Author
Grant Gilmour B.Sc. _HONS , MBA, CPA _{BC Canada} , CA, CPA _{Arizona USA}

Recently I attended training on VAT in the UAE. That experience made me think about how different VAT programs are similar and different around the world. VAT is new in the UAE. It was implemented in 2018. Like other VAT programs around the world many questions have already come up and the UAE taxation authorities are rapidly bringing forward guidance and clarification.

Looking at Value Added Tax conceptually it is similar around the world. It is usually levied by each participant at each step of the process. I realized when studying UAE VAT that business clients are often challenged by the basics of the system and our value as advisors is often explaining these basics and the similarities and differences between different tax systems. Armed with that knowledge we can help our clients avoid tax traps and build best practices. VAT can be a particularly costly mistake for a business if it is not recoverable and becomes an additional cost instead of a refundable charge. VAT rates vary from 5% to almost 30%. That size of impact on the margin earned by a business is huge.

Where can we as Advisors add value? Frequently over the years as an active Tax Advisor I found that clients often brought the problem of taxes paid after they were paid. Usually in VAT it was tax paid by a non-resident client to a tax authority that they had never dealt with before. The client assumed that since it was called VAT that meant that it was the same as VAT in their home jurisdiction and then they failed to pay attention to the differences and to the registration and reporting requirements.

Where are the risks? Where do Integra Members add value?

The key risk is not understanding the process and paying the tax and finding that it is not refundable or recoverable by participants in the transaction. A Secondary risk is triggering an audit that can be complex to manage and can result in further charges. Integra Members add value to their clients by understanding and addressing each of the basics and other factors. Let me walk through them

Does the name make a difference? VAT or GST

The most used names are Value Added Tax and Goods and Services Tax. We sometimes see other names like General Sales Tax used. The confusing factor for most businesses is distinguishing between the VAT and other charges like import duties and Sales taxes. They can often look the same to users and the documentation provided can add to the confusion by renaming them or combining them into other items so that they are hard to distinguish. 

Cyclic payment and refunding or crediting of previously paid taxes

The common distinction between Sales taxes and Value Added taxes is that for VAT usually each participant in the business cycle charges the tax and recovers the tax paid to others. The result being that only the consumer is unable to recover the VAT paid. We find exceptions in each VAT system, but the general concept is the same. A simple step by step chart to describe this process is used around the world. Here I describe lumber, but I have seen the same example used for coffee  and for fabric. The country that is explaining the VAT choses the commodity to illustrate the example. I happen to be Canadian, and we have lots of lumber.

• Trees grow in the forest and lumberjacks harvest them and sell them as raw logs to the forestry companies. VAT is charged for the first time. The lumberjack is the first person to charge VAT and is a net remitter.
• Local forestry companies purchase the logs and pay the VAT but also process the logs to lumber and charge VAT. They have VAT in and VAT out. The product produced sells at a higher price than the material purchased so the forest company is a net remitter of VAT.
• Furniture manufacturers buy the lumber and make furniture. They also have VAT in and VAT out and are net remitters.
• Furniture retailers buy the furniture and sell it to retail consumers. They also have VAT in, and VAT out and again are net remitters of VAT.
• The consumer buys a kitchen table from the furniture retailer and pays VAT but never recovers the VAT. Thus, by the time the Consumer buys the furniture the full amount of the VAT is charged but at each step some of it has already been collected by the government.

 Self Assessment

Sometimes a business in the middle of the supply manufacturing chain buys a supply but does not pay VAT. Perhaps the vendor is a foreign vendor. Perhaps the vendor is not registered. These situations vary some from VAT system to VAT system. The common treatment is that the VAT must somehow be recognized and charged. The result usually is that the same VAT that is recognized and charged by self assessment can be refunded as part of the supply chain cycle described above. But the critical thing that seems to catch people off guard is the timely reporting. This as described below can lead to one sided transactions that end up costing the business reporting the VAT a penalty or lost refund.

In some jurisdictions these self assessments that are recovered are called “wash” transactions. 

Free Zones

Most importers and exporters are familiar with “Free Zones” or special economic zones or bonded clearing zones. There are many names, but the concept is usually that products entering the zone are not subject to the normal VAT rules or other duties and charges. We don’t use the word exempt because it has another meaning, but businesspeople think of these zones as exempt from tax. 

Exemption from tax

Businesspeople generally like to hear that they are exempt from tax and will ask how they can be exempt. However, in many jurisdictions the word exempt when used with VAT means the opposite of what a businessperson might think. It usually means that the business that is exempt can not recover the VAT they pay and also does not charge the VAT. The result is that the input costs are increased by the amount of the VAT, which increases costs and lower profit margin for the exempt business. Thus, being exempt is generally the opposite of what a businessperson wants. 

