Should the rate increase, when and how? – TheNigerialawyer

Tayo Ogungbenro, Elizabeth Olaghere and Busayo Amoo

On September 11, 2019, the Federal Executive Council approved an
increase in the rate of Value Added Tax by 50 per cent. The Federal
Minister of Finance, Mrs. Zainab Ahmed, later explained that the
new rate would only become effective after approval by the National
Assembly. One can assume that the Federal Government is using the
opportunity of seeking approval from the lawmakers in order to
build consensus since the enabling legislation empowers the
minister to amend the rate. Thus, in the event that the new rate is
‘approved’, taxable persons will soon be required to charge and
account for VAT to the Federal Inland Revenue Service at 7.5 per
cent.

VAT was introduced in Nigeria in 1993 and had been chargeable at
five per cent. The Federal Government had tried, on various
occasions, to increase the rate. On each occasion, the public
vehemently resisted it. Indeed, in 2015, the Federal Government
doubled the rate to 10%, but retracted due to public outcry.

There is however no doubt that there is an urgent need for the
Federal Government to shore up its revenue base if the country
would not be plunged into a debt trap very soon. The current budget
deficit is not sustainable. There are strong indications that the
country currently borrows to finance recurrent expenditure, thereby
putting developmental programmes in jeopardy. One can therefore
understand the dilemma of the Federal Government to increase tax
revenue especially from the non-oil and gas sector as a basis for
diversifying the economy. The continuous dependence on oil and gas
as the mainstay of the economy is no longer tenable since the
country does not have monopoly over the price of crude oil.

However, the fundamental question then is, why does the general
public resent increment despite the fact that the current rate of
five per cent is one of the lowest in the world? Is the impact on
the majority of the people that significant? If the current rate
has been in use for more than 25 years, when will it then be
appropriate to increase the rate to align with the rest of the
world? Is there an approach that government can adopt to achieve
the same objective without further impoverishing the populace?

Nigeria’s VAT system is unique. It is more of a sales tax than
typical VAT available in most countries. Typical VAT is a tax
imposed on value added along the production value chain. It permits
recovery of a similar tax incurred on input goods and services
while the taxable person remits the positive difference to the
government. In most countries, government refunds the deficit.

Nigeria’s VAT system is however everything other than this
typical model. It only permits recovery of input VAT on tangible
goods supplied or used to manufacture items in respect of which
output VAT is collectible. The law does not permit recovery of
input VAT incurred on cost of services, overhead and fixed asset.
Thus, service providers or suppliers of other non-tangible items
are not permitted to recover any form of input VAT from the output
VAT. The Nigerian economy is however dominated by the service
sector. This implies that the bulk of VAT collectible in the
economy is remitted in whole to the Federal Inland Revenue
Service.

The refund system is also extremely complex and onerous. The law
requires the FIRS to audit the tax and accounting records of
taxable persons who apply for refund to confirm the veracity of the
claims. In addition, the law requires the Accountant General of the
Federation to include it in the national budget before cash can be
released. Thus, in most instances, taxable persons in refundable
positions simply write it off as part of the cost of doing business
in Nigeria. In most other countries, government willingly and
effortlessly pays the refund at the port of exit once it can be
established that the beneficiary is entitled to it.

The implication of the foregoing is that most businesses simply
absorb VAT as part of the cost of doing business in Nigeria. This
is where a majority of Nigerians feel the impact of the VAT payable
in the country. It may interest the government to note that the
uniqueness of Nigeria’s VAT system is at the root of resistance to
any increase in the rate. The proposed increment, without a
concomitant adjustment in the structure of VAT system, will no
doubt further impoverish Nigerians. The worst hit will be the lower
and middle classes. It is not unexpected that the manufacturing
companies will unilaterally pass the additional cost to the
consumers in the form of higher prices. This is because greater
percentage of Nigerian consumers are sensitive to price increment.
Consumers will simply shift away from the product to very many
available cheaper substitutes. There are currently so many close
substitutes for most items that are consumed largely at the lower
rung of the Nigerian society, ranging from popular brands to the
absurd; imported to locally manufactured. Companies will thus have
to absorb it.

The purchasing power of our currency does not also help matters.
Most items are priced in multiples of N50, making it difficult to
accommodate slight adjustment such as increase in VAT rate. There
is hardly any use for smaller denominations. In most instances,
products with smaller values are bundled together and priced at
multiples of N50. In a highly competitive environment where the
demand for a product is highly elastic, suppliers will simply
become ingenuous in cost recovery. This may happen either by
reduction in quantity or quality or both. For instance, in order to
absorb the spiralling cost of production in the country, most
manufacturers of toiletries have continued to adjust the size
downward. One may try to check the size of anyone that has been in
Nigeria for a while in the last 10 years. The sizes have been
reducing since the prices have largely remained the same. A similar
thing has been happening to quality where manufacturers are
experimenting with cheaper inputs. Thus, whilst the consumer may
hardly notice, they have actually borne the impact of cost and tax
increment.

Finally, the proposed increment may increase the level of
unemployment in the country. Companies that have hitherto been
struggling to stay afloat may not be able to bear the added cost
that may arise from increment in VAT rate if they cannot push the
added tax to the consumer. Such companies may therefore be forced
to either fold up or relocate to a nearby country. It may thus be
cheaper to manufacture such items across the border at much reduced
cost and import it into the country. Thus, whilst it will be
possible for government to achieve its target of increased revenue
from VAT rate change, it may lose the larger war of attracting
further investment into the country.

In conclusion, we are not in any way suggesting that government
should retain the current VAT rate. The need to change the rate is
long overdue. It is not sustainable. However, increasing the rate
may be a mundane way of solving a complex problem. It may lead to
unintended consequences. Even the targeted N2tn expected within the
first 12 months from the date that the new rate becomes effective
may not be achievable.

One of the things that government should do to achieve a win-win
solution is to revisit the entire VAT structure. Even if it is
difficult to adopt, in one fell swoop, the proper VAT system as it
is available in most other economies, government can gravitate
towards full adoption progressively. For instance, the Federal
Government can permit the manufacturing and power sectors (together
with small and medium scale enterprises) to adopt full input VAT
recovery system simultaneously as it increases the rate. After
sometimes, say two years, government can extend a similar structure
to the oil and gas sector while it also increases the rate to 10%
for the entire country. In the final analysis, say in four years,
the rest of the country can move up to 12.5 or even 15 per cent
under a proper VAT system.

The next major issue that should be addressed to encourage full
compliance is the VAT refund system. The current onerous system is
not encouraging. Government should fine tune the process to make it
smooth and transparent. This can easily be achieved with the use of
proper technology. It is not acceptable to require approval at such
a high level as the Accountant General of the Federation before a
refund is granted.

Finally, there should be proper notification that will enable
companies to plan and adjust. In France, government gave an advance
notice of about 24 months for the introduction of digital tax.
Likewise, the United Kingdom indicated more than 12 months ago that
a similar tax will be introduced in another 12 months. There is a
need for Nigeria to embrace the need for advance notice that will
permit proper planning by taxpayers.

The authors are partner and staff of KPMG in Nigeria.
The opinion expressed in this article is that of the
authors.

Culled from Punch