How Do Nations Do so without Victimising Genuine Importers?
While tariffs on customs are a key income generator for developing countries, they also have the potential for misuse. Government agencies may inflate figures to increase tariffs. Importers, however, may under-invoice products to pay lower taxes or increase profit margins. This tension, experts argue, is best solved through a fair and consistent valuation system to help a country earn as much income as possible. EBR’s Ashenafi Endale spoke with key stakeholders and consulted researches to learn more about what’s being done to bring this type of system to Ethiopia.
Sub-Saharan countries like Ethiopia are increasingly relying on tax revenue to cover much of their growing annual budgets in an attempt to maintain strong, sustainable economic growth. As a result of increasing global trade integration, taxes and duties on import trade, which comprise the lion’s share among different sources of indirect taxes, is becoming the major source of tax revenue for developing countries.
Despite its importance and potential, importers and manufacturing companies that are required to pay a number of tariffs – customs duty, withholding tax, excise tax, value added tax and surtax – say that due to the absence of a modern, efficient and uniform customs valuation and tax administration system, they are facing a great deal of challenges, which ultimately affects the sustainability of taxes and duties from foreign trade.
Solomon Abera, a manager at an emerging local textile company operating on the outskirts of Addis Ababa, is one of the stakeholders affected by the inconsistent customs valuation system. Two months ago, he says his company was forced to pay an exaggerated tax and duties when it imported raw materials at a 30Pct increment from the previous amount.
“[We] produce garments by importing dyes and other raw materials from China, India and Bangladesh. [We usually import] two to four times a year,” he told EBR. “Two months ago, we imported the same amount of raw materials from India but officials at the customs office thought we were under-invoicing and forced us to pay taxes and duties based on the price they came up with.”
A manager of a printing press in Addis Ababa encountered a similar problem. Paper that they imported for USD800 per tonne was taxed 25Pct higher than their previous shipment. This company used to import the same product for USD1,000 per tonne. However, due to the current declining price of commodities around the world, it bargained with a new supplier and shipped it at a 25Pct lower rate. This was a success for the printing company, as it would enable them to lower their rates locally and attract more customers.
However, the Ethiopian Revenues and Customs Authority (ERCA) didn’t accept the new invoice they provided from the new supplier. The importer had no option other than to enter a commitment with the Authority to get their imports taxed with the price they had previously recorded. This is a problem importers in Ethiopia have been facing for many years. “It’s pointless; even if we bargain with our suppliers and get better quotes, the tax authority takes the difference,” said the manager.
The importance of a uniform and well-documented custom valuation system is evident in other contexts, especially given the potential for corruption by regulators and importers alike. According to a study in the European Journal of Science and Technology, the monetary and logistical success of intra-European trade is due, in part, from “the application of the common customs tariff and uniform Customs procedures” that streamline procedures, thereby “facilitating trade and protecting the state‘s economic interests.”
Another study, by researchers at Purdue University in the United States, found that custom valuation in developing countries whose systems might be out-dated or prone to inefficiencies benefit from revision: “[There is a] strong economic case for a non-discriminatory tariff reform that, if necessary, should be accompanied by a reform of the tax system. Developing countries that currently tend to maintain higher and more dispersed tariff barriers are particularly well positioned to benefit from a tariff reform….”
Globally, customs valuation consists of procedures that are used to identify and assess the true value of imported goods. In Ethiopia, the tax and customs duties are calculated by multiplying the cost, insurance and freight value of imported goods with legally set rates. Since 2004, a customs valuation method was aligned with the World Trade Organisation (WTO) valuation criterion.
According to the WTO, their methods of valuation aim to reduce arbitrary values and, by extension, corrupt practices: “[T]hat the value for customs purposes of imported merchandise…should not be based…on arbitrary or fictitious values.” They maintain that regulators can use a number of methods for valuation, including international standards they provide and formulas when there is no predetermined value for a product.
To achieve this end, the ERCA, the government body responsible for collecting revenue from customs duties and domestic taxes, has used a price data base system that contains the price of different imported products in order to verify the purchasing price presented by importers. “Until last year, the import price database has been stored in a CD,” says Daniel Tekleberhan, Customs Valuation Senior Officer at the Authority. “The CD, which had price list of over nine million imported products, has been revised every six months.”
However, last year the Authority introduced the Ethiopian Customs Valuation System (ECVS), a web-based price database built by an Indian company for ETB3.5 million. The price data on the CD is transferred to the new system, but filtered and shrunk in number, according to Daniel: “Customs branches of the ERCA access the system through an Internet network and only the Authority’s officers have the password to the system. Similar to the CD data, the price of products stored in the ECVS is revised within 180 days.”
Currently, the ERCA fills its price storage data, which it uses to decide import taxes and duties, through three methods. The first is based on the documents the importers present to it, which is from the manufacturer or the supplier. The second means is through extracting the price of a product from the Internet directly from the manufacturers’ and suppliers’ websites or international marketing platforms.
The third method the Authority uses to determine value is cross-referencing the invoice price with other importers of the same product. If the first two methods fail and there is a similar company that has imported the same product before, that price can be used as a reference to decide the tax and duty amount for the other importers. Under this method, a price of a similar or identical product imported up to 180 days ago can be used as a reference.
