Ethiopia introduced value added tax (VAT) as a replacement of sales tax in January 2003. The Ethiopian VAT has annual turnover threshold of ETB 500,000 and is chargeable with zero rate on exports and 15 percent on all others except exempted supplies. One of the purposes of the Ethiopian government in replacing the previous cascading type sales tax with VAT is to improve the revenue to Gross Domestic Product (GDP) ratio and enhance economic growth. Examination of the revenue performance of VAT since its introduction indicates that even though there has been an increase in government revenue after the introduction of VAT, it appears that the ratio of tax revenue to GDP has been fluctuating.

The government’s commitment to use the VAT as an instrument of enhancing its revenue position and fostering economic growth is noted in its efforts of strengthening the administration such as the establishment of the Ministry of Revenue and computerization of the VAT system although there remains a lot to be done to make the VAT achieve its intended objectives. To support the government’s efforts of enhancing its revenue position and enable the VAT system achieve its intended objectives, the design needs to be based on the principles of fairness, efficiency and administrative simplicity, among others.

In the light of the above the purpose of this paper is to examine the design of VAT in Ethiopia focusing on such features as tax coverage, exemptions, small traders and threshold level, rate structure, VAT accounting and reporting, collection and refund. In order to assess the Ethiopian VAT design in terms of these features, comparative analysis is made with the VAT system in Kenya and the model VAT design in the world – GST in New Zealand. The study reveals the areas which currently have their bearing on the operation and the revenue generation capacity of the VAT that could be improved without significantly affecting the government’s other objectives.

1. Introduction

While the principal source of a government’s revenue should be taxation, in many Sub-Saharan African nations this is often not the case. Many of the Sub-Saharan African countries rely on foreign sources of finance namely foreign loan and aid. For instance taking foreign aid only, in Guinea Bissau, aid represents about 37.3 percent of GDP; similarly in Malawi and Sierra Leone the aid to GDP ratio is 26.2 percent and 28.7 percent respectively. In Kenya the ratio is 4.9 percent (Cheeseman and Griffiths 2005, p. 3).

Expanded domestic revenue base (especially taxation) offers a promise of greater autonomy in the future and a break from restrictive aid and loan conditionalities. With this vision, recently, many poor countries have become preoccupied with improving tax systems. For instance, in the case of Ethiopia in an effort to increase the government’s domestic revenue the government replaced the sales tax with Value Added Tax (VAT), the Ministry of Revenue was established giving autonomy to the government’s revenue organ, and the tax system is computerized. Similarly, in Kenya the introduction of VAT and the establishment of the Kenyan Revenue Authority are claimed to have contributed to the improvement in the revenue position of the government.

In light of the above, the purpose of this paper is to assess the design of VAT in Ethiopia focusing on such features as tax coverage, exemptions, small traders and threshold level, rate structure, VAT accounting and reporting, VAT credits and refunds. In order to assess the Ethiopian VAT design in terms of these features, comparative analysis is made with the VAT system in Kenya and the model VAT design in the world – GST in New Zealand. Although both Kenya and New Zealand have had longer experience than Ethiopia in administering VAT, the choice of New Zealand is because New Zealand’s GST/VAT is cited by many tax experts as a model towards which VAT systems in the world need to strive. In the case of VAT in Kenya, with the intention of looking at Ethiopia’s VAT in relation to that of other developing countries, the choice is primarily based on the availability of information. Thus, the paper intends to identify the areas on the Ethiopian VAT design, which are currently having adverse impact on the operation and revenue generation capacity of the tax and also on the fairness and administrative simplicity of the VAT system. Accordingly, section two presents a review of the financial structure of the Ethiopian government. Section three discusses the design of Ethiopian VAT focusing mainly on issues such as tax base, rate structure, exemptions and refund. Section four presents an overview of VAT design in Kenya. The fifth section presents the main design features of goods and services tax (GST) in New Zealand. Section six presents a comparison of the main design features of VAT/GST in Ethiopia, Kenya and New Zealand. Finally, lessons from Kenya and New Zealand and concluding remarks are presented in section seven.

