Reverse Charging Mechanism in the context of Value Added Tax (VAT)

3
2+
1 year ago

REVERSE CHARGING MECHANISM

IN THE CONTEXT OF VALUE ADDED TAX

Reverse Charging is the mechanism where the liability to pay tax is created by the tax payer on itself. It is a specific provision in the context of Value Added Tax (VAT) laws. When a person purchases goods from a vendor who is registered in VAT, the vendor collects VAT from him and deposits to the government. In an alternative scenario, when he purchases goods from a vendor who is not registered in VAT, he may need to pay VAT on his own.

In the case of Nepalese VAT laws, the provision of reverse charging can be observed specifically in two scenarios, namely:

  1. international service supply, and
  2. construction of structure.

The objective behind the provision of reverse charging system is to ensure the equal treatment in international service supply. Generally, the service imported is not declared in the custom point and thus no VAT is levied at custom point. If any service procured from local service provider attracts VAT and the same service from international service provider does not attract VAT, then the competitiveness of local service provider diminishes in the market. By keeping this is mind, VAT act has inserted the provision of levying VAT on the import of services.

Similarly, the provision of reverse charging system is also incorporated in case of construction of structure. It intends to increase the tax base, to systematize the construction work and to motivate persons to get registered in VAT.

Overview of this Article

Section 8(2) of VAT Act 2052 Section 8(3) of VAT Act 2052
  • Definition of service
  • Definition of Commercial Purpose
  • Conditions for attracting Section 8(2)
  • Construction to be done through registered person
  • Tax set off
  • Special provision regarding construction
  • Tax assessment
  • Tax assessment
  • Circulars related to Section 8(2)
  • Circulars related to Section 8(3)
  • Examples from VAT Directive
  • Examples from VAT Directive
  • Questions asked in ICAN Examinations
  • Questions asked in ICAN Examinations

Figure 1: Reverse Charging Scenario

Section 8(2) of VAT Act 2052

Assessment and Collection of Tax regarding service from abroad

Any person, whether registered or not, receiving service from a person who is outside Nepal shall have to assess and collect tax at the taxable value in accordance with this Act and the Rules framed under this Act at the time of payment or at the time of receipt of service, whichever earlier.1

Definition of service

‘Service’ refers to anything other than goods. [Section 2: Clause (cha)]

‘Goods’ refers to any kind of property whether movable or immovable. [Section 2: Clause (nga)]

Conditions for attracting Section 8(2)

  1. A person at foreign country should provide service to person at Nepal.
  2. The service should be supplied from foreign country.
  3. The service should be VAT attractive.
  4. The service should not be imported via customs.
  5. The supplier of service should not be registered in Nepal. 2

Tax set off

As per Section 17(5Kha), tax set off is allowed for tax paid under Section 8(2)3, Section 12Ka and Section 15(3).

Section 17 of VAT Act has provided for the set off of tax paid on purchase made by registered person in relation to the business. Tax paid on purchase includes the tax paid on purchase from local market or tax deposited on import from foreign country or tax deposited on service as per Section 8(2).

Tax assessment

The person has to deposit VAT at the rate of 13% of the total payment made.4

1. Finance Bill 2066 clarified the time when VAT is to be collected, i.e. “at the time of payment”. Later, Finance Bill 2075 preponed the time by stating “at the time of payment or at the time of receipt of service, whichever earlier”.

Amendment regarding VAT registration status of service receiver was done by Finance Bill 2066, and amendment regarding VAT registration status of service provider was done by Finance Bill 2075.

2. Before 2073’s amendment, only the first 3 conditions were mentioned in Clause 2.6 of Chapter 2 of VAT Directive 2069.

3. Finance Bill 2066 had inserted “Section 8(2)”.

4. If VAT is not deposited at the time of payment, then penalty @ 25% of tax shall be levied under Section 29 (1Ka) of VAT Act 2052, as clarified by Clause 10.15 of VAT Directives 2069 (second amendment 2076).

Explanation of conditions related to Section 8(2) (Circular dated 2060.07.05)

A circular regarding reverse VAT system was issued by IRD on 2060.07.05 regarding implication of Section 8(2). According to the circular, VAT shall be deposited on taxable amount by the person receiving service, and if the same is not complied, then tax officer shall make assessment under prevailing laws. The taxpayer shall be entitled to get credit on the basis of the voucher regarding the same.

Circular dated 2072.12.21

VAT and advance tax both to be levied on foreign consultancy service.