Importers, however, question the reliability of these methods, especially the third one. Solomon says the ERCA usually uses the price of the same material imported by another company if their value is higher, which may be questionable. “There are big companies who import frequently, so they want more foreign currency. Some foreign companies are also afraid of the political unrest in the country. Both types of companies import the same material with exaggerated prices, so they can stash away the scarce foreign currency from Ethiopia,” he argues. “The ERCA takes that as the right price without properly investigating.”
Government officials, however, suggest that regulators are making a concerted effort to fight over-pricing. Daniel says the government knows the significance of taxes on foreign trade, as the majority of its revenue comes in the form of indirect taxes. “This is why the government invested a lot of money to modernise the tax administration system,” Daniel stresses.
Indeed, the contribution of taxes on foreign trade to the total tax revenue is undeniable in Ethiopia. According to the information obtained from the Authority, the tax revenue from import trade increased from ETB39.4 billion in the 2012/13 fiscal year to ETB64 billion in 2015/16. However, its contribution to the total tax revenue shrunk from 46.7Pct to 44Pct over the same period.
According to Aschalew Ashagre, a lecturer at Addis Ababa University who specialises in tax law, the decline of tax revenue from import trade contribution to the total tax revenue is the result of a poor tax system. “The amount of imports dramatically increased in the past five years,” he says. “A poor tax system that is prone to valuation fraud by both importers and customs officers is the only thing that can explain the decline of tax revenue from import trade contribution.”
Aschalew states valuation fraud is pertinent in developing countries like Ethiopia, where there are relatively high rates of import taxes as well as a foreign currency shortage. “When the import tax rates are high, importers tend to under-invoice their purchases to pay lesser taxes and enable themselves to sell with lower price, which in turn leads to higher profits,” he argues. “Clearly, under-invoicing decreases tax revenue, which hurts the government as well as the public and discourages competition.”
In fact, duty evasion through undervaluation is an acute problem for customs administration throughout the developing world, according to a study conducted by Tenkir Seifu entitled ‘Customs Valuation System in Ethiopia’. The study reveals that widespread under-invoicing was observed in India, although the country accepted the concept of ‘transaction value’ as a primary method for valuation before it joined the WTO. However, importers in India take advantage of valuation based on the ‘transaction value’ concept and undervalue their imports with fake invoices, according to the study.
Experts argue that governments in developing countries tend to view the acceptance of transaction value reflected in invoices presented by importers will lead to under-invoicing to reduce the total tax amount. “However, such an assumption will create a negative perception among importers, which will affect the total tax revenue,” Aschalew stresses. “In any tax regime, one variable (source of revenue) definitely affects the others and vice versa.”
In this regard, Tenkir underscores the correlation between tax revenue from foreign trade and to the total amount of tax revenue collected in the country. In fact, his study found a high correlation between the two variables, which is the strongest among any other variables. As a result, he argues overall revenue performance depends on the applicability of an efficient, effective and unbiased customs evaluation system.
On the other hand, Aschalew argues that when there is a shortage of foreign currency, valuation fraud in the form of over-invoicing can occur by foreign companies that try to gain excess foreign currency for later use. “The number of international transactions between related companies is increasing,” Aschalew stresses. “Under this condition, hiding the foreign currency obtained by the practice of over-invoicing becomes easy.”
Solomon says that this act is making them uncompetitive: “Besides this, the problem is forcing us to increase the final price of our products for consumers.”
To remedy any potential conflicts, Daniel says that there is an appeal system at the Authority to dispute unjustly levied taxes. “So far, we are not facing many challenges on over-invoicing, since the tax hurts the importer itself,” he says. “Unless the power is gone or there is no network, our service is Internet-based and more efficient. We are trying our best to get the right price of products.”
Aschalew, however, argues that importers first have to pay the full price of the levied amount to appeal, which discourages them to appeal and correct the tax amount. “This is why the customs administration system should not be loose, and must be based on transactional values, so that the nation as well as the company do not lose what they deserve. However, ERCA’s lack of capacity in implementing the customs valuation law and creating a modern valuation system has opened doors for corruption and other problems, which will have a big impact on the economy if it continues like this.”
As a solution Tenkir in his study recommends that formulating and implementing comprehensible procedures based on transparency, objectivity and accountability, along with well-trained officials, can improve the situation: “[It] is equally important to maintain and update the facilities created by the Authority so that the full benefits in terms of enhancing trade facilitation potential may be reali[s]ed.”
Aschalew, on the other hand, says the price verifying system needs to be based on direct documents from the manufacturers, through bilateral and multilateral relationships: “Using all the different product specifications and standards under the similarity and identity method should be the final option. Then the database storage must be more legitimate than a CD or the Internet. And it must be updated, based on the actual transactional values, instead of waiting six months. You cannot simply decide taxes based on individual importers or because someone has imported a product at a higher price.”
If the Authority cannot improve its tax administration system, Aschalew says the final option will be to establish an independent institution that does customs evaluation. “Foreign investors have experience in manipulating developing countries like Ethiopia,” he argues. “By outsourcing customs valuation and the classification of goods to an independent company, it is possible to reduce valuation fraud, which in turn improves the poor level of tax compliance in the country.” EBR
5th Year • December 16 2016 – January 15 2017 • No. 46