2. A review of the financial structure of the Ethiopian Government

An examination of the government's expenditure program over the last decade or so reveals fluctuation. For instance, in the year 1992/93 government expenditure as a per centage of GDP was 19.57 per cent, which increased to 33.7 per cent in 2002/03 and then declined to 29.4 per cent[1] in 2003/04 (NBE, 2003/04). The structure of government expenditure is dominated by recurrent expenditures that absorbed about 66 per cent of the total in 1992/93, 68 per cent in 2002/03 and 59.5 per cent in 2003/04 (NBE, 2003/04). The trend in the two components of expenditure (recurrent and capital) is similar to that of the total expenditure. As a share of GDP, recurrent expenditure increased from 14.7 per cent in 1995/96 to 24.8 per cent in 2002/03 while capital expenditure showed a slight surge from 9.4 per cent in 1995/96 to 11.6 per cent in the 2002/03 fiscal year (AfDB/OECD 2004).

In spite of such a surge[2] in expenditure, government revenue showed a small rise. For example, total government revenue as a share of GDP increased from 18.4 per cent in 1995/96 to an estimated 20.5 per cent in 2002/03 (AfDB/OECD 2004). Government revenue that falls short of financing the entire expenditure program is raised mainly from taxation that contributed about 78 per cent (table 1 in the appendix) of total revenue in 2003/04; this was an increase from 69 per cent in 1992/93, evidencing the significance of taxation in the government's finance (G/Egzihabher 2005).

Examination of tax revenue of the Ethiopian government as a share of GDP indicates that the ratio increased from 12.5 per cent in 1995/96 to 15.3 per cent in 2001/02. The tax to GDP ratio[3] declined to 14.4 per cent in 2002/03 and then it showed a rise to 15.2 per cent in 2003/04 fiscal year (see table 2 in the appendix). In 2004/05 fiscal year, the tax to GDP ratio again dropped to 12.7 per cent (NBE 2004/05). This reveals that the tax to GDP ratio has been fluctuating. Furthermore, it is far below the resources needed to finance even the recurrent expenditures, which were estimated to be 24.8 per cent of GDP in 2002/03 (AfDB/OECD 2004; NBE 2003/04) evidencing the gap between the revenue and expenditure requirements of the government.

As mentioned above tax is the principal source of domestic revenue even though its magnitude in relation to GDP is at a low level. Clearly, indirect taxes such as VAT, excise taxes, turnover taxes and foreign trade taxes play a major role in raising domestic revenue in Ethiopia. For instance, in the fiscal year 2004/05 total tax revenue was ETB 12,265 million out of which ETB 3,940 million was from direct taxation representing about 32 per cent of tax revenue leaving the remaining 68 per cent for indirect taxes mainly VAT and foreign trade taxes (table 1 in the appendix).

3. Value added taxation (VAT) in Ethiopia

The literature on Value Added Tax (VAT) shows that VAT was first introduced in France in the early 1950s and since then VAT has spread around the world and it is now adopted by 136 countries and generally accounts for about 25 per cent of all tax revenues in these countries. In Sub-Saharan Africa, VAT has been introduced in many countries including Benin, Cote d’Ivoire, Guinea, Kenya, Uganda, Tanzania, Ghana, Madagascar, Mauritius, Niger, Senegal, Togo and Nigeria. Parallel to the international spread, in Ethiopia, VAT was introduced for the first time in January 2003 as a replacement of sales tax. Such international proliferation of VAT in several countries including Ethiopia owes its explanation, as the literature shows, from various factors including its revenue productivity.

In Ethiopia, the government replaced the sales tax with VAT with the expectation that VAT would enhance economic growth and improve the ratio relationship between gross domestic product and government revenue (VAT Proclamation No. 285/2002, p. 1832). Examination of the government’s objective (increasing its revenue position) in terms of VAT revenue performance shows that VAT is claimed to have raised revenue of ETB 262 million, ETB 902 million, ETB 1193 million and ETB 1413 million in 2002/03, 2003/04, 2004/05 and 2005/06 fiscal years respectively (VAT department, FIRA). It is also reported that, since its introduction, VAT has been more revenue productive than sales tax (MOR, No date). But, as G/Egzihabher (2005) indicates the Ethiopian Revenue Authority did not make cash refund at least for the first 17 months of its operations. In addition, the government made the first cash refund for those who are required to carry forward their credit to the next five accounting periods (five months) and are allowed to get any excess credit, which may remain unused after five accounting periods, in cash in February 2007. With this caveat in the operation of VAT, it would be hard to come to a firm conclusion on the revenue performance of the VAT. Furthermore, looking at the tax burden of the Ethiopian government in terms of the ratio between tax revenue and gross domestic product exhibits fluctuation, as discussed earlier (table 1).

