Accounting for input VAT/GST correctly and actively managing credits are essential aspects of any effective indirect tax strategy. These may seem like straightforward tasks. But detailed domestic rules on VAT/GST recovery and differences in how countries handle refunds can complicate the picture, especially for global companies.
VAT/GST — never a cost to business?
As a flow-through tax borne by final consumers, VAT/GST should not be a cost to businesses. But that is not always the case. Most VAT/GST payers encounter “sticking tax,” and the financial impact of negative VAT/GST cash flow on working capital may be significant.
The OECD view
The OECD’s International VAT/GST Guidelines
Guideline 1.2: The overarching purpose of a VAT is to impose a broad-based tax on consumption, which is understood to mean final consumption by households.
Guideline 1.4: The burden of the VAT should not rest on businesses.
- Absolute VAT/GST costs
VAT/GST may be an absolute cost to a business for a number of reasons:
- The business is not a VAT/GST payer because its turnover is too small or because it supplies goods or services that are exempt from VAT/GST.
- The business has not yet made any taxable supplies or is not yet registered for VAT/GST.
- The domestic VAT/GST law explicitly excludes the cost from recovery or explicitly excludes the business from recovering input tax.
- The VAT/GST payer does not have the necessary processes to identify the input tax.
- The VAT/GST payer does not have the documentation required to support its claim (e.g., customs document or tax invoices).
- The tax administration refuses the claim because the VAT/GST payer has not complied with the formal requirements (such as time limits or application details).
- The VAT/GST payer incurs an additional tax charge as a penalty for errors or omissions in its VAT/GST accounting.
- Negative VAT/GST cash flow
In most VAT/GST systems, VAT/GST paid on allowable business costs is recoverable as input tax as soon as the purchaser has a valid tax invoice — even if the tax has not been paid to the supplier. Where this provision applies, VAT/GST input tax is not always a cash flow cost to businesses; in fact, some VAT/GST payers may even gain a cash flow advantage if they can offset the VAT/GST charged on their purchases before they pay their suppliers.
However, in practice, terms of trade often mean that an invoice is paid before the purchasing business can offset the VAT/GST against output tax on its sales or before it can receive a refund for any excess. And, increasingly, tax administrations, concerned about VAT/GST fraud, are looking to impose conditions that prove the tax has been declared and paid before they will allow input tax credit.
VAT/GST may contribute to negative cash flow in a number of ways:
- The terms of business require the purchaser to pay VAT/GST to its supplier before it can offset or recover its input tax.
- The business has not yet made any taxable supplies or is not yet registered for VAT/GST.
- The VAT/GST payer has an excess of input tax that cannot be used to offset output tax.
- The tax administration’s refund procedures are subject to long delays.
Where do credits accumulate?
Excess input tax is a common cause of negative cash flow for VAT/GST payers. Receivables may be outstanding for months or even years.
Understanding how and where credits arise and taking action to deal with excessive delays and “crunch points” can greatly improve management of working capital.
Different countries treat excess input tax credits in different ways. The excess may, for example, be refunded, carried forward or used to offset other taxes. These different approaches can have significantly different impacts on affected businesses and should be factored into strategic decisions about managing VAT/GST costs and cash flow.
- Automatic refunds
Automatic refunds: as of 1 January 2017, 43 of 120 countries listed in the Worldwide VAT, GST and Sales Tax Guide refund excess input VAT/GST automatically.In some jurisdictions (such as France), the VAT/GST payer must apply for the refund. In others (such as the UK), a refund is granted automatically on receipt of the VAT/GST return for that period. In some countries (such as Romania and Luxembourg), the VAT/GST payer may choose whether to carry the excess forward or request a refund.
- Carryforward before refund
Carryforward before refund: as of 1 January 2017, 65 of 120 countries listed in the Worldwide VAT, GST and Sales Tax Guide require VAT/GST payers to carry forward excess input tax — either to offset future VAT/GST payments or to offset other tax liabilities. Forty-one countries allow taxpayers to request a refund after some period of offset.
- Carryforward exclusively
Carryforward exclusively: as of 1 January 2017, 24 countries apply carryforward as the only way for most taxpayers to offset excess input VAT.
Managing input tax credits
Avoiding or reducing domestic VAT/GST credits
Managing VAT/GST refunds and credits involves looking critically at the VAT/GST you pay and identifying ways to buy goods and services VAT/GST-free.
- Pay the right amount of tax
VAT/GST is recoverable as input tax only if it is properly charged. Because tax administrations are likely to focus on supplies where the full rate of VAT/GST is not applied, suppliers may be reluctant to apply zero-rating, reduced rates or exemptions, even when they are fully justified. This issue may also apply to cross-border supplies, especially in countries where taxpayers face harsh penalties for errors in VAT/GST accounting. But this “extra” VAT/GST is not really a tax — it is an additional cost component. Actively examining where you may be overpaying VAT/GST — and challenging suppliers to apply justifiable exemptions and reduced rates — can greatly improve cash flow and reduce absolute VAT/GST costs.
