VAT and Cash Management

Working capital management is essential for financing day-to-day business activities. More so for SMEs which often have shorter runways (period taken to spend available cash resource) due to tight liquidity and limited cash management options. The business model applied plus the operating environment presents both opportunities and threats to how an SME can effectively utilize cash for operational efficiency (survival and growth).

Cash management

The tag of war is experienced while balancing meeting short-term liabilities and financing operations that generate cash. The cash generating activities of a business are mostly driven by converting inventory into sales (either credit or cash) and in the case of credit sales a further process of converting them into cash inflow is performed. Cash generated is required for expending in settling accrued expenses and other short-term loans (overdraft facilities) then finance operations and growth.

Cash Generated = Operating Income + (Current Assets – Current Liabilities)

Contextualizing this into our current operating environment adds volatility and regulatory compliance to how business operates, which in turn limits the creative opportunities with which one can deploy cash management tactics. This forces businesses to prefer cash receipts (as opposed to transactions via the banking system) as cash offers more control over the transaction being performed. It is also critical for managing cash in the different currencies expected to be used in settling various transactions, which allows businesses to project their runaway per currency more accurately.

Including taxes in the cash management matrix increases the burden for careful cash management which not only sufficiently covers general operations and growth prospects but encourages tax compliance with refunds and payments being processed timely. This morphs the cash generating activities into:

Cash Generated = Operating Income + (CA-CL) + (Tax Refund – Tax Payable)

Income taxes (including PAYE) are managed on a forecast basis which allows for predictability of obligation beforehand. This ensures proactive management of such tax heads. VAT, on the other hand, is tied to the transactional activities of the business, mainly revenue creation. While revenue growth is an indicator of business growth signaling product market fit and scope for scaling, it also brings with it the need to generate excess cash required to fund the growth and associated growth-induced obligations like VAT.

Riding on the growth curve burns cash and it is essential that a business has positive net cash generated positions in any trading period. Positive net cash positions are generated when? a business can meet its working capital requirements for a period while retaining excess cash. VAT creates operational cash gaps which present cash management opportunities. Simply put, the risk and rewards of this relationship are best summed up through understanding the number of days of a business cash requirements.

VAT System

The Zimbabwean VAT system was introduced in 2004 with four VAT categories. VAT categories are classifications in which a registered vendor is placed upon registration based on their business type and size. These determine the VAT period in which one submits returns and payments for the VAT due or place claims for VAT refunds. The charging of VAT is predicated on the type of supply of which there are three types: standard rate supply charged at 15% for goods and services not specifically deemed zero-rated or exempt; zero-rated supply charge at 0% for basic foodstuffs and exports and exempt supplies with no charge for specified goods and services such as financial services etc.?

Registration is both mandatory and voluntary. Compulsory registration is determined when one supplies standard rated and zero-rated supplies worth US$40,000 or ZWL equivalent in a period of twelve months from the date of registration. Voluntarily registering for VAT requires one to provide proof of why they should be registered when they do not meet the turnover threshold. Once one is registered, they become a registered operator issued with a unique VAT number which becomes an identifier in all their VAT communications with the regulator and external parties they trade with. In addition to this obligation are the following requirements:

• Charging and remitting VAT on prescribed dates with a proper declaration in the form of the VAT return
• Ensure fiscalization of issued invoices takes place.

The intersection of VAT and cash management

Running an SME means growth (or survival) is the target. This inevitably makes cash a key determinant for keeping the light on and achieving the growth milestones. Depending on the industry and size of business plus applied business model, cash requirements increase at the rate at which new business is developed. Growth is a futile exercise without the push and flow cash brings. This places a dilemma for the registered operator who is required to collect and remit VAT.

The intention of the VAT legislation is never to allow the registered operator to generate excess cash from collected VAT nor to build VAT asset with refunds due from ZIMRA. While the intention is for the ZIMRA to collect consumption tax, VAT due is collected with the cash received for the supply making separating the cash inflow a discipline task more than it is a compliance risk.?

Conversely, a registered operator may suffer from immediate cash outlay on operational or capital purchases when they have insufficient output VAT to offset the input tax. This may result in them being in a VAT refund position where the ZIMRA owes them. Such loss of cash has both a cash delay consequence and follow-up costs which are part of the compliance and burden of proof quest for the ZIMRA to process the refund.?

It is imperative to look at the common VAT positions that an SME may find itself which require VAT compliance and cash management principles to be applied in unison.

Practical consideration 1 VAT due and Cash

As highlighted above, VAT due collected presents the temptation of utilization. VAT due collected represents a short-term obligation that should be settled in the prescribed time i.e., 25th day of the month following the end of tax period in which the VAT was collected. Essentially, this presents the SME with excess cash available for use up to the point the short-term liability should be settled.?