3.1. VAT design in Ethiopia

The legal basis for VAT is stipulated in Proclamation No. 285/2002 and Regulations No. 79/2002. According to the legislation, VAT is imposed on the supply of goods or rendition of services in Ethiopia in the course or furtherance of a taxable activity and also on import of goods and services to Ethiopia other than exempted ones. Currently, VAT is administered by the Federal Inland Revenue Authority, Customs Authority and Regional Finance bureaus (in some of the regions that have already taken the responsibility of administering VAT from the Federal Inland Revenue Authority).

The Ethiopian VAT is based on the invoice credit method in which taxpayers are given credit for the VAT paid on inputs when it is supported by proper invoices and import declarations. It is also based on destination principle in that imports are taxed but not exports.

VAT is proclaimed to be paid by those who are required or are already registered, those who carry out taxable import of goods to Ethiopia and non-resident persons who perform services without registration for VAT and who are subject to taxation (VAT proclamation No. 285/2002).

3.1.1 VAT registration

Registration for VAT can be compulsory or voluntary. Compulsory registration is required when at the end of any period of 12 months the person made, during that period, taxable transactions the total value of which exceeded ETB 500,000; or at the beginning of any period of 12 calendar months there are reasonable grounds to expect that the total value of taxable transactions to be made by the person during that period will exceed ETB 500,000. In addition, the following are obligated to register for VAT regardless of the volume of their annual turnover.

· Share companies, private limited companies and state owned enterprises;

· Contractors from category 1 to 9;

· Leather and leather product manufacturers;

· Shoes factories;

· Computer and computer related devices suppliers

· Importers;

· Flour factories;

· Plastic and plastic products manufacturing factories;

Voluntary registration is used by those who are carrying on taxable activities and are not required to be registered for VAT, if those persons are regularly supplying or rendering at least 75 per cent of their goods and services to registered persons.

3.1.2. Tax invoices

As mentioned in section 3.1 above, the Ethiopian VAT is based on the invoice credit method. As a result, a taxpayer registered for VAT that carries out a taxable transaction is required to issue a VAT invoice to the person who receives the goods or services. According to the VAT proclamation, VAT invoice should contain the following information:

§ full name of the registered person and the purchaser, and the registered person’s trade name, if different from the legal name;

§ taxpayer identification number of the registered person and the purchaser;

§ number and date of the VAT registration certificate;

§ name of the goods shipped or services rendered;

§ amount of the taxable transaction;

§ amount of the excise on excisable goods;

§ sum of the VAT due on the given taxable transaction;

§ the issue date of the VAT invoice;

§ serial number of the VAT invoice.

According to the legislation, however, there are exceptions from the requirement to include all of the above details on the VAT invoice. Firstly, the supply of goods or rendering of services by a registered trader at retail to purchasers who are not VAT registered persons, the Ministry of Revenue may by directive provide that a receipt or simplified form of VAT invoice may be used instead of a VAT invoice. Secondly, the Ministry of Revenue may by directive waive a registered person’s obligation to issue a receipt or tax invoice for cash sales if the total consideration for the entire supply does not exceed ETB 10.

In practice nevertheless, the pertinent directives have not been issued and as a result there is no consistent way of dealing with the issue of tax invoice. It was learnt from the interview with tax officials that registered traders who have transactions with total considerations not exceeding ETB 10 are not waived from issuance of VAT invoice and there is no simplified VAT invoice allowed to be used by taxpayers.

