- What is the reverse-charge mechanism?
- How does the reverse-charge mechanism work?
- What is the need for reverse-charge mechanism?
- When is the reverse-charge mechanism applicable?
- Input tax recovery under the reverse-charge mechanism
What is the reverse-charge mechanism?
In a typical transaction, the supplier supplies goods or services and collects VAT from the recipients which is then paid to the government.
However, under a special rule named the reverse-charge mechanism, the responsibility for paying VAT on certain transactions is shifted from the supplier to the recipient. In such cases, the recipient pays VAT directly to the government and then reports it in their tax return as output tax (tax collected on sales transactions).
How does the reverse-charge mechanism work?
Let’s take the example of John, who is a VAT-registered business owner in Bahrain. He needs some renovation and interior design services for his workplace. He contacts Abdel for his services and gets the work done.
Now, Abdel happens to be a non-resident supplier. A non-resident supplier is someone who does not have a place of business or a fixed establishment in Bahrain.
The services cost John BHD 20,0000 and he will be taxed at 5% since these services are counted as real estate services. However, in this case the supplier is a non-resident supplier and the recipient is a taxable person in Bahrain, so the responsibility to pay VAT will be shifted to the recipient under the reverse-charge mechanism. So, John would self-account for 5% VAT (BHD 1,000).
Since the invoice is issued by a non-resident supplier, it won’t include the VAT amount. So, John will record the VAT amount digitally or manually. Finally, John will record this amount in his VAT return and it will be treated as output tax due.
What is the need for reverse-charge mechanism?
The reverse-charge mechanism allows non-resident suppliers to supply taxable goods and services to VAT-registered recipients in Bahrain without registering for VAT in Bahrain.
However, the reverse-charge mechanism is not applicable when taxable goods or services are supplied by non-resident suppliers to non-registered recipients in Bahrain. In such cases, the non-resident supplier will have to register for VAT in Bahrain to charge VAT on the supplies they provide.
When is the reverse-charge mechanism applicable?
The reverse-charge mechanism is applicable in the following cases:
Supply made by non-resident suppliers
The reverse-charge mechanism is applicable by default when:
- Taxable goods are supplied by a non-resident supplier to a taxable recipient in Bahrain.
- Taxable services are supplied by a non-resident supplier to a taxable recipient in Bahrain.
Reverse-charge mechanism for local supply
Under the VAT legislation laid down by the National Bureau for Revenue (NBR), the reverse-charge mechanism is applicable on certain domestic supplies. The domestic reverse-charge mechanism provides relief for taxable business owners selling out-of-scope supplies or supplies subject to 0% VAT. It relieves them from the burden of negative cash flow created by the VAT incurred on their expenses.
For the local reverse-charge transaction to be valid, the supplier must submit an application to the NBR for approval and meet certain conditions:
- The applicant should be a taxable person
- The VAT due on the goods or services supplied to the applicant must be fully recoverable by the applicant as input tax.
- The applicant should provide evidence to prove that the total sum of their intra-GCC supplies and exports exceeds 50% of the total value of their supplies.
- The applicant must provide credible evidence to show that they would be in a position to owe net tax and that this would impact their financial position.
When the NBR approves the application, the applicant will receive a certificate which allows them to apply the domestic reverse-charge mechanism on the specific supply mentioned in the approval. The applicant should provide a copy of this approval certificate to their suppliers so that they don’t charge VAT on the supplies sold to the applicant.
If the applicant no longer meets the conditions for the domestic reverse-charge mechanism, they should notify the NBR within 30 days, after which their approval will be revoked.
Input tax recovery under the reverse-charge mechanism
The output tax payable by the taxable recipient under the reverse-charge mechanism is also considered the input tax, or VAT incurred on business expenses, for that same recipient. The recipient can claim input tax in their VAT return under the normal input tax recovery rules.
If the taxable recipient is entitled to a full recovery of their input VAT, the amount of output VAT can be completely deducted against the recoverable input VAT.
To demonstrate, let’s go back to the example of John and Abdel. If John is using Abdel’s services to make taxable supplies, then he is entitled to fully recover the VAT charged on those supplies. Now John can treat the BHD 1000 VAT he recorded as recoverable input VAT. The net amount of VAT that John owes to the government for his purchase from Abdel would be nil, since the BHD 1,000 output VAT payable would be fully applied against the BHD 1,000 recoverable input VAT.
In case John is liable only for partial recovery of the input VAT, say about 50% of the VAT incurred on his business expenses, then he will be able to recover only BHD 500 as recoverable input VAT and he would have to pay BHD 500 to the government as the output VAT due.
- Federal Tax Authority - https://www.tax.gov.ae/