Can a business make more profit by registering for VAT?
The Sunday Nation
Nairobi,
17 November 2013
Charles Maingi is
wondering whether there is a way he can take advantage of Value Added
Tax (VAT) to make more profit in his business. He says that he is
employed but has a side-hustle. “It’s a small business that doesn’t
qualify for VAT but I’ve been told that I can make some extra cash if I
registered because I can claim back the VAT that I pay to my suppliers.
Is this true?”.
First of all, it is
important to note that there is a limit for VAT registration: Business
whose annual sales are less than Sh5 million are not required to
register. However, those who are exempt from registration can
voluntarily apply to enlist. I will assume that Charles fall into this
category.
Suppose Charles is
buying his products at Sh100 (including VAT) and then selling them at
Sh150 (excluding VAT). Since he isn’t registered for VAT, he is making
Sh50 profit per item sold. What would happen if he enlisted?
He’d have to decide
whether his customers are willing to pay the extra 16% increment on the
selling price (that is, Sh24). He can probably convince them using the
usual “new VAT act” excuse. If they accept, then his finances will go as
follows:
The item is bought at
Sh100 (including VAT); this means that its ex-VAT price is Sh100 divided
by 116%. That is, Sh86.21. Hands up all those readers who thought it was
100 – 16 = 84…you were wrong!
Now the way VAT works
is that, when filing his monthly returns, he is allowed to deduct the
VAT paid to his suppliers before making the payment. Thus he will
proceed as follows:
VAT collected from
his customers is Sh24 (16% of 150); VAT paid to suppliers is Sh100 –
Sh86.21 = Sh13.79. Therefore VAT payable to the taxman is Sh24 – Sh13.79
= Sh10.21.
His income statement
will then look like this: Sales are Sh174, purchases are Sh100 and VAT
paid to taxman is Sh10.21. Therefore the profit is 174 – 100 – 10.21 =
Sh63.79.
Before going on, I
must warn that this is NOT the normal way of doing the profit
calculation. It is preferable to work with ex-VAT amounts. This is
because the VAT is a “pass-through” item. Thus we should have subtracted
the ex-VAT sales from the ex-VAT purchases; that is Sh150 – Sh86.21 =
Sh63.79.
The two answers are
the same but the important thing to note is that now Charles is making a
higher profit of Sh63 compared to the Sh50 he made before registering
for VAT.
But business is not a
straightforward matter like accounts! Business has many variables at
play. For example, Charles’s competitors might keep selling at Sh150
thereby making it difficult for him to raise his price.
In that case, he’d be
forced to continue selling at Sh150, but now that figure includes VAT.
Thus his net ex-VAT selling price is Sh129.31. Subtracting the ex-VAT
buying price of Sh86.21 we find that his profit is now Sh43.10 – he is
worse off!
This is something
that Charles must prepare for when eventually his side-hustle becomes
the main hustle and crosses the Sh5-million threshold. His profit will
drop by the same margin – about 14%.
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