Assessing the VAT Administration in Ethiopia
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Upon its assumption of power in May 1991, the Ethiopian Peoples' Revolutionary Democratic Front (EPRDF) came to grips with the deficiencies that featured as the hallmarks of the public service. Dictated by the demands of the structural adjustment program (SAP) and the zeal to usher in new government machinery arrangements in accordance with its drives and preferences; the EPRDF introduced a wide range public sector reform program . Public expenditure management and control including the revenue sector has been one of the areas of critical focus under this broad reform program/package/.
On the top of this reform agenda, one of the new visions of Ethiopian government among other things is to bring rapid and sustainable development in the country. Hence the government recognized, that, the achievement of this rapid and sustainable development requires mainly sustained and dependable domestic revenue mobilization which otherwise be a dream to realize such a vision depending only on external finance source which is subject to uncertainty. In order to realize domestic revenue mobilization objectives, it is considered that the role of taxation is of vital importance. To this end, the government of Ethiopia has been making considerable efforts to reform its tax system that cover all the areas of direct and indirect taxes. Under the indirect taxation system, the major outcome of the reform was the introduction of VAT.
Ethiopia introduced VAT through proclamation No. 282/2002 which has been ratified or July 2002 and come in to force on January 1/2003 .The adoption of VAT into its tax system by replacing the former sales tax was with the objective in which VAT is considered to be important to enhance saving and investment, minimize the damage that may be caused by tax evasion and avoidance, stimulate economic growth and improve the relationship between gross domestic product and government revenue in the country.
In addition, some of the inherent deficiencies of the former sales tax system which contribute to the replacement by the VAT also include:
The former sales tax being a single stage collection system led to a greater loss of revenue as the base was much narrower than VAT.
It is in short that it leads to cascading effect.
As the VAT system requires strict use of invoices and allows input credit, it is expected to better mitigate evasion than the former sales tax.
VAT is a broad based tax on the consumption of goods and services with standard rate of 15% in Ethiopia. It is collected at all stages in the production and distribution process beginning with the importers and producers of raw materials and ending with the retailers. Unlike the sales tax system where by relief is granted only to raw materials used directly in the production of goods; the tax structure under VAT system take credit invoice method which allows the business to offset the tax paid on capital goods and purchase of inputs against the collected tax on sales of goods and services. Destination principle is the base in which only imports are subject to tax and exports are zero rated. Removing the tax content from exported goods is aimed at making the goods more competitive in international markets. The threshold for compulsory registration is annual turnover exceeding Ethiopian birr 500,000 (approximately $ US 30,414). Business establishments below this threshold are exempted. Basic goods (especially food items) and services are also exempt from VAT.
VAT is the youngest tax regime in Ethiopia with the age of only 7 years. As Eduart G. by his article on Albanian Tax Administration stated "much IMF experience suggests that first years are not nearly long enough to have a good VAT system up and running well. Ten years is perhaps closer to reality" (Eduart G. 2009, pp1). This notion tends to be relevant to the Ethiopian context in which due to this and some other factors, the VAT administration process is perceived to have various problems that range from filing returns, through processing refunds, and to enforcement and facilitation problems.
Under this short report paper, attempt is made to discuss the major problems in VAT administrative process in Ethiopia and to recommend some solutions deemed relevant to solve the problems and improve the VAT administration and compliance. Thus, section one is introduction and deals with the overall picture of the VAT system in Ethiopia. The VAT administrative process and associated problems and risks are discussed under section two. And finally, section three deals with concluding remarks by summarizing the major problems and compliance risks of the VAT administration in Ethiopia.