3.1.3. VAT rates

VAT is chargeable on taxable activities at the rate of 15 per cent and zero per cent depending on the nature of the supply. 15 per cent is chargeable on those transactions and imports of goods and services other than exempted and zero rated ones. Zero rated transactions are mainly exports. More specifically, zero rate applies to the following:

§ the export of goods or services;

§ the rendering of transportation or other services directly connected with international transport of goods or passengers, as well as the supply of lubricants and other consumable technical supplies taken on board for consumption during international flights;

§ the supply of gold to the National Bank of Ethiopia;

§ a supply by a registered person to another registered person in a single transaction of substantially all of the assets of a taxable activity or an independent functioning part of a taxable activity as a going concern.[4]

3.1.4. VAT exemption

The VAT proclamation, regulations and supporting directives exempt various transactions, goods and services from VAT. These exempted transactions, goods and services include:

bread;
enjera;
milk;
domestic flight air ticket,
liquefied petroleum gas (LPG);
the sale or transfer of a used dwelling, or the lease of a dwelling;
the rendering of financial services;
the supply or import of national or foreign currency (except for that used for numismatic purposes), and securities;
the import of gold to be transferred to the National Bank of Ethiopia;
the rendering by religious organizations of religious or church related services;
drugs, medical equipment and rendering of medical services;
the rendering of educational services provided by educational institutions, as well as child care services for children at pre-school institutions;
the supply of goods and rendering of services in the form of humanitarian aid, as well as import of goods transferred to the state agencies of Ethiopia and public organizations for the purpose of rehabilitation after natural disasters, incidental accidents, and catastrophes;
the supply of electricity, kerosene, and water.[5]
goods imported by government organizations, institutions or projects exempted from duties and other import taxes to the extent provided by law or by agreement.
supplies by the post office authorized under the Ethiopian Postal Services proclamation, other than services rendered for a fee or commission;
the provision of transport;
permits and licence fees;
the import of goods to the extent provided under schedule 2 of the Customs Tariffs Regulations;
the supply of goods or services by a workshop employing disabled individuals if more than 60 per cent of the employees are disabled;
the import or supply of books and other printed materials. The exemption applies to a bound or unbound printed version of scripture of any religion.
agricultural inputs

In addition to the goods and services listed above, the revenue authority exempts humanitarian aid institutions, embassies and international organizations from VAT. Hence, humanitarian aid NGOs and Embassies can request the revenue authority to write a letter addressed to the supplier expressing their exemption entitlement and they can buy without paying VAT.

3.1.5. Tax credit

According to Article 21 of VAT Proclamation No. 285/2002, in Ethiopia, VAT credit is the amount of VAT payable (paid) by a registered person in respect of tax invoices or customs declarations issued to the person for:

· imports of goods (including capital goods) that take place during the current accounting period when the goods are entered into the customs declaration.

· taxable transactions involving the acquisition of goods (including capital goods) or rendering of services that are considered to take place during the current or preceding accounting period where the goods or services are used or are to be used for the purpose of the registered person’s taxable transactions.

However, there are exceptions to the creditable VAT. VAT paid on vehicles and for entertainment is not creditable. VAT paid on the acquisition or import of a passenger vehicle[6] unless the buyer or importer is in the business of dealing in, or hiring of, such vehicles, and the vehicle was acquired for the purposes of such business, or the person is engaged in the business of transporting passengers for hire and the vehicle was acquired and is licensed for that purpose. Similarly, VAT paid on the purchase or import of goods or services for the purpose of entertainment[7] or providing entertainment, unless the person is in the business of providing entertainment.

The VAT legislation allows taxpayers to credit the VAT paid or payable on goods including capital goods that were on hand on the date of registration, but only to the extent that the purchase or import of the goods occurred not more than six months prior to the date of registration.

The other item that should be noted in connection with VAT credit is the allocation of VAT paid on purchases or imports of goods and services (input VAT) by taxpayers who make mixed supplies. For the apportionment of VAT paid on inputs used for mixed (exempted and taxed) supplies, the Ministry of Revenue issued a directive on Tir 3, 1996 (January 11, 2004). According to this directive, the input VAT credit is apportioned according to the following formula:

T = A X B/C

Where “T” is the amount of VAT credit;

“A” is the total VAT paid on inputs used for mixed supplies;

“B” is the amount of taxable supplies that the registered person conducted during the accounting period;

“C” is the total value of supplies (both taxed and exempted supplies) that the registered person carried out during the accounting period. When the ratio B/C on the above formula is more than 0.90 the total input VAT is allowed to be credited against the output VAT.

