Why VAT?

Taxes “are the dues that we pay for the privileges of membership in an organised society”. As this quote from US President Franklin Roosevelt suggests, governments across the world need to collect tax revenue to be able to provide public goods and services to their citizens. There are several forms of taxes. The most common are Personal Income Tax, Corporate Income Tax, and Value-Added Tax (VAT).

VAT was largely a European creation. It was introduced by French tax authority Maurice Lauré in 1954, although the idea of taxing each stage of the production process was said to have first been suggested a century earlier in Germany. The vast majority of industrialized countries have a VAT system however the United States remains a notable exception.

South Africa’s current VAT system was introduced in 1991 at a rate of 10%, replacing the general sales tax system which was levied at 12%. Since VAT is more broad-based than the general sales tax, the effect on tax revenue collected was deemed to be neutral in terms of tax revenue collection. In an attempt to increase tax revenue collection, the VAT rate in South Africa was increased from 14% to 15% on 1 April 2018 after it had remained unchanged for 15 years (since 1993).

The main difference between a VAT and a sales tax is that a sales tax is only paid once, at the initial point of sale. This means only the retail customer pays the sales tax. VAT is instead collected multiple times during the production of a finished product. Each time value is added or a sale is made, VAT is collected and remitted to the government. VAT and sales taxes can raise roughly the same amount of revenue. The differences lie in the point at which the money is paid and by whom.

Both critics and proponents of VAT generally argue it is an alternative to income tax. The South African VAT system is found to be mildly regressive, where a larger percentage of income is taken from the poor in comparison to the rich. It is a good source of government revenue in comparison to other tax types, as individuals in the informal sector also contribute to the revenue stream. Overall, however, the South African tax system is viewed as being progressive in nature, as the rich pay tax at a higher rate than the poor. For this reason, VAT should not be considered in isolation.

All businesses that make taxable supplies in excess of R1 million in a 12-month period need to register as a VAT vendor. These vendors need to levy output tax on all sales made and are seen as agents of the South African Revenue Service (SARS).

The entities can also claim input tax on all purchases made on which VAT was levied if it is used for business purposes. The net amount remaining after subtracting the input tax from the output tax must be paid to SARS.

Increasing the tax rate is a seemingly easy way to raise tax revenue. However, there are dangers, particularly around tax compliance and affordability. Increased taxes lead to less disposable income. In determining the tax rates, government needs to ensure the rate is conducive to sustainable economic growth and tax compliance. Better tax compliance will certainly lead to higher tax revenue being collected. Not an easy task as Jean Baptist Colbert stated: "The art of taxation consists in so plucking the goose as to get the most feathers with the least hissing."

Aneesa Khan

Head: Finance & ICT