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Accounts & VAT
Running a business of mixed taxable and exempt supplies requires careful handling of VAT regulations. The system of Proportional Input VAT Credit serves to meet this situation. Companies in Saudi Arabia must understand Proportional Input VAT Credit procedures since it contributes to the maximization of VAT returns within KSA VAT legal boundaries. Businesses that correctly distribute input VAT data will both enhance their tax deductions and minimize unwanted financial outlays.
Now, with the development of E-invoicing in Saudi Arabia, VAT compliance is less in hassle and therefore is easier to monitor and document the transaction. Companies located anywhere in Saudi Arabia should use E-invoicing in Riyadh to improve their report accuracy and successfully request input VAT claims. Businesses should understand the correct methods for handling Proportional Input VAT Credit to avoid taxation mistakes while maintaining successful VAT report processing.
The KSA VAT framework allows all business entities that perform taxable supplies to receive complete VAT refunds of their expenditure on goods and services related to economic operations. A company that conducts exclusively taxable activities has the ability to recover 100 percent of its input VAT expenses thus lowering its tax obligations and improving its financial flow. The process of claiming VAT credits functions smoothly due to proper registration practices and VAT invoicing requirements maintenance.
A business that makes taxable and exempt supplies while conducting economic and non-economic activites cannot recover all of its input VAT. The recovery of input VAT on exempted supplies becomes impossible which requires businesses to conduct tax credit divulgation against their expenses. When applicable businesses need to establish a proper method for determining their VAT credit claims that maintains Saudi VAT compliance regulations.
A business needs to understand how input VAT functions across various commercial operations to establish what amount of VAT they can recover fully or what deductions are restricted. Businesses can claim full input VAT in three distinct circumstances according to the specified protocol.
1. Input VAT Used to Make Taxable Supply (Fully Deductible or Partially Deductible)
In the case of a business, if it receives input VAT when it pays expenses in relation to taxable supplies, it can fully deduct this VAT. Goods and services subject to KSA VAT at the standard rate or a zero rate are taxable supplies. Nevertheless, if the input VAT is associated with economic and non-economic activities, only the part attributable to economic activities can be deducted. As a business, it is important that you ensure accurate record keeping and the correct proportion when claiming VAT or you can suffer compliance issues or penalties.
2. Input VAT Used to Make Exempted Supply (Not Deductible)
A business cannot claim a deduction if input VAT is incurred on expenses related to exempt supplies. The exempt supplies are transactions that are not subject to VAT, i.e. the business does not charge VAT on sales and does not recover VAT on related expenses. Since exempt supplies do not lead to taxable revenue, VAT paid on purchases of such supplies is deemed a non-recoverable cost. For businesses with taxable and exempt supplies, it is very important to segregate expenses to avoid mistakenly claiming non-deductible VAT.
3. All Other Input VAT and Overheads That Cannot Be Separately Allocated (Proportionate Deduction Available)
Some input VAT expenses (for example, general overheads (e.g., office rent, utilities or administrative expenses)) may not be directly linked to either taxable or exempt supplies. When it comes to such cases, businesses need to allocate VAT proportionally and claim only the part corresponding to taxable activities. If the company is engaged in taxable and exempt supplies, it should use a fair and reasonable apportionment method to calculate the deductible VAT. In order to avoid incorrect VAT claims, proper documentation and compliance with KSA VAT guidelines are necessary.
Taxpayers that are only engaged in making taxable supplies are entitled to a full input VAT deduction. It means that VAT incurred on their purchases that are related to their taxable activities can be fully reclaimed. In the case of taxable supplies only, there are no apportionment or proportionate deductions as long as the business is only engaged in such supplies. This scenario makes VAT compliance simpler, since all input VAT can be recovered without complicated calculations or adjustments.
If a business is carrying out both taxable and exempt supplies, or if it is engaged in both economic and non-economic activities, it cannot claim full input VAT deduction. In this case, businesses must calculate the proportional input tax credit and deduct the deductible part from taxable supplies and exclude the VAT related to exempt activities. This process makes sure that the tax system is fair and correct, and that only VAT on taxable supplies can be recovered by businesses.
However, in cases where a taxpayer conducts taxable activities predominantly but occasionally makes small exempt supplies, they can still claim full input VAT on their purchases. Businesses can make a one off adjustment in the final tax period of the year for any total non-deductible input VAT for the calendar year if the total non-deductible input VAT is less than SAR 5,000. It simplifies the process and eliminates the need to make changes in each VAT period which is a practical solution for businesses with little exempt activity.
Businesses that carry out taxable and exempt supplies use proportional input VAT credit. As input VAT can only be recovered on taxable transactions, businesses must decide carefully which part of VAT can be deducted. For this, the process starts by separating the economic and non-economic activities since only the VAT incurred on economic activities is acceptable for credit. After this distinction is made, further classification of input VAT associated with economic activities is required to conform to tax regulations in that it should be further classified in terms of taxable and exempt supplies.
