VAT is a broad based tax on final consumption designed in such a way that it is collected through a staged process as a result of value addition at each stage of production and distribution.
VAT is in most countries charged on destination principle and not the origin principle. Through destination principle VAT is charged by the country where consumption of the goods or services takes place.
As a result exports are zero rated while imports are charged with VAT. VAT applies on supplies made in relation to furtherance of economic activities. It identifies and tax economic contribution i.e. value addition. Thus VAT is restricted to business/economic activities and a result it is not imposed on activities of personal nature e.g. gifts for personal reasons or charitable activities with no commercial substance. The method of charging VAT at each stage of value addition is the invoice based credit method.
VAT on financial services
Practically it is difficult to impose VAT on the financial sector using the concept of value addition and thus few countries have imposed invoice based credit method VAT on the financial sector.
For instance if a bank receives a deposit from a customer at a rate of 4 per cent and issues a loan to another customer at a rate of 20 per cent the value added is 16 per cent. However the 16 per cent is a result of both value additional generated between the bank and the borrower and value addition generated between the bank and the lender. Thus an apportionment must be done to allocate the 16% which is practically difficult.
Further, the ability of the above transaction to yield tax revenue to the Government is small because only financial services provided to final consumers will be subjected to VAT in line with the principles of VAT. VAT will not apply to services offered to companies.
Thus generally financial services are exempt from the scope of VAT with the exception of fee based financial services due to practical challenges of allocating value addition and the its low revenue potential.
Introduction of VAT on financial services in Tanzania
VAT was introduced in Tanzania in 1998 through the VAT Act, 1997 (later Cap 148). In this Act, almost all financial services (included most of the traditional services of the banks) were VAT exempt.
A new VAT legislation (VAT Act, 2014) was enacted and became effective from 1st July 2015. Under this new VAT legislation, financial services were again mostly exempt from VAT except for services for arranging for financial services.
The exemption general exempt status for financial services, however, was only short lived as the legislation was amended from 1st July 2016 to make all financial services subject to VAT except for financial services supplied “free of charge”.
Challenges for Financial Institutions
As a result of the amendments introduced in July 2016, financial institutions may be faced with several practical challenges on various aspects of the VAT legislation.
For instance, what financial service is taxable and what is exempt i.e. out of the scope of VAT? These challenges will form the subject matter of discussion in these series of articles on VAT on financial services.
Mr Makundi is a partner with Auditax International