VAT can be a powerful tool for advancing ESG goals across the GCC. By offering incentives for green products, promoting social equity through exemptions on essential goods, and enhancing governance with digital tax systems, VAT can support sustainability, fairness, and transparency.
Today, the Environment, Social and Governance (ESG) criteria are crucial for shaping corporate strategies and investment choices. Integrating sustainable practices is not only perceived now as ‘the right thing to do’ but a strategic need that can both boost your organisation’s reputation and, ultimately, its bottom line. This has been highlighted in our latest Sustainability in the Middle East 2024: Breaking through barriers that indicates a growing momentum on the sustainability agenda, with business leaders in the region increasingly embedding sustainability principles and making structural changes to act on them. In the Gulf Cooperation Council (GCC) region, the integration of ESG criteria is becoming increasingly vital for shaping corporate strategies and investment decisions.
One often overlooked tool to promote sustainability within the GCC is the Value-Added Tax (VAT). When used effectively, VAT policies can help achieve ESG goals, blending financial strategies with sustainable development.
This article explores how VAT can support ESG frameworks for both governments and businesses. Let’s look at the opportunities and benefits.
1- VAT and environmental sustainability
Environmental sustainability is vital for companies and countries, driven by consumer demand, regulations and concern for the planet. VAT can encourage eco-friendly practices. By reducing VAT on green products and services, governments can motivate manufacturers and consumers to make environmentally conscious choices. For example, lower VAT on renewable energy equipment, electric vehicles, and recycling services can speed up the shift to a low-carbon economy. On the other hand, higher VAT on products with a large environmental impact can discourage unsustainable consumption.
Reducing VAT on locally produced goods or products with lower carbon footprints can also have significant impacts on consumer behaviour, production practices, and retail strategies. Here are some key incentives from adopting a reduced VAT rate:
Impact on consumer behaviour: Consumers are generally price-sensitive. A reduction in VAT for environmentally friendly products can make these products more affordable, encouraging consumers to choose them over conventional alternatives. This in turn will increase consumer awareness and preference for sustainable options, potentially leading to a long-term shift in purchasing habits.
Impact on producers: Producers may be more inclined to adopt sustainable practices if they see a clear financial benefit, such as reduced VAT. This can lead to increased investment in green technologies and sustainable production methods. In addition, companies that produce environmentally friendly products can differentiate themselves in the market, potentially gaining a competitive edge.
Impact on retailers: Retailers might be more likely to stock and promote green products if they are more affordable and in higher demand due to reduced VAT. In addition, retailers can leverage the price differential to market green products more effectively, highlighting the cost savings and environmental benefits to attract eco-conscious consumers.
The PwC 2023 Climate Tech report discussed the potential for incentivicing private investors to fund start-ups focused on technological solutions for climate change. Various incentives, such as subsidies or tax breaks, can play a crucial role in this context. Moreover, reducing VAT for incubators and accelerators can help grow these ecosystems, fostering innovation and entrepreneurial energy in the region.
In the GCC, Oman has taken a pioneering step to promote the adoption of electric vehicles (EVs) by introducing VAT incentives. Effective from 1 July 2023, Oman has implemented a zero percent (0%) VAT on the supply and import of electric vehicles and their spare parts. Additionally, EVs are now exempt from customs duties and registration fees. These measures are designed to lower the initial cost of EVs, encourage their widespread adoption, and support sustainable practices within the transportation sector.
2- VAT and social equity
The ‘Social’ part of ESG focuses on the importance of people in driving success. This includes labour rights, community involvement and diversity. VAT policies can promote social equity by offering exemptions or reduced rates for essential goods and services used more by lower-income groups. For instance, removing or reducing VAT on basic food items, healthcare and educational materials can ease financial burdens on vulnerable populations, leading to a fairer society. VAT exemptions for services provided by social enterprises can also support businesses that address social issues.
The GCC VAT Framework Agreement, concluded in November 2016, incorporates social equity considerations by granting each member state the authority to exempt or zero-rate specific sectors, including education and healthcare.
