With Egypt’s economy struggling to get out of the decline it suffered owing to the political turmoil brought on by the Arab Spring uprising in 2011, talk has been going on among economists that a tax imposed on purchases, Value Added Tax (VAT), may save the day. Discussions abound about the experience of countries that preceded Egypt in applying VAT, particularly France, who took the lead in 1954.
VAT is a consumption tax levied on any value that is added to a product; it is an indirect tax, in that the tax is collected from someone who does not bear the entire cost of the tax. Many experts believe VAT is one of the best taxation methods owing to its unified system of application and calculation with respect to all taxpayers. Some even argue that applying VAT in Egypt would help attract foreign investors because the system is widely applied worldwide; it has been tested and approved and investors have long been familiar with it. In many if not most countries tourists can claim back sales tax when they leave, which would promote sales of national products.
There is a wide view, however, that selecting the right time to apply VAT in Egypt, and educating taxpayers about the new system could be a decisive factor for its success. And now is not the right time, they say.
Minister of Finance Hany Qadry stresses the importance of applying VAT. The application of VAT, he says, has already partially started, and the full application of this taxation method should increase the share of collected taxes in the State revenue to 14 per cent. Currently, if the revenue from the Suez Canal is put aside, tax revenue amounts to a mere 8 per cent of the total State income. The change in tax system must bridge the economic gap and help finance national projects, Dr Qadry adds.
In the September issue of its publication series “What If?”, the Egyptian Centre for Economic Studies (ECES) raised the question: “What if Egypt replaced its General Sales Tax (GST) with the Value Added Tax (VAT)?” The two proposed scenarios were developed basing on the statements made by the Finance Minister.
The first scenario suggests that the government applies VAT in a “transparent and just manner”. This would lead to the expansion of the tax base and consequently to a EGP30 billion increase of government revenues in the fiscal year 2015/2016. The publication expects that this would also cause the price of non-basic goods and services to incur a one-time increase and the inflation rate to rise by 2.6 per cent. Applying VAT would also result in easier processes of billing and refund incentives, which would in turn lead to the formalisation of a substantial part of the informal sector and to the elimination of double taxation which would encourage tax compliance.
Revenue vs. inflation
The second scenario suggests that the government rules out the application of VAT and instead keeps and augments currently applied GST. If this system is adopted, it must be associated with GST legislative reform that would include providing compliant tax payers with incentives and imposing strict penalties on tax evaders, leading thus to an increase in tax revenues. As a consequence, inflation is not expected to increase, which would lead to the expansion of both the informal sector and the cash economy. But this also leads to non-uniform tax rates on various goods and services, entailing the complicated administration of taxes.
Hazem Hassan, chairman of KPMG Public Accountants and Consultants, says the first step in reforming the Egyptian tax system was taken in 2005 with the application of the unified income tax [law No 91 of 2005]. This law constituted a quantum leap in the income tax system in Egypt, and generated a substantial increase in tax revenue. More tax reform is required, however, he says, and VAT ought to be applied in a comprehensive and complete way to all goods and services.
Applying VAT, he adds, will be viewed by investors from all over the world as the beginning of a new era of modernisation of the Egyptian tax system. Currently, VAT is only partially implemented in Egypt.
What is VAT?
According to economic expert Mokhtar al-Sherif, the difference between VAT and the currently applied GST lies in the fact that the latter is applied only to the last phase of the production chain which is the retail sale of goods. In this case the tax is paid by the consumer alone. In case of VAT, a tax is applied on each phase. For instance, in the case of furniture production, a VAT is applied on the raw material such as wooden boards; it is included in the price at which the manufacturer buys the raw material and it is the seller of the wood who pays it. When the wood is manufactured into a closet, another value is added to the manufacturing phase and the manufacturer pays the VAT which is equal to the value added in the manufacturing phase. And so on, a VAT is levied on the value added at each phase of the production chain and is paid by the contributor to the added value alone. Because the VAT requires a considerable amount of bookkeeping, its application necessitates that all manufacturers and sellers commit to issuing receipts so that the prices of inputs and outputs be carefully documented. This guarantees the fair application of taxes to both buyers and sellers because it proves the origin of all goods and services.
Farid Fawzy, board member of the self-employed accounting and auditing practitioner branch at the Syndicate of Commercial Professions, believes that the difference between VAT and GST is minimal. The currently applied GST, he says, adopts about 80 per cent of the mechanism of calculation of VAT. However, the societal burden resulting from the application of VAT will be huge since the tax will be increased from 10 to 14 per cent.
The Egyptian association of tax experts is demanding that the State fix a suitable unified VAT for goods and services. The association suggests that the value of VAT must not exceed 10 per cent of the value added to a product at each stage of production in order to limit inflationary effects and the increase in prices it will entail. It also advises the Finance Minister to think carefully about choosing the best time to apply VAT because it could cause an unjustifiable increase in taxes.
Chartered accountant Ashraf Abdel-Ghani, chairman of the association, says the VAT law must provide a number of mechanisms to ensure a smooth transition from GST to VAT. Mr Abdel-Ghani also suggests that the tax authority reconsider the legal deadlines for presenting tax return statements. This could relieve the tax authority from many administrative burdens and allow for the availability of cash. He calls for the establishment of a clear legal mechanism that will guarantee VAT refunds for exporters and put an end to the delay in the reimbursement of tax dues resulting from procedural and bureaucratic complications.
Timing of utmost importance
Omneia Helmy, acting executive director and director of research at ECES, says that 50 years ago VAT was only known in France, but now it is applied in more than 150 countries. The input of VAT deduction can be an incentive for the informal sector to legalise their status, she says. The implementation strategy must guarantee that VAT becomes an incentive for companies in the informal sector to join the formal sector, not the other way round.
Shifting from GST to VAT, Dr Helmy explains, will eventually lead to an increase in revenue and help bridge the increasing budget deficit which has reached EGP240 billion, representing 14 per cent of the GDP. Other benefits of applying VAT include promoting production efficiency, encouraging exports, increasing revenue, putting an end to tax evasion and increasing tax proceeds.
There is, however, another aspect to the application of VAT. Dr Helmy says that a well-designed and well-implemented VAT can yield high revenue for the government but would at the same time cause inflationary pressures, especially at the beginning of its implementation. She therefore insists that choosing the right time to apply VAT is a key factor for its success. The current period must be avoided, she says, owing to the increase in the prices of goods resulting from various factors.
In total agreement with Dr Helmy is former Prime Minister Ali Lotfy who insists that timing is the most significant factor in applying VAT. It is of utmost importance, he insists, that the average citizen and taxpayer be informed about the advantages for the Egyptian economy of applying VAT. Because if this new tax system increases tax revenue, traders may be reluctant to apply it, thinking that it will increase the taxes they pay.
Dr Fawzy is among those who support the application of the VAT system but believes that applying it at this particular time would be wrong, owing to the tax burden which the average citizen would have to incur. “Applying the VAT would have been more suitable had it been done years ago,” he says. “I expect that the government is smart enough to delay its application until we overcome the current economic crisis.”
VAT was applied for the first time in France in 1954 by Maurice Lauré, the then Joint Director of the France Tax Authority. Most economists believe that it is the best method for fixed sales taxation; however, it has been criticised by popular movements and rights organisations for not benefiting small producers while on the other hand benefiting major companies with huge production.
18 January 2016