Liquidity Risks for Businesses
Regarding the aforementioned allocation issue, there is also a future risk for the businesses “benefitting” from such VAT holidays in the short run. The purpose of an accrual is to set funds aside for future obligations. By allowing businesses to delay the remittance of VAT, which will still be due at a later stage, does (or should) not release any cash. The principle of prudence, a basic principle of accounting, requires a business to record liabilities and expenses as soon as they occur.
VAT holidays do not take away the VAT liability, and as a result, an accrual for VAT cannot be released. Businesses are at risk of facing liquidity issues once the tax authorities resume collecting VAT. This, in daily practice, is how many first-time entrepreneurs go wrong — by not having the assets available to pay their taxes at a later date. If this results in bankruptcy, both the business that initially benefitted from a VAT holiday, as well as its suppliers, will be affected.
Short-Term Fixes with Long-Term Consequences
Ultimately, there is an element of unfairness in these measures at a time where solving issues collectively is more important than ever. As an example, many businesses in the medical industry are exempt from VAT and will not benefit from a VAT holiday the same way other companies will.
Although VAT holidays are intended to be a short-term fix, they could have consequences lasting long after COVID-19 subsides. Instead, governments should look to provide economic relief measures that help stimulate the economy during and after times of crisis.
Please remember that the Tax Matters provides information for educational purposes, not specific tax or legal advice. Always consult a qualified tax or legal advisor before taking any action based on this information. The views and opinions expressed in Tax Matters are those of the authors and do not necessarily reflect the official policy, position, or opinion of Vertex Inc..