10 Dec 2017

VAT Regulations – Part 1: Input and Output Tax and the importance of the audit trail

Authored by: James Farn

VAT Regulations – Part 1: Input and Output Tax and the importance of the audit trail

In Brief:

  • Considers the available mechanisms in place to allow the offsetting of input tax against output tax.
  • Discusses the importance of record-keeping and the creation of an audit trail.
  • Lastly, in Part 1, looks at some of the basic elements of the VAT Law relating to taxable supply,

Introduction

One of the principal elements of the new Federal VAT Law concerns the treatment of input and output tax for VAT purposes. The Law is supported by a set of Executive Regulations (Regulations) which (following a lengthy consultation period) have just been published. Both the VAT Law and the Regulations will have effect as and from 1 January, 2018.

The VAT mechanism as described in the Law and the Regulations is basically straightforward. It operates on a VAT-invoice credit basis.

The Taxable Supply (ITC) mechanism

Registered persons are required to apply the VAT rate to the price (or consideration) paid in respect of a taxable supply. Outputs are calculated as a percentage of the price and inputs are offset against this amount. There are some exceptions to this general method of calculation based on an assumed VAT-inclusive method of calculation. However, these only apply to a limited category of supplies, such as second-hand goods.

This process allows a registered person to offset total input VAT against the total output VAT when filing his VAT return for an accounting period (otherwise known as input tax credit or ITC). The main condition is that a registered person must possess a VAT invoice or other relevant documents to prove the payment or liability for the input VAT. The offset covers input VAT incurred on imports as well as domestic purchases. 

  • The ability to claim input VAT is a self-assessment process, subject to meeting the conditions on invoicing and documentation described in the Regulations. A registered taxpayer does not need a tax office approval to do the offset. Businesses must therefore have the appropriate internal mechanisms in place in order to carry out this process efficiently and accurately, including an efficient invoicing system.
  • Registered businesses can claim inputs only when they possess a purchase invoice, receipt or customs entry or declaration showing the input VAT, as paid or payable. Suppliers will be required to issue sales invoices and cash receipts to customers and must obtain purchase invoices and receipts to support their ITC claims.
  • To reverse an invoice value, a registered person must be in possession of debit and/or credit notes - forms of ‘negative’ purchases or sales invoices.

Record Keeping and the Audit Trail

  • The Regulations contain detailed rules concerning record–keeping which apply to both suppliers and customers as well as provisions which allow adjustment of output VAT as well as input VAT through the issue of credit or debit notes between suppliers and customers. These may arise for various reasons – for example, sales returns or purchase returns for damaged goods or to correct invoicing errors.
  • Adjustments can be made to cater for the any of the following (i) a change in output VAT if the output VAT due exceeds the output VAT accounted for; (ii) cancellation of the supply; (iii) a change in the nature of tax treatment of the supply; (iv) return or rejection of the service supplied; (v) error; (vi) adjustments through the issue of credit notes (affecting output VAT); and (vii) adjustments for bad debts.
  • Adjustments may be made in the current or subsequent periods after a transaction has been processed. However, it will not be possible to cancel a disputed invoice and simply re-issue a new invoice for a smaller or larger amount – to do so would distort the tax point of the original invoice.

By following these basic requirements, a clear audit trail is formed.

Basic Principles of the VAT Law

To fully understand how the ITC mechanism works however, the following basic principles as set out in the VAT Law have to be understood as well.

  • Supplies are either standard-rated, zero-rated or exempt. A taxable supply is a supply made by a taxable person which is either standard-rated or zero-rated. Supplies which are exempt are not taxable supplies.
  • To be taxable, the supply must be made in the UAE. All supplies concerning land will be treated as made in the country in which the land is situated.
  • To be taxable, a person must make a supply in the course or furtherance of a business – which ordinarily means that that he operates with a profit motive.
  • VAT is charged on the value of the taxable supply. If the only consideration received for the supply is money, the value of that supply is the amount that, once the tax charged on the supply is added to it, equals the consideration for that supply. This means that the consideration will be inclusive of VAT unless the contrary is specified. If the supplier wants his customer to pay him an amount that covers the suppliers’ liability to VAT on that supply (i.e.; his output on that supply), he must ensure that his contract specifically requires his buyer to pay the VAT element in addition or charge a price which is inclusive of VAT. Many suppliers will no doubt need to review their standard Terms and Conditions of business to reflect this position.
  • VAT charged by a supplier may only be treated as input tax by the person to whom the supply is made. If a supply is made to A but payment is to be made by B, B cannot recover the VAT element as his own input tax.

In Part 2, we will look at the recoverability of Input Tax and some practical accounting issues.

 
 

This article, including any advice, commentary or recommendation herein, is provided on a complimentary basis without consideration of any specific objectives, circumstances or facts. It reflects the views of the writer which may, in some cases, differ from those of the firm, especially in the developing jurisdiction of the UAE.