Vat policy and its impact on tax revenue

In the 2016/2017 National Budget presented by the Minister of Finance, Economic Planning and Development Goodall Gondwe, value added tax (VAT) standard rate supply of 16.5 per centum on some products and services which were exempt and zero-rated supplies in the previous VAT regime was introduced.

Having insight at how the VAT system and mechanism works, it is of paramount importance to analyse the impact of the introduction of standard rate VAT on both zero rated and exempt supplies to government tax revenue, business enterprise’s cash-flow and the new cost to the final consumer.

Impact on government revenue

The introduction of import VAT on some imported products will marginally increase import VAT at the point of entry of goods into the country, assuming other parameters are to remain constant. In absolute terms, Malawi Revenue Authority (MRA) will maximise tax revenue through the introduction of import VAT if and only if the products in question are to be used by final consumers other than for resale by VAT registered traders who are legally entitled to claim the input VAT incurred.

Similarly, when the products on which import VAT has been introduced are to be used by traders not registered for VAT, the VAT paid will be a plus to government coffers because input VAT will not be claimed.

However, when the products on which import VAT is levied are to be resold or used by VAT registered traders and those products attract a standard supply rate of VAT or alternatively a zero-rate supply at the domestic scene, then domestic VAT will suffer contraction because import VAT incurred will have to offset output VAT something which was not the case before the new VAT policy measure.

The introduced import VAT on some products is going to reduce domestic VAT payable through input VAT claims and in this regard the new VAT policy will only shift the point of collection of VAT from domestic offices to customs border offices.

When products on which import VAT is suffered are to be sold internally, VAT exempt or are being used to produce products exempt from VAT, the import VAT so suffered will marginally increase at the customs border while at the same time the outturn of domestic VAT will remain constant since the import VAT incurred will not be claimable.

We have to pause for a moment because if traders are not entitled to claim input VAT at domestic level, the gesture will not necessarily lead to tax revenue maximisation when we consider the bigger picture since when input VAT is not claimable that becomes a cost to the business and will have to reduce taxable profits when claimed as expenditure of revenue nature or indeed claimed through capital allowances on the capitalised VAT and the operation will reduce taxable profits which are currently levied to corporate tax at 30 per centum.

The introduction of VAT on products which were zero-rated at domestic level will lead to tax revenue maximisation on part of government because the output VAT to be charged will be deemed to outweigh input VAT claims hence minimising VAT refund claims.

Presumably government has only changed the point of collection of VAT by introducing import VAT on products since the device will now lead to VAT registered traders paying drastically reduced output VAT at domestic level because of huge input VAT claims.

When import VAT is levied on products which were exempt from VAT before, the catch to government will be the instant realisation of tax revenue other than tax revenue maximisation because previously VAT registered traders were accounting for output VAT after selling the imported products or at times after subjecting those products to processes; hence, giving tax revenue to stagnation or deferment.

Government will marginally register a positive variance on VAT when import VAT incurred by business traders is not claimable as input VAT as guided by the provisions of the VAT Act. However, we have to be mindful that input VAT not claimable will become a cost of revenue nature or capital nature; hence, to reduce taxable profits through deductibility of cost of revenue nature or capital allowances.

A real and genuine catch to government is introduction of standard VAT supply rate on products which were once zero-rated supplies because government will run away from universal subsidy through forfeiture of VAT in those products by letting customers shoulder the burden regardless of their economic status.

Impact on businesses

On the domestic scene, business enterprises to suffer import VAT at customs border will react depending on whether those products or by-products attract either VAT or not at domestic level.

When import VAT is incurred by VAT registered enterprises and those products or by-products attract VAT at local level, then import VAT suffered will be claimable as input VAT thereby reducing output VAT reported at domestic level. When a VAT registered vendor suffers import VAT at customs border and the VAT is claimable by the vendor that principally is not supposed to trigger increase in product prices because the VAT suffered will offset output VAT.

In short-term, the introduction of import VAT on products will stretch the working capital of traders since the point of VAT payment has been partially oriented from domestic level to customs border; hence, traders will need immediate substantial working capital to react to the new trend. The reaction to this trend is arguably not to increase the price of the products since import VAT to be suffered at the border will not be a cost to the trader as it will reduce output VAT payable at domestic level.

It can be conclusively said that when import VAT is incurred for furtherance of VAT exempt supplies at domestic level then the input VAT becomes a permanent cost to the products and this will automatically trigger upward price adjustment because the VAT Act bars business traders to claim such VAT against output VAT.

Import VAT which is input to mixed products and services i.e. products with a face of VAT exemption supply and standard VAT supply on the other end will be claimed depending on the level of composition hence proper assessment has to be carried out to determine the level of price adjustment on the products if at all it is to be considered necessary.

Business enterprises which were previously selling zero rated supplies will now ship and offload VAT to customers and in real terms that is not price increase to products but rather playing a role of a government agent to upload VAT to product prices and download the same to customers.

The proposed VAT policy is motivating to enterprises because they will be charging VAT at standard rate supply on the once zero rated supplies and the enterprises will offset the output VAT with input VAT and thereby reducing perpetual VAT refund claims and in the process boosting up the cash-flow since the funds which were trapped in VAT mechanism will be immediately available through VAT paid by customers.

Business traders to be affected by import VAT on their products and services will in short to medium term require financial stimulus to resuscitate their working capital because of the immediate needs to have the negative variance addressed.

In the process of addressing working capital, the business traders might be obsessed to reposition their businesses by increasing selling prices of their supplies to have the deemed losses recouped without carrying out proper assessment as to whether the import VAT to be incurred is claimable or not.

Business traders with consumers at their heart will not rush at grabbing jugular veins of customers because they will realize that their duty is to pack and unpack standard VAT on supplies which were once zero rated and that their cost structure will remain constant with input VAT being claimable. Business enterprises under this category will now breathe a sigh of relief because by charging output VAT on the once zero rated products is one way of claiming immediate VAT refund from government and this is a shift from the agonizing prolonged wait for the VAT refund before the current proposed VAT Act amendment.

Enterprises should not undermine the possibility of consumer action as they might react by shunning away supplies which are not basic necessities and business enterprises might end up sailing in turbulent conditions by failing to meet fixed overheads because of reduction in sales volume which might not be compensated by price increase adjustment.

Impact on consumers

In an environment where economic fundamentals are stable, the introduction of import VAT on products could not stimulate increase in prices because when the business enterprise is registered for VAT, the input VAT paid at the customs border will be claimed and this is not to be deemed as a final cost to their business.

When a business enterprise suffers import VAT to its input costs and the supplies are VAT exempt at the point of disposal and we employ the eye of an eagle, it will emerge that the scenario will lead into price increase to those products because business enterprises will not be legally allowed to claim input VAT incurred hence to be pushed to final consumers.

When import VAT is incurred on VAT exempt supplies which are eventually exempt from VAT at one end and chargeable to VAT on the other end, then the prices to the said products cannot be easily determined and business traders might arbitrarily burden consumers with unjustified price adjustment.