Recoverable Input VAT Incurred on Capital Asset

Value added tax (VAT) is usually charged on purchase of capital assets. However, the recoverability of this VAT is not straightforward. There are a number of considerations for registered businesses when seeking to recover input VAT incurred on capital assets.

In general, a taxable person may recover the input VAT incurred subject to meeting certain criteria such as the expense being incurred for conducting an economic activity, the required documentation is retained, and the input tax is deducted within the specified timeframe. In addition to these requirements, the input VAT incurred must not be specified as non-recoverable under the VAT regime.

The VAT law in Bahrain defines a capital asset as a tangible or intangible asset that is assigned by the taxable person for long-term use as a business instrument. In other words, a capital asset would be a tangible or intangible asset that is capitalized by a business (i.e., to be expensed over the useful life of the asset). In order for the cost to be capitalized, several components are taken into consideration depending on the type of asset. These typically include purchase price, construction cost, import duties, inbound freight and handling, site preparation, installation and assembly and asset start-up testing, among other costs.

Under the VAT regulations, a taxable person must deduct the input tax in the first tax year during which the capital assets are used for the first time. In practice, businesses may be purchasing different components of a business asset before fully recognizing it—a common situation in the construction and oil and gas industries when business assets require a period of time in order to be operational. In such situations, the cost of items is recognized as an asset only if it is probable that future economic benefits associated with the item will flow to the entity and the cost of the item can be measured reliably.

From an accounting perspective, prior to recognizing the costs as an asset, these costs are accumulated as work-in-progress until the asset is placed into service and then transferred to the relevant long-term asset account. Depreciation will begin once the asset is put into service. Thus, it is imperative that the “first use” of the asset occurs when the asset is capitalized which gives rise to the right to input tax deduction. However, VAT compliance functions within registered businesses generally have been mostly setup in a way when the input VAT is claimed based on documentation (i.e., once a compliant tax invoice is received or a customs import declaration is in hand), and this poses a serious compliance risk from a VAT perspective because the input VAT is being claimed prior to the “first use” of the business asset.

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