The value-added tax is characterized as a consumption tax and not a production or commercial tax, that is, it is focused on the person who consumes the goods (the consumer).

Despite this, the stages of supply chain operations and the number of traders who trade the commodity before it reaches the consumer cannot be determined, which is reflected in the impossibility of determining the value that will be added to the price of the commodity before the end of the supply chain cycle, and before of the commodity or service reaches the consumer.

For example, when a manufacturer supplies the goods to a wholesaler, who then supplies them to a retailer, which eventually reach the consumer; In this case, the value-added tax is calculated at 5%.

It is not possible to know the final value of the tax until after the end of the supply chain processes and the commodity reaches the consumer.

This financial reality compels the tax administration to collect the amount of tax from each merchant who contributes in the supply chain cycle; so that the good or the service reaches the consumer and the final value of the tax can be identified.

What is the financial deduction mechanism and refund in value added tax?

The public treasury cannot wait until the goods are distributed and reaches consumers, so it collects tax from merchants at each stage of supply chain.

This collection does not mean that the merchant is the final taxpayer, but rather that the merchant plays a dual role regarding the collection of this tax based on the financial deduction mechanism; which is the role of the temporary taxpayer and tax collector.

A‑First: The temporary taxpayer

If we start with the manufacturer, he sells the commodity to the wholesaler, so the manufacturer is the only one in the supply chain who is not temporarily charged with the commodity he makes himself.

But in this situation we have to emphasize here , that the manufacturer may pay a value-added tax on his import of raw materials as a consumer and not as a temporary taxpayer, as the Gulf agreement considered electricity, gas and air conditioning to be Taxable commodities (Article/1), and it is one of the materials that the manufacturer may need to import, which means that he is the one who pays its tax as long as he imports it from a member state due to the concept of collection on behalf of the supplier or what the agreement called Reverse Charge Mechanism (Article/9).

Then the manufacturer supplies the goods to the wholesaler, who is the first temporary taxpayer in the chain, as he has a direct tax burden to pay the value added on the commodity calculated from the price of the commodity as he purchased it from the manufacturer.

This also applies on the retailer who is obligated to pay the value of tax on the goods he purchased from the wholesaler.

However, these temporary taxpayers do not bear the final tax burden according to the financial deduction mechanism.

B‑Second: The tax collector:

At this stage, each of the temporary taxpayers during the supply phase turns into tax collectors towards the subsequent taxpayers in the supply process until the cycle reaches finally the consumer.

The wholesaler who was temporarily charged while dealing with the manufacturer plays the role of the tax collector, when he deals with the retailer. The wholesaler collects the amount of added value from the retailer, but he does not deliver it in full to the public treasury, but instead he deducts from it the amount that he paid as a temporary taxpayer.

The same thing happens to the retailer who pays the tax to the wholesaler as a temporary taxpayer, but he turns into a tax collector when it comes to the consumer, and when he deals with the public treasury, he does not hand over the full amount of tax that he obtained from the consumer, but deducts from it the amount that he had previously paid to the wholesaler.

What is the purpose of the financial deduction mechanism?

•  The taxpayer is the collector; the temporary taxpayer has been turned into a person who works for the tax administration without costing this administration any effort or money.
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• However, this may lead to the spread of fraud cases in commercial invoices. The value of goods is reduced below its value in order to minimize the accumulated added value, and thus decrease the value of goods and services and facilitate their supply and sale. 

•  Encouraging consumer to purchase directly from producer;The more stages of supply chain, the greater the added value, and thus more burden on the consumer, which may push consumers to find alternatives; Such as markets that combine producers with consumers without stages of supply.
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• This contributes to increase factory production, import operations, and also reduces the increase in commodity prices, reduces inflation of prices, increases competition, and lowers prices for consumers while maintaining the same quality.

•  Encouragement towards saving rather than consumption; One of the indirect goals of the financial deduction mechanism is to encourage people to save instead of consuming goods with added values that increase the cost of consumption and make the consumer obligated to pay the tax value in cash with each time he consumes, at a time when the merchant is not obligated to pay more than once when he is charged tax Temporarily, then he has the right to collect the amount of tax and keep it after deducting what he paid.

• Providing an encouraging environment for entrepreneurs; the financial deduction mechanism helps provide a fruitful environment for building new small or medium businesses that need to provide financing, at a time when they cannot pay taxes at high rates, and they cannot freeze their funds that are paid in the temporary assignment stage until the final consumption is completed. These businesses benefit from the discount mechanism in which the amounts they have paid are returned to them with the first next stage of the supply chain, and this makes the liquidity revolve quickly again.
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International Department Team

Dr. Bader S. Al-Otaibi

Law Firm & Intl. Arbitration