Businesses also have to deal with additional complexities with regards to general overheads and other non-attributable costs. For example, factory rent, utilities, and statutory audits support both taxable and exempt operations, and it is difficult to allocate them to one category or another. In such circumstances, companies need to employ an appropriate apportionment method to determine the recoverable VAT. This prevents the claiming of only that portion of the expenditure that deals with taxable activities while keeping the financial records transparent.
Businesses must follow the approved methods as prescribed by ZATCA for VAT apportionment to remain compliant. It is important to properly document and record keeping to justify the applied calculation method in audits or reviews. Accurate assessment of input VAT and apportionment of the same ensures that businesses can recover the VAT without errors and without incurring penalties. Learning how to deal with non-attributable costs and how to apply proportional allocation correctly will help you keep VAT reporting accurate and in compliance with the regulations.
Businesses will claim proportional input VAT credit on a business’s accounting method of accrual or cash basis. Under the accrual method, businesses are allowed to claim the input VAT deduction in the tax period it is issued and the supply is received even if the payment has not been made yet. On the other hand, businesses following the cash basis can only deduct the amount when the payment is made to the supplier. This is to ensure that the timing is correct as per the VAT regulations and keep track of the filing of accurate tax.
An accrual accounting method records a business’s transactions when they happen, not when the payment is made. This implies that the expenses and revenues are recognized on the basis of invoice date instead of actual cash flow. According to VAT, a business using the accrual method may claim the input tax credit in the tax period when the invoice is issued and the supply is received, irrespective of the time when the payment is made. This approach will give a clearer financial picture and make sure that VAT deductions are in line with the actual business activities.
For instance, if a registered Saudi business buys goods from a local supplier and receives an invoice in May, but pays for them in June, the transaction will still be recorded in May. The VAT credit from input VAT can then be claimed in the VAT return for May or the corresponding quarter, as the business is filing VAT returns for the same period. This method will help businesses to get rid of the unnecessary delay in reclaiming input VAT while also making sure that the accounting standards are adhered to.
Cash accounting method records the transactions when actual cash is received or paid and is a simple way of recording cash flow in real time. Cash accounting is different from the accrual method where transactions are recorded based on invoice dates, and revenue and expenses become book kept while money is actually not exchanged. This means that a business can only claim an input VAT deduction in the tax period when the payment for a purchase is made and not when the invoice is received.
For instance, if a restaurant purchases goods from a registered supplier and gets an invoice in January but pays in February, the transaction will be recorded in February only. In the VAT return for February, the input VAT credit can be claimed, and VAT deductions will match the actual outflow of cash. This method is particularly useful for small businesses that want to have more control over their cash flow and not pay VAT until expenses are settled.
Cash accounting does limit the reporting of VAT for businesses with fluctuating cash flow, however, must still be tracked closely for payments. Invoices and payments are recorded accurately and VAT deductions are claimed in the right period. This method thus allows businesses to avoid discrepancies between recorded expenses and actual payments and a more transparent and manageable VAT filing process.
Before claiming proportional input VAT credit, businesses have to distinguish between input VAT charged on purchases of taxable supplies and input VAT charged on purchases of exempt supplies or non-economic activities. The business can fully deduct VAT that is directly linked to taxable activities. Nevertheless, non-recoverable input VAT connected with exempt supplies or non-economic activities cannot be claimed. The importance of this distinction is to ensure compliance and avoid errors in VAT filings.
In the event of a business making taxable and exempt supplies or economic and non-economic activities, the input VAT needs to be apportioned accordingly. The process is of allocating the VAT paid on purchases between taxable and exempt activities, claiming only the portion attributable to taxable supplies. Such an apportionment must be based on a reasonable and systematic method, in accordance with the guidelines set by the tax authorities, to accurately reflect the business’s activities and to allow for a correct VAT recovery.
When a business is conducting economic and non-economic activities, the apportionment of input VAT has to be done with care so that only the portion of VAT attributable to economic activities is claimed. The method of apportionment must be fair and shall represent how supplies are used for economic purposes. Therefore, businesses need to clearly distinguish between economic and non-economic activities to determine which VAT incurred on supplies used for the non-economic activities is not eligible for input tax recovery.
The VAT must be allocated by the taxpayers first between economic and non-economic activities, as mandated by the ZATCA. Then, the VAT incurred on economic activities can only be further allocated between taxable and exempt supplies. This process makes sure that businesses actually claim input VAT in a correct way, according to tax regulations and avoid errors or overclaims. The apportionment needs to be clear and transparent, as a method of avoiding possible penalties or not complying with the law.
If a business does taxable and exempt supplies, the input VAT must first be apportioned between economic and non-economic activities. Recovery is only possible for the VAT linked to economic activities. The VAT is once allocated to economic activities, it must next be further apportioned between taxable and exempt supplies. The VAT incurred in making taxable supplies can be fully recovered; VAT on exempt supplies cannot be deducted. This is a process that allows businesses to claim only VAT on taxable transactions and avoid claiming for non-deductible input VAT.
For instance, Al Raul Jewelers from KSA has provided the following supply:
1. Personal Use (Non-Economic Activity)
Any input VAT incurred on purchases in relation to non-economic activities is not deductible for personal use. In this case, Al Raul Jewelers bought goods worth SAR 250,000 (including SAR 25,000 VAT) for personal use. Since the input VAT of SAR 25,000 is related to a non-economic activity, it cannot be claimed as a tax credit. This is in accordance with the principle that VAT on non-economic activities is not recoverable under the tax law.
