What is VAT and how does it work?

1st January,2019, Bahrain will be third GCC Member state to implement VAT after UAE and Saudi Arabia. You must have read our previous article’ Important terms under VAT in Bahrain’, which talks about the common terms frequently used in dealing with VAT. In this article, let us understand what is VAT and how does VAT system work?


What is VAT?

Value Added Tax known as VAT is an indirect tax charged on the supply of goods and services as well on imports. In general, it is consumption tax levied on value addition in each stage of the supply chain. This is achieved through the concept of input VAT deduction which allows the business to set off the VAT paid on purchases (Input VAT) with the Vat collected on the sales (Output VAT).
To know What is input VAT and Output VAT, please read our article ‘Important terms under VAT in Bahrain’

How does VAT System work?

The businesses registered under VAT act as an appointed agent of the government to collect and remit VAT and the entire burden of paying 5% VAT is on the final consumer. To make it clearer, we need to understand the mechanism of the VAT system.

Let us understand how VAT System works with the example.

Name Type Purchase Sales VAT
Cost VAT Total Selling Price VAT Total Input Vat Output VAT Vat Payable
5% 5% Output Vat – Input VAT
Max Metal Supplies LLP Raw Material Supplier 3,000 150 3,150 150 150

Max Metal Supplies LLP, supplies material to Terrain Cars LPP for 3,000 BHD and Charges VAT at of 5

5 i.e. 150 BHD.  The VAT payable of Max Metal Supplies LLP is 150 BHD since they don’t have any input VAT deduction

Terrain Cars LLP Manufacturer 3,000 150 3,150 3300 165 3465 150 165 15
Terrain Cars LLP, a car manufacturer pays VAT @ 5% i.e. 150, on the purchase of raw materials which are required to manufacture a car. After manufacturing, he sells a car to Crystal Distributors Ltd at 3700 BHD plus VAT 5% which 185 BHD. In arriving the VAT payable to the government, Terrain Cars LLP need to adjust the input VAT of 150 BHD with the output VAT of 165 BHD and the balance 15 BHD is payable.
Crystal Distributor LLP Distributor 3,300 165 3,465 3700 185 3885 165 185 20
Crystal Distributor LLP sells the Car at 3700 BHD + VAT 185 BHD to Favourite Cars who is a retailer. Since they have already paid VAT of 165 to Terrain Cars LLP, they will be allowed to adjust the input VAT of 165 with the output VAT of 185 and the balance 20 BHD will be payable to the government. If you observe, the VAT of 20 BHD is exactly 5% on the value addition of 400 (3300 -3700).
Favourite Cars LLP Retailer 3,700 185 3,885 4000 200 4200 185 200 15
Favourite Cars, a retailer, sells the car to Mr. Abdul who is an end consumer for 4000 BHD with VAT 200 BHD. Like Crystal Distributor, Favourite cars adjusts the input VAT of 185 BHD with the output tax of 200 BHD and pays the balance 15 BHD to the Government.
Mr Abdul Consumer 2500 250 2,750 200

Now, if you closely observe, the total VAT paid by all parties (Max metal Supplies LLP 150 + Terrain Cars LLP 15 + Crystal Distributor LLP 20 + Favorite Cars LLP 15) is 200 which is exactly the same amount paid by Mr Imran on purchasing the car. Therefore, the businesses engaged in the supply chain will pass on the burden of tax to the next stage and ultimately, VAT is paid by the end consumer.

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