Examples from VAT Directive

Illustration 1:

Suppose a foreign person or institution is running preparation classes for TOEFL, IELTS, GRE, GMAT, SAT, PTE, ESOL and other similar tests in Nepal. This kind of service is VAT attractive as per VAT Act 2052. The person providing such service should be registered in Nepal.

In case such service is being provided from outside Nepal, the receiver of service should deposit VAT on the amount of payment.

Illustration 2:

A I Pvt. Ltd. is a company providing internet and telecommunication services. It has purchased technical services from Skynet Company in Singapore. It has been paying USD 100,000 per month for such services.

Since such transaction is VAT attractive, A I Pvt. Ltd. should deposit VAT amount of 13% of the amount equivalent to USD 100,000 at the time of payment or at the time of receipt of services, whichever earlier. The VAT amount paid on such purchase is allowed for input tax credit.

Illustration 3:

Department of Mines and Geology of Nepal Government appointed two scientists from Canada for feasibility study on commercial production of minerals. The agreement was made for payment of USD 10,000,000 for the same. The scientists conducted the study and submitted final report.

Such service provided by those scientists is VAT attractive. The service of such kind is not a regular type of service, as it is of occasional basis. As the scientists have provided service from outside Nepal, the service is deemed to have been supplied under Section 8(2) of VAT Act.

Illustration 4:

Department of Electricity Development of Nepal Government appointed scientists from Korea for feasibility study on commercial production of electricity in Nepal. The agreement was made for payment of USD 1,000,000 for the same. The scientists conducted the study and submitted final report.

Such service provided by those scientists is VAT attractive. The service of such kind is not a regular type of service, as it is of occasional basis. Although the taxable amount is more than NPR 1 crore, there is no any provision for getting those scientists registered in VAT in Nepal. So, the service is deemed to have been supplied under Section 8(2) of VAT Act. The Department of Electricity Development should deposit VAT amount of 13% of the amount equivalent to USD 1,000,000 at the time of payment or at the time of receipt of services, whichever earlier.

Illustration 5:

A resident airlines company in Nepal has to send the engine, gear box and other important parts of its airplanes and helicopters for repair and overhaul to an institution located abroad which is an institution authorized by Civil Aviation Authority of Nepal. While doing so, the airlines company has to send these goods after depositing the amount equivalent to customs duty in the customs office.

After being repaired, if those goods re-enter into Nepal, and if the VAT has been paid at the custom point, then no further VAT under Section 8(2) of VAT Act 2052 shall be assessed or recovered.

Illustration 6:

A resident airlines company of Nepal has to send its pilots, engineers and other technical staffs for training to an institution located abroad as per the guidelines set by Civil Aviation Authority of Nepal.

Such service is not benefitted in Nepal. Hence, no VAT under Section 8(2) of VAT Act 2052 has to be assessed or recovered.

Illustration 7:

A resident airlines company uses Online GPS Data service in Nepal. This service is based on information technology that is useful in the information, communication and Navigation Tracking in order to ensure safe and secured air flight service. For this service, it has to make payment to a company located abroad.

On such payment, VAT under Section 8(2) of VAT Act 2052 has to be assessed and recovered.

Questions asked in ICAN Examinations

June 2010 CAP II

S C P. Ltd hired a Technical Expert from India for consultancy service architect design of Hydropower projects on contract basis. The consultant charges Rs. 621,500 towards his service.

In such case, the amount of Rs. 621,500 is exclusive of VAT. Thus VAT = Rs. 621,500 x 13% = Rs. 80,795.

June 2013 CAP II

M P. Ltd is a company providing telecommunication services in Nepal. It has purchased a consultancy service from a company in US for setting up and expanding its operation in Karnali zone of Nepal. The company has paid USD 500,000 against such services in the month of Jestha 20XX.

5 Illustration 5, 6 and 7 are new illustrations in VAT Directives 2069 (second Amendment 2076).

In such case, M P. Ltd has to assess and collect VAT on the amount paid (i.e. USD 500,000) against the consultancy services in the month of Jestha 20XX. VAT is charged at the rate of 13% on the amount paid as consultancy services. The amount paid as VAT on such consultancy service is allowed to take VAT credit while submitting the VAT return.

Dec 2014 CAP III

S I P. Ltd deals in computer and related IT business. In the course of its business, it received services from M Tech Corp., Japan. M Tech Corp. raised bill of Rs. 21.60 Lakh against the services provided.

