In August 2018, we had the first glimpse of how the Ministry of Finance was planning for the 2019 National Budget through the publication of the Medium Term Expenditure Framework and 2019 Budget. In particular, the Government proposed to increase domestic Value Added Tax (“VAT”) collections by K2 billion in the 2019 projections, a 50% increase over the 2018 collections. This was substantial. Speculation about restricted inputs or an increase in the VAT rate engulfed the business community. On 28 September 2018, Honourable Margaret Mwanakatwe, the former Minister of Finance, announced that the VAT regime would be abolished and a new Sales Tax would be introduced, effective 1 April 2019.
‘Mr Speaker, the need to enhance domestic revenue mobilization cannot be overemphasized. Government has, therefore, undertaken a review of the various taxes currently being implemented with a view to improve their contribution and minimize revenue leakages. To this end, the Government proposes to abolish the Value Added Tax and replace it with a simpler and non-refundable Sales Tax. 195. Sir, as we implement the new tax, the Government, through the Zambia Revenue Authority will finalize audits of all outstanding VAT refund claims and enforce all outstanding VAT assessments in order to collect any unpaid taxes. Government also remains committed to settling the verified VAT refund claims that have so far been accumulated’
Sales Tax? Nobody thought we would have Sales Tax again; this was last tested in Zambia in the pre-economic liberalization era. Little detail has emerged about the proposed Sales Tax administration. Uncertainty in the implementation of Sales Tax and details of the administration have concerned taxpayers. Many taxpayers don’t understand why a consumption tax abolished in 1995 would be reintroduced. Is it better or worse than VAT?
I will write a series of three articles in which I will discuss:
1. Main features of VAT and its implementation globally and in Zambia;
2. Sales tax by design; and
3. The verdict – ‘Sales Tax or VAT?’ with the hard facts.
The purpose of any tax reform is to optimize the principles of a good tax regime which include equity, simplicity, certainty, predictability, and efficiency (Osoro,2013).
The OECD (2018) Consumptions Tax Trends report states that many developing countries have introduced VAT within the last two decades to replace lost revenue from trade taxes following global trade liberalization. In the European Union (“EU”), VAT is directly associated with the development of its internal market. The EU adopted a common VAT framework to remove the trade distortions caused by cascading effects of indirect taxes and to facilitate the creation of a common market.
Currently, 35 out of the 36 Organisation of Economic Co-operation and Development (“OECD”) member countries have adopted and maintained a VAT regime. The United States has maintained a retail sales tax regime. It is important to note that Zambia is not a member of the OECD but has adopted principles and guidelines that govern our tax legislation from the institution. The United Nations Member States (including Zambia) consists of 193 countries, of which only 41 Member States do not implement VAT (UN, 2018). By contrast, a handful of countries have introduced and maintained sales tax and this will further be discussed in the subsequent article.
Whilst there is wide diversity in the way VAT systems are administered across different jurisdictions, VAT can be defined by its specific purpose and tax collection mechanism. The OECD highlights the key features of VAT. VAT is a tax on final consumption. VAT administration occurs through a stage collection process, this means that tax is collected through a staged process on the value-added at each stage of production and distribution. Businesses collect VAT on the value of their outputs from their customers and are entitled to deduct the tax they have paid on purchases and must account and remit the difference (or receive a refund from ) to Zambia Revenue Authority (“ZRA”). In this respect, VAT differs from Sales Tax which requires the supplier to pay on taxable purchases and charge on taxable sales. There is no credit mechanism under the Sales Tax. Finally, VAT is neutral. In principle, tax is only collected on the value-added at each stage of production or distribution. This gives VAT its essential character as an economically neutral tax. The full right for a business to deduct input tax through the supply chain ensures the neutrality of the process, whatever the nature of the good or service (OECD, 2018).
From a review of OECD member countries, standard VAT rates have evolved over the past five decades progressively increasing from 15% to approximately 27%, depending upon the jurisdiction. Although major differences in standard rates are still observed globally with rates ranging from 5% in Canada (where some Canadian provinces levy sales tax) to 27% in Hungary. VAT regimes make extensive use of exemptions in order to reduce rates. In this context, exemption means that the supplier does not charge VAT on its outputs, and as a consequence, has no right to recover its VAT on its related inputs. A wide variety of motivations exist for the application of VAT exemptions, including the difficulty to determine a tax base or the desire to exclude activities from the VAT base that are considered a public service or as serving a purpose of the general and/or social interest such as foodstuffs and healthcare. In addition, certain sectors that are exempt from VAT may be subject to specific taxes (e.g. insurance and financial services).
To quickly recap, I have briefly explained, from a global perspective, why VAT became popular over the past 20 years, the core features of VAT and the applicable rates and exemptions.
With this basic knowledge, it would then be useful to understand how VAT has performed in Zambia, and whether it has served its purpose, and achieved the principles of a good tax system.
VAT performance can be measured through different methods but most commonly a VAT Revenue Ratio (“VRR”) is used to provide a comparative measure of a country’s ability to effectively secure the potential tax base for VAT (OECD, 2018). The VRR measures the difference between the VAT revenue actually collected and what would have been theoretically raised if VAT was applied at the standard rate across the entire VAT tax base. For example, a ratio of 1 in Zambia would mean that the ZRA has managed to collect the VAT revenue equivalent to 16% of the VAT tax base. Across OECD countries, the average VRR has remained relatively stable over the past decade ranging from between 54% and 57%. This means that on average 44% of the theoretical potential VAT revenue is not collected. The main fundamental difficulty with the VRR is the assessment of the actual VAT tax base because this may include mixed suppliers, exempt suppliers, and individuals.
