|This article will discuss the impact of VAT on the VAT-registered contractor when making a supply of construction services and other related services to their clients.|
Construction services can be broadly defined to include a wide range of building and construction services that are performed by businesses. They include services such as site preparation, foundation work, scaffolding, bricklaying, roofing, renovation and repairs.
The key parties in the construction industry cycle are usually the following:
- Developer — who acquires land and engages contractors to construct the building or structure on the land
- Main Contractor — he is engaged by the developer to carry out the construction and he takes full responsibility for the completion of the construction project
iii. Sub-Contractor — he is engaged by the main contractor to perform part of the main contractor’s work. Sub-Contractors include specialists such as plumbers, electricians, painters and bricklayers.
All construction services performed on residential and non-residential properties in Kuwait are likely subject to VAT. Hence, the business will have to charge VAT on all supplies of construction services performed in Kuwait.
It remains to be seen as to whether the DIT will exempt certain contractors who undertake projects of national interest such as key infrastructure projects. If indeed this is the case, then it remains to be seen if there will be special provisions in the legislation that stipulate that these Contractors will be able to recover the VAT Input Tax that they are required to pay on the purchase of business goods and services. Further, it is likely that this ‘relief’ from charging VAT on the supply of construction services is only likely to be extended to the main contractor and not the sub-contractors as is the case in other countries with VAT regimes.
Constructions services performed outside Kuwait by a Kuwaiti based construction company.
Where your business provides construction services that are in connection with land or improvements situated outside Kuwait, you do not have to charge and account for VAT on these supplies. These are likely to be classified as international services which can be zero-rated. This is so even though the developer is a Kuwaiti company and you are billing the developer from your company in Kuwait. If however, you subcontract the services to your related company or a third party in the other country, then depending on the VAT rules in the place where the construction activities are performed, the related company or the third party in the other country is required to charge VAT to you. This will result in VAT leakage as you will not be able to recover the VAT Output Tax which is levied to your business in Kuwait. This is in line with international norms of VAT legislation and practice.
A VAT-registered Kuwaiti construction company, Kuwait 1LLC was engaged by a Kuwaiti based developer to develop a hotel in Oman. As the construction services would be performed in Oman, and not in Kuwait, Kuwait 1 LLC need not charge VAT on its supply of construction services to the developer.
As your business supplies construction services that are in connection with land or improvements situated outside Kuwait, Kuwait 1LLC does not have to charge and account for VAT on these supplies. These are likely to be prescribed as international services which can be zero-rated under the proposed VAT law.
Most construction contracts contain provisions for the retention of an amount due to the contractor. This amount (commonly known as the “retention sum”) is a specified amount withheld at each stage of progress payment and will only be released to the contractor when the customer is satisfied with the work performed. Usually, the total retention sum is released only after the construction project has been completed.
Depending on the proposed VAT law, your business will have to account for VAT on the retention sum at the earlier of the:
- date of receipt of payment; or
- date of issuance of an invoice for the retention sum.
Tax invoices and letters of claims
It is common in the Construction industry to issue letters of claim to the developer or main Contractor stating the value of work completed after each completed stage of the construction. Their architect will then perform a valuation and certify the value of work done before payment is made. The certified amount may differ from the amount stated in the letter of claim. The Contractor or sub-contractor will then issue a VAT tax invoice to the Developer or the sub-contractor for an amount as stipulated in the Architect’s certificate.
The letter of claim cannot be treated as a tax invoice, as it does not contain the final amount payable by the customer. If your business has issued an invoice before the receipt of the Architect’s certificate and the value of works approved are different than the amount billed, adjustment to the tax invoice issued previously, may only be made through the issue of a credit note or issuance of an additional tax invoice (to increase the value of your supply and corresponding VAT) to reflect the adjustment.
Tender Deposits and Security Deposits
If you receive a deposit from a customer to obtain copies of the contract documents (e.g., plans, specifications, schedule of quantities), you have to charge and account for VAT on the deposit as this is likely to be treated as a sale of documents.
Additionally, if a payment of deposit received by your business is intended to be used to offset against the future payments (partly or fully) once the supply has been made, you would have to charge and account for VAT on the deposit. Such situations can occur if the main-contractor receives as advance payment from the Developer for mobilization payments where he does not have sufficient funds to mobilize large scale resources such as rental of equipment or hire of labor.
However, if the payment of deposit received by you is a security deposit to ensure that the tenderer proceeds with the contract or to ensure that the successful tenderer carries out the obligations detailed in the contract, you do not have to charge and account for VAT on the security deposit as there is no supply made for VAT purposes.
Counter Supplies or Back Charges
There may be situations where your business is contracted by the main contractor to provide lighting works which include the supply of light fittings and light installation services. The main contractor purchases the lights directly and provides them to you for the light installation activity.
In this case, there are two separate supplies:
- the supply of the light fittings from the main contractor to your business; and
- the supply of the lights and light installation services from your business to the main contractor.
Both the main contractor and you should each issue a tax invoice for the gross value of the supply made to each other and account for the VAT accordingly. It is incorrect for your business to charge and account for VAT only on the amount of payment made by the main contractor, net of the value of the tiles. You have to charge and account for VAT based on the gross value of the supply of tiles and tile-laying services.
However, if you are contracted to provide only the light installation services and not the light fittings, there is only one supply from you to the main contractor, that is, the provision of this light installation service. This is because the main contractor has engaged you to provide the light installation services only. In this case, you are required to charge and account for VAT on the supply of the installation services.
Compensation for Suspension of Work
In the process of developing a property, the developer may request your business to suspend work for a certain period of time and in return, pay a certain sum of money to you as compensation.
If the payment is to compensate you for the loss of income or for costs incurred as a result of the suspension of work, this payment will not attract VAT. However, if the payment relates to work carried out by you prior to the suspension of work, this payment is a consideration for the supply that was made by you to the developer.
Accordingly, you will have to charge and account for VAT on this payment.
Damages and Out-of-Court Settlements
Your business may enter into construction contracts which contain a provision for compensatory payment to be made if you delay the completion of the contract. If payments are paid for a breach of warranty or delays in the completion of project, it is not subject to VAT as the payments are compensatory in nature.
However, if the settlement payments are paid in relation to the supplies made by you, you have to charge and account for VAT on the settlement payments received.
Kuwait LLC, a property development company holds a retention sum of KD 200,000 hires another contractor to rectify the poor workmanship of the main contractor. Kuwait LLC incurred KD 150,000 for the rectification works and can recover the KD 150,000 from the main contractor.
In this case, there are two separate supplies made.
- The first supply is from main contractor to Kuwait LLC for completing the building project (though not entirely to Kuwait LLC’s satisfaction). The main contractor has to charge and account for VAT on the full value of the building project.
- The second supply is from Kuwait LLC to the main contractor for the supply of rectification works because Kuwait LLC is making good the defects that should have been done by the main contractor to the Kuwait LLC and the main contractor has to charge and account for VAT on KD 150,000.
As you would have noted, VAT is likely to have a significant impact to your business operations. VAT readiness has to be undertaken while your business operations continue on a day to day basis. VAT readiness will take several months and therefore preparation is essential.
By Zubair Patel
Partner, Tax & Corporate Services
KPMG Safi Al-Mutawa & Partners