What is Value Added Tax (VAT)?

Taxation systems in companies are considered one of the most important factors that influence a country's economic growth. In prosperous countries like the Kingdom of Saudi Arabia, the state imposes a suitable tax regime based on the current situation of its companies, which helps develop their capacity to enhance economic growth.

Under Saudi Arabian law, taxes are imposed on companies to help the government effectively fund various projects that achieve economic growth, such as infrastructure projects and others.

In this article, we will review: What is Value Added Tax (VAT)? and clarify how to avoid Value Added Tax (VAT) penalties in Saudi companies.

1. What is the Concept of a Tax in Saudi Law?

Article two of the Saudi Companies Law defines it as: "A company is considered a legal entity established in accordance with the provisions of the Law, based on an incorporation contract or bylaws, by which two or more persons commit to contribute to a profit-seeking project by offering a share of money, work, or both, for the purpose of sharing the profit or loss resulting from this project.

As an exception, and in accordance with the provisions of the Law, a company may be established by the unilateral will of one person.

Non-profit companies may also be established in accordance with what is stated in Chapter (Seven) of the Saudi Law.

2. What is Value Added Tax (VAT)?

Value Added Tax (VAT) is an indirect tax imposed on all goods and services that businesses sell and purchase. VAT is considered one of the most important sources of income in over 160 countries worldwide. The tax rate is calculated at 15% of the value of supply or import to be added to the final price.

3. How is Value Added Tax (VAT) collected?

Value Added Tax (VAT) is imposed on all stages of the supply chain, that is, from the (initial supplier of the product or service to the final consumer, passing through the distributor and then the dealer).

Here is the breakdown:

• The consumer pays the amount of Value Added Tax (VAT) on any product or service they purchase.

• Businesses pay the State the Value Added Tax (VAT) resulting from consumer purchases.

• Consequently, businesses reclaim the Value Added Tax (VAT) they paid to the distributors.

4. How to Avoid Value Added Tax (VAT) Penalties in Saudi Arabia?

All institutions and companies must know and be aware of all types of taxes imposed on them by the government, in addition to being familiar with the rules and regulations of all imposed taxes, in order to observe and adhere to their standards. Therefore, learn with us how you can avoid Value Added Tax (VAT) penalties in Saudi Arabia.

We previously defined VAT in this article as the tax imposed on the final consumer, collected at every stage of the supply chain, starting from the supplier to the distributor to the dealer and ultimately to the final consumer.

The question now is: How can you avoid VAT penalties in Saudi Arabia? Here are the points:

1. Resident foreign companies in Saudi Arabia must calculate their supplies during a twelve-month period. If the value exceeds 375,000 Saudi Riyals (SAR), they must apply for registration with the Zakat, Tax and Customs Authority (ZATCA) within 30 days from the end of that month, according to Article Three of the Saudi VAT Law.

2. Article Forty-Five of the Law stipulates a penalty of 50,000 Saudi Riyals (SAR) in the following cases:

   • Failure to comply with maintaining accounting documents and tax invoices for a period of 6 years, calculated from the end of the tax period in which they concluded. The penalty is calculated for each tax period.

   • Failure to allow ZATCA or one of its employees to perform their duties.

   • Failure to comply with ZATCA standards and violation of the rules and laws of Value Added Tax.

5. Where Does Value Added Tax (VAT) Appear on the Balance Sheet?

Value Added Tax (VAT) is not just a number on an invoice; it's a key element in financial reports and the Balance Sheet.

At the end of each accounting period, the tax appears as follows:

1. VAT in Accounts:

   - Input VAT (VAT on Purchases).

   - Appears under Current Assets as a Debit Balance, representing a right for the company to recover/reclaim the tax.

2. Output VAT (VAT on Sales):

   Appears under Current Liabilities as a Credit Balance, representing an amount due to the State (the tax collected).

3. VAT Settlement Account:

   - Represents the difference between Input VAT and Output VAT.

   - It appears as a Credit Balance (VAT Payable) or a Debit Balance (VAT Recoverable), depending on the case.

   - Its balance must be zero after payment or recovery.

4. On the Balance Sheet:

The net payable or recoverable tax appears under the item "Other Credit or Debit Balances" (or sometimes specifically as "VAT Payable" or "VAT Receivable"), depending on the nature of the balance.

5. In the Final Accounts:

   - The tax is not considered an expense; rather, it is a temporary liability (to be paid) or a recoverable amount (to be refunded/reclaimed).

   - It is handled within adjustment entries (or settlement journal entries) to ensure the accuracy of financial reports.

6. What is the Difference Between Sales Tax and Value Added Tax (VAT)?

Both Sales Tax and Value Added Tax (VAT) are considered indirect taxes. While they share many similarities, there are also several key differences, including:

• VAT is levied on all stages of the supply chain, starting from the manufacturing process and ending at the production stage, whereas Sales Tax is levied on the total value of the goods.

• VAT is paid by multiple parties, starting from the initial supplier to the distributor to the dealer and finally to the final consumer. In contrast, Sales Tax is paid entirely at the point of sale.

• With VAT, it is difficult for various parties to engage in tax evasion. However, Sales Tax can be illegally evaded through illicit means.

• VAT is levied on both the product (through the supply chain) and the consumer, while Sales Tax is levied on the final consumer only.

• Collecting Sales Tax is considered easier than collecting Value Added Tax (VAT).

 7. Frequently Asked Questions (FAQs) about the Article: What is Value Added Tax (VAT)?

1. What Entities are Exempt from Value Added Tax (VAT)?

Entities exempt from Value Added Tax (VAT) include: Government entities, non-profit organizations, charitable associations, and all approved services and educational institutions, among others, registered with the Zakat, Tax and Customs Authority (ZATCA).

2. What is the Difference Between Income Tax and Value Added Tax (VAT)?

The difference between Income Tax and Value Added Tax (VAT) involves several key points, including: VAT is deducted at every stage of the supply chain, whereas Income Tax is deducted based on the income of individuals and companies.

3. Is Tax a Debit or a Credit?

The journal entry for Sales Tax is recorded as a Credit balance (VAT Output/Payable), which is the opposite of Purchases Tax (VAT Input), which is recorded as a Debit balance (VAT Recoverable/Receivable).

8.  Conclusion:

Finally, the corporate tax regime creates a fertile environment for foreign companies to invest in Saudi Arabia, which increases the attraction of investments and capital—considered the cornerstone of economic development.

This is especially true in a prosperous state like the Kingdom of Saudi Arabia, which is characterized by an exceptional and robust global market thanks to the adoption of the most suitable taxation systems for corporations.