3.1.6. VAT refunds

There are two main provisions in the legislation concerning VAT refunds. The first provision is for registered taxpayers who have at least 25 per cent of the value of their taxable transactions for the accounting period, other than zero rating of the disposal of a going concern, taxed at zero per cent. For these taxpayers the VAT law obliges the tax authority to make a cash refund of the amount of VAT applied as a credit in excess of the amount of VAT charged for the accounting period within a period of two months after the registered person files an application for refund, accompanied by documentary proof of payment of the excess amount. The second provision is for other registered taxpayers. For these taxpayers, the amount of VAT applied as a credit in excess of the amount of VAT charged for the accounting period is to be carried forward to the next five accounting periods and credited against payments for these periods. Any unused excess remaining after the end of this five month period is legislated to be refunded in cash within two months after the registered person files an application for refund, accompanied by documentary proof of payment of the excess amounts.

In both of the above cases, when the tax authority is satisfied that a person who made an application for refund has overpaid VAT, the authority is allowed first to apply the amount of the excess in the reduction of any tax, levy, interest or penalty payable by the person under the VAT proclamation, the customs proclamation, income tax proclamation, or the sales and excise tax proclamation. After applying the credit in reducing the VAT payer’s debt under the income tax, VAT, customs, sales and excise taxes proclamations, the tax authority is required to repay any amount remaining to the person if the amount to be refunded is more than ETB 50.

3.1.7. Accounting for VAT

The accounting period for VAT purpose is one calendar month. As per the VAT proclamation, taxpayers are required to file returns within 30 days from the end of each accounting period.

VAT is due at the time of supply. A supply occurs when a VAT invoice is issued for that transaction. If invoice is not issued, supply is considered to take place at the time the goods are made available to the recipient, sold or transferred, or the services are rendered; in the case of a delivery of goods that involves shipment of the goods, when the shipment starts. But, if payment is made in advance of the actual sale or shipment of the goods and if invoice is not issued within 5 days from the date of payment the supply will be considered as having taken place at the time of payment. This shows that VAT is due and, hence, accountable at the earliest of issuance of invoice, payment receipt or the delivery of goods or rendering of services.

3.1.8 Treatment of capital goods

Capital goods are treated in the same way as other merchandise items. As a result, the VAT paid on capital goods[8] has to be carried forward to future periods no matter how long the time (in practice) that a company would take to offset it against future VAT liabilities. Furthermore, although it is not clearly stated in the law, VAT paid on construction materials for a project undertaken by a registered taxpayer engaged in another activity is not allowed to be offset against the VAT on supplies by that registered person. Instead such a VAT is required by the tax authority to be treated when the project starts operation and generates revenue.[9] Such a treatment as per the interview with tax officials is because it is not known whether the building is going to be used for exempted or taxed activities.

This treatment of capital goods has several problems. First, it ties up investors’ money for a very long period of time and is likely to discourage investment. Secondly, especially in connection with VAT on construction in progress, it makes difference between the VAT treatment of capital investments in that when capital goods (like loader truck for construction) are imported from abroad, VAT would not be paid, but the VAT paid on local acquisition of materials for construction projects is not allowed to be even offset against the output VAT arising from related activities while the construction is in progress.

4. VAT design in Kenya

Kenya moved from a sales tax towards VAT in 1990. The reason for replacing the sales tax with VAT is explained by the Kenyan Revenue Authority as follows: VAT was introduced to increase the government’s revenue through expansion of the tax base, which hitherto was confined to sales of goods at manufacturing and importation level under the sales tax (KRA no date). Accordingly, assessing the revenue performance of VAT in Kenya reveals that from its introduction until 1994 fiscal year, revenues from VAT constituted 37 per cent of total Kenyan tax revenue and it was the largest proportion of revenue garnered by taxes (Muriithi and Moyi 2003 quoted in Cheeseman and Giffiths 2005, p. 9). During 1999/00 fiscal year, VAT raised about 40 per cent of tax revenue and 21 per cent of total government revenue, which later increased to 45.8 per cent of tax revenue and 25 per cent of total government revenue in 2000/01 fiscal year. In addition, in absolute terms, the revenue raised by VAT increased from KSh 22143 million in 1993 fiscal year to KSh 50220.9 million in 2001 fiscal year (Cheeseman and Griffiths, 2005, p. 9). This shows that like in most other countries which have already introduced VAT, the Kenyan VAT can be argued to have higher revenue potential and is contributing a major share to government’s revenue.

