Poor Tax Compliance System Leads to Tax Evasion-Nation Loses Billions

Tax compliance in Ethiopia has a long way to develop. According to the International Monetary Fund (IMF), the amount of dodged taxes in the 2009/10 fiscal year amounted to ETB19 billion, which accounted for 5Pct of gross domestic product (GDP) that year. This money would have covered more than 20Pct of the amount the nation spends on the construction of the Grand Renaissance Dam. In order to reduce this, the government enacted a plan to improve tax evasion, particularly when it arises from contraband and illicit business activities. But all these years later, has the plan proved fruitful? EBR’s Ashenafi Endale explored the issue to learn the details of what’s worked and what hasn’t.

The issue of taxation and revenue mobilisation has become one of the most important topics in developing countries. Considering that the tax to gross domestic product (GDP) ratio in Ethiopia is one of the lowest in Africa, promoting compliance and equipping collection institutions with adequate enforcement power, which will boost revenue mobilisation, is an important priority as the government aims to increase domestic revenues.
However, reports suggest that compliance is the main challenge in growing the country’s tax base. Although the existence of tax dodging is not a recent phenomenon, it wasn’t until after the Fiscal Affairs Department of the International Monetary Fund (IMF) reviewed the status of revenue administration reforms in 2010 that the extent of the problem was fully understood. In response to the request of Melaku Fanta, former Director General of the Ethiopian Revenues and Customs Authority (ERCA), researchers studied the situation and discovered that tax evasion, especially on custom duties, was high and on the rise in Ethiopia.
According to the report, published by the IMF in December 2010, the amount of dodged taxes comprised 5Pct of the GDP in 2009/10, which was equivalent to ETB19 billion at that time. The year-on-year growth of taxes that were forgone was also shocking, considering that in 2008/09 it stood at 4.5Pct of GDP. This means that within a year the nation had lost close to an additional ETB2 billion in taxes.
The heart of the problem, according to the report, originates from Merkato – Addis Ababa’s biggest open-air market, where 11,653 registered businesses were located out of the total 230,036 throughout the country in 2009/10. Resting on just two square kilometres of land, Merkato is estimated to command at least half of the nation’s cash transactions and is generally acknowledged as the business hub of Ethiopia, serving all regions of the country as a wholesale centre. Since not all traders in Merkato are licensed nor registered for tax purposes, the IMF mission estimated that the tax compliance rate in the area was around 25Pct five years ago.
They attribute this high evasion rate to the nature of business in the area. Most enterprises are inherited from one generation to the next within families; they’re also governed by tight-knit links between families, religion, ethnicity, business type and level; and supplies are often acquired through illicit means and informal transactions. Most of the transactions take place outside of formal banking systems and are cash based, which makes traceability difficult.
Based on the recommendations of the IMF, ERCA finalised its own detailed study in the area in November 2011, with assistance from the Fund. Right after the findings went public, Meles Zenawi, the then Prime Minister, ordered the establishment of two ERCA branches in Merkato, with four tax centres under each.
“We did not understand the importance of controlling Merkato before the study,” says Yared Fekade, former head of one of ERCA’s Merkato branches and now head of the Addis Ababa Tax Assessment and Collection Programme Development and Support Office, which is currently under formation with four directorates.
When the branches located in the Addis Ketema District started operating in the 2012/13 fiscal year, they managed to collect ETB224 million, only 2.39Pct of the total tax collected from Addis Ababa, and less than the amount collected by each of the other nine districts. Three years later, the two branches collected ETB1 billion combined, more than the amount collected by any other district.
The efforts of the ERCA to better regulate business practices in Merkato seem fruitful. When the branches became operational, 1,000 companies registered for value added tax, a figure that currently stands at 4,000. The number of taxpayers under the two branches is 22,000, which is up from 6,740 when they went operational. Of the 6,000 businesses that should be using a cash register machine, 92Pct are currently utilising them, which was only 17Pct when the branches opened.
Ten years after cash registers were introduced as one of ERCA’s moves to modernise the tax system, there are 161,286 cash register machine users throughout the country, 59Pct of the 246,419 that should be in use. Over the last nine months, 10,410 taxpayers have purchased 13,862 machines nationwide.
The tax compliance rate currently is 57.4Pct, up from 25Pct five years ago, although it is still less than the 80Pct the IMF estimated would be reached at this time.
For the current fiscal year, the two branches plan to collect close to ETB1.5 billion combined. The first branch collected ETB560 million in the first nine months of the current fiscal year. In Addis Abba, ETB15.4billion has been collected over the last nine months, of the ETB17.7billion the ERCA planned for the period. The Authority plans to collect a total of ETB165.8 billion in the 2015/16 fiscal year, including ETB22.8 billion from Addis Ababa.
