Nadine Hawa
CNBC Arabia

Since its establishment in December 1971, the UAE has prided itself as one the world's tax havens…a reputation which some now question in light of the planned introduction of VAT next year.

Dubai Customs recently announced that the UAE was planning to introduce Value Added Tax as early as January 2009.

The tax under consideration, will be imposed on consumer goods and services, and would probably be set at 3%, towards the lower end of the 2-5% scale commonly quoted by officials. Even if the VAT is set closer to 5% by the Federal Government, its introduction will be offset by the cancellation of the current 5% Customs Duties.

So why the rush to taxation? There are two main drivers behind the introduction of VAT. The first is diversification of revenue base - essential for places that are less reliant on oil revenues, such as Dubai. The second is to ensure harmonization with Free Trade Agreements between the UAE and the West, which are expected to be finalised by year end.

Certain sectors and businesses will be exempt from VAT, notably healthcare and the education sector, as well as small businesses with revenues under $1 million per annum. Moreover, tourists will be able to claim tax refund on VAT upon their departure from the UAE.

According to Abdul Rahman Al Saleh, Executive Director at Dubai Customs, the introduction of VAT will strengthen the economy: "it is well known globally that implementing VAT in many countries has significantly contributed towards boosting economic sustainability, as VAT is considered the ideal tax for already strong economies. While the UAE seeks to strengthen and diversify its economy, the country will not be an exceptional case in this regard."

Al Saleh added that the tax will help raise the current standard of living; though many residents have voiced concern over the fact that the tax might actually inflate what is already an overheated economy. The UAE's inflation rate currently stands at 11%.

Dubai customs was quick to respond, pointing out that "any inflation caused by the tax should be less than a diminishable half a percent".

The Emirate's tax free environment has always been the expat community's core incentive. The country has one of the world's highest percentages of foreign nationals, with immigrants roughly representing 80% of the UAE's 5 million inhabitants.

According to a recent survey conducted by a leading business publication in the UAE, 65% of respondents said they would consider leaving the Emirates upon introduction of the tax. Some of them viewed VAT implementation as a possible catalyst for increases in the tax at a later stage, or for the introduction of new tax measures, namely income tax.

It is unlikely that Dubai would lose its reputation as an Income-friendly haven just because of VAT. Switzerland, for example introduced the sales tax in 1995, it now stands at 7.6% but the country still attracts expat workers and expat savings.

Introducing VAT isn’t without implications though. As the Americans said to the British, "No taxation without representation". The move may cause foreign workers to not only re-evaluate corporate packages but also take a closer look at how the government spends its money.