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Why VAT only makes sense if there is ‘value added’ to a product or service along the value chain
COMMENT | PETER NYANZI | The ongoing fight between traders and the tax authorities is a clear indicator that the administration of Value Added Tax (VAT) has glaring gaps, which must be addressed to promote national development.
VAT is a ‘consumption tax’ (paid by the final consumer), which is levied on products or services whenever value is added at each stage from production to the point of sale.
In an ideal situation, producers and businesses collect VAT on their sales, but they also deduct the VAT they may have paid earlier on purchases for their own input activities. The final consumer then ultimately bears the entire burden of the VAT because it’s included in the final price that he/she pays for the goods or services.
Let me use the example of the National Water & Sewerage Corporation -supplying clean water to Company X that makes juices and bottled drinking water – to explain this process.
NWSC incurs VAT when it purchases raw materials, equipment, services, and other inputs that are necessary for its water production processes. This VAT, which is paid on inputs, is known as ‘input’ VAT.
Now, when NWSC sells its ‘value-added’ water to Company X to make juice and mineral water, it charges 18% VAT on the water. This VAT (which NWSC collects from Company X), is known as ‘output’ VAT. In an ideal situation, the value of output VAT is higher than that of input VAT because of the value- addition aspect.
Now, the difference between the output VAT that NWSC collected from Company X and the input VAT that it paid on its inputs, represents the VAT liability of the producer (NWSC) and it must be remitted to the tax authority.
Similarly, after Company X has used NWSC water to produce ‘value-added’ juices and mineral water, it will deduct the input tax paid to NWSC for the water, from the output VAT paid by businesses (that sell juice and drinking water to the final consumers) and remit the difference to URA.
But should the input VAT exceed the output VAT at a certain point, then the producer is entitled to a VAT ‘refund’ in form of a tax credit. This entire system becomes self-regulating as producers will only want to supply to VAT-registered companies in a bid to reduce on their VAT liability.
From the above example, it is important to note that VAT only makes sense if there is ‘value added’ to a product or service along the value chain.
But apart from local products and services, VAT may also be applied on imports – intended to ensure that imported and locally-produced products can compete on a level playing field in terms of price competitiveness.
Therefore, as soon as say a bale of used clothes arrives in Uganda, it is assumed that value has been added to it, so the importer has to pay VAT of 18% as required by law.
If it is a large importer who is going to distribute the bales of clothes to other VAT-registered companies that sell to other VAT-registered businesses, the input/output VAT process must happen as discussed above.
However, the bone of contention now is that of the small-scale trader operating a shop in kikuubo. Of course, he/she is a small-scale importer, he/she would have to pay the mandatory 18% VAT as required by law when clearing the goods with the Customs authorities.
But, should this small trader also be subjected to the input/out VAT process? I mean, what value has been added to the imported clothes along the distribution chain so as to warrant further payment of VAT? Technically, that would amount to double taxation.
Realistically, any subsequent transactions involving finished imported products at the lowest level should be inclusive of VAT. That is exactly why the shopkeeper near your home does not remit VAT. You can’t accuse her of evading VAT, can you?
I contend that such ‘double taxation’ only serves to raise the prices of imported goods, to the utter disadvantage of the citizens and eventually, national development. If the prices of essential goods become too high, citizens cannot save, which negatively impacts aggregate savings in the economy.
If indeed the intension of the tax policy is to make imports unattractive, ostensibly to support import substitution, then we might be barking the wrong tree. The Government must instead create a more conducive environment for local investment.
Take the example of the Government’s own Teso Juice factory in Soroti. To what extent is it supporting import substitution for juices?
But most importantly, curtailing importation carries the unintended consequence of reducing employment opportunities for citizens. For example, importing just one container of used clothes does provide jobs for several people including clearing agents, drivers and driver’s assistant, truck owners, loaders, and traders at various levels. If it ain’t broken, don’t try to fix it, as our American friends often say.
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The writer is a business journalist
