By Kalima Nkonde
The Zambian government’s intention to replace VAT with sales tax may be a well-intentioned decision and done in good faith. However, the majority of tax and financial experts agree that the planned change from VAT to sales tax is a leap in the dark which comes with immense risks. It is generally agreed by experts that there are less costly options that Government could have explored.
This article touches on some practical problems that are awaiting ZRA, the Private sector, the economy at large and the Zambian consumer. It also suggests alternatives which are less disruptive to the proposed one and also calls for some delay, and serious introspection before sales tax is implemented.
The Zambian Government wants to switch over back to sales tax because according to the finance Minister’s budget speech: “VAT works better when you have an economy that has a strong manufacturing base. But we don’t have it! We are in constant refund and it cannot work now. We have to grow the manufacturing base because that is the sector that needs that support of a VAT refund. Right now, VAT is a subsidy and we are in austerity – we can’t afford subsidies. It is as simple as that. So, 1st April sales tax comes into play”.
The VAT system was introduced 23 years ago by the MMD government on 1st July 1995 to replace sales tax. The VAT system had served various administrations since then very well, until recently, it appears. Some of its major advantages include the following: the fact that it is invoiced based, it is therefore not a complex tax and makes it easier to collect tax, it is also a fairer tax as it avoids levying tax on tax, and it has potential to promote exports as well as the domestic manufacturing industry. VAT also provides for a wider tax base.
The above advantages are still very compelling and therefore it very curious that Zambia wants to switch over purely due to low manufacturing base and excessive refunds. It is crucial that before the government implements the new system, some of the costs and the disruptions that will be caused by the changeover are considered.
The costs, disruptions and economic impact of VAT abolishment
The implementation of sales tax comes with immense risks to the Zambia revenue authority as an institution. In addition, there are risks of increased cost of doing business, increased cost of living for Zambian consumers and general inflation, increased unemployment, may affect foreign investor sentiment and generally dampen the economic growth and delay Zambia’s economic recovery. One hope that all these facts and risks were considered and some sensitivity analysis done when the decision was made.
First and foremost, there will be need to set up a new administrative regime by Zambia Revenue authority for sales tax which will be difficult and costly as Zambia does not have the experts on sales tax. ZRA staff simply does not have the institutional memory of the sales tax regime nor is there a ready benchmark in the region to use. The issues of who is to pay the tax, which goods and service to charge sales tax on, what will the rate be, which goods will be exempt etc. will need to be figured out within five months
Secondly, there is the issue of accounting systems. Vat is an established tax and Zambia revenue Authority has accounting software which will need to be replaced with a Sales tax system. The new software could cost as much as $25million and the old VAT system will have to be thrown in the dust bin. In addition, the private sector will also have to install new accounting systems to account for VAT. They will require new software to change to the new sales tax systems and this will cost them money.
The negative impact on employment both at ZRA and the private sector should not be underestimated. ZRA employees has a large number of staff handling the VAT tax regime and these will not certainly be needed considering that activities like vat audits for refunds will not be required and so these employees will have to be retrenched. The private sector on the other hand will have to retrench some of its staff for variously reasons including the increased cost of business that sales tax will entail. Employers will consider cutting costs and employees will have to be the first target. Job losses should not be ruled out as a result of Sales tax.
There will be need to train staff at ZRA and in private sector on the operation of the new sales tax system and there are simply no expertise on the market who understands the sales tax system as it was discarded twenty three years ago.
The issue of inflation and consequently increased interest rates should not be underestimated. There is no doubt that Sales tax will increase the cost of doing business in Zambia especially as it will result in tax on tax as as all business inputs will not be recoverable and businesses will have to increase their prices and this will be contribute to increased inflation.
The Sales tax Bill has proposed a 9% Local Sales Tax and 16 % on Imports which will replace the 16% Value-Added Tax currently used on 1st July. In the past under VAT consumers used to pay 16% regardless of the value chain. Under the Sales tax regime, the longer the value chain, the higher the tax paid.