The legal basis for VAT is contained in the Value Added Tax Act, Cap. 476 of the laws of Kenya and the related Regulations. According to the VAT Act, VAT is chargeable on any supply of goods or services made or provided in Kenya where it is a taxable supply made by a taxable person in the course of or in furtherance of any business carried on by that person.

Before examining VAT design in Kenya, it is worthwhile to look at the revenue organs, which are responsible for the administration. The responsibility for the administration of VAT is given to the Value Added Tax and Customs and Excise departments. While the VAT department administers VAT from domestic transactions, the Customs and Excise department is responsible for VAT on imports. The VAT department is under domestic taxes and Customs and Excise department is under customs services. Both domestic taxes and customs services are headed by their respective commissioners and they are within the Kenyan Revenue Authority.

With this short introduction on the revenue performance and administrative organs of VAT in Kenya, the following section will look at the main design features of VAT including tax base, rate structure, exemptions and refunds in Kenya.

4.1. VAT registration

In Kenya, VAT registration is required by any person who, in the course of his business:

a) has supplied taxable goods or services, or expects to supply taxable goods or taxable services or both, the value of which exceeds, in any one of the following periods, the values respectively specified-

Twelve months KSh. 3,000,000[10]

Nine months KSh. 2,400,000

Six months KSh. 1,800,000

Three months KSh. 1,200,000; or

b) is making or expects to make the following taxable supplies, which are not subject to the threshold levels given above

§ jewellery, pre-recorded music cassettes, timber, motor vehicle parts and accessories and household or domestic electric or electronic apparatus and appliances; or

§ four or more motor vehicle in any one year;

§ any of the following services:

1. accountancy services including any type of auditing book keeping or similar services;

2. the provision of reports, advice, information or similar technical services in the following areas-

a. management, financial and related consultancy services;

b. recruitment, staffing and training;

c. market research;

d. public relations;

e. advertising;

f. actuarial services; or

g. material testing services, excluding medical, dental or agricultural testing services.

3. computer services of any description, including the provision of bureau facilities, systems analysis and design, software development and training but excluding training offered to students in the furtherance of education and which is not part of user training or other business training.

4. legal and arbitration services including any services supplied in this connection.

5. services supplied by architects (including landscape architects) draughtsmen and interior designers.

6. services supplied by land and building surveyors, quantity surveyors, insurance assessors, fire and marine surveyors, loss adjustors or similar services.

7. services supplied by consulting engineers.

8. services supplied by agents, excluding insurance agents

9. services supplied by brokers, excluding services supplied by insurance brokers, stock exchange brokers and tea and coffee brokers dealing exclusively in tea and coffee for export;

10. services supplied by security and investigation organisations including rental of security equipment and installation;

11. advertising services, including the placement of notices and announcements in the print and electronic media and services connected therewith or incidental thereto, but excluding death and funeral notices and announcements.

12. telecommunication services including rental of telecommunication equipment and installation services.

13. services supplied by contractors.

14. services provided by clearing and forwarding agents.

15. secretarial services supplied by certified public secretaries.

4.2. VAT invoice

A registered person who makes taxable supplies is required to furnish the purchaser with a tax invoice. In the case of a supply on credit, the invoice has to be furnished at the time of the supply or within fourteen days from the date of supply and for a cash sale, immediately upon payment for the supply. If cash sales are made from retail premises, suppliers are required to provide the purchaser a simplified tax invoice. In addition, if cash sales made to any one person in a day do not exceed five hundred shillings, the taxpayer has to account for tax in a manner that the commissioner may authorize.

