Are you ready for the VAT Audit?

Many entities make the mistake of combining multiple transactions and recording a single line item

By Ujjwal Kumar Pawra and Tanish Doshi

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Ujjwal Kumar Pawra, Associate Partner at WTS Dhruva Consultants (left) and Tanish Doshi, Executive at Dhruva Consultants
Ujjwal Kumar Pawra, Associate Partner at WTS Dhruva Consultants (left) and Tanish Doshi, Executive at Dhruva Consultants

Published: Thu 28 Sep 2023, 7:21 PM

Since January 2018, everyone is hearing about VAT audits someday seeing the light of day. However, after the announcement of Corporate Tax in January 2022, all the focus suddenly transformed from VAT to Corporate Tax. Many CFOs/ Tax Heads did not pay much attention to a few amendments in the VAT Law in December 2022 which empowered the Federal Tax Authority to audit a taxpayer for an additional period of four years in case the audit notice is issued before the end of the fifth year.

Due to the extension of the limitation window, it is witnessed a lot of taxpayers are being issued VAT audit notices. Depending on the complexities, revenue, size, and industry, one of the three kinds of notices is being issued:

1.For all the tax periods starting January 2018 to December 2020

2.For all the tax periods starting January 2018 to December 2018

3.Sample tax period between January 2018 till December 2020

The audit notice is accompanied by a questionnaire encapsulating basic information such as accounting system details, tax advisor, FOC supplies, bad debts, etc. There is a transaction data template capturing all the line item details pertaining to supplies (local as well as exports), procurements (local as well as imports), out-of-scope supplies, etc. All such transactions are to be recorded with complete information such as TRN, invoice number, customs declarations, revenue and expense with corresponding VAT amount, etc.

Many entities make the mistake of combining multiple transactions and recording a single line item. This is quite common for petty cash expenses and is an incorrect method of recording from a VAT perspective. In addition to the detailed transaction-wise details, financials, trial balance reconciliations, group structures, revenue listing, etc. also must be submitted. Another common mistake is preparing a reconciliation basis for the VAT ledgers only. In addition to the ledgers, details of the revenue declared in the financial need to be provided. The intent is to evaluate whether the revenues recorded in the VAT return reconcile with the revenue recorded in the financials. In case of any difference, reconciliations are required to be prepared by segregating the accrued revenue, out-of-scope income, etc. from the amounts disclosed in the VAT return. This mammoth task is required to be done for each tax period which should ultimately reconcile with the audited financials. In the case of VAT-grouped TRN, this activity is required to be extended for each taxable entity. The ultimate reporting of revenue not only impacts the output tax liability but impacts the input tax apportionment for each tax period as well.

It is interesting to note, apart from the generic information, the FTA is also requesting industry-specific details. For e.g., a taxpayer engaged in real estate is requested beneficial ownership details of infrastructure projects, a list of land owned, projects being developed, off-plan units sold, etc. This information helps the tax auditor analyze transactions and the corresponding tax treatments adopted. For e.g., there may be a scenario where the land belongs to one entity and infrastructure is being built by the other entity on the land. The second entity is also recovering input VAT on construction expenses, leading to multiple aspects such as deemed supply from one entity to another or who owns the title of the infrastructure. Another aspect is whether the first supply has occurred within three years of the completion date, etc., and thereby its corresponding tax exposures. The event of completion date is altogether a different subject to debate. Lastly, the discussions wherein entities act as disclosed or undisclosed agents always remain a point of contention. All the above scenarios lead to a different tax treatment impacting retrospectively.

The FTA has always encouraged taxpayers to rectify past mistakes and be tax compliant. It has issued over 100 public documents to provide clarity on tickling tax issues to assist taxpayers. However, during the review, one may come up with a few scenarios in which further clarity is required. In such cases, the taxpayers should draft a position paper to seek private clarification from the FTA. It is another mechanism to help taxpayers in which FTA’s views on a transaction can be requested. On average, a private clarification may take up to 1-2 months (in totality), so relevant time should be factored in while gearing up.

The penalties for Voluntary Disclosures were substantially reduced (from ~300% to ~50%) depending on the year in which the error occurred. However, if the mistake is rectified post-issuance of the audit notice, a higher penalty (up to 200%) may be imposed. The intent is taxpayers should ensure ample attention and focus on tax compliance and governance, and timely rectification of any mistakes. In the case of procrastination, the benefit of reduced penalties should not be available.

All the information requested in the notice must be furnished within 10 working days. With high penalty exposure and limited time to provide data, it is high time taxpayers internally assess their readiness by identifying exposure, resolving past errors, focusing on documentation and data, and eventually being ready for the VAT audit.

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