In the given case, the bill raised by M Tech Corp. is for Rs. 21.60 Lakh. Thus, taxable value for VAT is Rs. 1 Lakh. Hence, amount of VAT to be charged shall be: Rs. 21.60 Lakh x 13% = Rs. 280,800.

Section 8(3) of VAT Act 20526

Assessment and Collection of Tax regarding construction work

In case the construction of building, apartment, shopping complex or similar other structure as specified by IRD, of value more than Rs. 50 Lakh for commercial purpose, has been done from a person who is not registered in VAT, then VAT has to be deposited as if it has been constructed from registered person. If VAT is not deposited so, it shall be assessed and collected from the owner of such structure.

Definition of Commercial Purpose

As per the Explanation in Section 8(3) 7, for the purpose of this sub-section, “commercial purpose” refers to the act of construction of building, apartment, shopping complex or similar other structure as specified by IRD to sell, or to account as current or permanent assets for use in income generation.

Construction work to be done through registered person

As per Rule 6Kha of VAT Rules 20538, in case of construction of building, apartment, shopping complex or similar structure as prescribed by IRD of cost more than Rs. 50 lakh for commercial purpose, a person is required to construct only through a registered person.

Special provision regarding construction of building or similar structure

Group 12 of Schedule 1 of VAT Act 2058 has provided exemption to the purchase, sale or transfer of building. This provision includes the structures such as residential and commercial building, apartment, shopping complex. The transaction of building construction does not attract output tax. However, for such construction, various tangible and intangible goods and services are purchased in which input tax might have been paid. So we can see that if a registered person provides the construction service, it attracts VAT. Similarly, if an unregistered person provides such service, then no VAT is seen to be attracted. In order to avoid such situation, the provision of Reverse Charging has been introduced. Another objective of this provision is to ensure equal treatment in supply of taxable goods/service and to control tax leakage.

The construction of building, apartment, shopping complex, etc. for commercial purpose of amount more than Rs. 50 Lakh should be carried out through person registered in VAT. If a person does not carry out such construction through a registered person, then the owner of such structure shall calculate and deposit the VAT attracted on such transaction. If not, the tax officer can recover VAT from the owner.

VAT Directives 2069, from its first amendment in 2073, has incorporated the following procedure regarding implementation of Section 8(3) which is in line with IRD Circular dated 2070.07.03:

6 Section 8(3) was incorporated by Finance Bill 2066.

7 The explanation was inserted by Finance Bill 2071.

8 Rule 6Kha was added by the 11th Amendment dated 2066.03.29.

1. Structure falling under Section 8(3):

For the purpose of implementation of Section 8(3), building, apartment, shopping complex, road, bridge, power production house, stadium and assets of similar nature which cannot be transferred from one place to other shall be included. Apart from these, if any other structure is prescribed by IRD, then those shall also be governed by Section 8(3).

2. Meaning of commercial purpose:

For the purpose of Section 8(3), commercial purpose refers to the business where the building, apartment and shopping complex and any other structure prescribed by IRD are constructed and sold. Further, it also refers to the act of accounting such asset as fixed asset and using it for generating income.

3. Identification of structure:

For the purpose of implementation of Section 8(3), such structure shall have to be constructed in a single place. The structures of any person constructed at various trading spots, branches or head office which aggregate to more than Rs. 50 Lakh shall not be included for this purpose. However, residential complex, road, bridge and similar structures shall be included for this purpose despite being constructed at different places.

4. Calculation of cost of asset:

For the purpose of calculation of taxable amount under Section 8(3), all the costs having direct relation with construction work, except financial overhead, shall be included. The costs like mapping, design, supervision shall also be included.

5. Components of cost:

The construction of structure of building, apartment and similar assets can be carried out through a single person or through different persons. All the costs incurred in the electrification, sanitation, painting, interior decoration and similar components shall be considered as inseparable element of the structure and included in the cost.

6. Calculation of Taxable amount of the asset:

All other expenses shall be included, except the expenses incurred prior to construction of the asset, such as mapping cost, map approval costs, financial cost, supervision cost paid to third party etc. For this purpose, all other VAT attractive goods and services used in construction work should be included.