2. Sale to Customers (Taxable Activity)
However, when Al Raul Jewelers sells to customers, it is involved in taxable activities and the input VAT associated with these activities is fully deductible. In this case, the jeweler had purchased goods worth SAR 300,000, of which SAR 30,000 was input VAT. As the supply to customers is a taxable supply, Al Raul Jewelers can claim the full input VAT credit of SAR 30,000. This means that the business only pays VAT on the value added part of the transaction so that the overall tax burden is reduced.
3. Exempt Supply (Exempt Activity)
The VAT incurred on purchases in relation to these activities is not recoverable for exempt supplies. In the first case, Al Raul Jewelers made an exempt supply worth SAR 400,000 and incurred SAR 3,000 in input VAT for related purchases. Since exempt supplies are not subject to VAT, the input VAT of SAR 3,000 cannot be claimed. To avoid penalties, businesses must not claim input VAT on expenses connected with exempt supplies.
4. Non-Attributable Expenses Related to Both Economic and Non-Economic Activities
Input VAT on non-attributable expenses, i.e. overhead costs that cannot be attributed to either taxable or exempt supplies, must be apportioned. The expenses incurred by Al Raul Jewelers (including SAR 5,000 input VAT) at SAR 50,000 are both economic and non-economic. In this case the input VAT has to be apportioned on the basis of the proportion of economic and non-economic activities. The exact proportion will depend on how the business determines what amounts of expenses relate to taxable activities.
The owner of Al Raul Jewelers apportioned the input VAT between economic and non-economic activities by allocating 57% of the total non-attributable expenses (SAR 50,000) to economic activities, amounting to SAR 28,500. The input VAT corresponding to economic activities was calculated to be 57% of SAR 5,000, i.e., SAR 2,850. From this, the input VAT attributable to taxable supplies is 71% and claimable input tax credit is SAR 2,023.50. This apportionment satisfies VAT regulations and maximises recoverable VAT.
The default method is for those businesses that cannot separate input VAT between taxable and exempt supplies. This method is designed to apportion the input VAT credit fairly in proportion to the total value of the taxable and exempt supplies. This approach helps businesses to calculate the deductible input tax credit percentage from the total VAT paid on purchases. This method is particularly useful when it is not possible to identify the particular use of the purchased goods or services for taxable versus exempt supplies, and it is a simple and effective means of determining recoverable VAT.
Where,
Taxable Supplies include the value of all goods and services that are taxable in Saudi Arabia. It includes supplies made in KSA which are taxable at the standard rate or zero rate, or supplies which would be taxable if made in the country. Taxable supplies however do not include capital assets (i.e., land or buildings) or supplies made outside of KSA by businesses within the country. These exclusions make sure that only transactions that are relevant to the VAT deduction are taken into account.
Goods and services that are not subject to VAT under Saudi Arabian tax laws are referred to as Exempt Supplies. Some of these supplies are out of the scope of VAT, such as healthcare, education and some financial services. Supplies exempt from VAT also include capital assets and supplies imported from outside KSA by an establishment outside the country. For businesses, the difference between taxable and exempt supplies is important when it comes to claiming VAT credits as VAT paid on exempt supplies is not recoverable.
For example, the company’s total sales in January 2022 were SAR 250,000, of which SAR 100,000 was taxable and SAR 150,000 was exempt sales, for which no output tax was paid. Input VAT of SAR 25,000 was incurred by the company for buying raw materials, which were used in the making of both taxable and exempt supplies. Nevertheless, since the company cannot distinguish the precise usage of raw materials for taxable versus exempt supplies, the default method must be applied to apportion the input VAT.
The default method of calculating the deductible input VAT is based on the proportion of taxable supplies to total supplies. For this case, the SAR 100,000 of taxable sales out of SAR 250,000 total sales is 40%. Therefore, the input tax credit of 40% of SAR 25,000 input VAT (which is SAR 10,000) can be claimed. The VAT relating to exempt supplies cannot be recovered. To avoid any incorrect claims that would result in penalties and to comply with the apportionment process, it is necessary to understand it.
In conclusion, for businesses that make both taxable and exempt supplies, it is necessary to understand Proportional Input VAT Credit and how to claim it. KSA VAT regulations can be followed by using methods like the default method for apportioning VAT between taxable and exempt activities to ensure that businesses only claim VAT that is recoverable. Properly applying the apportionment process (whether using the default method or some other apportionment technique) helps businesses avoid mistakes, errors and noncompliance issues that can lead to penalties or audits.
Accurate quantification of deductible input VAT for businesses allows it to seek maximum recovery of the VAT while ensuring compliance with KSA VAT requirements. Knowing when and how to claim Proportional Input VAT Credit will not only help businesses to manage their VAT returns effectively but will also prevent them from making costly mistakes. For every business operating in Saudi Arabia, it is crucial to maintain transparency and accuracy in VAT apportionment processes.
