VAT and Its Impact on Economy and Real Estate

Thursday, 13th October 2016

Following the tumultuous events of the 2011 and 2013 uprisings and the socio-political instability of the region, foreign investors and tourism have evacuated Egypt in large numbers – both of which have caused the government’s foreign reserves to drop to an all-time low since 2010. The collapse of tourism and declining revenues from exports and Suez Canal tolls further contributed to the shortage.  As a country heavily reliant on imported goods and services, the dwindling foreign reserves have fueled the black market for US dollars, where the dollar is sold at 25% and higher than the official value.

In addition to the dollar crisis, the populous nation recorded a budget deficit of EGP 311 billion in May, constituting 11.2% of Egypt’s gross domestic product (GDP), according to Mada Masr. To cover Egypt’s financing needs, as well as restore investors’ faith in Egypt and resolve the deteriorating dollar crisis, Egypt has opted for international loans.

A three-year, $3 billion loan from the World Bank was approved in August, and the government has been seeking a three-year $12 billion loan from the International Monetary Fund (IMF), according to Mada Masr.

The IMF stipulated various economic reform policies to be implemented as pre-requisites for the loans, including the Civil Service Bill, subsidy reform, increasing exports and decreasing imports, and the adoption of the value-added tax (VAT), according to Daily News Egypt.

The Egyptian parliament approved the VAT Law on August 29, setting it at 13%, which is set to be increased to 14% in the 2017/2018 fiscal year, coming into force on July 1, 2017. The tax law has been applied since September 2016.

VAT

The VAT, a tax on consumer spending, is a composite tax made up of the difference between the manufacturing cost and the selling price of domestic and imported goods. The VAT will be applied to goods and services, except a government specified list of exempted items, according to Daily News Egypt.

Aimed at eliminating tax evasion, the new law will be applied to each step in the production chain of goods and services to replace the current sales tax. Under the previous sales tax, taxes are only paid on the final sale to the consumer only, according to Al Ahram News.

Some of the VAT exemptions include exported goods and services, goods and services produced in free zones or cities, and free market projects outside Egypt. Certain machinery and equipment will be taxed at the reduced rate of 5%, according to Bloomberg. The list of exempted goods also includes 56 goods and services which include banking services, medicine, medical, health, and education services, certain real estate supplies, and certain staples such as tea, sugar, and milk.

Effect on the Economy

The introduction of the VAT to all goods and services, while it will increase all the values of goods and services, promises to cure the country’s financial woes in the long term. The expected revenues to be generated from the VAT law range between EGP 20 and EGP 30 billion.

“The VAT is regarded as a consumer tax, which means those who consume a lot will pay more,” Minister of Finance Amr El-Garhy was quoted as saying in Al Ahram News.

The stated advantages of the VAT are expanding the current tax base, increasing tax compliance, and facilitating the inclusion of informal business activities.  Egypt’s informal economy accounts for up to 68% of the country’s GDP, and 48-70% of employment, which is not taxed under the current system, according to Daily News Egypt.  Thus, the VAT will streamline tax collection through every step of the supply chain. As a revenue generator for government coffers, it is expected that the VAT law will reduce the country’s budget deficit by up to 3%.  However, it is also expected to increase inflation by 1.3%, Minister of Finance Amr El Garhy said, according to Mada Masr.

Even though essential goods are exempt from the tax, the overall increase in tax and the incorporation of informal businesses into the system will contribute to price inflation. Egypt’s wealthiest will see a 2.3% inflation, while for low income earners, price inflation should not exceed 0.5%, added El Garhy.

“It [the VAT Law] is a tax reform that Egypt needed to begin its economic reform process. This is the start of an economic reform program that will see Egypt have a stronger tax regime that will make the economic system stronger and will allow it to draw foreign investment,” Yasser Omar, an MP on the House Budget Committee, told Reuters.

Disadvantages

While the VAT will bring more money to the cash-strapped government, it will likely lead to price inflation, whereby small and medium enterprises and low to middle-income earners are more likely to feel the crunch due to the extra costs incurred.

Moreover, there is some concern that the VAT law, if inadequately enforced, could strip the law of its relevance. According to Salma Hussein, a researcher at the Egyptian Initiative for Personal Rights, weak enforcement of the law could potentially cause prices of goods to flare up as businesses take advantage of the lax law conditions, according to Mada Masr.

VAT and Real Estate Sector

The real estate sector will see a surge in prices due to the newly enforced law as well. The tax percentage imposed on construction contracts is set at 5%, and consequently, the prices of real estate will increase in all sectors, according to Daily News Egypt. Construction materials will be taxed at 13% though the added tax combined with the already ballooned prices will garner a significant spike in construction material prices. For example, in recent months, steel prices have increased by almost 50% per ton, which will be increased further with the tax added.

A rise in construction material prices will translate into an increase in the cost of implementing projects, unit prices, and, consequently, increasing prices on customers

“The new tax will not affect the real estate projects directly, but it will affect construction work, as well as the prices of construction materials. This is in addition to increasing global steel prices,” said Ahmed El-Hitamy, General Manager of Madinet Nasr Housing and Development (MNHD), to Daily News Egypt.

Tarek Bahaa, Sales and Marketing Director at IGI Real Estate, projected that while the VAT tax would definitely result in an increase in the value of residential units, this would not necessarily affect sales significantly.

“If there is a decline in sales, it will only be slight,” he told Invest-Gate. “There will be an increase in costs of the building materials, which will naturally translate to an increase in prices. However, demand is still high.”

Bahaa further predicted that trends would be similar for off-plan properties, whereby sales would remain largely unaffected by the application of the VAT.

In conclusion, where the VAT is implemented in over 160 countries worldwide, since its inception in France in 1948, it has been a fruitful source of revenue for governments. A populous nation like Egypt will struggle with the price increase for all goods and services, particularly with the high rate of poverty and a population that is largely reliant on subsidies.

However, the pain is anticipated to be short-lived, and if employed correctly, policy-makers have claimed the revenues from the tax will result in services that offset its cost. The economic reforms introduced by the government, including the VAT law, are indicators of the government’s efforts to resolve the ongoing financial crisis, particularly to restore investor confidence in Egypt once again.

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