OECD research suggests that the closer a VAT system of a country is to a pure VAT, the closer its VRR is to 1. A lower value reflects factors such as the effects of reduced rates, exemptions, and failure to collect tax due. Further, the OECD highlights the factors that would negatively or positively influence the VRR. These include:
Lower VAT rates to specific goods and services would reduce tax revenue and negatively impact VRR.
Exemptions may reduce the tax revenue (when exemptions are applied directly to goods and services supplied to final consumers like health care) or may increase revenue where the exemption occurs early in the supply chain.
Final consumption by Government is the second largest final use after household consumption, because Government activities are exempt from VAT. As a result, Government bodies cannot deduct input VAT paid on the taxable expenditure, nor can suppliers account for the VAT on their revenues from Government bodies.
The capacity of the tax administration to manage a VAT system efficiently and the degree of compliance by taxpayers influences the VRR as low compliance has a negative impact on actual VAT revenue
Failure of a tax administration to operate an appropriate VAT refund process (with timely refunds of excess input-VAT credits to domestic business), which is contrary to the fundamental principle of VAT-neutrality, may influence the VRR upwards for the wrong reasons.
Countries are increasingly implementing measures to broaden the tax base for revenue collection and reduce revenue loss through fraud. This includes alternative collection mechanisms such as domestic reverse charge and split-payments in sectors that are particularly vulnerable to fraud, real-time VAT invoice reporting, and electronic data transmission requirements; and enhancing the international administrative cooperation in the area of VAT (OECD, 2018).
I have identified that tax reforms are intended to provide efficiency and fairness. Fairness means equity, wide sincere stakeholder consultation, and opportunity for growth.
The World Bank ranks Zambia as a developing country with high levels of poverty and inequality. Conversely, Zambia is resource-rich and is one of the world’s largest copper and cobalt producers (Worldbank, 2018).
VAT was introduced in Zambia in 1995 at a rate of 20%, replacing sales tax. The regime eventually evolved to incorporate the three categories of VAT including standard rates, zero rate, and exempt supplies. The current standard rate is 16% for companies with an annual turnover in excess of K800,000. Over the years, measures have been applied to achieve simplicity, certainty, equity, and efficiency. The monitoring mechanism of VAT through the staged collection process and input/output returns has allowed ZRA to predict and manage revenue collection. This accrual method permits business owners to predict and budget their cash flows. Furthermore, the use of Electronic Fiscal Devices initiated in 2018 consented ZRA to further monitor the performance of VAT and detect fraud. Approximately a quarter of a century later, the disparity in VAT global trends between Zambia and the rest of the world is thin.
A key mitigating measure of the costly effects of VAT on poor families is the exemption of basic foodstuffs, education, and health care. Statistics show that poverty has reduced in Zambia by 2 % from 2010 to 2015 (Worldbank, 2018). However, the extent of the levels of poverty are not documented sufficiently, indicating that social development programmes cannot be fairly assessed.
Besides the increase in revenue collection, VAT was pioneered to promote business growth in line with the loosening of economic and political restrictions. Benefits of the VAT regime have been studied by various global institutions including a World Bank analysis of the growth of Zambia’s business environment that has shown that 80 percent of private-sector business in Zambia is conducted by enterprises with fewer than 50 employees. Most of these businesses are small informal operations, with less than five employees.
In spite of this, little is known about how these businesses perform and the constraints under which they operate, As a result, policymakers might induce misinformed policy changes.
In May 2019, the former Minister of Finance, Margaret Mwanakatwe addressed business leaders and advised that the change in tax regime was necessitated to stop “debt escalation”. In addition, the former Minister advised that it was necessary to “increase revenue collection to support the government’s social development programmes”.
So the question I ask is did a poor performing VAT regime cause the debt escalation and why? In addition, will the abolishment of VAT be the answer to an increase in revenue collection for the Government?
Subsequent articles will address these questions.
The author is a BSc holder and Member of ACCA and ZICA, is a Tax Manager at KPMG Zambia. The views expressed in this article are her own and not necessarily those of KPMG
Osoro N.E, 1993, Revenue Productivity implications of tax reform in Tanzania, AERC research paper 20, Nairobi
UN (2018), Value Added Tax country review Available at: https://library.un.org/unms (Accessed: 1 July 2019)
World Bank (2017) Systematic Country Diagnostic report. Available at: http://documents.worldbank.org/curated/en/290011522954283481/pdf/Zambia-SCD-March-29-Final-04022018.pdf (Accessed on 22 June 2019)
OECD (2018), Consumption Tax Trends: VAT/GST and Excise Rates, Trends Policy Issues, Consumption Tax Trends, OEC Publishing, Paris. https://doi.org/10.1787/ctt-2018-en
ZRA (2013), 2014 Annual report. Available at: https://www.zra.org.zm/manageUpload.htm?ACTION_TYPE=view&CIRCULAR_KEY=REPORT&DOC_ID=999000000001591 (Accessed
ZRA (2017), 2017 Annual Report https://www.zra.org.zm/manageUpload.htm?ACTION_TYPE=view&CIRCULAR_KEY=2017%20ANNUAL%20REPORT&DOC_ID=999000000005561
Medium Term Expenditure Framework and 2019 Budget
Medium Term Expenditure Framework and 2015 Budget
Bank of Zambia (2013), Issues on the Zambian Economy, The BOZ Reader, Vol.1 No. 9
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