The UAE government announced in January this year that it will introduce a 9 percent corporate tax from June 2023.
Generally, businesses react negatively to any tax announcement, but the companies themselves might be the ones who benefit the most from it.
Essentially, companies have three major options.
- Increase the prices to achieve the same “after-tax” profit.
- Increase investment costs to lower the burden of taxation.
- Raise a white flag and accept the 9 percent drop in their net profits.
Since the third option will likely be deemed unacceptable by most businesses, let’s concentrate on the first two.
Increasing price
Although an increase in prices might seem very tempting, it comes with the risk of customer complaints. Thus, not all industries will benefit from it.
There are only a few companies that can get away with it, since they have the so-called “high pricing power.”
This gives them the ability to raise their prices without having to worry about a drop in sales or demand.
Who are these companies? They are often industries characterized by high barriers to market entry, such as pharmaceuticals and biotechnology.
Switching to a competitor, like in the software sector, is rather complicated for customers.
These companies typically have strong brand equity (eg luxury brands), control over distribution (eg Apple), and very few competitors (eg telecommunications).
Companies like these, which invest heavily in innovation and product development (eg patents) have a competitive edge that makes it difficult for rivals to emulate their products and services.
However, that has not been the case in this region.
It has so far been quite tempting for many regional businesses — especially those in the Gulf Cooperation Council (GCC) — to focus on a maximum dividend payout to owners and shareholders, since they were tax-free.
Our latest study even shows the percentage of net profits invested in R&D in GCC to be amongst some of the lowest in the world.
Now, the sudden 9 percent corporate tax is a significant one, which multinational enterprises (MNEs) must factor into their strategic business plans. It will most likely spur further investment — including funding R&D activities.
The third option
The transition is, however, more challenging for the region, considering both corporate tax and transfer pricing specialists are in scarce supply.
The UAE could also suffer from an increased cost of doing business, given its relationship with Saudi Arabia.
Under Saudi Crown Prince Mohammed bin Salman’s initiative to wean the kingdom off oil revenue, international firms have been given until 2023 to move their headquarters to Riyadh or lose government contracts.
Such factors leave the UAE clinging to the region’s business-hub status.
Rather than investing in expensive innovations, I predict regional businesses will postpone making that decision and allow shareholders to enjoy a larger dividend instead.
This will shift investment decisions in favor of long-term investments in product and service quality.
By doing so, companies will become more competitive. As a result, a more robust valuation will occur, attracting more investors and consolidating the UAE’s role as the innovation hub for the region.
Lovrenc Kessler is Managing Partner of strategy & marketing consultant firm Simon-Kucher & Partners Middle East.
The opinions expressed are those of the author and may not reflect the editorial policy or an official position held by TRENDS.