The standard tax invoice is required to contain the following information:

§ the name, address, VAT registration number and personal identification number of the person making the supply;

§ the serial number of the invoice;

§ the date of the invoice;

§ the date of the supply, if different from the date of the invoice;

§ the name, address, VAT registration number, if any, and personal identification number of the person to whom the supply was made, if known to the supplier;

§ the description, quantity and price of the goods or services being supplied;

§ the taxable value of the goods or services being supplied;

§ the rate and amount of tax charged on each of those goods and services;

§ details of whether the supply is a cash or credit sale and details of cash or other discounts, if any, that apply to the supply; and

§ the total value of the supply and the total amount of VAT charged.

The simplified tax invoice is also required to contain the following information:

§ the name, address, VAT registration number and personal identification number of the person making the supply;

§ the serial number of the invoice;

§ the date of the invoice;

§ a brief description of the goods or services being supplied;

§ the total amount charged to the customer, VAT included; and

§ the explicit statement that the price includes VAT.

4.3. VAT rates

In Kenya, VAT is chargeable on taxable goods and services with 14 per cent, 16 per cent and 0 per cent. Services such as restaurant services, including bar and beverage services supplied by a restaurant owner or operator; accommodation and all other services provided by a hotel owner or operator including telecommunications, entertainment, laundry, dry cleaning, storage, safety deposits, conference and business services are stipulated to be charged with VAT at 14 per cent. All other taxable supplies of goods and services other than those mentioned above and zero rated ones are chargeable at 16 per cent.

According to the VAT Act, and subject to the satisfaction of the Commissioner supplies including the following are zero rated:

§ the exportation of goods and services;

§ the supply of goods or taxable services to designated foreign aid funded capital investment projects where the agreement specifically provides for tax exemption, provided that the supplies are acquired prior to payment of taxes;

§ the supply of goods or taxable services to an export processing zone enterprise as specified in the export processing zones act, as being eligible for duty and tax free importation;

§ goods imported or purchased before clearance through the customs or purchased, before the imposition of tax, by or on behalf of public bodies, privileged persons and institutions including the president, the Kenya armed forces, Commonwealth and other governments, Diplomatic Privileges, Charitable institutions, Aid agencies, the East African Development Bank, War graves commission, the British Council, Museum exhibits and equipment;

§ aircraft operations including goods imported or purchased for use by any airline designated under an air service agreement between the government and a foreign government;

§ deceased person’s effects; materials and equipment for use in the construction or refurbishment of tourist hotels; equipment for electric power generation, chemically defined compounds used as fertilizers;

§ urine bags and diapers for adults and hygienic bags;

§ coffee and tea supplied to coffee and tea auction centers;

§ plastic sheeting for agricultural, horticultural or floricultural use;

§ jet fuel and aviation spirit, and electrical energy imported for distribution into the national grid;

§ shipstores supplied to international sea and air carriers on international voyage or flight;

§ the supply of goods and taxable services under a contract to an official aid funded project where the agreement specifically provides for the remission of tax;

§ services supplied by hotel establishments to foreign travel and tourism promoters undertaking a tour in promotion of tourism in Kenya provided that the tour is recommended by the director of Tourism and conducted in conjunction with local tour associations in accordance with a predetermined written itinerary;

§ the supply of electrical energy to a domestic household where the consumption does not exceed two hundred kilowatt-hours;

§ the supply of taxable services in respect of goods in transit;

§ the supply of taxable airport services to transit aircrafts;

§ taxable supplies to aid agencies for their official use;

§ the supply of taxable goods or services to any person who carries out cotton ginning;

§ supply of water drilling services including any services supplied in connection therewith.

4.4. VAT exemption

According to the VAT act, exemptions from VAT include:

§ financial services with some exceptions;

§ insurance and reinsurance services;

§ education and training services offered to students by institutions and establishments registered by the Government, other than in respect of business or user training and other consultancy services designed to improve work practices and efficiency of an organization;

§ medical, veterinary, dental and nursing services;

§ sanitary and pest control services rendered to domestic households;

§ agricultural, animal husbandry and horticultural services;

§ social welfare services provided by charitable organization registered as such, or which are exempted from registration, by the registrar of societies or by Non-governmental organizations co-ordination;

§ burial and cremation services, including services provided in the making of arrangements for or in connection with the disposal of the remains of the dead;

§ transportation of passengers by any means of conveyance, but excluding where the means of conveyance is hired or chartered;

