The Value Added Tax (VAT) is the closest a tax has come to becoming a household name in Nigeria. It’s regularly on the news with politicians, tax experts and industry leaders going back and forth on the potential costs and benefits of a rate hike. If you have found yourself wondering what VAT is, how it is administered and what effects it can have on the economy, this introduction is for you.
MEANING OF VAT
A value-added tax is a consumption tax charged on a product whether goods or services at a specified rate for value created at each stage of production up to the point of sale and ultimatelypaid by the end consumer. There are two ideas central to the understanding of this definition of VAT: VAT is paid by the end consumer and VAT is charged on value created at each stage of production.
Unless a product is exempted, VAT must be paid on it. This means that, since it is a form of consumption, all the firms involved in the various stages of production are required to pay VAT on the goods and services used in creating their products such as raw materials and rent. This is known as input VAT. However, in a perfect VAT system, such firms would be allowed to deduct all the VAT paid in the making of their products from the VAT charged on the finished products (output VAT). This process continues from the supplier of raw materials, the manufacturer, down to the retailer, until it reaches the consumer who cannot pass the cost to anybody else. Thus, VAT is collected at each stage of production but ultimately paid by the end consumer.
VAT is charged on the value added at each stage of production or on the gross margin of a firm. A retailer who buys a product for ₦150 from the manufacturer and sells to the end consumer for ₦200 has added value of ₦50 which amount is the subject of the VAT at the specified rate.
PRACTICAL ILLUSTRATION OF VAT
To illustrate, assuming a VAT rate of 10%, a manufacturer B who buys raw materials from a supplier A for ₦100 would pay a VAT of ₦10 on the purchase. At the end of the manufacturing process, if B puts his finished product for sale at ₦150, the retailer would pay ₦150 plus ₦15 for VAT. However, B would only transfer ₦5 of the VAT collected to the government since he had previously paid a VAT of ₦10 in the making of the product. If the retailer in turn puts the product for sale at ₦250plus a VAT of ₦25, he would remit only ₦10 to the government since he previously paid a VAT of ₦15 on the product. This ensures that the amount collected in total by the government as VAT is the ₦25 on the final product and eliminates double payment. Note that the amount remitted by the manufacturer and the retailer equals exactly 10% of the value they added to the product.
The benefits of the VAT system is that it has a broad base since it is based on consumption, and, compared to the retail sales tax where the totality of the tax is collected at the point of sale, it is harder to cheat because it involves many more parties. On the other hand, critics say that it is regressive because the flat rate takes a higher proportion of a lower-income person’s means, and, compared to a retail sales tax, it is more complex to administer.
HISTORY AND ADMINISTRATION IN NIGERIA
In Nigeria, VAT was first introduced in 1993 through the ValueAdded Tax Decree No. 102 of 1993. This law has been amended several times over the years. The latest amendment to the VAT law in the country has come from Finance Act 2019, which has increased the rate of the tax among other things. Before the introduction, Sales Tax was under the control of the states and was somewhat inefficiently administered.
Now, although VAT is collected by the Federal government, the states are the biggest beneficiaries of the proceeds which are shared between the three levels of government at the ratio of 15:50:35 starting from the federal government at the top down to the local government.
OPERATION AND STRUCTURE IN NIGERIA
At 7.5%, newly introduced under the Finance Act 2019, Nigeria has one of the lowest rates of VAT in the world which partlyexplains why the government is constantly looking to jack up the rate. In West Africa, the average rate is 18% while South Africa and Kenya have rates of 15% and 16% respectively.However, due to some peculiarities in the Nigerian structure a rate for rate comparison with other jurisdictions may not be appropriate.
In our sister nations, firms are allowed to recover the totality of their input VAT as illustrated above, a fact that makes the burden of a higher rate easier to bear. Nigeria, on the other hand, places restrictions on the type of “input VAT” that can be recovered.For inputs used directly in the manufacturing process, amanufacturer can recover VAT in accordance with the ordinary rules, just as a retailer can recover VAT paid on goods bought for resale. However, VAT paid on services such as rent and VATpaid on fixed assets are not recoverable in Nigeria even though they may form part of the input for the manufacture of the product in actual fact.
Businesses are required to obtain registration for the purpose of VAT administration since firms handle collection on behalf of the government. Before the passage of the new finance bill, every business whether small-, medium-, or large-scale was essentially required to be registered for this purpose because our law did not prescribe any income threshold for liability to account for VAT. This marked another difference between Nigeria and other African countries where there was an income threshold to protect the smaller businesses from the burden of VAT. The finance bill now requires that only firms with an annual turnover of at least ₦25m will account for VAT.
Another interesting aspect of VAT in Nigeria is the current imposition of VAT on calls and sms. As you might have noticed, VAT charges now apply to your mobile phone calls and sms.
Lastly, some products are exempted from VAT in Nigeria. These include basic food items, medicinal and pharmaceutical products, books and educational material; plant, machinery and goods imported for use in the export processing zones or free trade zone; fertilizers, tractors, ploughs, farming equipment and implements purchased for farming purposes; services by community banks, people’s banks and mortgage institutions and many more.
EFFECTS ON THE ECONOMY
VAT is an important source of revenue for the government accounting for 21% of the 5.3 trillion collected by the FIRS in 2018. It is easy to see how the government might consider increasing the rate to generate even more revenue in the future. The problem with this idea is that increasing the rate might not necessarily lead to increase revenue generation and might even turn out to be counterproductive.
Increased revenues from the increased VAT rate offer a lot of opportunities for our economy. It could help to pay for the increase in minimum wage and help to offset the budget deficit for the year. The plan to introduce VAT to the digital economy also has enormous revenue potentials.
On the other hand, it is an axiom that as tax rate increasesefficiency falls and taxpayers work harder to avoid paying the tax or, in some cases, they may no longer be able to afford to pay. Concerns have been raised to the effect that, in a country with about half of the population falling below the poverty line, the increase rate would have an adverse effect on the most vulnerable groups or even force more people into poverty by essentially reducing their purchasing power. The government on its own part has issued assurances that the effect of the increase on the most vulnerable groups should be insignificant since the articles of basic sustenance are exempted
Perhaps the biggest threat is that the increase could drastically drive up cost in the formal sector as firms are forced to pay more VAT for good and services without the opportunity to recover from their output VAT. This could be passed on to consumers in the form of higher prices. Businesses may lose customers if consumers are forced to look for cheaper substitutes. It may also reduce household consumption as a result of the desire to avoid the higher rate, just as it may reduce the actual purchasing power of the household. If the productivity of firms or the consumption of household is thus affected, the VAT tax base may contract or there may be only an underwhelming growth since production and consumption drive VAT.
VAT is one of the most important revenue sources for the government and the newly increased rate can be a revenue boost for the government. However, it also contains potential pitfalls for the economy which the government has to manage well.
ABDULKAREEM ABEEB is a scholar of law. Abeeb is currently a final student of the faculty of law, university. He enjoys contributing to knowledge and holds a peculiar interest in tax. He can be contacted as follows:
Mobile No: 09028262719