This, however, should be treated on a cash use basis with the business being able to answer the question: Is there sufficient cash generating activities in the next 25 days to allow for the utilization of these funds?? When the answer to this question is NO, the business risks non-remittance of the VAT resulting in interest on late payment of VAT due. The interest is charged at 25% plus 100% penalty i.e., 4 times higher than the amount utilized or 200% interest plus 100% penalty when the VAT due is in local currency. The interest and penalty make careless utilization of VAT due the fastest way to lose cash!

Oftentimes VAT due is triggered without any cash settlement. This creates the VAT obligation that requires settling within the prescribed time whether the consumer/customer has transferred cash for it. The SME will have to use cash from its operations to settle this VAT due. VAT is triggered by the earlier of invoice issuance or receipt of payment. Consideration for performance or the actual time the transaction occurs or transfer of goods and/or services is performed should also be made as this builds conditions for invoicing or indicates payment is now due whether an invoice is raised or not. Time of supply rules should be engraved in business terms around the supply of goods and services to customers so that the VAT trigger is in line with receipt of cash required to settle the accrued VAT debt.?

It should be noted that the VAT trigger varies according to the nature of the business one is conducting. For some businesses which supply goods and services that have lengthy periods of completion or delivery, it is wise to evaluate each transaction and structure it in ways that allow for VAT due to be closely linked to cash receipts.

Practical consideration 2: Type of supply and cash

The three types of supplies under VAT need to be considered when incorporating VAT into cash management. A registered operator who supplies all three supplies is presented with a peculiar challenge which requires attention to the tactical cash objectives in managing the impact of VAT. This challenge is sustained by the mechanics of computing VAT and spreading it only to the production of VAT-able supplies meaning cost wise, exempt supplies produced with inputs which have VAT claimable will be costed at full cost i.e., input VAT becomes an expense and cannot be claimed. Conversely, avoiding this by purchasing inputs from non-VAT businesses results in losing the portion that is claimable when producing zero-rated and/or standard rated supplies.?

Analysis is necessary to determine the best options available to a registered operator. Within the premise of VAT management for such a registered supplier is the need for the business to achieve VAT neutrality, i.e., the state in which no VAT obligation is created by carefully arranging the trading activities of the business resulting in no real impact on the cash available.?

VAT Neutrality = Output VAT – Input VAT = Zero (No cash impact)

In practice this feat is near impractical as value creation activities of the business are not designed to achieve this VAT ideal. Obviously, input VAT has twelve months in which one may claim it against output VAT but only this offers future cash flow benefits to the extent that the input VAT can be claimed. When future VAT-able revenue projections do not offer an opportunity to claim back the input VAT it is wise to claim it as a refund.?

Practical consideration 3: VAT refund and cash

This means one outlays cash immediately by purchasing supplies required then claim refund of the VAT component incurred on the purchase from ZIMRA. Refunds are subject to strict administration and verification by ZIMRA and until ZIMRA approves the refund it cannot be factored into the short-term cash expected. Even after approval of refund the actual refund may take anywhere between 45 to 90 days for actual receipt, in some cases the refund is indefinite. Placing the refund on the short-term cash projections can be counter productive and it is better one treats refunds as medium to long term receivables with a high risk of default.

VAT refund scenario is necessitated by both the type of supplies and nature/size of the register operator. These factors tilt the likelihood of VAT refunds to industries with outputs that are zero rated such as mining, agro-processors, and those operating as net exporters. Generally, and as discussed above, refunds are the order of the day when:

• SME supplies largely zero-rated supplies with VAT charged at 0%. All input VAT will be at 15% claimable while output tax will be at 0%.?
• The purchase of capital goods often incurs huge sums of input VAT. A registered operator has the benefit of claiming this VAT. Since this would be a substantial cash outlay, the input VAT for that period will often be more than the output VAT.?

Practical consideration 4: VAT on cross border trades and cash

Cross border trading activities are also charged VAT. The exporting of goods from Zimbabwe into an export country has VAT levied at 0% i.e., the registered operator charges VAT at 0%. There is no VAT collected in such export transactions, therefore do not accrue any excess cash benefit to the business in the form of VAT collected but yet to be remitted.?

Importing services attracts VAT on imported services which would ordinarily be standard rated should the service have been provided in Zimbabwe. This raises the cash outlay implication of paying this VAT. The same applies to importing goods in which a cash outlay is immediate. While the import VAT can be claimed the value of imports may place a business in a refund position raising refund implications discussed above.

Importing capital goods allows for deferment of import VAT payment. This has a direct impact on the cash management of the importing business as it defers the settlement of the import VAT by 90 – 180 days. When embarking on capital goods transaction arrangement a business should seek to see if it qualifies for this deferment and apply for it beforehand if the goal is to extend the runway and/or invest available cash into cash generating activities as opposed to settling an oftentimes huge VAT on import bill.

Conclusion

While doing business has the key objectives of achieving profitability and maintaining sustainability, taxes require compliance. Merging these goals into one is therefore not an afterthought nor should it be treated as such. Following this discussion, one can clearly see there is an opportunity to merge cash management with tax compliance. Every business or registered operator should consciously align these goals for maximum benefit of the scenarios they may find themselves in.