Deemed Value-Added Tax (VAT) is a relief mechanism which requires no payment of the VAT charged by a person to its customers or clients. In otherwards, VAT is considered paid without the recipient of the supplies/services incurring any out of pocket expense for VAT.
Under the current VAT regime for the upstream operations, VAT on supplies made by contractors to licensees (tier 1 contractors) is deemed paid. Normally, a VAT registered person supplying goods and services to its customers would issue an invoice and charge VAT at the rate of 18 percent. The customer would pay the supplier the value for the supplies plus the VAT charged. The supplier would declare output VAT of 18 percent in the VAT return and pay the VAT received from the customer to URA. In turn, the customer would also be entitled to claim the same VAT in their VAT return.
However, under the deemed VAT regime, the VAT registered person will issue an invoice to its customers and charge VAT at a rate of 18percent. When the customer receives it, they will pay the supplier the value of the supplies but without the VAT as it is “deemed paid”. Further, the supplier will not be required to pay the VAT to URA but will disclose it in the VAT return for tracking purposes by the Uganda Revenue Authority (URA). The customer will not claim any VAT in the VAT return since it was not paid in the first place.
This means if a tier 1 contractor issues an invoice to a licensee (such as CNOOC or Total Energies) and includes VAT on that invoice, CNOOC or Total Energies will settle the invoice net of VAT. The tier 1 contractor will have no output VAT to declare to the URA (since they did not receive it from the licensee) and the licensee will have no input VAT to claim (since they did not incur it). However, this incentive does not extend to supplies made by the subcontractors (tier 2 contractors) to the tier 1 contractors and the rest of the supplies down the chain.
This means if a tier 2 contractor issues an invoice to a tier 1 contractor with VAT, the tier 1 contractor will settle the invoice and pay the VAT. The tier 1 contractor will therefore have input VAT to claim. Since there is no corresponding output VAT (on grounds of deemed VAT explained above), the tier 1 contractor will accumulate significant input VAT claimable/refundable which cannot be offset against output VAT on their supplies to the licensees. This could pause a significant cashflow challenge for the contractors unless such VAT can be refunded by the URA expeditiously which may be a big challenge in practice. This situation will majorly affect tier 1 contractors who have a single revenue stream attributable to upstream operations or minimal revenue from other operations.
For the pipeline project, the EACOP Act provides that the VAT charged on supplies made exclusively for the pipeline project by a contractor to the pipeline company or by a subcontractor to such contractor is deemed paid. Contrary to the upstream operations, the deemed VAT incentive extends to supplies made by tier 2 contractors to tier 1 contractors. As a result, the potential cashflow challenge highlighted in connection with upstream operations will not after the tier 1 contractors. Tier 1 contractors will have no output VAT on supplies made to the licensees as well as no input VAT on supplies made to them by tier 2 contractors.
However, the tier 2 contractors will have no output VAT on supplies made to tier 1 contractors but will have input VAT on suppliers made to them by tier 3 contractors. The cash flow constraint will therefore affect the tier 2 contractors to the extent that such contractors have a single revenue stream attributable to pipeline project or minimal revenue from other operations.
While deemed is a well-intentioned incentive and may improve cashflow constraints (for example in the case of tier 1 contractors under the EACOP project), it may create cashflow challenges further down the chain (for example, for tier 1 contractors under the upstream operations and tier 2 contractors under the EACOP project).
In order to achieve the objective of minimising the overall cost of the oil projects, government could consider extending the deeming provisions to cover more transactions between subcontractors further down the chain or otherwise consider restructuring the regime altogether. Further, the regimes for both the upstream and EACOP projects should be aligned.
Contractors and sub-contractors are already exposed to a number of financial and operational risks associated with execution of these projects. Subjecting them to more risk associated with “VAT financing” is an added burden that may discourage meaningful participation in the sector.
Pamela Natamba is a senior manager in tax at PwC.
Source: The Daily Monitor
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