In order to put the impact on sales tax on the Zambian consumer/ voter, here is a scenario. Under the sales tax regime, if a Zambian manufacturer imports raw materials he will pay 16%, on selling to a wholesaler, 9% local sales tax will be levied, when the wholesaler sales to a retailer, 9% will be levied and when a retailer finally sales to the consumer, 9% will be charged. This means that the Zambian final consumer- the farmer, villagers, informal sector worker, they will be paying 41% tax instead of 16 % VAT. In the case of certain Zambians workers who are paying Pay and as you earn (PAYE) at the top rate of 35%, the total effective tax on their income would be 76% without taking into account all sorts of levies. The sales tax is not a smart tax to introduce from the social, economic and political view, especially when a general election is on a horizon
Zambia will be the only country in SADC and possibly COMESA region to have a sales tax system and this may influence foreign investors in their decision to locate their companies. The country will be less competitive as a destination for foreign investors in comparison to our neighbours.
There is no question that the current VAT system has been abused by the private sector especially the multinational companies and excessive refunds have been made by ZRA as pointed out by the Commissioner General, Kinglsey Chanda sometime ago.
“I wish to inform the nation that our vigilant audit teams discovered some fraudulent refund claims. This discovery prompted us to take a more cautious approach when paying refunds,” he said
In November, 2017 according to ZRA Commissioner General Kingsley Chanda, Zambia Revenue Authority (ZRA) paid out over K4 billion in values added tax (VAT) refunds to the mines and other sectors in six months. Mining companies were paid 76% of the amount, while the remainder paid to other sectors of the economy. It is estimated by some experts that the Zambian Government pays over a billion US dollars in terms of refunds per year with the mining industry getting approximately US$700million and the rest get $300million.
Options to VAT abolishment
The analysis of the problems that Zambia faces with VAT administration reveals that the bulk of refunds goes to the Mines, and two, ZRA has cash flow problems in making refunds and three, there is widespread fraud in VAT refunds claims. It follows, therefore, that these are the problems that should be addressed rather than switching to the risky sales tax which may result in negative effects on the economy may even result in less tax collections. Sales tax may do more harm than good to the overall economy.
First and foremost, the government should revise the VAT Act. The act should exempt all traditional exports like copper, cotton and tobacco. The main rationale behind the current legislation of Zero rating exports is to promote exports by making them competitive but mining exports for example, cannot be promoted through VAT because prices and demand for copper are determined at the London Metal Exchange and other international markets. Zero rating exports should, therefore, be targeted and reserved for Non- traditional exports.
Alternatively, since the VAT refunds have largely been claimed mining houses (estimated at 76%,), the easy way out could be Zero rate both the input and output of the mining industry unlike now where the Output (exports or sales) is zero rated but the input (imports and whatever they mines use in production) is standard rated at 16% and thus are able to claim refunds,
Thirdly, there is need to improve the cash management of VAT in order to avoid the cash flow problems that ZRA faces. It is advisable that in order to avoid having VAT arrears, the introduction of prudent accounting practice by ensuring that VAT funds are not comingled with other taxes but banked in separate bank account accounts will be a solution to the refund conundrum.
The issue of VAT refund fraud is a major problem but other countries have found solutions to it. One of the most efficient Tax authorities in Africa is South Africa Revenue Service (SARS). They are sophisticated and have minimized VAT fraud. It would be advisable for ZRA to send a study team to SARS to go and learn tricks on how to catch the cheats as SARS have immense experience in a more sophisticated economy.
In the event that the Government still wants to go ahead with Sales tax, it may be advisable for them to shelve the whole decision for a year or so. On the basis of the author’s experience in a foreign country as an Advisor, when major policy decisions with immense impact on the economy were at hand, studies were conducted and widespread consultation made in order to make informed decisions. The knee jerk approach to major economic decisions can be disastrous and embarrassing when reversals are made. It may be advisable for the government to commission an independent study by professional consultants to carry out an in- depth analysis to address some of the issues raised in this article and by others. Thereafter, an informed decision could be made after serious consultations with stakeholders and the people in the know.
The advice to government is that VAT is a good tax regime and should be retained. The areas that have been the cause of the problems should be addressed. The costs of switching from VAT to Sales tax far exceed the benefits. The risks are also immense. If Sales tax is implemented against all advice from experts, it will join the long list of economic own goals or unforced errors committed by the current administration- to use football and tennis analogies- which have resulted in the mess the Zambian economy is today. The abolishment of VAT and replacing it with Sales tax is tantamount to the proverbial “throwing the baby with the bath water”.
The writer is a Chartered Accountant by profession, a Private Sector Development expert and an Enteprenuer. He is an independent finance and economic commentator/analyst and a Patriot.