However, compared to the business transactions in Merkato, ERCA officials argue that the amount of taxes being collected is still minimal. “It is like fetching the Nile River with a spoon,” said Yared. “The two branches were installed just to fulfil the suggestion of the study. They started with the capacity that was enough for other regular districts, because much attention was given just to open the branches, without boosting capacity. Even now the capacity of the branches does not meet the minimum of what Merkato needs.”
When Abreham Nigussie, acting Director General of the ERCA, presented his office’s nine-month performance in front of Members of the Parliament (MP) on April 19, 2016, his speech mentioned that limited capacity isn’t the only issue plaguing the tax collection system. “Forgery documents, informal markets, contraband, transactions without receipts, tax evasion, under and over invoice declarations are the major problems challenging the tax system, especially in Merkato,” he told the MPs.
Yared suggests compliance is a key hurdle in harnessing Ethiopia’s domestic mobilisation potential. “In February and March, of the 109 companies and 177 individuals the Intelligence Directorate of the Authority investigated for failing to issue bills and involvement in contraband in Merkato, 90Pct were found responsible,” he says. “More than 1,600 businesses were also found operating outside of the tax system during that period.”
While officials of the Authority argue that most of the challenges emanate from the nature of business in Merkato, they say another challenge is the importers. “Businesspersons in Merkato work for a few months a year,” argues Yared, who stresses that in Merkato, it is simpler to be illegal than legal. “Even if you ask importers for a receipt, they do not give it to you.”
Others close to the issue have their own perspective. “There will always be transactions without receipts in Merkato because of the huge contraband activity there,” says Eyasu Temesgen, who represented the Ethiopian Freight Forwarders and Shipping Agents Association during a meeting the ERCA held with sectoral associations on April 21, 2016.
Indeed, business owners have complained that the reason why they’re involved in contraband, fail to issue receipts for imports and don’t pay taxes is because they cannot attain adequate Letter of Credit (LC) approval on request for imports.
Yared agrees. “Because the foreign currency they get from banks is very small and only covers the transportation cost, or they might not get it at all for a long time, they get the hard currency from the black market to import,” he explains. “Therefore, the importers cannot bring valid documents that are issued by appropriate authorities.”
This is how imports become contraband. An under-invoiced import also becomes contraband. The act also includes tricks, bribing officers and force using rifles, which might include fighting with law enforcement or using the local society and groups that are against the government, according to Yared, who says Merkato is the last destination for all this contraband.
In the first nine months of the current fiscal year, ETB450.8 million worth of commodities were seized as contraband, a figure that was ETB380 million in 2014/15.
For Aschalew Ashagre, a lecturer at Addis Ababa University who teaches tax law, it is inexcusable that a shortage of foreign currency should lead to contraband and illicit activities. “It shows the failure of the government…because there is limited access to foreign currency,” Aschalew told EBR.
The failure of the private sector to comply with the tax regime is not only attributed to limited foreign currency access. At the aforementioned April 21st meeting, taxpayers expressed numerous challenges through a supervision committee formed from the private sector and ERCA.
Specifically, participants mentioned ERCA’s poor, time-consuming services; lack of skilled experts; power interruptions; the Authority’s underpaid employees; and its limited capacity as the top problems reported to the committee.
“There are various directives and laws issued by ERCA every now and then. Most of them do not work after some time,” said Gezaye Ambaye, President of the Ethiopian Sugar and Sweet Products Producers Association. “ERCA is not working hard to expand the tax net; it is always hammering the few existing businesses in the formal sector.”
Ashalew says this is because of the limited capacity of public institutions to properly enforce the laws. “Although there are enough legal frameworks, the capacity of institutions like ERCA should be boosted,” he added.
“ERCA has numerous accumulated problems and around the tax system. But these problems do not require special skills,” says Desta Bezabih, Director of the Inland Tax Programme Development Directorate at ERCA. “Although technology is needed, it cannot lead us unless we have efficient and responsible labour.”
In spite of the inefficiencies, some officials at the tax authority say things will be different soon. With over 11,000 employees, the Authority has finalised a study to establish its own training centre. “But the time to start has yet to be decided,” explains Alebachew Nigussie, Deputy Director General of ERCA. The Authority has received more than 5,000 tax claims over the last nine months alone, according to Befirdu Meseret, Director of the Change Management Directorate at ERCA. Over the last nine months the Authority also fired 49 officers that showed rent seeking behaviour.
According to ERCA officials, precise assessment, audit and intelligence are areas identified as high-risk areas for rent seekers, opening the gate for contraband. In order to quell the corruption and tax losses at customs gates, the Authority currently is developing software. The customs price list, which is compiled on a database, has been revised 15 times before. The data changes every six months or annually, if possible, but the business changes every second. That hurts the taxpayer and also the government,” says Yared.
Still, he argues that government regulations alone won’t solve the entrenched issues that thwart tax collection in Ethiopia. In addition to boosting capacity, Yared argues that full compliance comes only if places like Merkato undergo redevelopment. EBR