Zero rated or the use of different rates to target relief or create penalties for the consumer

Consumers are rewarded or punished by the tax authorities for their buying behaviours by changes in the VAT rate. For example, VAT could be zero (zero rated) on regular food items like milk purchased at a grocery store but could be the regular rate or a higher rate when purchased as a beverage as part of a restaurant meal. VAT could be higher on “sin” foods like sugared sodas or wine. These differences are not in the control of the business owners but have an impact on consumer choices that might affect the businesses’ ability to attract customers.

 Structure for reporting

Most VAT systems I have encountered have online web-based reporting. Some even are tied directly to transaction processing. This moves the compliance efforts away from data collection and submission to data management and self audit to ensure no overpayments occur.

Limits on recovery and penalties for non-compliance (late reporting)

A risk for businesses is being unable to recover VAT paid. And instead of having a cash flow recovery they have an added cost. This I call a one-sided tax payment. A unique thing about UAE VAT that I learned was that missed reporting of recoverable VAT (paid on inputs) can result in never getting to recover that VAT. Apparently there is only one regular reporting period extra allowed before an input recovery is disallowed. The time period for reporting and being eligible for a refund of VAT paid is essentially six months. This was really a contrast to my experience with Canadian GST (also a VAT) where the business has four years to report and claim a recovery of input VAT. Other VAT systems allow an annual reconciliation of VAT to correct missed items during the year. These types of limits and the difference in reporting and limits can be a real challenge to international businesses. Imagine a business doing business in an environment that allows annual reconciliation and learning at the end of the year that reporting deadlines for recovery of the missed items have passed and now that VAT that would normally be recoverable is not recoverable.

Requirement to register in order to participate in relief

A significant problem for businesses is trying to recover VAT paid when that business is not registered in the jurisdiction that the VAT was paid. The VAT paid might normally be considered part of the pay and recover cycle described above with the furniture sales but because the business paying it is not registered the tax authorities consider the business paying a final consumer and do not allow recovery. I have experience with this happening in Canada with foreign businesses that enter the Canadian market and are not registered for the GST.

This is another example of a one-sided tax transaction.

Third party agents (shippers, customs brokers, customers of your clients)

Often businesses engage customs brokers and shipping companies to handle the VAT and duties as well as the shipping and handling. Or they use an online platform for sales like Amazon, which may or may not be responsible for the collection and remittance of taxes like VAT.

Delegating the responsibility for reporting and collecting and charging taxes like the VAT can have mixed results. The responsibility of the agent or other representative might be limited to calculation and the responsibility for proper registration and reporting and payment of the taxable transactions remains with the business.  Failure to understand the responsibilities of the shipper and online sales platform and failure to understand shipping terms (see incoterms below) can lead to either surprise liability or unrecovered input VAT.

Harmonization

Readers in the European Union might wonder why a conversation about the differences in VAT is new to many other readers. That is because the EU has worked to coordinate and harmonize its VAT system – but to be honest – there are still differences in local VAT rules throughout the EU countries. Other groups of countries have also worked to harmonize and coordinate. For example, the UAE VAT is coordinated with the GCC (Gulf cooperation council) VAT. This coordination is still under development, but the important thing is that in the EU and the GCC the need for consistency has been recognized and efforts are made by tax authorities to coordinate. In contrast sales taxes in the USA are not harmonized and jurisdiction can have confusing and overlapping taxation.

Goods and Services

VAT usually applies to both goods and services. Interesting things can happen when goods and services are bundled or delivered as a package, but the jurisdictions of delivery are different. For example, a product delivered to a free zone but bundled with service or software that is delivered outside of the free zone. This can often test the understanding of the VAT rules in that country. And can have different results in different countries. There is risk of one-sided tax transactions here because a bundled product and service might have VAT that is not recoverable because it is not correctly reported or charged due to the confusing nature of bundles multi- jurisdiction transactions.

INCOTERM

It often surprises me how infrequently businesspeople consider their sales and shipping terms with their customers when reviewing their VAT and other transactional liabilities like duties. INCOTERMS provided by the ICC (international chamber of commerce) provides a starting place for the analysis of who is responsible for VAT and who is acting for themselves and who is acting as an agent. This analysis can often lead to identifying risk points where VAT or other charges might be charged and normally recoverable or at a minimum deductible against other charged but because of gaps in  registration or poor structure the charges are not recoverable. One particular INCOTERM DDP, has foiled many of my clients over the years because it stands for delivery duty paid and that means the responsibilities and costs fall on the vendor. In my experience courier companies recommend this shipping structure to small transactions vendors and the vendors do not realize the risks.

Concluding thoughts

VAT itself is not a new concept for many businesses. Over 140 countries in the world have VAT. But what is often new is the difference in rules and regulations for VAT in the destination country for a business conducting business overseas. The nuances of things like registration, time limits and shipping terms can catch a business off guard and end up becoming a major expense.

Integra members can and do add value by analyzing VAT and the transactions with their clients to avoid problems before they happen.