Compliance on Value Added Tax (VAT) in Zambia still remains a challenge. The VAT gap (the difference between the VAT liability and the actual collections of VAT) is estimated to be over 30 percent. In other words, the government collects under 70 percent of what it can potentially realize from all VAT receipts. Factors contributing to this significant VAT gap include; underreported sales and high VAT refunds which have averaged around K1.3 billion quarterly in the last 6 years and pose a risk of inflated VAT claims. Also, the high VAT registration threshold set at K800, 000 may be contributing to lower VAT receipts. While a higher threshold is beneficial in reducing administrative costs, it may create opportunities for more tax evasion. Large volumes of transactions made using cash also create a thriving environment for tax evasion. Furthermore, new businesses under VAT registration tend to be less compliant than older businesses.
Value Added Tax (VAT) is an indirect tax introduced in Zambia in 1995. It is an important source of government tax revenues contributing to over 20 percent of total tax revenues. The VAT standard rate in Zambia is 16 percent with a relatively narrow scope of goods that are exempted or Zero rated. Given the large VAT gap in Zambia, there is great potential for improving VAT revenues in the country. Closing this gap, however, requires targeted interventions that deal with the challenges. Moreover, due to the already high tax burden, broadening the VAT base and revenue through an increase in the standard rate may prove difficult.
The major concerns with VAT lie in its distributional effects and the low levels of compliance. VAT is largely held to be a regressive tax because the VAT burden tends to fall as disposable income increases. Higher-income earning individuals save relatively more of their income compared to low-income earners who spend most of their income on consumption. This means that larger amounts of income escape the VAT net as more of it is saved. However, this position does ignore the fact that saved income will be consumed in future and thus will incur tax. The extent to which future consumption compensates for current losses will largely depend on how and where the consumption is done.
Resolving the VAT challenges and increasing revenues can be achieved by making a number of reforms. s. The VAT registration threshold can be reduced to allow for more Small and Medium Enterprises (SMEs) to register for VAT which will increase VAT receipts. Further, VAT refund claims must be comprehensively investigated and an understanding of what is driving the high VAT refund claims would enable better-targeted interventions. Also, improving compliance checks will enable the revenue authority to detect fraud. In addition, the use of cash payments in business transactions must be limited to a certain threshold. This will enhance the monitoring of VAT-registered businesses and reduce opportunities for tax evasion.
There is also a need to identify the sectors with large VAT gaps. Empirically, manufacturing, construction, and Mining tend to yield larger VAT gaps. Finally, as opposed to VAT zero-rating or exempting goods that do not advance progressivity and have little benefit for low-income earners, the government needs to consider alternative ways of cushioning the poor. More often, while reduced rates provide minimal benefits to lower-income households, they provide greater benefits to richer households in aggregate terms.
Ibrahim Kamara (Mr)
Zambia Tax Platform Coordinator