Thursday, June 7, 2018

MANAGING TAX RISKS: Of Tanzania tax regime and industrialisation


The Budget for 2018/19 will be read in the next few days: Thursday next week to be precise. Industrialisation has been the key priority of the 5th- phase government.

Tanzania aims to become a semi-industrialised country by 2025. By that time the contribution of manufacturing to the national economy must reach a minimum of 40 percent of the GDP. And the desire is not just in any industry.

But on industries that use local raw materials, produce goods for mass consumption and create decent employment to Tanzanians.

The industries will work better if agriculture, livestock, and fishing sectors also work better.

The industries are also dependent on healthy and developed workforce (human capital). We also need financial capital.

We can also not escape the power of technology. It is not so difficult to see how all these fit with industrialisation.

Some researchers cite obstacles imposed by the agricultural sector, lack of human capital and little knowledge of technology and some of the key reasons the import substitution policies in sub-Saharan Africa (Tanzania included) failed in the past.

But the structure of our economy is dominated by SMEs and the informal sector. Currently, sectors that are expected support industrialization are heavy dominated by SMEs and informal sector.

For industrialisation to succeed, we need suitable tax policies. Policies that will nurture SMEs and the encourage informal sector to formalize.

The question, I think, is what are these suitable tax policies? It is not always easy to answer this question.

And to determine whether a particular tax policy is suitable or not is mostly a “postmortem” exercise.

Laffer Curve?

In mid-1970’s, to stimulate production in the US, most economists advocated for more government spending to stimulate demand for products. But the supply-side economist, Arthur Laffer, offered a different view. Laffer argued that the problem isn’t too little demand but rather the burden of heavy taxes and regulations that create impediments to production, which impacts government revenue. The more a production activity is taxed, the less of it is generated. Likewise, the less an activity is taxed, the more of it is generated. For every type of tax, there is a threshold rate above which the incentive to produce more diminishes, thereby reducing the amount of revenue the government receives. The more money is taken from a business in the form of taxes, the less money it has to invest in the business. Investors in the industries are less likely to risk their capital if a larger percentage of their profits are taken.

Currently, our corporate income tax rate is 30 per cent of taxable profit, regardless of the size of the company. VAT registration kicks in at an annual turnover of Sh100 million. Skills and development levy at 4.5 per cent of employment cost also triggers if one employs four or more people. The current presumptive tax upper cap of Shs20 million annual turnover is too low. This sort of tax environment is not suitable for SMEs and may well be working against the efforts to formalise the informal sector. Last week I saw an interesting piece of an article containing tax proposals for SMEs circulating in the social media. The article proposes an increase in VAT registration threshold to Shs500 million, reduction of corporate tax to 15 per cent for companies with less than Sh500 million annual turnover and a 3 percent flat rate presumptive tax of for companies or sole proprietorships with annual turnover below Sh100 million. It also proposes the removal of SDL on companies below VAT registration threshold and with fewer than 50 employees.

Obviously, these may seem to be radical changes but certainly, they do merit consideration by policymakers.

Mr. Maurus is a Partner with Auditax International