By Ahmed Mostafa and Karim Mohy

While rising costs due to currency depreciation and inflation are seen as largely positive for real estate demand in Egypt in general, and neutral to positive for developers in particular, rising costs due to the recent and long-delayed imposition of the value added tax (VAT) are being deeply felt by the country’s contractors.

VAT, imposed based on the value added to goods and services at each stage of production and in place in most countries of the world, was passed into law in Egypt in late August by the House of Representatives (full text, Arabic). While there was some confusion as to the law being applied starting from October, the law actually went into immediate effect upon its publication in the Official Gazette on September 8 at a standard rate of 13% on most goods and services, set to increase to 14% next year.

How Will VAT be Applied to the Industry?

While VAT will not be applied to the buying, selling or financing of vacant agricultural or non-agricultural land plots or finished residential or non-residential units, a 5% rate is applied to all construction contracts, which are classified under Schedule No 1 of the new VAT law, and the same rate will also apply to machinery and equipment. All imported construction materials, however, will be taxed after custom duties at 13% this year and 14% in the following year. And while VAT is set to replace the old Goods and Services Tax (GST), one should keep in mind that VAT in no way affects or abolishes the flat real estate tax, which is still in place at 10%.

The 5% VAT rate on construction contracts applies to all contractors, regardless of their size or annual revenue. Contractors have not had to register for VAT if they are already registered under the old GST, but they will need to submit a monthly Schedule Tax return, due within two months from the end of each month, with the exception of April returns, which must be submitted within 45 days of the end of the month.

Contractors Less Than Enthused with VAT

The imposition of the VAT amid an already high rate of inflation, set to increase from 14% this year to 17.3% next year, along with a devalued EGP, has prompted a major lobbying pushback by the industry, aimed at getting the government to reduce the rate applied and possibly provide other ameliorating measures. In response to contractors’ concerns, the Ministry of Housing, Utilities, and Urban Communities last month promised to form a committee to address the industry’s demands, including possible compensation.

The Real Estate Investment Division at the Federation of the Egyptian Chambers of Commerce has for months demanded the reduction of the 5% levied on construction to 4%. Contractor heavyweight Orascom Construction previously called for an exemption from VAT altogether for ongoing projects, according to its Executive Director Osama Beshay last month, who said the rate should instead only apply to new projects, as current projects were priced without having taking VAT into account.

The application of the VAT in its current form, prescribed at 5%, is expected to have negative effects on the construction sector, said Daker Abdellah, Member of the Construction Committee at the Egyptian Businessmen’s Association and Member of the Egyptian Federation of Construction and Building Contractors, speaking to Invest-Gate.

“The tax will add new burdens on companies working in the sector, who have faced continuous challenges since 2011, contributing to heavy losses incurred and the closure of many of contractors,” Abdellah said. “The sector has faced further challenges in recent months as a result of the decline of the pound relative to the US dollar, and the consequent impact on construction material and input prices such as iron, which has witnessed increases of up to 50% in price per tonne,” he added.

Abdellah pointed to the importance of paying heed to these challenges to save the industry, especially given the state’s ambitions to implement major national projects that require the rehabilitation of the sector and the increase, rather than the closure, of contracting firms.

“There is a need to reconsider the prescribed percentage of the VAT on construction and to reduce it in line with current market conditions and to help fully realize potential investment, support companies and to reduce the serious challenges and financial burdens which they face,” Abdellah added.

Taxation will reduce the volume of investment as a result of its direct impact on expected returns, he said, adding: “The private sector will resort to reducing its expenditures as much as possible in an attempt to reduce the impact of tax on profitability. Companies may resort to laying off workers and or reducing their wages, which will only exacerbate the country’s unemployment crisis.”

Abdellah further noted that the private sector is cognizant of the challenges facing the state, and as such is willing to contribute to aid the state in executing its development plans.

Devaluation also Weighs on Construction Sector

Meanwhile, the Egyptian Federation for Construction and Contractors held a conference last Tuesday to call on the government to intervene to reduce the losses suffered by contractors after the devaluation of the Egyptian pound.

“The union submitted a memorandum to the prime minister, which calls on the government to take into account all construction inputs when considering differences in prices between the time contractors were hired, the devaluation of the EGP earlier this month, and the present. The memorandum further asks the government to adjust prices on government work contracts, as such agreements are currently limited to taking into account recent price increases in steel and cement only, despite that all building materials witnessed major prices increases,” said Hassan Abdul Aziz, the Federation’s chairman.

The union would instead like to see the government price all inputs according to the most recently documented retail prices, as reported by the Central Agency for Public Mobilization and Statistics, as well as disbursement of 15% of the value of the work carried out from mid-March until the committee finalizes its calculation of compensation owed to contractors.

“I received a phone call from Mustafa Madbouly the Housing Minister, in which he promised to form a committee to re-price and review contractors’ contracts with the government within a week,” Abdul Aziz added.

Abdul Aziz called for the prompt adoption of a balanced contract to protect the interests of companies, and also to compensate the contractors for previous contracts that do not take into account the differences in prices, and to extend deadlines by six months for the existing contracts so the contracting companies would not be subject to fines for delay.

Construction companies have moreover had to suspend their work in water and sanitation projects due to the lack of dollars.

He added: “There are approximately 80 facilities project threatened by delays on the schedule agreed upon, because of the difficulty to acquire USD by the contracting companies operating these projects.”

Looking Forward

There remains a number of uncertainties with regard to the VAT’s full impact on contracting companies: the law’s oft-delayed executive regulations have yet to be released, though will reportedly be submitted for public discussion sometime this week. While contractors attempt to individually re-negotiate with developers on an ad hoc basis, eyes will be on whether the industry can succeed in securing concessions from the state on government projects on behalf of the entire sector.

Whether increased pressures from the VAT, along with devaluation and inflation, will be enough to push smaller contractors to go under or consolidate with other firms also remains to be seen. The bottom line for property investors, however, with regard to the ability of contractors to pass their costs down to developers and and possibly homebuyers, as noted previously, is that considering competition, it is likely that the pricing of the luxury segment is the only aspect that has room left to grow.