URA’S ATTEMPT AT AUTOMATING INFORMALITY - THE EFRIS QUAGMIRE: IS IT A TAX OR A TAX SOLUTION?

In Uganda, VAT was introduced in 1996 and will be turning 28 in July this year! It is, without a doubt, a crucial source of revenue that is better than the cascading sales tax that it replaced. However, informality, compliance costs, and weak administrative capacity has constrained its effectiveness over the 28 years it has been in existence. If you ask me for #AlternativeFacts, I will tell you that anything that compulsorily reduces my disposable income is a tax; and that the EFRIS quagmire is merely a manifestation of fears associated with reduced incomes resulting from reduced sales occasioned by higher prices attributed to VAT on the purchases made by informal sector operators (read “Kikubo Traders”), from formal sector operators, on the one hand, and reduced income from their imports, on the other. This is compounded by highhandedness in enforcement by URA, and the prospect of being exposed to full taxation by the taxman! ?

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For starters, the so-called informal sector accounts for a large proportion of Uganda’s economy in terms of jobs, and make no mistake, it comprises more than just unregistered street vendors and small businesses, but includes numerous well-to-do individuals, professionals, politicians, and businesses employing hundreds of people across a diverse range of industries but without being registered for tax and therefore going untaxed or paying less than their fair share of tax! This represents both a costly narrowing of the tax base and a potentially serious distortion of economic activity.

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When VAT was introduced as an indirect tax, many countries started with a low VAT registration threshold, but after some practical challenges, realized the need to adjust the threshold to a new and significantly higher level. In Uganda, a single positive rate of 17% was introduced on July 1, 1996 to replace a sales tax on goods and selected services levied at rates between 12% and 30%. The VAT rate was subsequently raised to 18% effective July 2005. The initial registration threshold was set at shs.20 million, and then increased to shs.50 million in November 1996, following a strike by traders. The threshold was further increased to shs.150 million in 2015, and it was argued, that including small businesses in the tax net by setting a very low VAT registration threshold can drain the limited resources available to the tax authority for administration, and yet the revenue potential is insignificant because of the low turnover and low value addition. This is because VAT tends to impose high compliance costs on small informal traders who generally do not have sufficient resources to keep proper records of their transactions and to comply with accounting rules. However, excluding small businesses can ultimately threaten the sustainability of the whole VAT system since informal businesses do not remit VAT on their output, and also do not get to claim credits on their inputs thus distorting the VAT mechanism. Consequently, if an informal business were to buy its inputs from a VAT-registered business, it would face a VAT liability that its formal counterpart would not.

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The appeal of VAT as an indirect tax was partly explained by its perceived self-enforcement mechanism where registered businesses can deduct VAT paid on their inputs (input VAT), from their final VAT liability (output VAT), and therefore have an incentive to ask their suppliers for an accurate tax invoice or receipt. With periodic (monthly) tax return filing, URA receives sales information from both buyers and sellers. The ability to cross-check data should deter false reporting. However, this self-policing mechanism breaks down in two?situations: ?1) When qualifying businesses sell to final consumers who have no incentive to ask for a proper tax invoice or receipt; and 2) When taxpayers misreport their purchases or sales under the conviction that the threat of detection by URA is not possible. This is where the now notorious EFRIS comes into play as a game changer for URA, to improve VAT compliance and enforcement!

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EFRIS which is an electronic invoicing and receipting system, records business transactions, monitors stock movement, automatically applies the correct taxes on a VAT inclusive basis (which directly eats into profits of informal traders), issues accurate and traceable invoices, and reports sales data to the revenue authority – all in real time. Since URA can more easily match buyer and seller invoices (ideally through automated cross-checks), taxpayers are not able to claim input VAT credits without a matching report from a seller. In theory, the system curbs evasive behaviour in two?ways: 1) By generating a more accurate digital ‘paper’ trail that allows URA to improve monitoring?and increases the (perceived) probability of detecting evasion; 2) Because the system provides clearer records of transactions and facilitates pre-filled tax returns, this increases voluntary compliance by making tax filing easier. However, from the informal trader’s perspective, EFRIS places them at risk of “premature formlisation” where their tax compliance costs (including penalties for non-compliance), increase faster than any gains in their effort at making ends meet.

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In order to better understand the EFRIS quagmire, questions about the proper role and design of VAT must be addressed. From the technical perspective, there are two ways in which a VAT can interact with the informal sector in consumer markets. First, on the supply side, a high VAT threshold and rate might drive some formal businesses into informality. This could have the effect of shrinking supply in the formal sector while enlarging it in the informal sector. On the demand side, instead, higher taxes on formal transactions might lead some consumers to switch to informal transactions of the same goods and services. Depending on which of these two effects prevails, the net effect on informal sector prices might be positive, negative, or null.

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The replacement of sales tax (with its cascading effect), with VAT should ideally have caused the number of formal businesses to increase; but a VAT design cluttered with exemptions and which includes a threshold below which a business is exempted from registration to reduce administrative and compliance costs, inevitably creates an informal sector and reintroduces tax cascading (imposition of tax on tax) under the VAT regime. Unravelling this distortion requires understanding what a VAT does, can, and cannot do. And a fundamental point here is that VAT is not, in practice, simply a tax on final consumption, or even on formal sector sales tax. The essence of a VAT is that it is charged on all imports, and on all domestic sales by registered businesses, with full credit or refund to registered taxpayers for the VAT that they have themselves been charged on their purchases. It is only if this chain of crediting and refunding is unbroken that VAT is equivalent to a tax on final consumption.

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There are many reasons why the chain is broken in practice, including in particular, the existence of traders who fail to register for the tax even if legally obliged to do so. But while such traders will not remit VAT on their sales, they will pay VAT (without benefit of any credit or refund), on both their imports and their purchases from VAT registered businesses. The VAT, in such cases, functions as an unrecovered input tax. It is, thus, not even simply a tax on formal sector sales but acts as a tariff on imports by informal sector operators, and a tax on their purchases from the formal sector. The truth of the matter is that businesses which are for any reason excluded from VAT either because they are below the compulsory VAT registration threshold, or because they dishonestly conceal themselves from the tax authorities, will nevertheless be charged VAT on their inputs that are either imported or purchased from VAT registered formal sector businesses, thus the discomfort! Should the VAT threshold be increased as proposed by the traders? Should the VAT rate be reduced? Should EFRIS be suspended? I leave this to the technocrats and politicians…after all taxation is as much a political question!