Difference between zero-rating and exempting VAT
The Sunday Nation
Nairobi,
29 January 2012
The Kenya Revenue
Authority (KRA) has recommended to the Minister for Finance that
zero-rating of VAT on essential commodities be scrapped and be replaced
with exempt status. A few readers have asked what the deference is
between “zero-rating” and “exemption”: “Don’t both have the same effect
of no VAT on an item?”
The answer is both
yes and no! Yes: at the retail point, the consumer does not pay VAT for
an item that is zero-rated nor for one that is exempt. The difference is
in the supplier side.
If the item is
zero-rated for VAT, the supplier does not collect the tax from the
consumer, but he can claim back the tax paid on the inputs for the item.
If it is exempt; again no VAT is charged, however, the supplier cannot
claim the input tax.
Let’s illustrate with
an example. Suppose the item costs the supplier Sh50. Since it is either
exempt or zero-rated, this Sh50 does not attract any VAT. But the
supplier might incur additional VAT-able costs (in, for example,
processing, packing, distributing etc).
Suppose these
additional costs come to Sh25. Since they are taxable, the supplier pays
16 per cent on the Sh25; that is Sh4. Thus the total cost of the item is
now Sh50 + Sh25 + Sh4 = Sh79.
He adds a margin of,
say, Sh21 and sells the item for Sh100. How is the tax treated in the
two categories: exempt and zero-rated? In the case of exempt status,
nothing changes and the supplier’s gross profit is simply the Sh21.
For zero-rated
status, the supplier fills a VAT return form in which he indicates VAT
collected as nil (zero per cent) and tax paid as Sh4 (16 per cent of
Sh25). Therefore the tax due is a
negative Sh4. In other words, the taxman owes the supplier Sh4.
So if also wants to
make Sh21, he should actually charge Sh96 instead of Sh100; after all,
he will get the remaining Sh4 from the taxman.
Ideally, the supplier
should get back this Sh4 refund immediately after filing the VAT return.
But since the taxman must verify and ascertain that he does indeed owe
the supplier the Sh4, the process can take several months before being
concluded. This is the reason why KRA was complaining that zero-rating
has left it with a mountain of pending VAT refund claims.
But what does that do
to the supplier? Since he is not certain when he will get the Sh4 back,
he has to hedge himself. This involves borrowing the money in order to
keep his operations running. While the interest charged may not be
crippling, the uncertainty on when the refund will be paid is a great
concern to any business person.
Consequently, most
suppliers simply ignore the Sh4 and charge the full Sh100. When the
refund is eventually paid back, they treat it as bonus of sorts. And now
you understand why suppliers don’t pass-on the tax benefit to consumers.
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