7. Tax calculation and recovery:

  1. If any person provides construction materials himself for construction of his structure and carries out such construction work through VAT registered person, and if the VAT on the goods and services has been fully deposited, then VAT need not be calculated on such amount.
  2. If any person purchases construction materials and gets the construction work done without giving it to another contractor (i.e. in Amaanat), then the taxable amount shall be: ‘Total cost’ – ‘VAT paid purchases’.
  3. If any person uses own production or available stock on which VAT has not been deposited; and if he carries out such construction through his employees or workers, then the market price of such structure shall be determined and VAT shall be recovered on such amount.

8. Period for identification of asset:

The asset identified for the purpose of this section shall be included no matter how much time is required for construction.

9. Tax assessment and recovery:

Person constructing physical structure, if registered in VAT, should deposit the VAT on expenses incurred while receiving goods or services during the construction as per his VAT filing period. For example, tax payer filing monthly VAT return should deposit within 25 days after the end of the month in which the payment is done. The person not registered in VAT shall deposit VAT on the purchase or consumption price of goods or services upto the amount on which VAT has not been deposited, within 25th day of the following month.

10. Penalties:

While making assessment by tax officer under Section 20 of VAT Act on the basis of Section 8(3) of the Act, penalty equivalent to 25%9 of amount in controversy shall be levied in line with Section 29 (1Ka) of VAT Act.

Tax assessment

If a person does not carry out construction as per Section 8(3) through a registered person, then tax shall be assessed from the owner of such structure as if he had carried out the construction through a registered person. For this purpose, ownership shall also mean the right to use the structure for commercial purpose.

Circular dated 2066.05.11

1.As per Sec 8(3) of VAT Act and Rule 6Kha of VAT Rules, construction of building, apartment, shopping complex, etc. for commercial purpose of amount more than Rs. 50 Lakh should be carried out through person registered in VAT.

2. The construction work can be carried through a registered person altogether with the materials required for such construction.

3. In contrary to above, only the construction work may be carried out through the registered person by providing materials by self.

9 Penalty @ 25% of tax shall be levied under Section 29 (1Ka) of VAT Act 2052, as clarified by Clause 10.15 of VAT Directives 2069 (second amendment 2076).

4. The works related to construction, electrification, sanitation, plumbing, interior designing, consultancy services etc. may be carried out through separate registered persons. The machinery and equipment required for construction may be taken on rent.

5. Small value goods/services required for repair, construction or cleaning of other structure, which are practically difficult to be acquired from business firm or entity, may be acquired directly through market or an individual. Examples: construction of well and deep boring for water supply, repair of generator and pumping set, etc.

Circular dated 2070.01.04

A. Regarding segregation of commercial purpose and personal purpose:

Construction of building or structure with the objective of generating income, other than for self-residential purpose, shall be considered as construction for commercial purpose.

B. Regarding the type of structures to be included in the bracket of Section 8(3):

In addition to building, apartment or shopping complex constructed for commercial purpose, the structures classified under Group “A” 10 of Section 1 of Schedule 2 of Income Tax Act 2058 shall be included in the bracket of Section 8(3). The structures constructed under lease shall also be included.

C. Taxable Amount:

The total estimated cost shall be the base for calculation of value of the structure to be constructed. If the cost estimate cannot be taken, then the capitalized value of such asset shall be the taxable amount. All the costs associated with the structure including finishing, electrification shall be included in the taxable amount.

D. Tax Assessment, Tax deposit and Tax Period:

The month in which such asset is capitalized, or the month of Ashad of every fiscal year, whichever earlier, shall be considered as the tax period. Assessment and deposit of tax shall be done by taking such tax period into consideration.

E. Tax set off:

Registered taxpayer shall get the facility of tax set off as per prevailing VAT Act and Regulation in the construction materials and such. However, both registered and unregistered person shall include the total cost while calculating the taxable amount; no amount shall be deducted from the taxable amount on the basis of input tax paid on purchase or import.

F. Penalties:

While making assessment by tax officer on the basis of Section 8(3), penalty equivalent to 25% of amount in controversy shall be levied in line with Section 29 (1Ka) of VAT Act 2052.

10 Assets under Group “A” of Section 1 of Schedule 2 of Income Tax Act 2058: Building, structure and similar works of permanent nature.

