6 June 2017Insurance

VAT introduction could cause cash-flow issues for Gulf insurers

Given the fiscal pressures in the member states of the Gulf Cooperation Council (GCC), the introduction of value added tax (VAT) seems inevitable and could cause short-term cash-flow issues for insurers, according to AM Best.

The GCC member states of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates (the UAE) are in the process of establishing separate national legislation to simultaneously adopt taxation on 1 January, 2018.

Public financing across the GCC has become more restrained in recent years, reflecting the decrease in revenue from the sharp fall in the oil price, the ratings agency wrote in a briefing called "VAT Implementation Poses Significant Challenges for GCC Insurers".

As a result, the introduction of VAT at a standard rate of 5 percent appears inevitable as governments seek to bolster their inward receipts.

The implementation of the VAT rules will increase the cost of doing business for insurers in the GCC as VAT will be applied to almost all goods and services in the value chain, including outsourced services. The degree to which this will impact individual insurers will depend on the classification of the product and whether they are able to reclaim input tax.

The greatest impact will be felt on those insurers that are deemed to be exempt as they are both unable to charge VAT to the end customer or reclaim input VAT on costs incurred.

In cases where the company has both taxable and exempt services, they will be classed as partially exempt and can only reclaim input VAT on shared overheads in proportion to the amount of taxable services they offer. This could take the form of non-life premiums attracting VAT whilst life business may be VAT exempt. In such a situation, outsourced services, such as marketing or professional service fees, may only be eligible for partial exemption.

Additionally, should non-life insurers be VAT exempted, an erosion of profit margins could take place as claims costs (including spare parts, garage repairs or medical treatment) would attract a VAT increment that the insurer will not be able to reclaim nor pass on to the customer. Alternatively, to maintain profit margins, the insurer could only reimburse to the insureds net of VAT costs, with the insureds themselves picking up the VAT burden.

It is expected that contracts underwritten in 2017, but with more than 180 days left in 2018, will be subject to VAT. Therefore, assuming VAT is effective as of January 1, 2018, insurers could potentially have a tax liability on any contracts entered from July 2017, without necessarily being guaranteed the income to cover this. AM Best believes that without a VAT-specific clause within the contracts, it is most likely that insurers will find it very difficult to retrieve the money at a later date in view of the lack of such provision in the existing wordings and due to prevailing market practices.

The introduction of VAT is therefore likely to impact cash flow in the short term and may also increase the claims ratio in the short-to-medium term. As this is not considered in insurers’ current underwriting approaches, it is expected that a one-off adjustment might be made once a new VAT regime is implemented.

Should Takaful (a type of Islamic insurance) operators be subject to the same VAT legislation, they will be hit the hardest owing to the way they recognise profit. A specific implementation law recognising the fact that profit is generated and recognised differently in Sharia’h compliant contracts is necessary in order to ensure the industry is not subject to a double tax hit.

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