VAT administrative process
2.1. Basic principles governing VAT Administration
a. Voluntary compliance
Voluntary compliance is considered to be the primary objective of revenue authorities. Like any other revenue authorities, ERCA has several tax laws and regulations upon which it operates with a spectrum of needed compliance instruments. The instruments that are in place to leverage compliance range from education to sanction. Sensitization and awareness creation on tax obligations is pursued as a primary avenue to bring about the desired compliance behavior following which penalties are to be considered. Severe penalties may even be exercised awhile depending on the nature and magnitude of the violations. The preferred option of ERCA though, is one of adopting an administrative approach that encourages voluntary compliance with in a co-operative and participative regulatory environment. Thus, voluntary compliance by tax payers is the basic approach of the authority also with regard to VAT administration. Although this approach can be viewed as the strength of the VAT administration, the practical observation is far apart from this wish. Voluntary compliance can be better achieved through intensive tax payer education and delivery of quality service and information. Tax payers should need to know their rights and obligations to comply with .Delivery of quality service and information is also equally important to attract them to do so. However, due to the low coverage and poor performance of these matters and some other cultural and administrative problems, voluntary compliance is hardly attained objective in Ethiopia.
b. Self Assessment
VAT is self assessed tax in Ethiopia and this can be viewed as its strength that, one of the important features of modern tax administrations is the provision for self assessment. The responsibility for the correct calculation and timely payment of VAT rests on the taxpayer himself. In fact there are variety of circumstances in which the authority may issue an additional assessment such as in the case, where a person fails to furnish a return as require by law, and if the authority is not satisfied for any reason of perceived risks.
One of the basic reasons to employ self assessed VAT system is administrative feasibility the fact that revenue authorities can not afford to knock every one's door to reasonably assess and collect tax liabilities. Rather, they need to focus on and direct much of their efforts and resources to those tax payers that are considered to be high risk traders.
As indicated by the Indian Government Department of Revenue report on international best practice in VAT administration, "in order for such a self assessment system to be effective, the apparent freedom granted to tax payers must be backed up with a supportive legislative framework and a comprehensive and integrated set of administrative processâ€¦ most importantly, as further indicated, the modern tax management therefore relies heavily upon risk assessment tools to determine which tax payers' matters must be examined very closely, not merely at the audit level, but at all stages of the tax process from registration to collection" (Indian Government Department of revenue 2006).
When we look at in to Ethiopian situation in light of this view; the risk assessment practice is in its infant age. ERCA has passed all its age with out formal compliance risk management policy and strategy. Currently, however, ERCA has this policy and strategy which is endorsed on June 2010. Although it is too early to evaluate its impact with in 5 months of its endorsement, it is believed that it will bring a significant improvement on the compliance management efforts of the authority.
2.2. VAT Registration
The VAT legislation in Ethiopia provides for two types of registration which are obligatory and voluntary. The threshold for obligatory registration is the annual taxable turnover that exceeds Ethiopian Birr 500,000.The primary intention to limit the registration threshold was consideration to administrative feasibility. However with this threshold limit even, the registration performance tends to be unsatisfactory. Regarding voluntary registration, a person, who carried on taxable activity and is not subject to mandatory registration, may voluntarily apply to the authority for such registration, if he regularly supplies at least 75% of his taxable goods and services to VAT registered person.
In line with the threshold limit for obligatory registration, the government set turnover tax as equalizing factor to enhance fairness in commercial relations and make complete the coverage of the tax system at the same time reaching those tax payers below the threshold value. However due to the low enforcement capacity and some other reasons it tends to be less performed and viewed by registered taxpayers as ill addressed area. For example the Ethiopian Chamber of Commerce and Sectoral Association in its release on National Business Agenda stated the following:
"A VAT registrant has to charge consumers an indirect tax of 15% of the value of goods or services sold. A non- registrant, however, pays a turnover tax (TOT) of 2% on goods sold and 2-10% on services rendered. Given these rates VAT registrants could not compete in the market. More over the tax Authority has limited capacity to enforce compliance. Knowing the authority's limitations, many business enterprises who are required to register for VAT do not comply. This situation has created a distorted market, where those registered for VAT are subjected to unfair competition" (Ethiopian Chamber of Commerce & Sectoral Association 2007-2008 pp8)
As we can understand from these statements, their argument refers to the wider gap between the VAT rate of 15% and the 2% rate for turn over tax which led to market distortion (unfair competition) together with the limited administrative capacity of the authority to enforce and facilitate the proper management of the turnover tax and the registration to VAT.
