by Florence Banda-Muleya and Mbewe Kalikeka
As dust settles from the bombshell of reintroducing Sales Tax in the 2019 Budget, the scale of its implementation challenge becomes clearer. Brought to light by increased debate over the pros and cons of Sales Tax, the Government’s selling point of simplicity of administration is certainly not convincing enough.
Our view leans towards making VAT more efficient, however, the policy decision for Sales Tax has been taken. Thus this article serves to visualise how best Sales Tax can be implemented in Zambia.
No clear-cut description has been given of what form Sales Tax will take, neither has a departure from the VAT targeted amount been announced. Surprisingly, the reintroduction of Sales Tax has happened at a point when VAT is out-performing other taxes and is currently the biggest source of revenue for the Government. The authorities’ withdrawal of VAT stems from the fact that the tax-type has not been without challenges. Until 2016, Zambia’s VAT history was poor with the tax recording negative intakes in certain years.
Tables only turned with the introduction of various VAT administrative strategies in 2017, including the appointment of withholding agents, the introduction of electronic fiscal devices and the establishment of pre-refund audit requirements. VAT collections rose from 3.7 percent of GDP in 2016 to 5.8 percent in 2017, and by mid-year 2018, about three quarters of the annual VAT target was collected.
However, this VAT performance was not a true reflection of collections, as the pre-refund audits led to backlogs in VAT repayments. Indeed, the Zambia Revenue Authority (ZRA) has lamented that they have been struggling with VAT refunds, requiring an approximate K800 million every month.
Sales Tax resolves the VAT refund challenge, because while VAT is charged at all levels of production with resellers paying tax to the vendor and reclaiming VAT paid on business inputs, Sales Tax is applicable to only final consumption sales at each level and not on goods to be used in production.
Thus, Sales Tax can be considered less complex for Government’s revenue collection. Herein lies the attraction: with only a single collection point, at retail stage, all tax collected is non-refundable, settling the refund challenge. Moreover, VAT and Sales Tax can supposedly yield equal amounts of revenue for the Government.
Though resolving the refund issue, Sales Tax suffers other setbacks that may end up reducing revenues. We highlight these key issues worth the Government’s consideration in Sales Tax design.
First, by disposition, Sales Tax does not have the sort of self-enforcing mechanism exhibited in VAT, where purchasers help enforce VAT as they insist on correct invoices from suppliers to claim input VAT. Thus, compliance levels under a Sales Tax are fragile. With taxes collected only at final point, the Government remains at the mercy of retailers who are responsible for remitting the tax collected from the consumer to the authorities.
Retailers may not remit the full amount of the tax since there is no third party to confirm with, or may choose to not charge the tax entirely because of its tediousness, or in a bid to boost their sales. Withholding agents and fiscal devices can remedy this evasion, but will require more enforcement vigour.
Second, Sales Tax can lead to cascading or the “tax on tax” effect, stemming from the tax burden falling on production inputs, which VAT avoids through refunds. Failure to address this ‘tax on tax effect’ can result in sellers passing on the tax cost accrued, to consumers. This may lead to economy-wide inflationary pressures and jeopardise the macroeconomic objective of keeping inflation within 6 to 8 percent.
Additionally, price increases will impact industry’s costs of production, and in turn result into slower economic activity (maybe below the 4 percent growth target) hence lower revenues. Mitigating cascading will require a lower Sales Tax rate, combined with use of resale and exemption certificates.
Third, and perhaps most importantly, Sales Tax is traditionally charged on goods not services. The Government has not explained how services will be taxed under the new system which can erode the tax base further. Will it be a sales and services tax?
Finally, transition to Sales Tax poses challenges. The Government will face system changes, will need to train staff and agents and confront other administrative costs in a short time period. Malaysia, which switched to Sales Tax on 1st of September 2018, estimated these requirements to cost US$6 billion, about 2 percent of GDP in lost revenue. With fiscal consolidation steering up through perceived increased revenue mobilisation, the Government needs to create a provision for more implementation time and lost tax revenue.
So, while Sales Tax presents an opportunity, it also poses risks to revenue which must be mitigated. We urge the Ministry of Finance and ZRA to work with ZIPAR and other stakeholders to think through the design of compliance systems, how to reduce the cascading effect through resale and exemption certificates, consider what tax can be applied sustainably for services and review the transition period.