On 5 October 2018, the Kingdom of Bahrain (Bahrain) issued Law No. 48 of 2018 with respect to Value-Added Tax (VAT Law). The VAT Law will come into effect from 1 January 2019, making Bahrain the third Gulf Cooperation Council (GCC) Member State to introduce value-added tax (VAT).
The VAT Law is the first step in Bahrain's implementation of the GCC VAT Agreement, which was agreed and signed by the GCC Member States in late 2016. Bahrain's VAT legislation shall be comprised of the VAT Law and its executive regulations, the latter of which are expected to be released shortly and will provide a greater insight in the details of the VAT regime.
Taking note of the swift introduction of VAT in the United Arab Emirates (UAE) and the Kingdom of Saudi Arabia (KSA), businesses operating in Bahrain are advised to start reviewing their (legal) arrangements and contracts. Based on our recent experience in UAE and KSA matters, please note the following potential VAT issues:
- Importance of contracts and appropriate VAT clauses
- Ascertaining correct VAT treatment
- VAT registration and gathering information from customers
- VAT recovery issues and VAT grouping
- VAT litigation prevention strategies
Importance of contracts
VAT is a transaction-based tax, meaning that the underlying legal documentation (i.e. the contract or terms) detailing the supply of a good or service is generally the start of the review process. Businesses need to carefully review their contracts to determine the Bahraini VAT impact. First and foremost, does the contract account for VAT (and/or other taxes)? If the contract is silent on VAT, this could mean that the amounts specified therein are inclusive of VAT. To avoid any misunderstanding, such 'silent' contract should ideally be updated. From a commercial perspective, parties may need to (re)negotiate the considerations to account for non-recoverable VAT (if any).
Businesses should also review the contracts to determine whether they reflect (economic) reality. Are the parties to the contracts the actual supplier and recipient of the service or good? This is particularly important in relation to the invoices issued by the supplier and, consequently, the right of the recipient to potentially recover VAT. With VAT, the (economic) reality in principle supersedes any (wording of a) contract. One exception to this rule is in case of Islamic finance products (i.e. under contracts which are Sharia compliant). It is anticipated that such products will be treated in the same manner as the equivalent non-Sharia financial products. As such, while a certain transaction may not be considered a loan under Sharia law, such transaction may be treated as a loan for the purposes of VAT. Scrutiny is therefore advised with Sharia compliant contracts such as the Murabaha.
In order to apply the correct VAT treatment of the supply of a service or good, the supplier may need to obtain additional information from the recipient. In this respect, contracts and/or terms and conditions may need to be revised in order to collect or store such information and to ascertain the correct VAT treatment of the services or goods supplied.
Ascertaining correct VAT treatment
The VAT treatment depends primarily on where a supply of a good or service takes place (or is deemed to take place). With respect to goods, the supply is in principle where the goods are located on the date they are placed at the recipients' disposal. With respect to services, the place of supply depends on (i) the type of recipient (is the service business-to-business or business-to-consumer) and (ii) the type of service. Special rules may apply to certain services such as real estate related services or electronically supplied services (or e-services). Real estate related services and e-services are always deemed to be supplied where the real estate is located respectively where the recipient is located. Particularly Bahrain business-to-consumer suppliers of e-services should be aware that they will need to charge, collect and remit Bahrain VAT to their customers.
Businesses in Bahrain 'importing' services or goods may need to account for Bahrain VAT by means of a reverse charge mechanism. Such VAT would in principle be recoverable if and to the extent the business renders VAT taxable activities.
Supplies may either be taxable at 5 percent or 0 percent (so-called zero-rated), VAT exempt or out of VAT scope. Examples of supplies out of scope for Bahrain VAT purposes would be the sale of goods or immovable property located outside of Bahrain or inside of a customs (bonded) warehouse. The correct VAT treatment is particularly important for the recovery of VAT at the recipient's level. Furthermore, fines and / or penalties may be imposed in case supplies are incorrectly treated for Bahrain VAT purposes.
VAT registration and gathering of information from customers
A person carrying on a business in Bahrain and making taxable supplies of goods or services exceeding the mandatory registration threshold will be required to register for Bahrain VAT purposes and file periodical VAT returns. Based on the GCC VAT agreement, the mandatory registration threshold will be set at the Bahraini Dinars equivalent of SAR 375,000 in annual supplies.
As mentioned above, e-services are subject to VAT if the recipient of such services is located or residing in Bahrain. A reverse charge mechanism applies in case of business-to-business supplies of e-services, under which the burden of VAT is shifted from an overseas supplier to the Bahraini recipient. As of 1 January 2019, foreign and domestic e-service suppliers should therefore actively obtain information (i.e. verified VAT number) from their customers to determine the status of their customers (business or consumer).
VAT recovery and VAT grouping
Businesses should in principle be able to recover incurred Bahrain VAT if and to the extent they render VAT taxable activities. VAT recovery will normally only be possible in case the recipient has received a tax invoice which adheres to the Bahrain VAT invoice requirements. Part of these requirements will be the inclusion of details on the supplier and recipient. As such, any incurred VAT on incorrectly issued invoices (e.g. wrong issuing party, wrong VAT rate and/or other missing requirements) may not be recoverable. Businesses operating in Bahrain should (pre-emptively) come up with VAT policies to ensure a proper VAT administration and invoicing.
A VAT group is a facility that allows two or more taxpayers to be registered for VAT purposes as a single taxpayer. The VAT group scheme may be particularly of interest to taxpayers with a restricted VAT recovery rate which are part of a group with non-restricted businesses. Inclusion of such payers in the VAT group may provide for (additional) VAT recovery.
In addition to VAT grouping, business should carefully review their existing Bahraini structures and supply chains, in particular with respect to 'inactive'/'dormant' holding companies which may incur irrecoverable VAT on a regular basis. There are various ways in which a holding company can strengthen its VAT recovery position.
VAT litigation prevention strategies
Going forward, businesses operating in Bahrain should take into account applicable VAT (if any). Although VAT may be recoverable, the recovery itself generally takes a certain period of time. This cash flow aspect should be one of the considerations during the (re)negotiation process, particularly with large supply contracts spanning several years.
The (re)negotiation of contracts, but even more so the absence of renovation, may trigger disputes between commercial parties, possibly resulting in litigation. To mitigate or prevent disputes, clear lines of communication and proper recordkeeping are required. In addition to contract-related disputes, we also foresee disputes related to invoices because incorrectly issued invoices can have significant consequences. Businesses should therefore implement and enforce a proper VAT administration (e.g. policies and invoicing).
Lastly, the introduction of VAT may result in tax (court) cases filed by or against the tax authority. Tax litigation may occur when taxpayers are (believed to be) not in compliance with the VAT law or when the taxpayers' position with respect to VAT is challenged by the tax authority. Generally speaking, such tax litigation is triggered when the relationship between the taxpayer and the tax authority has turned sour. Pre-emptively implementing appropriate VAT administration would ensure businesses operating in Bahrain to start with a clean record.
While some details of the Bahraini VAT system are still unknown, businesses operating in Bahrain should already start assessing their legal structures and supply chains to identify and highlight Bahrain VAT risk areas. Subsequently, legal arrangements (contract and terms) should be reviewed to determine whether they reflect the (economic) reality and whether they contain proper tax clauses. Contracts 'silent' on VAT should be revised, which may be challenging from a commercial perspective. Going forward, all contract should contain tax clauses.
In terms of VAT recovery, businesses should explore various opportunities to enhance the VAT recovery position. Such opportunities may include but are not limited to VAT grouping, revisiting financial arrangements and 'dormant' holdings.