Due to low compliance culture, low audit coverage, weak administrative capacity to detect and register potential unregistered tax payers; non registration is one of the most critical challenges in Ethiopian VAT administration system. The study by Tewodros Zewdie, also supplements this and the above view as he stated "the business community contends that taxes are disproportionately collected from a few formal sector enterprises, while large sums remain out side tax system due to evasion, ineffective tax administration and inconsistent registration" (Tewodros Zewedie 2010, PP1) .
Further more as the study by Her Majesty's Revenue and Customs (HMRC) of the UK indicates , only approximately 434,000 registered tax payers under all tax regimes out of population of 80 million- is biggest risk unregistered trading in Ethiopia" (HMRC, Mission Summary report 2009 , pp 55) . As the study further assumes in fact it may be crude to take all the 80, million populations as a potential. Let us consider that 85% of the population being agricultural society is not required to register. This drops down the figure to 15 million (15% of the population). Also assume that unemployed work force including children possibly reduce this to 10 million. So that we still have at least 9.5 million people unregistered. The same trend holds true of VAT registration. Really this is greatest risk for Ethiopian tax administration.
2.3. Filing Returns and Payment of Tax
VAT return is a form filled by a VAT registered person and filed with the tax authority at the end of each VAT accounting period showing if there is VAT payable or refundable. According to the VAT proclamation, every registered person is required to file the VAT return with the tax authority for each accounting period, whether or not tax is payable in respect of that period, no later than the last day of the calendar month following VAT accounting period. The payment of the tax liability is also expected at the point of declaration.
Non - declaration or frequently declaration of 'Nil' are among the significant risks currently identified by ERCA. On the other hand the business community is complaining that a one month period for declaration and payment of VAT is very short.
In fact, this is also evidenced by the study conducted by Wollea Abhodie as she stated "this is a problem especially for tax payers conducting business at several locations since gathering documents from different offices takes time. Further according to the survey respondents, the shortness of the reporting period puts substantial pressure on employees and disrupts the normal operation of businesses" (Yesgat WA 2008 pp151). The other problem is that every person registered for VAT is needed to go to tax offices in person to file and pay tax returns each month through out the year. No other option is provided and this may require the tax payer even to travel several kilometers in some instances.
In addition the payment of tax liability exceeding Ethiopian birr 1000 is required to be effected through Ethiopian Commercial Bank and after paying the money the tax payer is required to submit the bank advice to the revenue authority. Hence he is forced to go to the bank as well as to the revenue authority to pay and report the same amount of money. This imposes some cost of service charge and time on the tax payer.
VAT invoice is the central feature of VAT accounting. Under Ethiopian VAT law, the registered person is required to issue VAT invoice to the purchaser of goods and services upon the supply or rendering, but not later than 5 days after the transaction. A person who is not registered for VAT doesn't have the right to issue a tax invoice. It should be noted that only VAT registered person have to issue a VAT invoice if the total consideration for the entire supply does exceed Ethiopian Birr 10.
In principle, as Eng L. Ming stated "one key feature of the VAT system is the requirement to issue tax invoice that provides audit trail and the mechanism for the self- policing nature of the tax. In the light of the importance of the tax invoice, the material aspects relating to the use and form of the document are regulated" (Eng L Ming 2004, pp2).
However, if this is to work, all actors in the system should comply as per the law. Apart from this view, the VAT invoicing practice is serving much below than the expectation. In Ethiopia the problem is two sided. On the one hand the suppliers tend to use any opportunity to avoid the issuance of VAT invoice which may include negotiation with purchaser. On the other hand, most of the purchasers perhaps all citizens, unless they need it as evidence for claiming VAT refund or some other reason such as for accounts settlement with their organizations (employers) ; no one as civilized citizen, worries about demanding invoices. The other problem with VAT invoices is the use of fake or duplicated invoices. VAT sales invoices are printed by each tax payer with the provision of standard format and permission by the tax authority. However there is no criteria or procedure issued to select printing presses (firms) and it is up to the tax payer to select and negotiate with the printing firm nearby. This gives rise to the printing of fake and duplicated invoices.
