Removal of VAT zero rating second best prize to increased rate

The taxi industry will be hard-hit once the proposed scrapping of the Value Added Tax (VAT) zero rating on diesel and petrol is implemented.

Finance minister Pravin Gordhan proposed in the 2017 Budget Review the removal of the zero rating in an effort to expand the VAT base.

Ferdie Schneider, head of tax at BDO, says a rough calculation indicates that the potential tax on previously untaxed parts of the transport industry could contribute around R2.9 billion.

“Government indicated that it will consider combining the zero rate removal with a freeze or a decrease in the fuel levy to decrease the impact on transport costs.”

According to Schneider, the overall expected fiscal gain could be more than R15 billion.

VAT expenditures consists of relief to low-income households and the easing of the administrative burden on specific economic sectors. The VAT Act currently also zero rates 19 basic food items which include brown bread, rice, milk, eggs and vegetables.

VAT expenditures are estimated at R41.7 billion or almost 40% of the total tax expenditures of R109.6 billion. Tax expenditures include refunds, annual exclusions, tax deductions, preferential tax rates for small businesses and then also the zero rating of basic food items, petrol, diesel and paraffin.

“It is estimated that a 1% increase in the VAT rate could raise an additional R15 billion per annum. Removing VAT expenditure in total would therefore be akin to an almost 3% increase in the VAT rate.”

Deloitte indirect tax leader Severus Smuts says although government indicated that it may reduce the fuel levy or freeze it for a certain period of time, it certainly is no major concession.

The price will increase between 10% and 14% depending on the relief (or lack thereof).

“Petrol is a bear essential for most South Africans because people either use their own transport or public transport (taxies and buses) to get to work and back. Since transport is part of the basket for measuring inflation, it (inflation) will increase.”

This will certainly contribute to the further erosion of disposable income, says Smuts, who is vice-chair of the South African Institute of Tax Professionals (Sait).

Charles de Wet, indirect tax partner at PwC, says the initial decision to zero rate the sales of diesel and fuel was based on the fact that it would be a tax on top of a tax.

Currently 36% of the retail price of petrol represents the general fuel levy, the Road Accident Fund levy and Customs and Excise levy. In the case of diesel the taxes constitute 40% of the retail price.

It was also argued that the fuel levy was easy to operate and it was efficient because of the few collections points. It also eased administrative issues. De Wet says the proposed tax upon tax may increase the administrative burden.

“However, as VAT is only levied on the final consumer, businesses will be able to claim input tax on the fuel and diesel where certain requirements are met resulting in a lower additional revenue.”

The downside for the transport industry is that public road and rail transport are exempt from VAT, which means input VAT cannot be claimed. Other exempt services include education, financial services, property rates and public hospitals.

Schneider says he is a “firm believer” in a VAT base that is as broad as possible. “I do not see any principled reason why this should have been zero rated in the first instance,” he says.

Smuts says another area that has been targeted to broaden the VAT base is cloud computing and online application services.

“I think the entire list of electronic services is going to be revised. There is a whole host of other services (applications for downloads) which should be added to the list since the VAT on the sales are not currently collected.”

Smuts says it has already been done with the electronic sales of books and music and will most probably be expanded to other electronic services.

Schneider says it may be necessary to relook the 19 food items that are currently zero rated. The removal has a potential of R15 billion in additional revenue.

Marius van Oordt, senior lecturer at the African Tax Institute at the University of Pretoria, says his research has shown that richer households benefit more from the zero ratings than poorer households.

He says in an article, published by Sait’s Tax Talk magazine, although the social grant system is currently not “perfectly targeted” towards assisting the poor it is available.

Cash transfers through the system, obtained from lifting the zero rate on food items, does not hold a significant practical challenge.

If the zero rate is removed on fruit and dairy alone, government can expect to raise an additional R2 billion in revenue which can be channelled back through social grant payments, says Van Oordt.

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