For example, most healthcare services and related goods in the United Arab Emirates (UAE) and the Kingdom of Bahrain are zero-rated (0%), meaning no VAT is charged but providers can reclaim VAT on their costs. While the Kingdom of Saudi Arabia (KSA) and the Sultanate of Oman exempted government healthcare services from VAT. Additionally, Saudi nationals benefit from a special exemption from paying VAT on healthcare services provided by private healthcare providers, with the VAT cost covered by the government.
3- VAT and good governance
Good governance is key to achieving ESG goals. This includes compliance, board diversity, transparency and stakeholder engagement. VAT, linked with compliance, can strengthen governance frameworks. Implementing digital VAT reporting can improve transparency, reduce corruption, and ensure businesses follow tax laws. By adhering to strong VAT regulations, companies show their commitment to lawful and ethical practices, boosting investor and consumer confidence.
GCC countries have been actively implementing electronic invoicing (e-invoicing) systems to enhance their tax systems’ efficiency and transparency. The e-invoicing implementation is part of broader efforts to modernise tax systems, particularly with the introduction of VAT in these countries. E-invoicing helps streamline compliance, enhance transparency, and reduce the tax gap. Here’s a brief overview of the current status of e-invoicing in the GCC countries who implemented VAT:
The KSA was the first in the GCC to introduce e-invoicing. The implementation was structured in two phases: the generation phase which started in December 2021 and the intermediate phase which began in January 2023.
The UAE is preparing for its e-invoicing rollout, expected to be fully implemented by 2026.
The Sultanate of Oman and the Kingdom of Bahrain are also moving towards e-invoicing, with plans to introduce it soon.
Using VAT policies to support ESG goals
To make VAT policies work well for ESG goals, governments and businesses need to work together. Governments should involve all relevant stakeholders from the outset by building in time for a full and proper consultation phase with amendments to VAT law to allow businesses to express their views, suggest improvements, and ensure that the proposed regulation is practical and effective in supporting ESG goals. At the same time, businesses can use their influence to push for VAT policies that help them operate sustainably and responsibly.
For the two remaining GCC economies yet to implement VAT - Qatar and Kuwait - there is a real opportunity to learn from the experiences of their neighbours. By examining how other GCC countries have incorporated ESG thinking into their VAT rollouts and subsequent adaptations, Qatar and Kuwait can ensure that their own VAT implementations are not only efficient but also sustainable and socially responsible.
For instance, the UAE’s VAT legislation included a domestic reverse charge mechanism for hydrocarbons, which helps streamline tax compliance for businesses involved in energy production and distribution. In addition, to support social equity, Bahrain VAT policies provided a special exemption from VAT (zero-rating) for basic food items to reduce the financial burden on lower-income households.
By taking these examples into account, Qatar and Kuwait can design VAT systems that support environmental sustainability, promote social equity, and uphold strong governance standards. This offers a unique advantage of integrating ESG considerations from the outset, helping to create a VAT framework that not only boosts their economies but also aligns with global best practices in ESG.
Key actions for success:
Working together: Create spaces for discussions between policymakers, businesses, and the public to make sure VAT policies are practical and effective.
Encouraging innovation: Governments can provide VAT incentives for research and development in sustainability, motivating companies to find new solutions for environmental and social issues.
Regular updates: Businesses should keep track of how VAT policies affect sustainability goals and make changes as needed to improve their impact.
By carefully integrating VAT into the ESG agenda, governments and businesses can find new ways to promote sustainable development, social fairness and good governance. Referencing mature VAT jurisdictions, potential innovations for the GCC to consider sustainable VAT incentives include - for example - implementing lower VAT rates for products and services that contribute to environmental sustainability, such as renewable energy equipment, electric vehicles and energy-efficient appliances and offering VAT exemptions or reductions for businesses investing in ESG initiatives, such as green building projects or social impact programs.
VAT is a flexible and widespread tool that can encourage behaviours and investments that support a greener and fairer world.
The journey to fully achieve ESG goals is complex, but innovative VAT policies can help us make significant progress.
