MANAGING TAX RISKS: Value-added tax cash flow glitch

Value-added tax (VAT) has become a major source of revenue for governments around the world.

Over 150 countries around the world operate a VAT.

VAT has been in Tanzania since 1998 and has been making up 30 per cent of gross tax revenue on average.

Tanzania and most countries with a VAT employ the credit-invoice method. Under this method, traders are taxed on their sales at each stage of production but obtain credits for the taxes they incurred on their inputs. Only VAT on sales to final consumers cannot be reclaimed. VAT, therefore, taxes only final consumption and leaves production decisions undistorted. Sadly, it does not always operate smoothly in practice.

Once a trader issues a fiscal invoice or receipt with VAT, the VAT becomes payable (within 20 days after the month end) to the TRA regardless of whether the trader has collected the VAT from the customer or not. Therefore, if by the due date, customers have not paid the trader, then the trader is left with two options – to default the VAT payment or find some other means to fund the VAT payment like overdraft or similar short-term facilities. Either way, there is a cost - a penalty for non-compliance or finance cost.

In a short term, to remain VAT compliant, effectively some traders often end up providing credit to the state – the effect called “pre-financing”. This introduces economic distortions as borrowed funds to finance VAT could have been used to expand the economic activity of the trader. Pre-financing is one of the flaws of the current VAT system in Tanzania and also one of the reasons some VAT registered traders may be reluctant to use EFDs in cases of sales on credit basis.

Question of fairness

The problem is trickier if the trader is supplying to the government or its institutions.It is a question fairness. Should a trader be penalized for late payment of VAT occasioned by a government’s delay in honoring tax invoices? In the 2017/18 budget speech, the Minister of Finance stated that the government arrears reached shillings 2.1 trillion by December 2016 and out of this, Sh910 billion (44 per cent) related to construction activities and Sh 890 billion (43 per cent) in respect of suppliers of goods and services. Due to the huge amount per a single supplier, the impact is likely to be more severe for those in construction than in other sectors.

There are various approaches to unlock this. Rwanda adopted a VAT withholding in which the purchasing government institutions are obliged to withhold VAT charged by traders. VAT withholding also mitigates VAT leakage under the normalcredit-invoice method. But the approach may lead some traders into VAT refund position they are entitled to more input tax credit than the VAT withheld. Handling tax refunds has never been smooth. Therefore, VAT withholding will reduce but not clear the glitch.

Scheme that is prone to abuse

Another approach is VAT cash accounting scheme in which VAT on sales is accounted for when cash is received and input tax claimed only when VAT on purchases has been paid by the trader. But the cash scheme is prone to abuse by associated traders deliberately delaying cash payments. Zero rating of supplies to government institutions is another option but it poses similar VAT refund consequences like VAT withholding. An administrative approach on a case by case basis could also be considered where the tax authority could allow late payment of VAT without interest or penalty if a trader can demonstrate not to have been paid by a government institution. But such discretionary powers can easily be abused.