This issues are further evidenced by the study conducted by Yesgat WA as she stated "these problems include the difficulty of getting invoices on purchases and details of customers for the preparation of sales invoices, the problem of supplying with out invoices (by giving the option of buying with or without invoices to customers) and using duplicated invoices" (Yesgat WA 2008 pp 153).
VAT refund is the net VAT that a registered person expects from the tax authority when input VAT exceeds output VAT. At the end of a VAT accounting period, if output VAT exceeds input VAT, the difference is the amount of VAT payable to the tax Authority. On the other hand, if input tax exceeds output tax, the supplier may be allowed to carry the credit forward and a refund is made after five months if input VAT still exceeds out put tax. VAT refunds in Ethiopia are financed out of consolidated VAT collections and there is no specific expenditure appropriation for VAT refunds in the annual budget. This is one of the reasons to delay in VAT refunds when cash shortage occurs.
As Indian government department of revenue indicated "experience with VAT implementation in many countries shows that refund of credits has been the 'Achilles heel' of the VAT. It has been a source of tension between tax authorities and the business sector and in some countries has led to complex administrative measures that have significantly undermined the functioning of the VAT system â€¦as further indicated the prevalence of fraudulent claims is often cited by tax officials as a major reason for delaying payment of refunds. Often less advanced tax administrations pursue time consuming and labor intensive processes to verify claims before approving refunds, resulting in backlogs of refund requests and considerable disquiet among business tax payers who have been deprived of their working capital. In contrast, the most effective and efficient tax administrations tackle refund related fraud as part of a broader VAT compliance strategy based on risk management principles and generally limit pre-refund verification checks to perceived high risk claims " (Indian Government, Department of Revenue 2006). The view holds true in our context in which risk based compliance management practice is not matured and refund requests are subject to pre-refund verifications in most cases. The refund period is also relatively longer than those of advanced economies with a period of on month. By the side of the taxpayers, VAT refund is one of the areas with significant risk under ERCA'S current list of risk records. A common risk in this regard is that, goods declared for export and consequently declared as zero- rate on future declarations are diverted in to domestic consumption. The case of a declared export of sugar across the Kenyan border and its consequent identification of domestic consumption (which is repeatedly detected) is one of the specific examples.
Tax audit is one of the most important tools of treating compliance risk by tax administrators. However, it is also considered to be one of the capacity challenges to many administrations. For example, as the Indian Government Revenue Department study indicates, "it has generally been observed that audit is most often the weakest component of VAT administration, early in the implementation phase. This is because a completely new law is introduced, and both the department's staff and the dealers are in- experienced with it" (Indian government department of revenue 2006, pp 61).
The current audit status in Ethiopia shows this reality. As the study by HMRC of UK indicated, EARCA'S current capacity through its large tax payer's office for eg, is limited to "only 20 audits per month, each one requiring between 10 and 20 staff days to complete. At least 5000 (all category A) tax payers are expected to be subject to this audit and there fore it may take nearly 21 years to visit all the large taxpayer population to ERCA and they would not be selected at all if they continue to make payment declarations" (HMRC mission summary report 2009 pp 54). It worth, more attention would have been given to the VAT audit, the fact that the overall value of VAT share is considerably significant of all revenue income (about 85% )as the same study indicated.
For audit to be efficient and effective, it should be supplemented by sound risk management /selectivity practices. The lack of sound risk management practice is one of the most contributing factors for the insignificant impact of audit on VAT compliance efforts. In other words, audit efforts are considered to be only a futile attempt in some instances, which result in less benefit than its cost.
Penalties/Enforcement and Recognition.
In this regard, the legislative base is not the source of problem. It sets out the rights and obligations of the tax officers as well as the tax payers. There are clearly stated provisions about the powers and penalties available to the tax authorities including the administrative settlement of tax offences and other related issues. However, this strong side is dominated by the low enforcement capacity of the authority and the law is not serving up to the expectation.
