Lessons Learned from VAT Audits and Inspections in the GCC

The right tax at the right time

Basic VAT compliance: Submitting VAT returns and paying any tax due is the most important VAT obligation for a VAT registered business. If it is done correctly, VAT can be an easy tax to live with, and the taxpayer will have a good relationship with the tax authority. But if it’s not handled correctly, the result is likely to be high financial cost in the form of penalties and a drain on the taxpayer’s resources to put things right.

The objective underpinning VAT compliance should be to pay the right amount of tax at the right time. In this article, we will share some tips to help you achieve that objective and look at the key steps in building a sound compliance process. We will also share our experience of the VAT audit and VAT inspection programs, which are the ultimate test of a taxpayers’ performance.

At present, VAT has been implemented in four GCC countries: Bahrain, Oman (where VAT implementation is still in progress), Saudi Arabia and the UAE. The VAT rules vary a little from country to country. However, the principles behind good VAT compliance are consistent for each of the countries, and it is these principles we will focus on, starting with the question of identifying where the business is required to register for VAT.

Businesses in the GCC region, more often than not, supply goods and/or services from one GCC member state to the other. In case of supply of goods, VAT compliance obligations in the receiver GCC member state could be handled by the importer of record (subject to INCOTERMS which clarifies the rules and terms that buyers and sellers use in international and domestic trade); however, in the case of the supply of services, VAT compliance obligations in the receiver GCC state could fall on the supplier rather than the recipient, and the supplier could be exposed to VAT registration as non-resident. It is a misconception that VAT registration in one GCC member state, say UAE, will suffice for meeting VAT compliance obligations in another GCC member state, say KSA. The requirement to obtain non-resident VAT registration intensifies when supplies are made to non-registered recipients, such as private individuals.

Once it is determined that VAT registration needs to be obtained as either resident or non-resident, other compliance obligations under local VAT law and regulations are inevitable. It is another misconception that filing VAT returns and making timely VAT payments are the only compliance obligations; in fact, VAT compliance obligations are much wider, and include displaying a VAT registration certificate at the place of business, maintaining records, nominating a local responsible person, responding to queries from authorities in a timely manner, etc.

Last but not the least, if VAT registration is obtained as non-resident in a particular GCC member state, then businesses should be ready handle questioning from tax authorities as to whether the business is exposed from a Corporate Income Tax Permanent Establishment (PE) perspective.

Whilst the objective may be always to get things right, it is sometimes easier said than done. The risk of errors cannot be removed completely, and many different factors such as time pressures, staff shortages and difficult trading conditions can mean that sometimes, the tax does not get as much attention as it should. However, some basic building blocks can help reduce the risk of errors and non-compliance.

Firstly, it is essential that the business maintain the correct VAT records, including copies of all supporting documents such as tax invoices. The record-keeping requirements are slightly different for each of the GCC countries that have implemented VAT, but all the countries have published detailed guidance, so it’s easy for the taxpayer to find the information they need if they are not sure what is required.

Secondly, the taxpayer needs to build a process for extracting and collating the information required for the VAT return and for making the payment to the tax authority. As with record-keeping, the payment deadlines and the information needed for the returns are slightly different for each country, but again, the information on what is required is available from the tax authorities.

The compliance process will vary from business to business, but in all cases, it needs to be clear, it should be followed in the same way for each return, and it should include some controls to ensure that all the information is collected from the records. These controls should include a review or sign-off from an appropriate person. Later in this article, we go into more detail on the sort of areas that should be addressed by the checks and controls in the compliance process.

The final building block for effective VAT compliance is a question of the people involved. It is important that the responsibility is given to the right person, that they understand what they need to do, what the deadlines are, and what the consequences are of not complying. This seems a simple point, but often we see the job given to a junior member of the finance team, who has not had sufficient training. Alternatively, the role may be taken on by a senior member of the team who may not be close enough to the day-to-day transactions or may simply have too many other responsibilities. In either case, problems are likely to occur if the compliance is in the wrong hands. It’s important, therefore, that the business considers the needs of the VAT compliance role, that it identifies the right person (or people), and that they receive the training and support they need.

Having outlined those three key elements to managing compliance, we will now look at some of the area’s businesses should focus on during the compliance process, beginning with sales. The starting point, of course, is to ensure that all sales information is captured correctly and transferred to the VAT return working papers, and in due course, the VAT returns itself. The use of standard templates to ensure consistency, and verification checks from a reviewer, are good ways to achieve this. Special attention should be paid to any sort of advance payment, which can trigger an early date of supply. Adjustments and refunds are another risk area, and protocols for checking any large anomalies are a good safeguard against errors.

