Filing of Value Added Tax (VAT) returns and payment of tax due is made monthly but not later than the 21st day of the month following the month in which the transaction occurred. It is usually based on the value of the supplies done. There are some issues to note in calculating VAT payable where certain selling arrangements or circumstances are in place. One of the critical issues has been the point at which VAT should be computed under different selling arrangements.
Some of the arrangements include trade/ cash discounts, credit sales, deferred consideration, bad debts, returns/refunds, upfront fees and customer loyalty programmes. In some of these, the tax authority’s treatment may vary from the position of the taxable person. The difference is between the cumulative invoices and turnover disclosed in the audited accounts at the end of the trading period of a company. It is not likely that the invoices’ summary at the end of a trading period would agree with the turnover for the same period due to different provisions of the accounting standards, especially the International Financial Reporting Standard (IFRS).
Notwithstanding any variation in accounting standards, Nigerian Value Added Tax administration is invoiced-based. Consequently, whatever approach is adopted to determine the value of the consideration in accordance with the law, VAT becomes chargeable at the point of raising the invoice. Agitations have been expressed on the reasonableness of paying VAT on amounts that are yet to be collected from customers vis-à-vis the impact on cash flow of the taxpayer. While the fears appear sound and founded, it may be counteracted by the fact that a set-off exists by claim of input tax on credit purchases that have not been paid for by the taxpayer. Also, the choice of business arrangement is that of the business person and not universal; whereas taxation is of universal application.
The Concept of Tax Invoices Versus Accounting Revenue/Turnover
It is pertinent to note that since accounting ‘revenue’ or ‘turnover’ is usually a focal point for computation of VAT payable, determining the appropriate VAT treatments of these sale arrangements requires a sound understanding of the prescribed accounting treatments.
The law requires every taxable person who makes a taxable supply to issue a tax invoice showing, among other information, the gross amount of transaction, the rate of tax applied and the tax charged to the purchaser. The law therefore presupposes that the issuance of tax invoices for every taxable supply made, both in goods and services. This implies that the focus of the law is on value of taxable supplies as shown on the invoice rather than as shown in the financial accounting systems. In other words, by law, VAT payable is invoice-based.
In practice therefore, a meeting point must be established between these two focal points (accounting revenue and tax invoices). This is particularly important in dealing with reconciliation of VAT paid against the turnover in the audited accounts. Taxpayers experiencing this situation are advised to keep proper records of tax invoices issued and the cumulative VAT payable/ paid based on such invoices.
The unique selling arrangements discussed in this article are good examples of occasions where such discrepancies usually arise.
Trade/Cash Discounts Allowed
International Accounting Standard (IAS) 18 provides that the amount of revenue recognised for a transaction is the net of any trade discounts or volume rebates given because these discounts and rebates are not received as consideration by the seller (IAS 18:10).
Under a trade discount arrangement, invoices issued will reflect the amount of agreed consideration between buyer and seller less any trade discount granted. In this wise, the amount chargeable against the customer is the selling price less trade discount. This net value is the base for computing VAT.
The determination of VAT payable in a cash discount arrangement, on the other hand, is made on the basis of ‘above the line’ items on the invoice. i.e. actual selling price before cash discount is deducted. In other words, VAT at 5% is to be applied on the normal selling prices of such goods/services without any consideration for cash discounts allowed. This is because cash discounts are purely discretionary business decisions by business owners for the purposes of encouraging early payment and therefore should not affect the VAT payable to the tax authorities on the normal selling prices of those goods and services. In addition, payment of VAT burden is on the consumer and not the supplier.
Credit Sales
VAT on credit sales is required to be computed on the total supplies. There are controversies around payment of VAT on credit sales but the fact remains that no company’s trade credit policies are set in agreement with the tax authorities, neither are eventual payments by their customers monitored by the tax authorities. Credit sales are purely business decisions by management of business entities and should not affect the VAT payable on any taxable supplies made in the period. As pointed out earlier, partial equilibrium is attained with the allowance of input tax claims on credit purchases.
Deferred Consideration
Most trade receivables are due within a relatively short time frame, such as one month or less. But in special circumstances, the seller may allow the buyer an extended period of time for payment of the consideration, usually spanning months or years. This is all dependent on the nature of goods or service sold or rendered and the sales agreement between the buyer and the seller.
According to IAS 18, the consideration or selling price in such an arrangement consists of two elements- the actual price of the good or service (principal element) and the interest element arising from the financing plan. As the time value of money in such circumstance would not be the same as in a normal short-period credit sales transaction, an interest element is imputed into the price of the goods/services supplied to make up for the length of time it takes the buyer to pay up. In other words, this is treated partly as a financing arrangement.
