When VAT can create a real cost for businesses
VAT incurred on costs directly or indirectly associated with an exempt supply of goods or services is not fully recoverable from the tax authority. This is a particular problem for businesses in the financial services sector.
Businesses engaged in fully taxable activities, that is making supplies liable at 5% or 0% VAT, are generally entitled to recover VAT paid on associated costs from the tax authority on their periodic VAT returns. For them costs will generally be VAT neutral, with the end consumer bearing the burden of the VAT.
However, even fully taxable businesses can find that some VAT is specifically non deductible. VAT incurred on certain costs which are not viewed as being incurred wholly for the purpose of the business or which are specifically 'blocked' within VAT law are not recoverable from the tax authority.
In addition all businesses may incur additional administration and financing costs due to the management of VAT in their business.
Cash benefits to employees are outside the scope of VAT, but non-cash benefits can result in non-deductible VAT.
Even if VAT is recoverable on expenses in connection with non-cash benefits for employees, they may still trigger an obligation for a business to account for VAT on the 'deemed supply' of goods or services to the employee - as if the good/service had been sold commercially, again resulting in a real VAT cost to the business.
Examples of employee benefits
Many employee benefits will have a range of VAT treatments depending on the actual circumstances of the benefit. Here are some typical employee benefits:
- travel costs
- education allowance
- canteen facilities
- gym membership
- overtime pay / gratuity / bonus
- life insurance
- medical insurance
- motor vehicles
- expense reimbursement
- second-hand IT assets
- seasonal gifts
- events / tickets
- mobile phone
Each benefit should be analysed on a case by case basis in order to identify the correct VAT treatment and associated obligations for the employer.
Actions for businesses
Businesses need to:
- edentify all employee benefits – cash and non-cash – including their terms and conditions;
- identify any employee benefits creating non-deductible VAT cost for the business;
- identify any employee benefits creating deemed supplies and associated VAT cost for the business;
- determine (based on the business strategy for employee remuneration and the level of associated VAT costs) the business' appetite for employee benefit structure optimisation;
- implement new structure and optimisation in to the business through HR, internal polices and contracts of employment;
- update internal procedures and check-lists;
- monitor changes in VAT law, regulations and tax authority interpretations for employee benefits in the region.
Areas of difficulty
The following can create particular difficulties:
- purchases of goods/services not intended for employee benefit but later diverted to employees
- what would be viewed as 'business related cost'?
- what would be viewed as 'normal incidental office expenses' and 'entertainment services'?
- what types of costs would fall within the exceptions from 'blocked' VAT?
Joanne Clarke is a Middle East VAT expert at Pinsent Masons, the law firm behind Out-Law.com.