21 Dec 2017

VAT Regulations – Part 2: Recoverability of Input Tax and Practical Accounting Issues

Authored by: James Farn

VAT Regulations – Part 2: Recoverability of Input Tax and Practical Accounting Issues

In Brief:

  • Discusses where and how any Input Tax can be recovered by the registered person.
  • Looks at the situation where there is more than one type of supply involved (taxable, zero-rated and exempt).
  • Considers the practical aspects of when and how to file the VAT Return and the question of refunds.

Recoverability of Input Tax

Following on from Part 1 of this discussion, the question then arises as to whether all or part of the input tax is recoverable by the buyer (as the person incurring the input tax). 

  • Input tax is only recoverable if it is directly attributable to any taxable supply which that person makes in the course of his business. So, if all the supplies which a person makes are standard-rated or zero rated (i.e. taxable), he can generally recover all input tax. If all of the supplies he makes are exempt, he cannot recover any input tax. If some of the supplies he makes are exempt and some are taxable (i.e. he is partially exempt), his ability to recover input tax will depend on whether (i) the supply made to him is attributable to a taxable supply made by him; or (ii) to an exempt supply made by him; or (iii) is not directly attributable to any specific supply (such as an overhead). 

  • Input VAT cannot be recovered against inputs, expenses or purchases which are (i) used to make exempt supplies; or (ii) incurred by non-registered persons; or (iii) are not incurred in furtherance of a business (e.g., personal expenses). These costs will be irrecoverable and must be treated as an overhead or cost to the business and, where appropriate, passed on to consumers.

  • If a business makes taxable and exempt supplies, it must apportion the input VAT accordingly, and claim ITC for only the taxable part. In some cases, it should be relatively easy to attribute (or ‘assign’) purchases and expenses incurred to either the taxable or the exempt component of a supply in order to calculate the input tax payable.  However, in other cases, this may not be easy. The Law and its Regulations therefore set out a method by which a registered person is able to apportion his inputs against the taxable and the exempt elements of the supplies. The basic method is a ‘general apportionment’ method. However, the Regulations also allow an alternative basis for the appointment calculation, based on the special circumstances of the applicant’s business upon application to the FTA.

  • Some supplies may have more than one component (otherwise known as combined or composite supplies). For example, if one of the component supplies has a zero-rating and the other has a standard rate, there might be a commercial advantage for the supplier to try to treat the major element of the supply as the zero-rated item. The Regulations contain a methodology for deciding how liability may be fixed to the VAT rate applicable to the main supply (or supplies). The basic approach is that if a supply is seen as insignificant or incidental to the main supply, then for the purposes of VAT, it is usually ignored – the liability will be fixed by the VAT rate applicable to the main supply.

  • In case of certain supplies – specifically, business assets which are acquired for long-term use in a business - the amount of recoverable input tax may also be adjusted throughout a period after the acquisition of the asset under the Capital Goods Scheme described in the Regulations. 

Practical aspects of VAT accounting

These are also contained in the Regulations.

  • A refund for excess input tax should generally be made in the first VAT accounting period following which (i) the taxpayer has received the tax invoice relating to the supply which gave rise to the input tax and (ii) has made payment to the supplier in respect of that supply. However, the FTA may offset any excess input tax against an existing liability for payment of outstanding VAT or administrative penalties. 

  • There are specific rules for claiming inputs in circumstances where they are incurred before tax registration. 

  • A taxable person will be required to make VAT Returns quarterly (but with the possibility of a shorter period where allowed by the FTA). For those in a ‘net recovery’ position where they obtain repayments of the excess input VAT over their output VAT (principally those who make regular and substantial zero-rated supplies or supply goods or services from within the UAE for export), they may want to explore the possibility of seeking a shorter return period. 

  • Assuming a ‘standard’ quarterly return, a taxable person will calculate his total output tax at the end of the agreed quarter. This will be the amount of VAT charged on invoices issued by him in the relevant quarter and his recoverable input tax (calculated as described above). He will submit his return to the FTA accompanied, where appropriate, with payment of the excess of his output tax over his recoverable input tax. Where the recoverable input exceeds the total output tax, he will submit a claim for a refund. Rather than provide an immediate refund however, the Regulations (in conjunction with the Federal Tax Procedures Law), require the taxpayer to offset the excess credit against future output VAT. This offset mechanism enables the FTA to conduct audits, as necessary, before making the refund.

  • Where VAT is payable, payments will have to be made within a period of 28 days after the end of the relevant quarter.

Conclusion

By understanding these basic accounting procedures, it may be apparent that recoverable input tax does not represent an absolute cost to a business (but only affects cash-flow). Where a substantial amount of input tax is being incurred on a supply, it may, however be possible to mitigate the cash flow problem (or even turn it into a cash flow advantage) by careful planning of the timing of the supplies. Factors to consider may include;

(i) the time at which VAT invoices are issued; and

(ii) the credit period allowed to the buyer for the invoices to be settled.

It’s up to the contracting parties (seller and buyer) to agree the credit terms of their contract. Sellers may, for example, require the VAT element payable on a taxable supply to be paid at a different time to the consideration element (assuming that the consideration element is a VAT- exclusive amount).

 
 

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.