- Acquire cross-border goods VAT/GST-free
Imports: many jurisdictions allow importers to defer payments of VAT/GST on imports. Instead of paying VAT/GST to clear their goods at the border, importers may be allowed to account for and offset the tax due (using a reverse charge) on their VAT/GST declarations, thus avoiding a payment and refund.
Intra-Community supplies: in the EU, this procedure applies automatically to B2B acquisitions of goods acquired from other Member States. In the EU, even if VAT/GST deferment is not available for imports from third countries, routing the supply chain to increase intra-Community acquisitions can greatly improve cash flow (e.g., by purchasing from EU suppliers or by importing into another Member State).Exports: frequent exporters often carry excess VAT/GST credits because they pay tax on their imports and domestic purchases but do not charge VAT/GST on their export sales. Many countries allow frequent exporters to claim domestic VAT/GST refunds even if other businesses cannot. Others may let exporters claim tax more frequently (e.g., by submitting monthly rather than quarterly returns). In addition, some countries (such as France, Ireland and Italy) may allow exporters to reduce their VAT/GST credits by purchasing domestic goods free of VAT/GST. Under this system, domestic sales of goods and services made to certified export businesses are treated as if they were export sales, allowing them to qualify as VAT/GST-free. Stripping out VAT/GST at this stage of the supply chain can significantly improve cash flow for exporting companies, although certain restrictions or conditions may apply. This export treatment can also improve cash flow for domestic suppliers that sell goods and services to export businesses because it removes the need to charge and account for output tax on these sales. The Worldwide VAT, GST and Sales Tax Guide sets out the detailed conditions and effects of grouping in 120 jurisdictions.
- Investigate VAT/GST paid on global group contracts
Global contracts may be established centrally for purchasing goods and services for a number of subsidiaries in different jurisdictions. However, the application of VAT/GST to the contract may not be considered, and the availability of input tax recovery by the local entities covered by the contract may be easily overlooked by centralized procurement functions. This overlooked VAT/GST may become an additional cost of doing business. Proactively involving the corporate tax function in structuring global contracts and making local accounts payable staff members aware of these arrangements (and verifying that they are claiming the appropriate credits) can release trapped VAT/GST and improve the profitability of the arrangement.
- Reduce output tax for bad debts
VAT/GST cash flow issues affect suppliers as well as purchasers. VAT/GST charged on sales must generally be declared and paid to the tax administration by the supplier when a taxable event occurs, even if the customer has not paid (or never pays). Taxable events may include delivering goods, performing a service or issuing an invoice. In some VAT/GST systems (e.g., Bulgaria, Portugal and the UK), a supplier that can prove that its customer will not pay has a bad debt and may reduce its VAT/GST liability. Strict conditions generally apply (e.g., the purchaser must be insolvent) and may make claims time-consuming. However, adopting robust policies to identify qualifying debts and to claim the appropriate relief may significantly improve VAT/GST cash flow, and the benefits may outweigh the costs, especially for significant debts. The increased use of data analytics and automatic processing may also improve the feasibility and reduce the administrative costs of making these claims.
- Use VAT/GST grouping
VAT/GST grouping allows related companies to form a consolidated group. It may benefit payers with excess input tax in a number of ways by allowing for greater offset and by removing tax on intercompany supplies.
Not all countries permit VAT/GST grouping. The Worldwide VAT, GST and Sales Tax Guide sets out the detailed conditions and effects of grouping in 120 jurisdictions. Currently, 36 jurisdictions listed in the guide indicate that they allow some form of VAT/GST group. Of these, 20 are EU Member States.
Each country has its own rules about who can form a VAT/GST group. In most countries, grouping is restricted to corporate legal entities that are under common control. This condition typically requires a majority share ownership by one group member (or a common parent) or other close financial ties between the group members. Membership may be extended to qualified overseas companies or branches, or they may be excluded.
Wide differences also apply to the effects of VAT/GST grouping. The most significant effects on cash flow include:
- Consolidated VAT/GST balances. Grouping allows members to automatically offset input tax and output tax balances. This is an effective way to avoid long refund delays arising from excess input tax and the impact of carrying forward credits against future VAT/GST payments.
- Disregarded VAT/GST. Some countries allow VAT/GST group members to be treated as a single taxable person. Where this applies, members can disregard supplies made between them for the purposes of accounting for VAT/GST. Removing tax on intragroup sales can greatly reduce excess input tax, for example, for companies that export goods manufactured by related entities. This helps prevent vertical integration of legal entities for the sake of avoiding indirect taxes because it treats separate legal entities in the same way as branches or divisions.