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Bahrain VAT : Impact on Construction Industry

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VAT: Impact and challenges for Contracting / Construction Companies

With introduction to Value Added Tax (VAT) regime in Bahrain, now attention is turning to those industries where it has major impacts and posing serious challenges. Of particular interest is the construction sector in Bahrain. To put the issues into context the treatment of construction and real estate transactions presents many difficult challenges as the values of transactions in this sector are often very high and the effect of taxation evokes enormous interest amongst the general population and construction companies. This article intends to provide an overview of the importance and impact of VAT on the Contracting/Construction companies throwing light specifically on applicability of Zero tax on such industry.

As per Article 53(11) of the Bahrain VAT Law and Article 76 of the VAT Executive Regulations states that the construction of new buildings will be taxable at the zero rate. Zero rated supplies are those which are taxable at the rate of Zero Percentage and the supplier can still claim the input tax charged on expenses incurred in making this supply. Building includes residential, commercial, or industrial building. a building will be considered as “new” if the building is built from scratch on a green-field or brown-field site. Renovation or refurbishment works of a building will not qualify for zero rate and it will be taxable at the standard rate of 5%. The zero rate shall not apply to Goods or Services supplied after the building has been completed.

If an existing building is demolished prior to construction, this will not impact the building being regarded as new, although the costs relating to demolishing the existing structure will be taxed at 5% unless any other exemptions are specifically granted. Only the construction of new building will qualify for zero rate.

Further as per Article 76 of Bahrain VAT Law, we can continue to charge VAT at Zero rate on Supplies related to contracts signed with the Government prior to the Law coming into force, where the Supply is made in full or in part after the date of this Law coming into force, until the date of the contract's renewal, or its expiration, or 31 December 2023, whichever is earlier. If contract is not with government (Government means Bahrain Ministries, Government agencies, Institutions, and public bodies) the consideration shall be deemed inclusive of Tax if it is imposed under this Law.

The builder will not be required to account for VAT on the work undertaken by him to rectify the snags in construction works, since there is no further supply of construction services. If the builder does this work for additional consideration, this will be regarded as an additional supply of services subject to VAT at the relevant rate.

Lead times on major projects will be one challenge for construction industries. The issue associated with the duration of contracts drawn up in the industry, at the time of drafting they may not include any of the normal terms and conditions relating to VAT. Due to non-inclusion of such provisions in the agreement prior to this law and still continuing after the implementation of the law, there may be situations wherein the client may not be willing to pay the additional VAT amount if the standard rate of 5% applies. So the companies are advised to have proper discussions with those clients and make suitable alterations to those existing agreements appropriately.

As per NBR certain conditions must be met for the zero rate to apply. If these conditions are not met the supplies will, in principle, subject to VAT at the standard rate of 5%, unless a VAT exemption applies.

The zero rate of VAT applies to following services related to construction as well,

Construction of extension to an existing building (where the extension adds an additional room or functional space to the building)
Site clearance works prior to the construction of a new building
Services provided by engineers and surveyors and similar services of a supervisory nature that relate to the construction of a new building
Civil engineering works relating to a new building

If a taxable person supplies goods items included on the list of basic foods which may be zero-rated under certain circumstances are supplied to be used for the purposes of construction, these will be taxable at the standard rate. This includes sweet water and ice.

In order to apply the zero-rate on construction services and associated goods in relation to a new building, the supplier must obtain a certificate or a certified copy of the original certificate that the building meets the criteria to be a new building for the purposes of Article 76 of the VAT Regulations.

This certificate should be prepared by the main contractor or the property owner and should contain the following information:

The address of the land on which the building will be or is being constructed. This should be the full address (including block number, street number etc.), not a post office address or “in-care of” address. When this is not available, a map should be attached clearly marking the land and its location.
The name and address of the registered owner of the land. Again, the address should be a full address, not simply a post office box or “in-care of” address.
A description of the building to be constructed. This should state the type (residential, commercial, industrial etc.), the number of floors and the total area of the building.
The actual or expected start and end dates for the development.
The name, address, and VAT Account Number of the main contractor. Where there is no main contractor and the property owner will employ multiple contractors directly, this should be stated instead. In such a case, the property owner should state his VAT Account Number, if registered for VAT.
A certification statement stating that, to the best of the knowledge and belief of the issuer, the building is a new building for the purposes of Article 76 of the VAT Executive Regulations.
The date of issue of the certificate.

A copy of the building permit for the building should be attached to the certificate and certified as a true copy of the original building permit. The certificate should be signed by an authorised representative of the main contractor or by the property owner as the case may be. Standard rate VAT applies in the absence of a certificate regardless whether the building is new or not. If a certificate is obtained after a tax invoice has been issued, then supplier have an option to cancel and reissue the original tax invoice, provided the recipient of the supply has not claimed input tax in respect of the VAT shown on the invoice on its tax return.

The usual tax due date provisions will apply for retention payments and the tax due date for retention payments will be as follows:

For One-off supply: If the construction service is a one-off supply and the works are complete in accordance with the rules of the contract (e.g., they have been certified as complete), the tax due date will be the date of completion of the services (e.g., the date of certification), or the date of payment or issue of the tax invoice showing the retention amount if earlier.

For Continuous supply: The rules under Article 13 of the Law will apply in determining the tax due date for the retention amount. Hence, the tax due date will be the earliest of:

The date the retention payment is made
The issue of a tax invoice in relation to the retention amount
The due date for payment as specified on the tax invoice in relation to the retention amount
Twelve months from completion of the services (as determined by the contract, e.g., certification)

The above principles will still apply when a tax invoice is issued by the provider of the construction services showing the gross amount due and a deduction from that gross amount for a retention amount. The reference to retention on the tax invoice (and its deduction from a gross amount) does not in itself trigger a tax due date on the amount retained.

The VAT is giving a helping hand to the contracting / construction companies in the way of zero rate of VAT. If standard rate of VAT applies, it is critical for the business to perform a comprehensive impact assessment and determine the additional cash flow requirement. After the inception of VAT if there is no zero rate for construction works, the cost of materials and services related to the contract works is supposed to be escalated and hence the consideration chargeable for construction works will be proportionately increased. This may lead to huge infusion working capital to continue with the contract works and thus resulting in increased cost of capital.

If the taxable person exercises the benefit of zero rate, then they can avoid facing working capital issues. One has to note that there are more chances of having VAT audits if they have refunds claims due to zero rate taxation at outward supplies and claiming of Inputs on purchases from suppliers. Most of the contract/construction companies find themselves in a net VAT refund position and have encountered delays in receiving VAT refunds on construction costs (NBR sanctions refund within 60 days after filing the refund request). An alternate and much beneficial way to tackle this situation is to issue a Zero rate certificate to the concerned supplier, so that they can make the supplies without charging the standard VAT rate of 5%. Therefore, it is critical for construction industries to make necessary plans and arrangements to avail the benefits of zero rate taxation and minimize the challenges therein.

Article by

Muhammad Roshan

Senior Consultant, Alchemist Consulting

Opinions expressed here is of the author and the organizations's view may be different. And it is not to be considered as a legal opinion.