MANAGING TAX RISKS: Why it’s crucial to embrace SMEs

Industrialization has been the key priority of the fifth phase government. Tanzania aims to become a semi-industrialized country by 2025. This means that by 2015 the contribution of manufacturing to the national economy must reach a minimum of 40 per cent 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 a healthy and developed workforce (human capital), financial capital and technology. Some researchers cite obstacles imposed by the agricultural sector, lack of human capital and little knowledge of technology as some of the key reasons the import substitution policies in sub-Saharan Africa in the past. But the structure of Tanzania’s economy is dominated by SMEs and the informal sector.

In a parliamentary discussion last week, one MP argued that unfriendly tax policies in Tanzania scare away some businessmen. Some have hence moved their businesses out of Tanzania. For industrialisation to succeed, suitable tax policies need to be in place.

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 tax policy is suitable or not is mostly a “postmortem” exercise.

We are approaching half of the fiscal year 2018/19. The tax collection statistics for the first quarter have not been so impressive.

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 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 Sh20 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.

Earlier this year, I saw an interesting article containing tax proposals for SMEs circulating in the social media. The article proposed an increase in VAT registration threshold to Sh500 million, reduction of corporate tax to 15 per cent for companies with less than Shs500 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 proposed the removal of SDL on companies below the VAT registration threshold and with less than 50 employees. As radical as these proposals may seem to be, they certainly merit consideration by policymakers.