Adjusting for VAT
25 March 2013
Posted by: Author: Doria Cucciolillo
Source: Doria Cucciolillo
Where the calculation
of Value-added tax (VAT) is concerned, sufficient knowledge of the specific
entity and its business activities are important factors to consider. In
practice it can easily happen that a VAT return is incomplete if the
calculation of VAT is solely based on the documentary evidence provided by a
client, for example tax invoices and credit
In certain instances,
a vendor will be required (or allowed) to make adjustments to its output and input
tax estimations. The purpose of this article is to investigate the different
situations that may attract additional VAT implications. From a tax
practitioner’s point of view it is important to look out for these types of
events in order to prevent the understatement of a client’s VAT liability and additional
taxes (penalties and interest) that may be imposed. In addition, extra input
tax credits may be available and can be utilised to reduce a vendor’s VAT
current state of the global economy, it is almost certain that some clients
will be unable to settle their outstanding debts. Fortunately, a vendor will be
entitled to claim an input tax deduction if these amounts are written off as
bad debts. The input tax deduction is set at the total debt discharged
multiplied with the tax fraction. In order to allow this deduction, the South
African Revenue Service (SARS) must be convinced that the debt genuinely became
irrecoverable and that the transaction does not merely exists on paper. Therefore
the vendor’s accounting records must reflect the waiver of these debts and its
validity must be confirmed by the vendor’s actions. He or she had to end all
personal actions aimed at recovering the debt or had to appoint a third party,
like an attorney to collect these amounts. Unfortunately the opposite may also
apply and the vendor will become liable for output tax during the period in
which a creditor’s balance becomes outstanding for more than 12 months.
It is important to
note that the above adjustments will only affect vendors that are registered on
the invoice basis (for example: natural persons with an annual income that
exceeds R2.5 million in value, companies and closed corporations). This is
because the initial VAT implications were accounted for when a tax invoice was
issued. Therefore, a reversal must be made if output tax was previously
declared on taxable supplies that were made to debtors. Similar to the above
provisions, a vendor must account for output tax if he or she was initially
entitled to claim an input tax deduction on the acquisition of goods or
services but failed to settle the amounts due to its creditors within 12
settlement discounts will also have VAT implications for vendors registered on
the invoice basis. If such discount is received from a creditor and it relates
to an amount on which an input tax credit was previously claimed, the vendor must
account for output tax on the discount received. The same principle will apply
if discount is granted to customers for early settlement of their debts. An adjustment
can be made to reverse the initial output tax that was recognised when the
invoice was issued.
It is clear from the
above that a person involved in the calculation of VAT must first consider the
accounting basis on which a vendor is registered, before attempting a VAT
calculation. If the invoice basis is applicable, he or she must be convinced
that the full VAT implications of credit transactions are accounted for.
Specific information to look out for includes bad debts, trade discounts and
the outstanding period of creditors.
VAT adjustments are
not limited to transactions that relate to an entity’s debtors and creditors,
but may also arise from certain other events. In the following section these
events will be addressed.
A situation that is
often experienced in practice is that an asset is removed from a business’
operating activities and applied by the owner for private purposes. In such an
instance, output tax must be declared by applying the tax fraction to an amount
equal to the market value of that asset on the date the change in use occurred.
This provision will apply whenever an asset was initially applied to make
taxable supplies (given that an input tax credit was allowed with acquisition) and
an event occurred which led to a change in use of the asset for non-taxable
purposes (for instance, to make exempt supplies). This adjustment must be made
during the tax period in which the change in use occurs.
If the vendor was not
able to claim the full input tax deduction with acquisition of the asset, he
will be entitled to claim an input tax credit when the change in use occurs.
The input tax credit is calculated by applying the tax fraction to the lesser
of the adjusted cost of the asset (including VAT), the market value on the date
that any previous adjustment relating to the asset was made or the market value
on the date the change in use occurred. The credit must be apportioned to the
extent that the asset was applied for non-taxable purposes.
It may happen that a
vendor used an asset for non-taxable purposes (for example private usage) and
then decides to apply it in its business to make taxable supplies. In this
case, an input tax adjustment may be claimed provided that it is not denied in
terms of the VAT Act (for example: a "motor car” as defined or assets used for
entertainment purposes). In this scenario the calculation of the input tax
credit will be exactly the same as the above calculation but it will be
apportioned to the extent that the asset will be used to make taxable supplies.
Finally, a VAT
adjustment will also be required if an asset is already used to make taxable
supplies, but a change in usage occurs. If the taxable usage of the asset
increases, the vendor will be entitled to claim an additional input tax credit.
On the contrary, a decrease in taxable usage is associated with an adjustment
for output tax. The first mentioned adjustment for output tax will apply if the
taxable usage of an asset descents to zero. This means that the full amount
will be subject to VAT without any apportionment, but input VAT may be claimed
to the extent the asset was used for non-taxable purposes.
The adjustment is
made at the end of the vendor’s year of assessment. The calculation involves
applying the tax fraction to the lesser of: the adjusted cost of the asset
(including VAT), the market value of the asset on the date any previous
adjustment was made or the market value of the asset at the end of the year of
assessment in which the change in use occurred. The adjustment must be apportioned
to the extent that an increase or decrease in taxable usage took place.
It is important to
note that no adjustment needs to be made when input tax is denied in terms of
the VAT Act, the adjusted cost of the asset (excluding VAT) is less than R40 000
or the change in usage does not exceed 10 per cent.
VAT is considered as
a system that revolves around tax invoices and to some extend this is true.
However VAT implications may arise from certain business activities for which
no documentary proof may exists. Without proper knowledge of a vendor’s
business operations, the required VAT adjustments arising from the above
mentioned events can easily be left out.