On the purchase side, the key point is again ensuring the capture and transfer of all the relevant information from the purchase records to the VAT working papers. Adjustments are particularly prone to cause problems with purchases, and it is important to ensure input tax deductions are adjusted in line with any adjustments, returns or refunds in the sales records.

An additional factor with sales is that not all input tax is deductible, so checks need to be built into the process to ensure that irrecoverable VAT, for example, VAT on non-business expenses, is not claimed. It is also important to keep track of vendor payments to ensure that input tax recovered in the past need not be reversed.

It is always prudent to include some level of reconciliation between the VAT figures and the company’s financial statements or management accounts. This will act as a high-level credibility check on the VAT declaration. It’s not always possible to make a precise reconciliation because normal accounting practices and VAT accounting do not always match. However, making allowances for variations in accounting treatment, it should be possible to use the reconciliation to determine, at least broadly, whether the VAT return is a credible reflection of the taxpayer’s trading activity.

We have supported many clients through VAT audits or inspections. This is where the tax authority carries out a formal examination of the taxpayer’s business, and it is the acid test for VAT compliance. The officer will examine all aspects of the company’s VAT affairs and will check whether it is charging VAT correctly, whether it is deducting input tax correctly and whether the VAT returns are correct. It’s worth mentioning that although the word ‘audit’ is often used to describe these inspections, the officer will not give a final signoff that everything has been checked and is correct, and there is no guarantee that the records will not be re-inspected if new information comes to light.

When the audit takes place, the officer will carry out very detailed checks such as tracing individual postings back to the sales or purchase ledgers and will make investigations into individual transactions. We have noted that with some taxpayers, particularly in the UAE and Saudi Arabia, very large samples of sales and purchase documentation have been requested. These detailed checks are a very important part of the audit. It also highlights the importance of maintaining records correctly and ensuring the documentation to support the records is maintained properly and is easily accessible.

From experience, many of the errors found in tax audits tend to be because of missing or incorrect documents or incorrectly claimed input tax. These are very basic points, and the errors (and the resulting assessments and penalties) could be avoided if taxpayers paid attention to compliance basics.

Generally, we find the tax authorities are willing to work collaboratively and constructively with taxpayers when the audit comes around. But this is much easier if the taxpayer has played its part in making sure it keeps its tax records correctly and up to date, follows the tax law and keeps abreast of official guidance. If it does, there should be little to fear from the audit, even if the notification of an audit, or a request for information, comes at very short notice.

It is worth mentioning that there is an additional twist to VAT audits in Saudi Arabia and (once they get underway) in Oman. Both countries have a corporate income tax system as well as VAT. The auditors are therefore likely to make crosschecks and reconciliations between the two taxes, in addition to a reconciliation with the financial statements. Disclosure of certain overseas expenses under the Reverse Charge Mechanism and recovering input tax credit in VAT return, could easily open doors for tax authorities to question the same overseas expenses from a Withholding Tax perspective. Again, it reinforces the need to stay on top of all the businesses’ tax compliance obligations.

One final tip to keeping on top of VAT compliance is to regularly review the company’s tax accounting and compliance to ensure that everything is on track. The review could be undertaken by the taxpayer itself or by an external advisor. As a minimum, it should address the following points:

Is the business keeping all the records prescribed by the law?
Are the records up to date?.
Have all returns been submitted and paid on time?
Are all invoices, credit notes and other tax documents issued in the correct format and were they issued correctly, and on time?
Have copies of all tax documents been kept and filed in a way that makes them easily accessible?
Has the tax been charged correctly on all the activities of the business?
Have all deductions been made correctly?
Has any official guidance been issued that might affect the company’s liability to charge tax or its ability to claim a deduction?

Regular reviews of this type will ensure the taxpayer is ready for an audit and ensure the risk of VAT errors is kept to a minimum.

To sum up: VAT compliance should be given a high priority. Taxpayers should make sure they understand all their obligations and that they meet them. There should be processes in place to manage the risks, and the right staff, with the right training, should be given the job of managing the compliance process.

If you would like to learn more about this topic or if you would like to discuss how BDO can help with your VAT compliance in any of the GCC countries, please get in touch with your normal BDO contact or any of our VAT specialist team.

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