Financial Management

30 November 2024
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Understanding Value Added Tax & Spotlight on Saudi Arabia’s VAT Framework

Editor September 4, 2023

Value Added Tax, or VAT is a widely adopted form of consumption tax that governments use to generate revenue. It is levied on the value added at each stage of production or distribution of goods and services. Here’s a closer look at VAT, how it is collected, its benefits for governments, and how it differs from other taxes.

What is Value Added Tax (VAT) and How is It Collected?

VAT is applied at each stage of the supply chain, from the production of goods or services to their final sale to consumers. Each business in the chain charges VAT on its sales (output tax) and pays VAT on its purchases (input tax). The difference between the output and input tax is remitted to the government.

Steps in Value Added Tax (VAT) Collection:

Manufacturers and Suppliers: VAT is charged on raw materials supplied to manufacturers.
Producers: Manufacturers add value to the goods and charge VAT when selling to wholesalers.
Wholesalers and Retailers: Wholesalers charge VAT to retailers, and retailers charge VAT to consumers on the final sale.
Consumers: The end consumer bears the VAT as part of the price of goods or services.

Businesses play a key role in collecting and reporting VAT, ensuring transparency and accountability at each stage of the supply chain.

Benefits of Value Added Tax (VAT) to the Government

Revenue Generation: VAT is a reliable source of government revenue, contributing significantly to public budgets.
Minimized Evasion: VAT’s self-enforcing nature where each stage of the supply chain reports its VAT liability, reduces opportunities for tax evasion.
Economic Growth Contribution: By taxing consumption rather than income or savings, VAT encourages investment and economic activity.
Simplicity: Compared to other taxes, VAT is easier to implement and manage, particularly with advancements in technology.

Value Added Tax (VAT) encourages compliance across the supply chain, while sales tax is more straightforward but limited to the final sale. Income tax is more personal and depends on an individual’s or entity’s earnings.

VAT in Saudi Arabia

Saudi Arabia implemented VAT on January 1, 2018, as part of the Gulf Cooperation Council (GCC) VAT framework to diversify government revenue sources. Here are the key details about VAT in Saudi Arabia:

Standard VAT Rate

Initially introduced at 5%, the VAT rate in Saudi Arabia was raised to 15% in July 2020 to address economic challenges and increase government revenue.

Scope of VAT

Value Added Tax (VAT) applies to the majority of goods and services, including imports. Businesses must charge VAT on taxable supplies, which consumers pay on top of the base price.

Exemptions and Zero-Rated Goods

Zero-Rated Supplies: Exports, licensed healthcare, and education services are taxed at a 0% rate.

Exempt Supplies: Financial services (e.g., loans and insurance) and residential real estate leases are exempt from VAT.

Registration Requirements

Mandatory Registration: Businesses with annual revenue exceeding SAR 375,000 must register for VAT.

Voluntary Registration: Businesses earning between SAR 187,500 and SAR 375,000 may opt to register.

To register for Value Added Tax (VAT) in Saudi Arabia, businesses must prepare and submit the following documents:

Business Name and Identification: The name of the business and relevant ID details of the business owner or authorized individual.
Contact Information: Complete address, including email and other contact details for communication.
Electronic Identification Number (if available): The identification number provided by the General Authority of Zakat and Tax (GAZT), now known as ZATCA.
Commercial Registration (CR) Number: The unique registration number associated with the business.
Date of VAT Registration: The actual date of VAT registration or an alternative requested date if applicable.
Annual Value of Taxable Goods and Services: A declaration of the annual worth of taxable supplies made by the business.

These documents are essential for ensuring a smooth VAT registration process and compliance with the regulations set by ZATCA. Having them prepared in advance can help businesses avoid delays or complications.

Value Added Tax (VAT) Filing and Payment

VAT-registered businesses are required to file VAT returns either monthly or quarterly, based on their revenue. They must submit these returns and remit VAT within a month following the end of the filing period.

Monthly VAT Returns:

Businesses with an annual turnover exceeding SAR 40 million must file VAT returns every month.
Returns for a given month are due between the 1st and the last day of the following month.

Example: VAT returns for January must be filed between 1st February and February 28th.

Quarterly VAT Returns:

Businesses with an annual turnover of SAR 40 million or less can file VAT returns quarterly.
Returns for a quarter are due between the 1st and the last day of the month following the end of the quarter.

Example: VAT returns for the October to December quarter must be filed between January 1st and January 31st.

Refunds for Foreign Businesses

Under the updated guidelines, non-resident businesses that conduct economic activities outside Saudi Arabia but incur Value Added Tax (VAT) on goods or services within the country may qualify for a VAT refund. However, eligibility is contingent upon meeting specific conditions, primarily aimed at ensuring fairness and reciprocity.

The key requirements for applying for a VAT refund are:

Reciprocal Agreements:
The non-resident business must be based in a country that either enforces a VAT system similar to Saudi Arabia’s or provides reciprocal VAT refunds to Saudi businesses incurring VAT in that country.
Proof of Tax Registration:
Applicants must furnish proof of VAT registration or an equivalent tax system from their home country. This includes submitting a valid registration certificate and any supporting documents to confirm the ongoing validity of the registration during the refund process.
Principle of Reciprocity:
The foreign country of the applicant must allow VAT refunds under comparable conditions for Saudi Arabian businesses. This reciprocity ensures equal treatment for businesses operating across borders.

By adhering to these criteria, foreign businesses can reclaim VAT paid in Saudi Arabia, providing a significant financial advantage for cross-border operations.

Administration and Compliance

The Zakat, Tax, and Customs Authority (ZATCA) oversees VAT implementation in Saudi Arabia. ZATCA is responsible for providing guidelines, conducting audits, and ensuring compliance among businesses.

In 2023, ZATCA also introduced significant advancements in customs administration under the Clearance Within Two Hours Initiative. This initiative focuses on improving efficiency and transparency through automation, collaboration, and streamlined processes.

Value Added Tax (VAT) is a pivotal tool for governments to enhance revenue and streamline taxation. While its implementation requires businesses to adhere to stricter compliance measures, it also benefits economies by reducing tax evasion and encouraging transparency.

In Saudi Arabia, Value Added Tax (VAT) has become a cornerstone of the nation’s economic strategy, aligning with broader efforts to diversify income sources under Vision 2030.

As a chartered accountant, my advice to businesses is to stay compliant with VAT regulations to avoid penalties and maintain smooth operations. For consumers, understanding VAT’s impact on pricing can help them make more informed purchasing decisions.