VAT apportionment and credit notes at a mixed-retail chain
LankaMart (Pvt) Ltd operates a supermarket chain and is VAT-registered. For the month of June 2026 it reports total supplies of LKR 280 million: standard-rated groceries LKR 180 million, zero-rated exports of tea and spices LKR 40 million, and exempt rice, fresh vegetables and plain bread LKR 60 million. Input VAT invoices for the month show: LKR 12 million directly attributable to standard-rated supplies; LKR 3 million directly attributable to zero-rated exports; LKR 2 million directly attributable to exempt supplies; and LKR 6 million of common input VAT relating to rent, utilities and administration. The company also issued a credit note in July 2026 for LKR 5.4 million, VAT-inclusive, to a corporate customer for standard-rated goods overcharged in June. The prevailing VAT rate is 18%. The finance manager has claimed all input VAT except the LKR 2 million directly attributable to exempt supplies, arguing that zero-rated exports are outside the scope of VAT.
1. Compute LankaMart's net VAT payable for June 2026. Show output VAT, each input VAT pool, and the apportionment of common input VAT. State any assumption about the apportionment method.
Read the worked answer
Output VAT arises only on standard-rated supplies: 180m x 18% = LKR 32.4m. Zero-rated exports carry 0% VAT, and exempt supplies carry no output VAT.
Input VAT is treated by pool:
- Directly attributable to standard-rated supplies: LKR 12m, fully deductible.
- Directly attributable to zero-rated exports: LKR 3m, fully deductible because zero-rated supplies are taxable supplies at 0%.
- Directly attributable to exempt supplies: LKR 2m, not deductible.
- Common input VAT: LKR 6m, apportioned between taxable and exempt supplies.
The assumption is that the accepted apportionment basis is the turnover ratio of taxable supplies (standard-rated plus zero-rated) to total supplies: (180 + 40) / 280 = 220 / 280 = 78.571%. Deductible common input VAT is 6m x 78.571% = LKR 4.714m. The remaining LKR 1.286m is attributable to exempt supplies and is not deductible.
Total deductible input VAT = 12 + 3 + 4.714 = LKR 19.714m. Net VAT payable = 32.4 - 19.714 = LKR 12.686m.
If the company uses a different justifiable apportionment method accepted by the Commissioner General, the common input recovery and net payable would change. The LKR 2m exempt input and the non-deductible common portion should not be claimed.
2. Explain the correct VAT treatment of the July credit note, including the period of adjustment and documentation. Does it change the June return?
Read the worked answer
The credit note relates to standard-rated goods overcharged in June. It reduces the taxable value and the output VAT of LankaMart. The VAT element of the LKR 5.4m VAT-inclusive credit note is 5.4m x 18/118 = LKR 0.8237m. The net sale reduction is LKR 4.5763m.
The general rule is that the adjustment is made in the tax period in which the credit note is issued, here July 2026, not by reopening the June return. The July output VAT is reduced by LKR 0.8237m, and the customer should reduce its input VAT by the same amount if it has already claimed it. Reopening June would be appropriate only if the tax law permits an error correction or a revised return within the allowed time, and the company should not simply amend June without checking the rules.
The credit note must be serially numbered, dated, identify the original invoice, state the reason for the credit (for example overcharging or returned goods), show the value excluding VAT, the VAT amount and the total, and be cross-referenced to the customer. The company should retain the credit note and proof of issue. If the credit note is issued after the customer has claimed input tax, the customer's records must be adjusted to avoid understating VAT payable. The June return itself remains unchanged unless a formal correction is made.
3. Critique the finance manager's argument that zero-rated exports are outside the scope of VAT. How should zero-rated and exempt supplies be treated in the apportionment?
Read the worked answer
The argument is wrong. Zero-rated supplies are taxable supplies charged at 0%, not supplies outside the scope of VAT. That distinction matters because input VAT directly attributable to zero-rated supplies is deductible, as is a fair share of common input VAT. If zero-rated exports were treated as outside the scope, the company would lose input tax recovery on export-related costs and would overstate VAT payable.
Exempt supplies are different. They are outside the charge to VAT, and input VAT directly attributable to them is not deductible. Common input VAT must be apportioned so that the exempt portion is excluded. In a turnover-based apportionment, zero-rated supplies belong in both the numerator and the denominator because they are taxable supplies, while exempt supplies belong only in the denominator. Using the figures: taxable supplies are 180 + 40 = 220; total supplies are 280; the recoverable percentage is 78.571%. If the finance manager excludes zero-rated exports from the numerator, the recoverable percentage falls to 180/280 = 64.286%, which would understate input recovery and overstate VAT payable. If the manager also claims the LKR 2m exempt input, that would overstate recovery. Both errors should be corrected, and the apportionment method and calculations should be documented for audit.