The United Arab Emirates recently made headlines around the world when it announced that it would introduce a 9% corporate tax. It will come into force in June 2023 and is the first tax of its kind put in place by the government of the United Arab Emirates.
Whenever a government announces a corporate tax, businesses generally view it as a bad thing and are very skeptical. But I sincerely believe that this tax rate could actually be a unique opportunity for businesses operating in the UAE.
In light of the new corporate tax, companies can make three different decisions.
The first is to increase prices in order to achieve an identical after-tax profit. Their second option is to pursue higher investments and costs, reducing the tax burden. If companies hesitate to choose one of the first two options, they will have to deal with the fact that their net profits will drop by 9%. This, however, is something most businesses will want to avoid. And, for this reason, I will talk more about the first two options in this article.
Many companies will be tempted to raise prices in an effort to cover the financial burden of the 9% corporate tax rate, but it’s a move that could potentially upset consumers and lead to a deluge of customer complaints. This certainly wouldn’t work for all industries, although it might be a feasible option for companies with “high pricing power”. These are firms able to increase prices without decreasing product demand and sales.
Traditionally, a company with “high pricing power” operates in industries where barriers to market entry are high. Two notable examples would be the pharmaceutical and biotechnology sectors. People and companies using products in these industries are unlikely to opt for a competitor, such as software, as it would be quite difficult.
A company with “high pricing power” is likely to have a strong brand, control over product distribution, and reduced competition. Think luxury brands, tech giants like Apple, and telecommunications companies. Moreover, these companies spend a lot of money on innovation and product development, especially patents. As a result, they are at the forefront of their industry and are harder for competitors to copy.
I have seen many businesses in the region focus on paying their owners and shareholders the maximum dividends because they will not be impacted by the tax costs. Indeed, the owners of these companies probably viewed them as cash cows. Our research shows that GCC has one of the lowest percentages of net profits invested in research and development globally.
When this 9% tax rate hits the books of law next year, I expect strong growth in reinvestments – especially research and development funding – in the UAE. Businesses in the region will stop investing in expensive innovations and instead spend their money on quality products and services, which will allow them to become more competitive in the long run.
Overall, the tax rate unveiled by the UAE government will be a big win for businesses in the region. They will benefit from a higher commercial valuation, more investors and increased competition. At the same time, the UAE will become one of the world’s leading innovation hubs.
Lovrenc Kessler is the managing partner of Simon Kucher & Partners