The implementation of VAT is part of Bahrain’s commitment to The Unified Agreement for Value Added Tax of the Cooperation Council for the Arab States of the Gulf, which was signed by all GCC member states in 2016. It is an indirect tax charged on consumption and is levied on the supply and import of goods and services. It is crucial for every business to analysis the VAT impact on operations.
The exchange of goods and services, which includes production, sales and purchase in addition to all leasable transactions. VAT is a tax that is levied on supplies at every stage of the production and supply chain until it reaches the consumer. VAT is collected from taxable business owners registered with the tax bureau at every stage of the production and supply chain, until it is borne by the final consumer, and thus it is considered an indirect tax.
Following aspects could be relevant for consideration of top management to assist them in taking crucial decisions.
- Comparative tax outflows: This indicates the gap between taxes and other statutory levies payable before the introduction of the VAT and thereafter. The analysis may be made at a gross level (without adjusting recoverable input tax) as well as at net level. Considering the fact that there were not many taxes before the advent of VAT in Bahrain, VAT would be a mostly incremental tax. The impact of the tax on taxes i.e. VAT on Customs duty, excise duty, municipality fees should also be properly considered.
- Impact on margin: This is the area with which top management would be highly concerned with. With the introduction of any new tax, small erosion in margin is inevitable (i.e. there could be few irrecoverable input taxes adding to the cost) but there need to be conscious efforts to intact margins by focusing on all key areas. In fact, it could boost margin of those businesses who have robust infrastructural and compliance system in place in line with the tax law compared to competitors lacking in these aspects. The impact calculation on margin would require an in-depth assessment of financial as well as non-financial statements. The following could be the approach for computations:
- Take the base financial year which could be representative of the period immediately post taxation. Profit of this period may be taken as a base to make suitable adjustments as per below:
- The scenario may be built taking revenue at the same level as of past + likely revenues at different levels in coming period based on management projected growth plan appropriately adjusted with the impact of the new taxation system.
- Impact of tax on “top line” need assessment considering the type of business and nature of contracts with customers. If the contract does not have any tax clause and customer is not ready to amend the agreement, it could directly eat into the margins. Not only this, a business may have to compensate others also (i.e. pre-printed MRP where retailers may not sale on more than MRP and thus have to bear additional tax burden). All such factors need to be considered.
- Next would be recoverability of input tax on various expenses as this directly affects margins. Taxes payable on procurement (inputs, capital goods, services) need to be assessed as to whether these can be recovered. Wherever cannot be, would directly result in a drop-in margin else it would be neutral to margins.
- One important element is going to interest cost depending upon the impact on working capital. Incremental fund deployment entails interest cost which needs to be factored into margin computation.
Following broad format may be used:
|Net profit as per the financial year||XXX|
|Less: Factors resulting in margin reduction|
|Non-recoverable input tax||(XXX)|
|Impact of revenue drop on margin||(XXX)|
|Interest cost of additional funds deployed||(XXX)|
|Tax cost in all-inclusive contracts||(XXX)|
|Compensation of loss to successive supply chain||(XXX)|
|Any other factors resulting in decrease in margins||(XXX)||(XXX)|
|Add: Factors contributing increase in margins|
|Expected Net profit||XXX|
|Increase/ (Decrease) in profit||XXX|
- Impact on working capital: Imposition of tax has a direct impact on working capital as a business would have to put in more money in the business to meet the increased need of finance. The impact on working capital depends upon the following aspects:
- Credit period extended by suppliers
- Credit period extended to customers
- Inventory holding period (raw material, WIP, finished goods)
- Cycle of tax payment
One may evaluate the impact on working capital by analysing the tax involved in these items of current assets/liabilities and differential working capital needs.
- Impact on product pricing: With the introduction of the VAT, the product pricing is likely to go up but it requires consideration of multiple factors to determine the likely impact. It would not be correct to say that imposition of the tax by 5% would directly require an equivalent increase in the prices. Impact of recoverable and non-recoverable input tax also needs to be evaluated. It also depends on the nature of products, type of users, consumption pattern etc. In case of B2B supplies, the impact may not be much so long as other party is eligible to recover input tax. But in case of end user based/MRP products, the pricing determination is going to be very critical. One could have the following approach for determination of MRP based products considering variation in costs and tax involved:
- Keeping absolute margin constant at all channel of distributions and determine revised MRP
- Keeping variable margin constant at all channel of distributions and determine revised MRP
- Keeping MRP constant and determination of impact on margin at all level of distribution
One may have to evaluate the impact under each of the options and to take a final call as to what should be revised price and need for compensation to trade channel. In long-term, the price is determined by competitive market forces but failure to adjust the price correctly could have an impact on margin or sales volume especially in highly competitive industries.
- Strategic Decisions: Introduction of VAT could have implications on many strategic decisions for the entity. The following could be few instances:
- Model of doing business in terms of exports and imports
- Entering into or exit from new product line/segment of business
- Changes in the supply chain model (to reduce the intermediary chain so that final price does not increase much) and so on.
There cannot be straight jacket formula to evaluate the impact considering the diverse business scenarios. However, the discussion areas and approach discussed above could be used as a first-hand tool for professionals to make impact study on the business. Certainly, these may have to be tailored on the case to case basis to serve the ultimate purpose of the management.
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