For those of us in business we know and understand that it is very vital to safeguard our most valuable assets which generate income. Accordingly, one of the modest means usually employed to guard against risk or loss of an asset is insurance. Insuring assets provide some form of guarantee and comfort that if the worst event happens there is some degree of compensation or replacement. However, some business operators tend to face a predicament on how to treat such compensations for Value Added Tax (VAT) purposes. Allow me to provide you with some insightful detail that can help VAT registered operators deal with insurance compensation.
I must say, VAT is one topic that appears to be unpretentious, yet it requires one to be diligent when it comes to dealing with some of these uncommon and nonrecurring business transactions. Regarding the gist of our discussion i.e., VAT treatment of insurance compensations, the rule of thumb would be…Yes, it does have VAT implications. One might query why such a transaction would trigger VAT when in substance it’s just a mere a compensation for a loss or damage. To bring clarity, let us first have a look at a few basic principles and fundamentals of the VAT cycle before we get to the technical provisions of the law.
The basics
Primarily, it is crucial to note and understand that VAT is an indirect tax which technically means that the tax bearer is not assessed directly by ZIMRA rather, the assessment is done indirectly through transactions entered by various parties. Put simply, VAT is borne by the final consumer of goods or services therefore a VAT registered taxpayer in the value chain is simply a conduit for tax collection. Ideally most transactions conducted ang engaged by VAT registered operators are predominantly subject to VAT as they are the comer stone of the VAT collection system. Let us have a look at what the law says about insurance compensation.
The Law
The VAT Act provides that a VAT registered operator should account for VAT in respect of payment received for insurance compensation. Further, the Act provides that the compensation received is deemed to be payment received for a supply of services performed. Accordingly, the output tax is determined based on applying the tax fraction (14.5/114.5) of the amount received. Essentially, where the compensation amount is utilised towards the replacement of the damaged goods this transaction becomes neutral as an input tax credit can be claimed on the acquisition of replacement goods.
Conversely, where the compensation amount is channelled towards other purposes that do not result in a transaction providing an input tax claim, the output tax paid on receipt of the amount technically becomes a claw-back of input tax claimed on the acquisition of the damaged goods.
However, output VAT need not to be accounted for on a compensation that relates to an asset or goods which did not qualify for an input tax deduction e.g., passenger motor vehicle. Accordingly, VAT charged on a purchase where input tax claims are prohibited the purchaser is ultimately the final consumer and therefore VAT paid is final. Thus, no need to account for output tax when insurance compensation for the respective goods is received.
Conclusion
VAT payable on insurance indemnity payments technically completes the VAT cycle. As such, where indemnity payments are utilised on replacing the damaged assets, VAT becomes neutral in the sense that input tax can be claimed on the acquisition of a replacement. On the other hand, where the damaged asset did not qualify for an input tax deduction, no output tax need to be paid on receipt of the insurance compensation.