In fact, within the sphere of the limited capacity, enforcement actions to leverage compliance range from education to appropriate sanctions. Thus the current trend differentiate between violations leading to customer education or warning and deliberate non- compliance leading to penalties i.e. those who are willing to be compliant but don't understand (making mistakes) are tackled through simplification of procedures, guidance and taxpayer education. And those who deliberately violate are treated through ranges of appropriate enforcement actions and penalties. Similarly, the current system some how recognizes for good compliance in which such firms are subject to lower intervention and provided with increased self assessment. Given its low capacity to enforce the rules, these approaches can be considered as the strength of the current VAT system. As in the case of all other issues, the low level of risk management practice and the low coverage and quality of audit are some of the factors that contribute to the low achievement of the law enforcement efforts.
The VAT administration in Ethiopia is tending to follow approaches that are common to those modern tax administrations such as more reliance on self assessment and voluntary compliance. The fresh start of compliance risk management policy and strategy is also the current hope of the Authority for the better achievement of its law enforcement and compliance objectives. However, the low level of awareness by the tax payers, low compliance culture, the limited administrative capacity of the authority (institutional as well as man power capacity), lack of sound risk management practice to supplement the tax audit and law enforcement efforts etc. are some of the most critical challenges to ERCA to face currently. There fore;
Adequate and continuous taxpayer education together with the provision of quality service and information is on the top of the solutions to bring voluntary compliance and better achieve its objectives. This may include, providing additional explanatory materials on tax laws, free training and taxpayer education programs, using community radios, establishing permanent contact and help centers, free phone lines (information desks), and wider use of public media etc. Further more, the service delivery arrangements should also need to consider such aspects as special treatment of large tax payers through large tax payer units (LTU), establishment of special tax courts, one stop shopping and different options to file and pay return by the tax payer such as through post office, electronic mail etc as appropriate are some of the important elements that add some value to the current situation.
The approaches for self assessment and voluntary compliance by the tax payers should be followed by strong law enforcement through sound risk analysis and deterring measures focusing on high risk tax payers of non-complaints.
Enhancing risk aware management culture, properly implementing the risk analysis output to supplement and direct the audit and the law enforcement efforts is very crucial to economic deployment of scarce resources and achieve its objectives of control and facilitation in much better effective and efficient way.
More specifically, other comments include the following;
The VAT administration fail not only to detect and register the potential non- registrants; but it equally fail to properly enforce and manage the registered tax payers as well. This situation may call for upgrading the current threshold to a reasonably manageable level inline with strengthing its capacity to effectively cop-up with the situation. Much focus is also required to the administration and control of turnover tax (TOT) to minimize the current market distortion and unfair competition between the VAT registered and non registered businesses.
Building the capacity of VAT officers and auditors through intensive skill development trainings and education programs to up grade their skill an knowledge level is very crucial area that need due attention . Increasing the number of VAT auditors with adequate skill and hence widening the current level of insignificant coverage of audit to meaningful level is also another area that need fast action.
To promote better compliance culture and the use of VAT invoices, by both the taxpayer and the consumer, in addition to the above taxpayer education mass sensitization and civic awareness creation is very important. Further, to motivate individual consumers (purchasers) to claim receipts for the purchase (consumption) they made and the amount paid it will be helpful for the VAT invoices to bear some incentive in the form of lottery or like.
To eliminate the delay in VAT refunds due to cash shortage, specific expenditure appropriation for this purpose in the annual budget will be valuable. Similarly the VAT refund period also may need adjustments based on international best practice benchmarking such as to one month period.
As non- registration is one of the biggest risks; it is an area that requires much effort and enforcement. The current approach that mainly focus on the visit of the tax payer's premises once through- out the year by local inspectors should be supplemented by permanent 'tax messenger' that frequently visit the tax payers business and related affairs and report to the authority to decide on the registration or deregistration of the tax payer .
Finally, as the overall value of VAT share is considerably significant of all revenue income, much attention should be granted and there fore need to assure that income stream is protected. Resources should be directed to maximize the revenue income from the major taxes rather than trying to assure equally across all regimes that could, potentially, expose larger taxes to attack by customers.
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