Foreign Currency

Foreign Currency Shortage, Political Unrest Fuel Business Slowdown, Undermine TAX Collection

In the first six months of the current fiscal year, the Ethiopian Revenue and Customs Authority (ERCA) collected ETB90.8 billion, which is 83Pct of the target set for the period and 39.5Pct of the target set for the current fiscal year. Officials stress that a growing number of taxpayers are declaring losses or no income on their annual income tax report and Value Added Tax (VAT) refund. Businesses argue that this is due to the slowdown of economic activities attributable to the scarcity of foreign currency, and recent political unrest in the country. Several companies claim that their sales turnover is declining while overhead costs rise, ultimately affecting their capacity to pay taxes. EBR’s Ashenafi Endale explores the situation. 

Members of the Parliament (MPs) were unusually alert when Moges Balcha, director general of the Ethiopian Revenues and Customs Authority (ERCA) presented the 2017/18 six month performance report on January 30, 2018.

“In the past six months, the Authority collected ETB90.81 billion, which is 83Pct of the plan for the period and just 39.5Pct of the target set for the entire fiscal year,” Moges told MPs.

Members of the House raised fundamental questions on the tax deficit. “The economy is growing faster and a lot of wealth is being created,” said one of the MPs. “But tax collection doesn’t reflect this fact,” he said.

Moges agreed with the comment that the revenue from taxes doesn’t align with the economic growth. “A significant amount of wealth created in the economy is not [reflected in the] tax revenue. This indicates that there are phony reports or refunds from the tax payers.”

In Ethiopia, businesses are grouped under A, B and C categories for taxation purposes. Category A consists of large firms with an annual income of more than one million birr while category B, are medium firms whose annual income range between ETB500,000 and one million birr. Companies with a yearly turnover of less than half a million birr are categorized as Class C and are not required to use cash register machine.

Companies under A and B categories are required to use cash register machines. There are close to 35,000 large and medium firms under the direct control of ERCA.

In the first six months of the current fiscal year, tax revenue generated from medium and large companies in particular, was disconcerting. Only 65Pct of the 19,557 companies that declared their 2016/17 financial statements to the Authority paid corporate business tax, and 23.6Pct declared loss. Close to nine percent of the companies submitted unsound financial transactions, while the remaining requested tax refunds.

There are 18,178 VAT-registered large and medium businesses at the federal level.  However, only 31.8Pct of them paid taxes, while the remaining declared losses or no income on their monthly VAT refund form in the first six months of the current fiscal year, according to the report prepared by the Authority.

That more and more taxpayers are declaring losses, or no revenue on their annual income tax report and VAT refund form, is alarming to the Authority.

“The Authority is concerned about the new trend because it is affecting the government’s income and the economy,” said Moges. “This development is unhealthy and the Authority will take legal action against tax evaders.”

The situation compelled the Authority to conduct tax investigations and audits on 1,653 companies in the last six months, according to the report. The ERCA collected ETB7.4 billion as a result of this desk audit.

In addition to the tax that remained uncollected in the last six months, large and medium companies failed to pay ETB15 billion in the past few years. The ERCA planned to collect at least ETB10 billion of that in 2017/18 and 2019/20, but the progress, so far, has been sluggish.

“We are analysing the portion of unpaid tax that can be collected,” explains Sisay Bahru, director of Planning and Performance Control Directorate at ERCA. “The government will decide after the Authority finalizes its assessment on the issue.”

Even though the Authority did not conduct a concrete study to figure out the exact causes, officials indicate that sales without receipt, poor tax compliance, under-invoicing, contraband, inadequate capacity of the Authority to modernize the tax system and strictly monitor firms, and failure to expand the use of cash register machines are the major reasons for the tax loss.

Currently, there are 200,000 businesses using cash machines, according to Rahel Tigabu, cash register machine operation senior officer at ERCA. “Even though there are more businesses that should be using the machine, there is a supply shortage because of the lack of foreign currency.”

According to the six-month report, 1,728 companies started using cash register machines during the period. This represents only 66Pct of the companies that should use the machines.

Despite government figures depicting double digit economic growth over the last decade, various signs show that over the last few years businesses are witnessing a slowdown, which in turn has affected their capacity to pay taxes. For instance, many of the over 60,000 small businesses operating in Addis Ababa wrangled with the Authority since the end of the last fiscal year, over the new daily sales estimates levied on them, which they claim didn’t consider their real income and the business slowdown the country is experiencing. After several negotiations, the Authority accepted almost half of the requests and complaints and made some corrections.

It seems that the business slowdown that hit small businesses first is now looming over large firms. In Ethiopia, there are 1,100 Large Tax Payers (LTPs) who have an annual turnover of more than ETB46 million. Most of these LTPs (with a combined annual income of more than ETB50 billion) are private limited companies engaged in import and manufacturing sectors. Seven years ago, the revenue collected from such companies in the form of customs tax used to constitute half of the total tax collected by the ERCA. However, it gradually declined and now stands at 42Pct of the total tax revenue.

