PWC’s ‘Paying Taxes 2010’ report shows that little has changed in the EAC recently. Rachel Keeler finds out why the formal taxation system may not be the whole story, and speaks to David Tarimo, tax specialist at PWC in Tanzania, about the prospects for EAC tax harmonization.
Tax reforms are growing around the world, according to the Paying Taxes 2010 report released in December 2009 in Nairobi by PricewaterhouseCoopers. Both despite of distractions from the global crisis and because of its pressures, governments are looking for ways to build and streamline revenue collection. Taxes will not come down in most countries. But authorities are cutting compliance times and simplifying regimes, and as a result, widening their tax bases.
For East Africa, however, this year’s report shows very few signs of change. The only substantial reform made in the community comes from Kenya, which introduced a pilot system for electronic filing. But Kenya is still the region’s hardest country to pay taxes in. Not only do businesses part with the most money - 49.7% of profits -, but the system is also the most time consuming and complex. This continues to reduce the country’s competitiveness and lowers numbers of new registered businesses.
In Kenya’s defense (for once), there are a few things to note about the report’s methodology before drawing conclusions: All of the numbers are based on the experience of a standardised fictional flower pot manufacturer. The case study is designed to mimic an average small or medium enterprise that pays all of its taxes according to the laws of whatever country it is in. This approach is great for benchmarking, and for making points about how important the growth and formalisation of small business is to emerging markets. However, it fails to capture some important complexities in African tax systems:
Informal Tax Collection
Big companies often bear a disproportionate amount of the tax burden in African markets. That is precisely because tax systems have failed to enfranchise more small businesses. But it also means that this report offers less insight to large corporations. For example, the report gives Rwanda the highest overall scores in the East African Community (EAC), with an official total tax rate of 31.3%. But corporates operating in Rwanda tell us that that number can jump to as high as 60%. The range is the result of pressures placed on big business by Rwandan tax men to make up for national shortfalls, and the often subjective way in which authorities audit large companies and collect revenues.
This is part of another problem: Most African tax authorities do not collect taxes exactly by the books. Even when discussing the “formal” sector, the way in which taxes are administered can be quite informal. Much more than in developed regions, taxes here are subject to fluctuations unrelated to official legislation. These risks vary by country and are not reflected in the PWC report.
The report does capture some of these factors through additional questions not used to calculate the main indicators. Respondents to these questions said that the way tax audits are dealt with and the approach of tax authorities are the areas in their national systems that need the most improvement. Respondents from the African Union (AU) found tax guidance provided by their governments much less helpful than those from the European Union. And governments in the AU were rated as the least transparent on issues of tax collection in the world. Clarity, accessibility and stability of tax rules were also major concerns.
EAC Harmonisation
Methodologies aside, the most important thing to watch now on East Africa’s tax horizon is possible reforms to come with the EAC common market. The EAC Treaty contains several provisions that call for harmonisation of fiscal policy and policies – like taxation – that affect the free movement of goods, labor, services and capital. Reforms could include the spread of electronic filing from Kenya to Rwanda, Uganda and Tanzania, although introducing workable systems in all of these countries will take some time. David Tarimo, tax specialist at PWC in Tanzania, also highlighted other impending developments for EAC tax harmonisation:
- The most immediate reform could come with the ratification of the East Africa Double Tax Treaty, which would minimize double taxation on income taxes and lower withholding taxes: “One positive move in this regard was the agreement reached in November 2009 by the finance ministers of the three partner states that the treaty should cap intra-EAC withholding tax rates at 5% for dividends and 10% for interest, royalties and service fees. Whilst this is an important step in the right direction, the hope is that agreement can be reached in future to remove intra-EAC withholding taxes wherever these can be demonstrated to be discriminatory (that is where would not be applicable to domestic transactions).”
- On the potential for income tax and VAT harmonization: “Greater harmonisation of the VAT legislation, particularly in relation to cross border services, would hopefully eliminate any discriminatory VAT costs on cross border transactions. Such moves to reduce discriminatory tax costs would reduce the total tax rate of a business operating across the EAC and thereby the overall ease of paying taxes for such businesses… An area of particular divergence is the income tax systems in relation to the taxation of businesses. Uganda and Tanzania have relatively similar modern income tax legislation introduced in 1997 and 2004 respectively, whereas Kenya's legislation is an evolution of the legislation inherited from colonial times and amended over the years.”
- On incentive regimes and investment promotion: “As there is greater focus on harmonization, one could expect significant pressure to arise to equalise incentive regimes, and remove tax exemptions, so as to prevent unfair tax competition. Whilst this may result in a reduction of incentives or exemptions (assuming that vested interests do not block them), such a reduction (and consequent widening of the tax base) might provide scope for reduction in the corporate income tax rate and top marginal rate of tax, currently 30%. A reduction would not be inconsistent with the trend elsewhere in Africa and globally - for example, recent years have seen Cote d’Ivoire, Madagascar and Ghana reduce their corporate income tax rates to 25%. Equally, the move towards harmonisation will also put pressure on Governments to reduce taxes or administrative costs where these are perceived to be high compared to the other partner states. Examples in this regard that come out of the Paying Taxes survey would include (i) the taxes levied on payroll costs which are considerably higher in Tanzania than in the partner states, (ii) the administrative costs in relation to VAT in Kenya which are considerably higher than the other partner states.”
Perspectives
As always, perhaps the most important question is whether governments will implement these changes swiftly as the common market comes into effect this year. Tarimo is optimistic: “My general sense is that the will and momentum are there - this certainly is the impression I get from reviewing certain documents on recent meetings on tax harmonisation.” The incentive to attract investment within a borderless EAC market will be a strong motivator for states. Uganda and Rwanda have both long been on the prowl for ways to lure business away from Kenya. However, vested interests – especially in Uganda where political power is more centralised and a mindset for reform is lacking – may make the retention of control over tax exemptions more attractive than the prospect of equalising the tax system to create a level playing field for investors. As usual, Tanzania may be the most resistant to change. Tarimo says he has seen myopic behavior by authorities there, who sometimes balk at reforms that could lower taxes and decrease government revenues in the short run but widen the tax base and encourage investment over the years.
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