their internal business infrastructure to ensure a smooth transition into the new tax regime.
The viable option is to conduct an impact assessment, which can pave the way for implementation of VAT on an industry-wide level, as time is currently in favour of insurance businesses.
About the Author
Tax Advisory (VAT)
Grant Thornton Abdulaal
M +973 38967876