In fact, stakeholders say more and more companies are bringing their operations to an end.   “Strangely, we are handling more cases of companies that are in process of dissolving due to bankruptcy,” a lawyer at a law consulting firm, who requested anonymity told EBR. “Even huge companies are now coming to our office because the business slowdown is affecting their activities and they want legal advice.”

Mathewos Asele, CEO of Kaliti Metal Products Factory agrees with the lawyer. “Our profit has stagnated for the last three years. We have not imported raw materials since March 2017 due to lack of foreign currency. We have cut some of our products like roof tiles, even though there is high demand. In fact, many factories are not utilizing their full capacity at the moment.”

Kaliti Metal Products imports basic metals and truck engines; it manufactures various construction materials, and assembles trucks. It finalized installing three truck assembly lines just a few months ago.

According to Matewos, while the overhead costs of the company are running high, sales are declining. “Under these circumstances, the government cannot expect to raise the tax revenue from large companies in particular.”

Even the booming construction sector has been hit badly by the business slowdown. “The foreign currency has obviously become a serious national [problem]. In addition, the political situation in the country has affected our business,” explains Goitom Woldegebriel, managing director at Teklebirhan Ambaye Construction, one of the leading contractors in the country. “It has been particularly difficult to undertake road projects due to the instability and political tensions in the [states].”

Goitom says that in the past, the company earned better profits and had a lot of work. “But now business is almost dead; we hold stressful meetings each day, on how to solve the problems.”

Tsedeke Yihune (Eng.), owner and general manager of Flintstone Homes shares Goitom’s view. Last year, Flintstone’s revenue witnessed a 26Pct growth compared with last year’s income. However profit decreased by one percent due to a higher growth of operational cost.

Tsedeke estimates that companies operating in the construction sector have been registering 10Pct to 15Pct in losses in recent years due to the overall business slowdown. He believes that the government needs to introduce new policy interventions to reignite the sector.

The business slowdown, made worse by then chronic foreign currency shortage, adversely affected importers and manufacturers who largely source raw materials from foreign markets.

The situation was exacerbated after the National Bank of Ethiopia (NBE) ordered commercial banks to ration the available foreign currency for critical items like medicine, fuel, and capital goods for public projects.

While most importers are currently switching to other businesses or discontinuing their activities, others operate underground, beyond the watchful eyes of ERCA. Importers under-invoice receipts because they mostly access hard currency from the parallel market.

Officials also agree with the fact that many businesses and even some large taxpayers are involved in tax evasion. “ERCA will implement an aggressive audit operation and intelligence service because it is disappointed by the amount of tax collected. Companies have not considered the damage tax evasion can have on their businesses,” says Moges.

Experts, however, say businesses have no choice. “It is obvious that the country loses huge amounts of tax revenue because of the under-invoicing of imported commodities. However, that is not the failure of importers,” argues Tadesse Lencho (PhD), assistant professor of law at Addis Ababa University. “Importers under-invoice import bills because of the lack of foreign currency in the country.”

Tadesse says it is difficult to issue proof of payment to the end user once a product is imported through this method. “Since the exact price of the item is unknown from the start, the importer, distributor, wholesalers, and retailers cannot issue receipt and pay the proper tax.”

To reverse the situation, the NBE introduced a directive on December 4, 2017 forcing importers to declare financial proof of payment to the ERCA that show that the imported items match the foreign currency accessed from banks. Before the introduction of the directive, importers used to access a small amount of hard currency from the banks, and make up for the rest through the black market.

While the fate of many businesses is under question, the Authority is currently trying different mechanisms to tighten its grip, especially on large firms. “We are targeting larger businesses by pushing to collect the unpaid taxes,” says Ephrem Mekonnen, director of communications at ERCA.

Recently, the Authority introduced a Tax Transformation Programme (TTP), which focused on collecting the unpaid taxes, building the ERCA’s capacity and modernizing the tax system. The program has 19 strategic targets, one of which is maximizing tax revenue from LTPs. A new Tax Transformation Office (TTO) has also been established under the Authority. The TTO is directly led by the Prime Minister.

“The TTO is needed because with the current pace, we cannot increase the ratio of tax revenue to reach 17Pct of the gross domestic product by 2019/20,” argues Ephrem. “Currently, the Authority is under restructuring and preparation to establish Center of Excellence, where it trains its human resource.”

Ephrem stresses that the Authority has too few auditors to follow up on every LTP. “One accountant handles activities of 100 large tax payers. However, the Authority is currently working to partner with banks to expand electronic payment service for LTPs effective next month. The e-payment will hopefully reduce the hassle taxpayers may face.”

6th Year . February 16  – March 15 2018 . No.58

Ashenafi Endale

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