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The Davis Committee’s VAT report unpacked

What the industry thinks of its first interim report.

The Davis Tax Committee’s first interim report on Value Added Tax (VAT) opens the door for a possible increase in the standard VAT rate. The rate has been applied at 14% since 1993.

The report refers to a 3 percentage point increase to 17% as an example.

The debate on an increase in the VAT rate has been shunned for many years, mainly because of the political hot potato created by trade unions who insist it will harm the poorest of the poor the most.

However, the Davis Tax Committee found that from a “purely macro-economic standpoint” an increase in the VAT rate will be less distortionary than a rise in the personal income tax or corporate income tax rates.

The Davis committee was appointed by former Finance Minister Pravin Gordhan to assess the tax policy framework, and its role in supporting the objectives of growth, employment, development and fiscal sustainability.

The Davis report points out that VAT has accounted for approximately a quarter of the total tax revenue in the last couple of years. It amounted to 25.6% in 2011-’12, 26.9% in 2012-’13 and an estimated 27.8% in 2014-’15.

For government to generate an additional R45bn it will have to either increase the VAT rate by 3 percentage points, the personal income tax rate by 6.1 percentage points or the corporate income tax rate by 5.2 percentage points.

A simulation by the National Treasury on behalf of the tax committee shows that while the VAT increase will be inflationary in the short-run, the impact of a VAT increase on economic growth and employment would be less severe than a rise in individual or company tax rates.

Fiscal impacts of an increase in VAT vs. similar increases in PIT and CIT

Screen Shot 2015-07-12 at 9.55.56 PM

Source: Davis report

“Increases in direct taxes dampen growth, which in turn leads to reductions in tax revenues and constrains the ability of the State to reduce inequality through the expenditure side of the budget,” the committee concludes.

PwC Africa head of indirect tax Charles de Wet says in a statement that studies done by the Organisation for Economic Cooperation and Development (OECD) indicate that broadening the VAT base (no zero-rating or exemptions granted) is the best way to increase VAT revenues.

The OECD report on VAT also confirms that relief for poor households can be better provided through direct transfers such as the social grant system that South Africa already has.

“We hold the view that a reform of the tax mix in South Africa should commence with broadening of the tax base by the elimination of certain zero-rated supplies, with the exception of exports, and any increase in the VAT rate should be considered in tandem with targeted social grants,” says de Wet.

SA Institute of Tax Professionals (SAIT) VAT committee chair Victor Terblanche says a detailed economic analysis should be done on the items included in the basket of zero-rated food stuffs.

“It is not the ideal instrument to benefit the poor. No further zero-rated food items should be considered. It is better to collect tax revenue and redistribute through a targeted transfer to the poor,” he says.

In 2011-2012 more than R40 billion in revenue was forgone as a result of zero rating of certain supplies, of which R19 billion was in relation to basic food such as vegetables, fruit and milk.

SAIT Deputy CEO Keith Engel says the tax committee’s report favours “traditional VAT thinking” with the biggest surprise the openness to a debate around the VAT taxation of financial supplies.

Under the current legislation a non-fee based financial service is exempt from VAT. This means that the financial institution is not able to deduct the VAT paid to a third party supplier of services, which then becomes a hidden cost.

In order to avoid this cost financial institutions try to undertake the required service themselves and in the process the institutions have become increasingly vertically integrated.

This has led to less competition, less specialisation and less potential growth of the industry, says de Wet.

The Davis committee is of the view that various approaches in other jurisdictions should receive urgent consideration by National Treasury and the South African Revenue Service.

One of options to consider is to allow financial institutions to tax supplies of financial services to entities that are in a position to claim the VAT as input tax.

Terblanche warns that the complexity and compliance cost of these concepts deserve detailed analysis before implementation could be considered.

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