Should Nigeria’s VAT rate be increased? - TaxWiseNG Episode 22

There’s been a raging debate on possible increase in Nigeria’s VAT rate which is currently at 5%. While the pressure has been heightened by the sharp decline in oil revenue, the arguments dates back many years. The rate was increased to 10% in 2007 but was hurriedly reversed by FG under late President Yar’Adua due to widespread agitations.

VAT was introduced in Nigeria in 1993. From the very start, the rate was meant to be set at around 15%. VAT was introduced as a replacement for the then Sales tax which operated based on residence. As a consumption tax, sales tax coverage was too narrow as only few items were covered. Such narrow base negates the principle of consumption tax which by nature is expected to cut across most goods & services. It was this concern and the need to increase tax revenue that led FG to set up a study group in 1991. The group proposed introduction of VAT and a Committee was set up to carry out feasibility studies on its implementation. A low start rate with planned gradual increment was thought to be an easy way to gain easy acceptance.

It is a matter of fact that Nigeria has one of the lowest VAT rates in the world. Except for countries that do not operate VAT, I can’t immediately think of any country with lower VAT rate than Nigeria. VAT is 15.5% in Ghana (excluding National Health Insurance Scheme Levy of 2.5%) and 14% in South Africa. Algeria, Angola, Burkina Faso, Chad, Gabon and other African countries have higher VAT rates than Nigeria. There are countries with VAT rate as high as 25% like Croatia, Denmark. For comprehensive VAT (indirect tax) rates around the world, check out Deloitte‘s Global indirect tax rates here. http://deloi.tt/1YdMGEz

So, whenever there’s a debate over possible increase in VAT rate, the proponents have enough reference points to support their view. As Nigeria continue to battle with falling oil revenue and depleting reserves, raising VAT rates becomes more and more unavoidable. It’s now a matter of when, rather than if. I have said it repeatedly that 2016 may be the last year Nigeria will have 5% VAT rate.

Now, let’s be clear - the point that Nigeria’s has a very low VAT rate is only one half of the truth. Nigeria equally have the most restrictive VAT systems you can think of. Just like its predecessor sales tax, Nigeria’s VAT is no more than an improved sales tax. The full mechanism of VAT isn’t there. VAT is a consumption tax levied on goods and services at each stage of the value chain with the final consumer bearing the burden. This means the producer, wholesaler and retainer are expected to pass the tax to the final consumer. Whatever VAT is incurred/paid at each stage (input) is supposed to be deductible from VAT charged/collected on sales (output). The differential between output and input VAT is paid/recovered such that the business bears no VAT cost but final consumer.

Unlike in many other jurisdictions, Nigeria VAT has limited scope for “deductible” input VAT thereby adding to business cost. In Nigeria, input VAT incurred on overheads are ineligible for set-off against output VAT, only to be expensed to income statement. Similarly, input VAT on capital expenditure can only be relieved via tax depreciation rather than claimed against output VAT. Based on Nigeria VAT law, allowable input VAT is limited to those charged on goods purchased or imported directly for resale. Input VAT on stock-in-trade used for direct production of product on which the output tax is charged are also deductible.

In Nigeria, only VAT on tangible goods are able to operate the normal input and output VAT rule. Even for those in sale/manufacture of tangible goods, VAT on overheads & capital expenditure are ineligible for claim against output VAT. If the argument is stretched, service companies may not have deductible input VAT but expected to remit all output VAT collected.

Beyond limited input VAT claim, the VAT Act as currently phrased may run business into debt and eventual bankruptcy. The law mandates RETURNS on or before the 21st day of the month following that in which the PURCHASE or SUPPLY was made. Emphasis on the month following purchase or supply. The law requires remittance of excess of output tax over input tax. The inference from this is that VAT filing/payment are based on invoice date with no diff between invoicing and collection. It practically requires taxpayer that sells on credit to finance VAT payment with borrowings.

Another fundamental issue is the loose definition of imported and exported services which seems to be short-changing the country. Exported services are exempt from VAT while imported services attracts VAT in Nigeria. While the Act defined the two phrases, the ambiguity makes it plausible for otherwise chargeable services to escape. Exported service is defined in VAT Act as “service performed by a Nigerian resident or a Nigerian company to a person outside Nigeria”. Imported service is defined as “service rendered in Nigeria by a non¬-resident person to a person inside Nigeria”. As simple as the statements read, it is loaded with confusions around place of service/delivery, place of consumption and lots more.

The position of FIRS has often been to invoke the (unwritten) rule of place of consumption in application of VAT. By that approach, VAT will be expected to apply on any service consumed in Nigeria irrespective of the place of supply. By the same token, services performed in Nigeria but consumed overseas will be treated as VAT exempt in Nigeria. These rules appear very simplistic but quite complex in application. The new world of e-commerce complicates it further. Recent judgements had shown the fragility of our laws and exposes the country to potential revenue leakages.

From the points above, you’ll realise that the issues with Nigeria’s VAT goes beyond the low rate. We won’t solve the problem by merely doubling the rate. At best, we would only have succeeded in covering up bigger problems. In my view, Nigeria is better off with increased VAT rate but with a matching reduction in direct taxes after addressing identified lapses.

The argument for an increase in VAT rate appear very compelling with the IMF Managing Director joining voices with the proponents. There are many reasons why this is so. First, the current rate is very low in comparison with most jurisdictions. Two, indirect tax is a more effective and efficient way of collecting taxes. It is cheaper to collect and easier to administer. The National Tax Policy also advocated a gradual shift towards indirect tax.

Three, at a time that the country is focused on reflating and stimulating the economy, raising direct taxes negates that policy thrust. A compatible fiscal policy is reduction in direct taxes thereby increasing disposable income and matched with indirect tax increase. Increased disposable income and higher VAT rate will far more than compensate any reduction in direct taxes.

Nigeria is nation of consumers. We consume everything with a high propensity to import. Consumption tax fits us better. Nigeria’s propensity to import is said to be higher than 0.6. That is, every N1 spent, has 60k import content. With a consumption tax, we are far more likely to raise higher tax revenues than depressing people’s disposable income via direct tax hike. But before the increase in VAT rate is implemented, all the fundamental issues around the current system need to be addressed.

The VAT law needs a complete overhaul to make it more suitable and relevant in the new world order. The restrictive input VAT rule should be revised to allow for a full input VAT claim regimen. Threshold for VAT registration should be introduced. VAT remittance should also be based on collection rather than invoicing. An alternative provision will be to make provision for adjustment of unpaid invoices to accommodate credit system.

Technical weakness on the rules around non-resident companies, imported and exported services should be addressed. We must urgently revisit and make clear provisions on the application of place of service versus place of consumption.

Until these issues are addressed, it won’t make enough sense to proceed with VAT rate increase. It requires a holistic approach.

Footnote:
This article was posted in verses via my Twitter handle, @YomiOlugbenro, on Wednesday 6 April 2016, during my weekly “tweetax” session with hashtag #TaxWiseNG. The tweets are subsequently posted as article on my blog www.yomiolugbenro.com and my social media accounts - facebook.com/YomiOlugbenro and LinkedIn.com/YomiOlugbenro.