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Despite recent debates and public discontent in relation to the enforcement of value-added tax (VAT), a large segment of the population that earns low wages enjoy exemptions on basic needs such as housing, grain, flour, injera, bread, and milk and the cost of healthcare, education, transport, and utilities, writes MAMMO ABDI, a tax and customs affairs advisor to the deputy general of the Ethiopian Revenues and Customs Authority (ERCA).

VAT System Fuels Growth, Benefits Poor

 

Talking about tax is usual among people in the developed world, while the collection of the taxes commensurate to the economy is a serious concern of countries.

Tax is a source of revenue to meet the ever-growing needs of citizens and also ensures political and economic stability that all citizens at all levels benefit from and equally share.

Nowadays, tax is widely discussed as a serious agenda in Ethiopia. This has never happened before. It is not as if some people view it as a threat to the business community. Rather, it is a sign of a positive change in the public's attitude towards tax obligations.

Understanding tax as a civil duty is the foundation of voluntary compliance with tax laws, whereby all citizens pay tax from their economic activities on their own initiative. The government’s commitment to inform the public about tax obligations exhibits an effort to release the country from financial dependency on aid and foreign loans. It is the right path toward sustainable national economic development, and many of the advanced nations have gone through it.

The very few types of major income taxes applied in Ethiopia’s tax system include employment (income), rental (capital gains), and profit (corporate) taxes from formal economic activities. On the other hand,consumption tax, levied on purchased items, comprises value-added tax (VAT) and turnover tax (TOT).

The number and types of taxes in the country are very limited when compared to the rest of the world. Most of the taxes are very common ones. Other countries have many taxes imposed on their citizens for pollution, inheritance, and property.

The principal difference between income and consumption taxes is that principal tax is derived from any economic activity above the legally limited threshold, while consumption tax is levied when one spends one’s money. So it is sometimes called expenditure tax because, unless one spends, one is not liable to be taxed.

VAT is one of the major consumption taxes that came into operation following the national tax reform that was launched 10 years ago. It is a broad based tax, which has made significant changes in the process of mobilising revenues for the state.

The federal government collected over 13 billion Br in VAT last year, according to a report by the Planning Directorate of the Ethiopian Revenues and Customs Authority (ERCA), in July 2010.

The VAT system is not only a means of collecting state revenue but also stimulates investment and trade in the economy and supports the low-income segment of the population.

The tax has not imposed a burden on the majority of consumers, as a wide range of products (bread, injera, milk, and all types of grain and flour) and services (utilities) have been left out of the scope of the tax system, mainly to avoid or neutralise the regressive effect of tax. The result is the VAT system enjoying the full support of people with low earnings.

All imports meant to be used for agriculture (seeds, chemicals, and fertiliser), transport, health and education services, and housing are exempt from VAT, but this appears to be disregarded by most people.

Contrary to the practice in some countries, Ethiopia’s VAT system provides credit for any kind of capital expenditure related to business activities. VAT paid for the purchase of capital assets are credited or offset against the output tax that is collected by the business. It also allows for crediting taxes paid on the purchase of raw materials and services, including administrative expenses.

VAT is not charged on export supplies of goods and services; it is rebated to the exporter after shipping the goods overseas. This is intended to promote export trade as it plays an important role in the economy.

The generosity of the country’s VAT system, in comparison with that of other countries, has been pointed out by some donors. Most of the tax base is exempted, forgoing considerable portions of revenues, resulting in its inability to significantly fill the budget deficit, they argue.

Despite this form of tax having been well managed by both suppliers and consumers for the past eight years, voices against VAT have recently been heard. The timing of the critics is more surprising than their arguments as the tax rate has not been changed for about 10 years. The state, considering the impact of inflation caused by global financial crises, has exempted basic food items from VAT, which has helped the lower income sector tremendously.

The latest outcry against the enforcement of VAT may have something to do with the measures taken to organise a tax data system useful for development and at the same time to ensure a fair tax administration.

As the ability to access data for tax assessment is the fundamental requirement for a good and fair tax system, the state issued a law that forces businesses to use electronic cash register machines. Its use enables tax authorities to compile data on the real-time transactions undertaken by taxpayers.