Such arrangement is also similar to a finance lease arrangement where both the capital element and the interest element are inherent. Usually, such sales are covered by written agreements which stipulate the business terms and how the periodic payments are to be made. Tax invoices are issued as each payment falls due. VAT element is required to be inputted to such invoices, but only to the portion of the consideration which relates to the actual selling price of such goods or services supplied. The interest element should be clearly separated on the invoice as VAT is not applicable on it. This is similar to a finance lease arrangement where the interest portion is a return on investment and is not liable to VAT.
This treatment is buttressed by section 5 (2) of VATA which provides that where the supply of taxable goods or services is not the only matter to which a consideration in money relates, the supply shall be deemed to be such part of the consideration as is properly attributed to it.
Where this split is not properly reflected on the invoice, it will be difficult to differentiate the interest portion of the consideration to which VAT will not be applicable. Clear disclosure is therefore very important.
Bad Debts
Bad debts proven to be uncollectable and on which VAT had been paid in earlier periods can be allowed as offset from VAT payable in future periods.
Returns/Refunds
Sometimes companies have a refund policy for goods sold but returned by the customer for whatever reason that is agreeable to both parties. Amounts refunded would be deducted from revenue originally recognised. VAT is to be calculated based on the subsisting revenue at the end of the monthly reporting period. Since VAT returns are to be made 21 days following the month of transaction, and the window for returns is usually very short in practice, it is expected that any refunds that may impact revenue for any particular tax period would have been reflected in revenue/turnover before the associated VAT returns are filed in the month.
However, where the returns and refunds are made after the VAT attributable to the sale has been remitted, amounts verifiable as refunds would be accorded the same treatment as bad debts and allowed as offset from VAT payable in future periods.
Goods on Test Usage
For goods given out on test usage, revenue for both accounting and VAT purposes is recognised when the test period is over and the test-user opts to buy the product. At this point, the owner raises invoice for the sale of the product. Thus, VAT is applicable once there is sale.
Upfront Fees
Where fees for services rendered are payable upfront, e.g. mobilisation fee (under a construction contract or deposit for supply of goods or services), and there is neither exchange of goods or services nor transfer of risks and rewards of ownership to the buyer, such payment may not be recognised as revenue but deferred as unearned revenue. Payments are only recognised as revenue only to the extent that goods or services have been provided and by reference to the stage of completion of the transaction.
Invoices may not be issued but receipts may be issued to acknowledge payment received. VAT may not be due on such payment unless the advance payment is invoice based. If VAT is paid in line with the revenue recognition method, the onus is on the taxpayer to keep record of the basis for the difference between the sales invoice amount and the accounting revenue recognised in the affected periods.
Customer Loyalty Programs
Some entities make use of customer loyalty programmes to incentivise customers to buy their goods or services. Customers buying goods and services are granted customer award credits (often described as ‘points’) by the entity, which can be redeemed for awards such as free or discounted goods or services.
The accounting standards require the consideration received or receivable on such sale to be allocated between the award credit and the main component(s) of the sale. The award credit portion is deferred and not recognised as revenue until the seller has fulfilled its obligations in respect of the award credits i.e. when the free or discounted goods have been redeemed by awardees.
Under the customer loyalty program, the accounting turnover for the periods involved would most likely differ from the invoice turnover. This is because the tax invoice is usually issued on the actual offer price of the main good or service which fetches the future awards/discounts, while the accounting revenue for this good or service would be lower at the initial periods, since the revenue recognised would be split between the main good or service which is sold and the award (which is recognised only at later periods when the awardees claim them).
Only the actual selling price (under normal circumstances) of all the goods or services involved – both the main goods or services sold and the award credit (either as free or discounted products) would be considered for VAT purposes. As explained earlier under ‘cash discount arrangements’, the invoice should reflect the actual selling price of the goods/services and the 5% VAT payable on it prior to recognising any award components ‘below the line’. This is because customer loyalty programs are also not the making of the tax laws/authorities. They are pure business decisions taken at the discretion of the business owners and therefore should not affect the VAT payable on the actual prices of the goods and services. It should also be noted that VAT is paid by the consumer and not the person that is implementing the loyalty programme.
There are several sales strategies employed by companies, depending on the managements’ focus and sometimes industry practice. The general interpretations of the provisions of the VAT Act should always guide determination of VAT liability on such transactions.