There is a misplaced notion among many businesses that Value Added Tax (VAT)
is a very simple tax compared to other taxes. VAT carries the benefit of simplicity
at first sight but is this really the case? This wrong perception about VAT
determines the level of priority accorded to management of this tax. In majority
of business, it is given a backseat. As a result, simple but important procedures
like review of the VAT 3 returns by senior officer of the organisation or compliance
reviews are deemed unnecessary costs. For such business, VAT occupies management
agenda when Kenya Revenue Authority (“KRA”) knocks the door or when
the company is in a huge VAT refund position and seeks the refund settlement
from KRA.
VAT was first devised by a German economist during the 18th century. However
it gained general acceptance within Europe when France adopted it in 1954. VAT
has now been introduced by many countries as it is generally accepted that it
is equitable and also easier to collect. In Kenya, VAT was enacted in the year
1989 and become operational from 1 January 1990. VAT is a tax on consumption.
This means that the more you buy, the more tax you pay. It is levied on taxable
goods and services. These are items on which VAT is charged at either 16% or
0%. Output VAT is tax charged on sales while input VAT refers to tax incurred
on purchases. The difference between output VAT and input VAT results in VAT
position for the business. This could either be a VAT payable or VAT refund.
Unfortunately, because of this misleading view, much emphasis is placed on
the difference between output VAT and input VAT to determine the business’s
obligations without reviewing the make up of this final amount to see if they
are accurate or not. This situation is not made any better considering that
the responsibility for VAT accounting and compliance in many organisations is
usually assigned to junior staff or new staff. Yet as will see later, this tax
presents the greatest risk to organizations. In this article, we have considered
three examples to dispel the myth that VAT is merely the difference between
input VAT and output VAT.
There is no better area to demonstrate the hidden complexity of this tax than
to start with input VAT recovery. There is often great emphasis by business
on input VAT to ensure that all “eligible” amounts are summarized
and total offset against the output VAT due. This is because the input VAT claimed
represents savings. However, most staff handling VAT in organizations tend not
to be aware of the “blocked VAT”. Blocked VAT refers to input VAT
which is not deductible. Over the years, the business will recover all input
VAT including the non-allowable VAT such as VAT incurred on staff welfare, restaurant
services and many others. This in effect means that input VAT claimed by the
organization will be overstated every month by the non-deductible portion and
this is real VAT risk. In the event of an audit by KRA, this non-recoverable
VAT will be disallowed and penalties levied. KRA are aware of the ease with
which VAT registered entities make errors in this area and often focus on it.
As an illustration, suppose over a period of three years, a company recovers
incorrect VAT averaging about KShs 150,000 per month. Three years later, when
the business is subjected to a KRA audit, the total VAT demand will be KShs
8.2 million made up of principal tax of KShs 5.5 million and interests amounting
to KShs 2.7 million. .Yet this error seems very harmless.
A more interesting but much more risky situation for business arises in the
case of partially exempt enterprises. These are business which sell items which
attract VAT at 16% or 0% plus those which are not subject to VAT, normally referred
to as exempt. The law requires that where the proportion of the exempt sales
is 5% or more, input VAT should be restricted. Examples of organizations that
would fall under this category include hospitality sector, retailers such as
supermarkets, agricultural companies and the oil industry.
However, it is not unusual to find partially exempt business which are recovering
all the input VAT without apportionment as required by the legislation. This
non-compliance portends real VAT exposure to the business. When the taxman visits
and is lucky, there may be collateral damage to the business depending on the
amounts involved. Infact, what business are failing to do is to compute the
annual adjustment at the year end. This is a review of the input VAT claimed
at year end to correct any overclaim or underclaim.
A third example involves transactions with non-resident persons. How many business
are aware that when they receive services from non-resident persons, there are
VAT implications? And if they are aware, how many comply? Payment for management
fees, royalties or computer consultancy services will attract VAT, known as
reverse VAT. The recipient of the service is required to account for the reverse
VAT and pay it to KRA. Failure to do this, presents major risk to the business
and will render the VAT payable incorrect as opportunity to recover the VAT
paid is lost. It applies to all persons irrespective of whether they are VAT
registered and herein lies its great risk.
It is important to point out one fact. All the above examples relate to only
one source of VAT risk, which fall under category of risks resulting from ignorance
of the law or misinterpretation of written VAT guidance. We have not discussed
about the other common sources of VAT risk such as human error, financial accounting
system errors or legal and policy changes. This says a lot about the many common
sources of VAT risk and therefore any business that still regards management
of VAT as low priority, will be doing so at their own peril.
There are few steps that can be taken to minimise the frequency of the risks.
We only mention two here. Increased training to help develop VAT knowledge of
less experienced staff will reduce the errors arising from ignorance of basic
VAT principles. The other recommendation is to have a VAT review by professional
firms to identify areas of risk and exposures to enable business rectify. Overall,
no prudent business would like to operate with potential risk that is uncertain.
This is what a business would be doing if VAT management is given a backseat!
They would be relaxing on a time bomb which will explode when the taxman visits.
