Effects of No Income Tax Policy on Dubai - Essay Example

Effects of No Income Tax Policy on Dubai's Economy The east is east and west is west, and the twain shall never meet, said Rudyard Kipling. However, Dubai seems to have proved this famous poet wrong. Today, the melting pot of various cultures and nationalities, Dubai seems to offer the best of both worlds to any tourist, business venture or just a resident. The location, infrastructure and no income tax policy practiced by the government make it an ideal business hub and the biggest re-export center in the world. "There is no tax on personal income, while corporate taxation applies only to foreign oil firms and banks, and municipal tax is imposed on house rentals."7 "Dubai has changed dramatically over the last three decades, becoming a major business center with a more dynamic and diversified economy. Dubai enjoys a strategic location and serves as the biggest re-exporting center in the Middle East. The city now has thriving manufacturing, finance, information technology, big choice of Dubai property and tourism sectors and is home to numerous multinational companies such as AT&T, General Motors, Heinz, IBM, Shell, and Sony."1 In Dubai there are no personal taxes other than import duties (mostly at rates up to 10%), a 5% residential tax assessed on rental value, and a 5% tax on hotel services and entertainment.1 Being an oil-rich country, the government is not dependent on direct taxation as a source of its revenue and thus, there is no income tax. This attracts not only petty businessmen but multinationals too to invest in trading opportunities in the country. It has been noted that while tourism has grown exponentially in the last ten yeas, people are also looking forward to investing in property in Dubai. Since investing anywhere else in the world would attract taxes from the government: both direct and indirect, both during purchase and sale of land; foreign nationals, especially western Europeans are attracted to Dubai as an investment center. The government has made huge investments in hotels, leisure and recreational facilities to attract a large number of tourists, who might later be interested in buying property. This would attract people not only for business but also for buying property and migrating to Dubai. For an economy that was primarily dependent on its oil reserves, this would be a boon. With more and more investment in both people and land by foreign companies and high net worth individuals, the economy is all set to grow. Manufacturing industries have been set up in sectors like beverages, chemicals, paper, pharmaceuticals and rubber. As the diversity of the population grows, so would the needs and a necessity to increase economic activity. Thus, the no income tax policy followed by the Dubai government has benefited the economy immensely. Can other gulf states emulate this policy Is it feasible Yes or No Other gulf states can emulate this policy to a certain extent. While most countries like Oman and Saudi Arabia are already following a No Income tax policy, there are certain restrictions on investment in property by foreign nationals. Not all governments might be as open to change as the government in Dubai. There could be a small fear lurking in the minds of the authorities of being overpowered or misused by vested interests. Investment in land by a foreign national is allowed only in partnership with a local company or individual in some gulf countries. This might have been followed to safeguard the interests of the local population. "Free capital movements raise concerns about the loss of national sovereignty and other possible adverse consequences. Foreign direct investment ("FDI") even more so than other types of capital flows has historically given rise to such concerns, since it may involve a controlling stake by multinational corporations over which domestic authorities, it is feared, have little power."2 "Islamic law goes into great detail about family, inheritance, foundations, property rights and obligations, and public law operates along with rules of usage and custom."4 Since the popularity of Islam rose in the region from the seventh century, countries in the Middle East have been following the legal system described in the Holy books. There have been different interpretations of the law as described in the Quran by different governments. Even today, the governments tend to follow the Islamic law regarding rules and regulations w.r.t legal and financial transactions as described in the Holy books. Islamic law goes into great detail about family, inheritance, foundations, property rights and obligations, and public law operates along with rules of usage and custom.4 Shari'a is the primary source of law in Saudi Arabia as in some other Middle Eastern countries and Turkey is a Muslim secular state which adopted more modern version of the civil code system.2 Egypt has been one of the first countries to have adopted secular legal rules in addition to following the Islamic Law. Impositions laid down by WTO have also forced certain counties to relook into their existing laws and governing practices when taking FDI into account. The International Finance Corporation has in its Annual Report (2006) "Doing Business in 2006" mentioned that Saudi Arabia occupied the 38th position in providing a competitive and investment friendly environment for global commercial transactions. It was also ranked in first place in the Arab world by the same agency.2 Many countries in the gulf have restrictions and regulations regarding foreign direct investment. Certain countries like Egypt, Saudi Arabia and Turkey have a negative list restriction that debars some industries completely from investing in the country. A list of industries for partial closure for FDI where there is a restriction on the contribution made by the foreign investor. Other restrictions could be in the form of local agent restriction and local sponsor restriction. Inspite of its religious nature, Saudi Arabia has a flexible system of law. AS there is no uniform code of regulations and practices, decrees and notices are issued by the authorities in line with the requirements of the country and economy. According to a report by US, commercial analysts in 1999, disincentives to foreign investment under the current rules and regulations include lack of national treatment in some sectors, preferences for Saudi firms and joint ventures with Saudi participation, prohibition of foreign investment in some sectors, restrictive Saudi visas and Saudization requirements.9 In 2000, Saudi Arabian General Investment Authority (SAGIA) was set up as a part of The New Saudi Foreign Investment Act. This body has played a very positive role in bringing about changes in FDI in Saudi Arabia.Though not as investor friendly and cosmopolitan as Dubai, Saudi Arabia has also opened its doors to major multinationals in the past few years. In contrast to the above-mentioned countries, Turkey introduced and started encouraging FDI since 2003, all