Examples from VAT Directive

Illustration 1 – Impact on unregistered person

ABC Housing Company Pvt. Ltd carries out the business of constructing and selling buildings. It has constructed a three storey building on cost of Rs. 1.76 crores including various expenses. For the purpose of determining the taxable value under Section 8(3), the expenses to be included shall be as follows:

Particulars Amount (Rs.)
Payment to engineer for drawing design 1,00,000
Payment to engineer for electrification works 1,00,000
Payment to engineer for sanitary works 1,00,000
Building construction license fees paid to Municipality 1,00,000
Cost of materials 50,00,000
Labour charges 20,00,000
Cost of materials for electrification and sanitary works 10,00,000
Wages for electrification and sanitary works 5,00,000
Engineer’s salary for supervision and monitoring 6,00,000
Cost of furniture items 15,00,000
Other overhead 5,00,000
Fees for electricity, water and telephone installation 1,00,000
Painting and flooring works 9,00,000
Taxable Amount 1,25,00,000
VAT amount to be deposited @ 13% 16,25,000

Illustration 2 – Impact on registered person:

ABC Hotel Pvt. Ltd (registered in VAT) has constructed one more storey in an existing building. It has done all the engineering works through a firm registered in VAT. It has purchased all the construction materials. The construction, however, has been carried out through a person not registered in VAT.

For the purpose of determining the taxable value under Section 8(3), the expenses to be included shall be as follows:

Particulars Amount (Rs.)
Amount paid to engineering firm for drawing design, electrification and sanitary work

Rs. 565,000 including VAT Rs. 65,000

500,000
Cost of materials Rs. 50,00,000 including VAT Rs. 260,000 47,40,000
Labour charges 10,00,000
Cost of materials for electrification and sanitary works Rs. 11,30,000 including VAT Rs.

130,000

10,00,000
Wages for electrification and sanitary works 200,000
Painting and flooring works Rs. 22,60,000 including VAT Rs. 260,000 20,00,000
Taxable Amount 94,40,000
VAT amount to be deposited @ 13% 12,27,200
Less: VAT paid (Rs. 65,000 + Rs. 260,000 + Rs. 130,000 + Rs. 260,000) (715,000)
Net VAT amount to be deposited 512,200

Questions asked in ICAN Examinations

Dec 2012 CAP II

E Ltd. has given a contract to G Construction, a party not registered in VAT, for construction of a shopping complex built exclusively for commercial purposes. The cost of shopping complex is Rs. 55 Lakh.

In such case, since E Ltd. got the construction of a shopping complex for commercial purposes from non VAT registered party. Hence, as per Section 8(3) of VAT Act, E Ltd. has to deposit the VAT on transaction value, i.e. 13% of Rs. 55 Lakh = Rs. 7.15 Lakh to IRD. With regard to taxability of G Construction, since the amount of transaction has exceeded minimum slab, it has to get registered itself in VAT.

Dec 2013 CAP III

Mr. Buddhi Bahadur builds his house through a contractor who is not registered in VAT for own living. The total value of the contract comes to Rs. 90 Lakh. He gets another house built from the same contractor for a cost of Rs. 45 Lakhs for letting out on hire.

Regarding the first case, when a person builds his building for own living, it is not for commercial purpose and no VAT is payable by the owner. In the second case, since the value is less than Rs. 50 Lakh, no VAT is payable.

July 2015 CAP III

The owner of building who constructed the building at a cost of Rs. 4 Lakh for the purpose of his business paid VAT of Rs. 40,000 on account of non-submission of VAT bills for purchase of materials and labour under Section 8(3) of VAT Act 2052. The businessman wanted to set off this VAT payment of Rs. 40,000 against his VAT liability on sales he makes when he starts his business of trading.

In such case, since the VAT paid under Section 8(3) of VAT Act is not listed under Section 17 (5Kha) for set off, such VAT paid on construction is not allowable for set off from the VAT liability on account of sales he makes.

References:

Value Added Tax Act 2052, Value Added Tax Rules 2053 VAT Directives 2069

VAT Directives 2069 (First Amendment 2073)

VAT Directives 2069 (Second Amendment 2076) Income Tax Act 2058

Finance Bill 2066, 2071, 2075 IRD Circulars and Notices

ICAN Suggested Answer Papers

Kar sambandhi paripatra sangalo, 2066 by Bhavanath Dahal Income Tax and Value Added Tax by Bhavanath Dahal

VAT – Theory and Practice by Bishnu Prasad Bhandari & Surya Bhakta Pokharel

3 comments

  1. Kailash

    Very elaborate and insightful article. I believe this is relevant for payments against online ads in social media as well.

    0
  2. Shishir Thapaliya

    Sec 17 of VAT Act, 2052 does not allow tax deduction for the reverse VAT amount as per Sec 8(3).
    Am I right?

    0

Leave a Reply

Your email address will not be published. Required fields are marked *