A number of businesses have been evading tax for a long time and the tax authority was unable to access accurate data in its bid to determine the proper tax amount. The new technology makes data for all sales accessible and will help to limit evasion and fraud and ensure a fair tax system.

Quite a number of businesses had never paid the tax collected from the consumers on the state’s behalf, but, following the enforcement, they began to seriously collect VAT. Although the machines have nothing to do with the VAT rate, which has not been revised, some taxpayers have increased their prices in an attempt to compensate for the amount of tax that used to be evaded before.

In some cases, it was not only because the businesses did not know how to determine the tax. It had been long enough since its introduction, and both the suppliers and the consumers were well practiced in it from their day-to-day transactions. It was well understood that most of them were able to assess the tax in accordance with the law.

However, a few consumers, without a thorough understanding of how the system worked, bitterly complained.

VAT has different methods of computation, but Ethiopia’s system was designed to be invoice based for simple calculation and lodging of the tax with the authority. It is a mere deduction of invoices issued for output tax against invoices paid for input tax. Invoices are thus crucial for the VAT system, without which it would remain non-functional.

The taxable base is the newly created value at any stage of production or service. The newly created value multiplied by the VAT standard rate equals the net VAT rebated to the tax authority.

However, some businesses may miscalculate and increase the margin by again adding the input VAT, which could be credited from the output tax (collected tax). Accordingly, the tax charged from the consumer will relatively increase and the input tax, which should be counted as a credit, is included as a cost.

Whether this is done intentionally or not is unclear, but it could be considered part of a profit margin or new value, which is later subject to VAT. This is not the right method of assessment, according to the tax law and neither does the state want to collect more taxes in this manner.

VAT registered taxpayers, including new ones, need to become more familiar with the self assessment method to comply with the system. More effort should be exerted to upgrade the knowledge of registered businesses, the authority admits.

However, being aware of the adverse situation caused by some businesses, consumers at large should defend their interests and fight price escalation, perhaps in the form of consumer associations. The other advisable defence against the unfair rise in prices is to choose suppliers with fair prices, as all businesses are not skyrocketing prices for consumable goods.

It is obvious that consumers who can afford to enjoy goods and services in a relatively higher range, pay VAT. The largest segment of the population does not complain about VAT; the regressive effect of the tax has been well addressed by providing a wide range of tax exemptions.

What would be a significant danger is if the tax induced distortion occurred in terms of the mobility of factors of production. This has not happened; for almost two planning periods, since the inception of the tax regime, agricultural and manufacturing industries have registered growth due to the privilege of tax credit for capital assets.

The tax system thus serves as an incentive tool for the promotion of important economic sectors.

Not all taxpayers collect VAT. It is only businesses whose annual turnover exceeds half a million Birr that are eligible for VAT registration. Taxpayers whose turnover is below the threshold collect TOT at the rate of two per cent for goods and 10pc for service provision. 

Although the VAT law imposes the obligation to register as businesses’ turnover attains the legal threshold, a great number of taxpayers are not willing to voluntarily register. These include certain restaurants, cafés, hotels, goldsmiths, and retail shops, which cause distortions in some supplies of goods and services with less backward linkage effects of input taxes.

Tax authorities conduct enforcement to bring the nonregistered taxpayers into the tax net. This is intended to avoid market distortions caused by the different prices between the registered and the nonregistered taxpayers.

However, they should do more to eliminate the adverse effect of this in the system and to avoid such challenges.The business community should also do its part, by voluntarily approaching the tax authority.

The rise in prices of some service providers in the hospitality industry, such as cafés and medium sized restaurants, can be mainly attributed to different kinds of enforcement. As a result, a number of businesses began to use electronic cash registers to tax all supplies and those out of the tax net were forced to join the system.

The imposition of VAT on food in cafés and restaurants is objected to by some people. However, food served in cafés and restaurants contain some kind of integrated services, which is subject to VAT or TOT, because the café or the restaurant does not only provide mere food.

TESFAYE KIDAN (PhD) (tesfayekidan@gmail.com),
 An economist and independent consultant in Addis Abeba.

 
 
 
   
   
   
 
 
 

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