companies - regardless of nationality of ownership - face a number of obstacles: excessive bureaucracy, weaknesses in the judicial system, high and inconsistently collected taxes, weaknesses in corporate governance, sometimes unpredictable decisions taken at the municipal level, and frequent, sometimes unclear changes in the legal and regulatory environment.2 Thus, to emulate Dubai's investment model in totality might be difficult for some gulf countries as they might not be able to offer equally attractive tourism opportunities to visitors, nor might the governments be willing to invest huge amounts in infrastructure, the way Dubai has done. Also, the support and encouragement from the governing authorities regarding FDI might lack clarity and consistency when it comes to countries other than Dubai, thus putting the investors at risk and constant worry. Disadvantages of this no tax policy What effects does that have on the economy While the no tax policy makes all tourists, workers and consumers happy, there could be a side that has not been looked into. There are certain disadvantages of this no tax policy. A disadvantage of this no tax policy could be that the contribution of the working population to the government treasury becomes nil. In times of recession and financial downtrend, like the current global crisis, this could have a negative impact on the country's economy. While tax on personal income is nil in Dubai, there is also no tax on corporate income and profits. "Corporate Income Tax could be designed to tax only economic rents i.e. profit levels above the normal level of return required for a successful business. This would not create any efficiency losses, but would shift the corporate's decision between high and low tax-jurisdictions and it might continue to discourage foreign investors from investing in their domestic markets."5 This would create an imbalance in the global economy that would have serious repercussions. Inflation seems to be major problem in UAE and GCC countries due to the rapid economic growth. As the economic growth has been very rapid and beyond all expectations in the past few years, Dubai being the world's richest region in oil reserves, enjoyed inflated receipts from its crude exports.7 Conclude with what you think Dubai should do in the future about their income tax policy. Should they continue having no tax Should they change this around why or why not In my opinion, to avoid a possible imbalance in global and regional economies, Dubai should look into taxing income, if not personal, at least on corporate profits and sales. Today, the country has reserves of oil and can survive on the back of it, but tomorrow, when the reserves dry up the government might have to think of drastic steps to manage the economy. Also crude prices are not stable throughout the year. The price swings from a high of $140 to a low of $45 a barrel during different periods. This may not bode well for the economy as the selling power of oil and in turn, buying power of other goods keeps fluctuating and is not under the control of the local authorities. Thus, while the global population is attracted to Dubai as an investment center, it might be a good opportunity to start levying taxes on a few products and services. A small amount of the profit going in taxes would not hurt anyone, but an additional source of revenue for the government might certainly be welcome. Thus, in my opinion, it might be justified to levy reasonable amount of tax on corporate goods and services. However, I feel personal income must continue to be free from tax, as that is one of the most attractive incentives about working in the gulf. A small portion of the profits earned by corporates could be deducted as tax by the government and utilized in times of need. Again, if the authorities think of levying tax at par with global standards right away, it might just drive away the investors and compel them to look for other investment avenues. However, to draw benefit from the huge amounts already invested by the government in tourism, hotels and recreational facilities, it might be pertinent to start levying taxes : maybe in the form of sales tax or value added taxes to help boost and sustain the economy. Sales Tax Sales tax is one of the most important revenue sources for the state and local governments - and is also one of the unfair taxes used by states.6 Till last year, there were no sales taxes levied on products in Dubai. However, there have been considerations by the government of UAE to impose sales tax and value added tax on a majority of the products since a few years. In 2005, IMF was asked by the UAE authorities to help develop a value added tax system in an attempt to widen the country's tax base.8 "The IMF has also urged the UAE to introduce a property tax and widen the corporate tax net across all sectors, warning that state budget surpluses, which have been dependent on high oil prices in recent times, are unsustainable without longer-term sources of tax revenues."8 But although the IMF was advising Dubai Customs on ways to implement VAT, the fund's Middle East director warned lately of inflationary repercussions of an imminent introduction of VAT in the UAE, where inflation is already a major problem.7 It is a good thing that the government has started imposing VAT on certain items on sale in Duty Free shops. This is a beginning and will probably pave the way for an even better country and economy. References: 1.Holmes,Jenny. Dubai Economic Overview, posted on 21-12-2007, accessed on 30th April,2009. http://www.streetdirectory.com/travel_guide/67476/dubai_properties/dubai_economy_overview.html 2. Khyeda, Svitlana. Foreign Direct Investment in the Middle East: Major Regulatory Restrictions INSIGHT TURKEY, vol 9, No 2, accessed on 30th April,2009. http://www.ili.org/publishing/FDI_Article_SKhyeda_Turkey_09-09-07.pdf. 3. Turkey: Investment Regulations: Country Briefing, The Economist Intelligence Unit Limited (June 29, 2005) 4. Engin Ural, Handbook of Turkish Law, Ankara (1999) at 26 5. OECD, Policy Brief, July 2008, accessed on 30th April,2009. http://www.oecd.org/dataoecd/30/16/41069272.pdf 6. Policy Brief # 14, 2005. Talking Taxes, Institute on Taxation and Economic Policy , Washington DC. accessed on 30th April,2009. http://www.itepnet.org/pb14crex.pdf 7. Tax-free UAE on course to introduce VAT in Gulf Agence France-Presse, 05/29/2008 accessed on 30th April,2009. http://business.inquirer.net/money/breakingnews/view/20080529-139583/Tax-free-UAE-on-course-to-introduce-VAT-in-Gulf 8. Lorys Charalambous, Cyprus. UAE Considers National Sales Tax, Taxnews.com,9-8-2005. accessed on 30th April,2009. 9. Saudi Arabia's Investment Climate: Debating Revisions to Encourage More Private Foreign Investment. Existing Investment Regime in Force as Timing, Scope and Content of Changes are Uncertain., Middle East Executive Reports, Middle East Executive Reports, Ltd., Washington, DC (July 1999) http://www.ili.org/publishing/FDI_Article_SKhyeda_Turkey_09-09-07.pdf. Read More