Why KSA contractors may struggle to recover VAT from clients

HKA’s Brian O’Connor on the need for contract provisions to facilitate payments

The introduction of VAT is a key part of the Kingdom’s broader plan to improve fiscal sustainability and diversify government revenues. Due to recent declining oil prices and revenues in the region, the Saudi and other GCC governments agreed a treaty to levy VAT. They hope that applying VAT on goods and services will generate revenue to fund infrastructure and social development projects. As VAT is a valuable source of government revenue in over 160 countries worldwide, its introduction in the Middle East was inevitable, a matter of when rather than if, based on the financial pressures governments were experiencing.

Due to the complexity of the implementing regulations, taxpayers were given a reasonable period from the date of publication of regulations to fully acquaint themselves, so that they could assess the impact to their businesses and ensure that they were fully prepared for the change by January 2018.

Pitfalls for Contractors

A pitfall exists for unwary contractors that entered into contracts with private sector employers prior to implementation of the new law, with no express contractual mechanism to recover VAT from the employer. Here, employers probably have no allowance in their budgets for VAT and in any event are highly unlikely to compensate their contractors.

In fact, HKA contractor clients advise that they are being met with this response from employers: “VAT is deemed to have been included in the contract price.” It is hard to argue with this (private sector) position. This will undoubtedly give rise to cash-flow difficulties for the affected contractors, the magnitude of which will depend on the value and duration of the contracts and the ability of these contractors to find alternative sources of funding.

Contractors fortunate enough to have a facility in their contracts, such as a Change in Laws clause, could offer a remedy to the extent that an entitlement may exist at law to recover the VAT from employers under their contracts. However, there may still be practical difficulties in recovering VAT from employers in circumstances where a Change in Law clause exists in the contract but employers have not been prudent in making provision in their budgets.

Other potential pitfalls include failing to register with GATZ in due time and failing to make VAT returns by the due date under the law, particularly as it is understood that this will be policed robustly by the authorities, who can impose penalties for non-compliance.

The situation in the public sector is different, in that the Government Tender and Procurement Law allows for recovery of increased costs arising from “customs tariff, fees, taxes or officially priced materials or services after the bid submission date”. Thus, VAT will be recoverable.

However, Aramco’s Schedule C states that the Contract Price includes “government-caused cost increases imposed at any time, all applicable taxes”. Thus, when tendering, contractors should carefully check the tender documents vis-a-vis the payment of VAT, make due allowance for these risks and include VAT in the tender price, if necessary.

Contractors need to: be fully conversant with the law and register for VAT with GATZ; be fully conversant with their rights and obligations under tender and contract documentation; make sure that all sales invoices are issued with the addition of VAT at 5%; make sure that they receive VAT invoices/receipts for purchases post 1 January 2018; consider opening a separate account for VAT receipts on sales; make sure they maintain proper books of account; make sure that they make VAT returns on time and seek professional advice if they run into difficulties.

While VAT is invoiced by contractors at 5%, the VAT due to the government in any applicable VAT period is the difference between the contractor’s VAT receipts from the employer and its VAT payments to its supply chain, in respect of goods and services received.

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