§ renting, leasing, hiring or letting of:

o land;

o residential buildings;

o non residential buildings;

The exemption entitlement is not applicable where the rental services are supplied in respect of: -

o car park services; or

o conference or exhibition services, except where such services are provided for educational institutions as part of learning;

§ postal services provided through supply of postage stamps, including rental of post boxes and mail bags and any subsidiary services thereto;

§ community, social and welfare services provided by Local Authorities;

§ insurance agency, insurance brokerage, stock exchange brokerage and tea and coffee brokerage services;

§ tour operations and travel agency services including travel, hotel, holiday and other supplies made to travellers but excluding in-house supplies[11] and services provided for commission other than commission earned on air ticketing;

§ services rendered by:

o trade, professional and labour associations;

o educational, political, religious, welfare and other philanthropic associations to their members unless such services are rendered by way of business.

§ the following entertainment services-

o stage plays and performances which are conducted by educational institutions, approved by the Minister for the time being responsible for education as part of learning;

o sports, games or cultural performances conducted under the auspices of the Ministry for the time being responsible for culture and services;

o entertainment of a charitable, educational, medical scientific or cultural nature as may be approved in writing by the Commissioner prior to the date of entertainment for the benefit of the public; or

o entertainment organized by a non-profit making charitable, educational, medical, scientific or cultural society registered under the Societies Act where entertainment is in furtherance of the objects of society as may be approved in writing by Commissioner prior to the date of the entertainment.

§ accommodation and restaurant services provided within the following premises by the proprietors:

o establishments operated by charitable or religious organizations registered under the Societies ACT for charitable or religious purposes; or

o establishments operated by educational training institutions approved by the Minister for the use of the staff and students by that institutions; or

o establishments operated by a medical institutions approved by the Minister for the time being responsible for health for the use by the staff and patients of such institutions; or

o canteens and cafeterias operated by an employer for the benefit of his low income employees which the commissioner may approve subject to such conditions as he may prescribe.

§ conference services conducted for educational institutions as part of learning where such institutions are approved by the Ministry for the time being responsible for education;

§ car park services provided by local authorities and by an employer to his employees on the premises of the employer.

§ transportation of tourists by any means of conveyance;

In addition to the above services there is a very long and detailed list of goods exempted from VAT in Kenya. To mention some, exempted goods include aviation spirit, motor spirit (gasoline) premium and regular, wheat flour, millet, buckwheat, meslin flour, maize (corn) flour, other cereal flours, banana, dates fresh or dried, pineapples, fresh or dried, avocados fresh or dried, guavas, mangoes and mangosteens fresh or dried, oranges fresh or dried, mandarins, grapefruit, lemons, other citrus fruit, grapes, watermelons, apples, and milk in various forms,

4.5. VAT credit

In Kenya, input tax may, at the end of either the tax period in which the supply or importation occurred or the next following tax period, be deducted by the registered person, from the tax payable on supplies (output tax) in that period if the registered person is in a possession of:

§ a tax invoice issued;

§ a customs entry duly certified by the proper officer and a receipt for the payment of tax; or

§ a customs receipt and a certificate signed by the Commissioner of Customs and Excise stating the amount of tax paid, in the case of goods purchased from a customs auction; or

§ an import declaration form duly certified by an authorised officer and proof of payment made for the tax, in the case of imported taxable services.

There are some exceptions on the deductibility of input VAT. Exceptions include:

§ no input tax may be deducted more than twelve months after that input tax becomes due and payable;[12] or

§ in the case of a motor vehicle or other asset purchased under a hire purchase or a lease financing agreement, no input tax may be deducted more than twelve months after the issuance of a letter of undertaking or a clearance certificate;

Furthermore, the legislation excludes any tax payable (input tax) on the following goods and services from being deducted from output tax except where the goods are purchased as stock in trade.

1. all oils for use in vehicles (including motor vehicles[13] and similar vehicles), ships, boats and other vessels;

2a. passenger cars and minibuses, bodies, parts and services for the repair and maintenance of such vehicles and the leasing or hiring services of such vehicles other than:

§ goods and services used in the supply of passenger car and minibus hire and leasing services;

§ bodies, parts, and repair and maintenance services, used in the supply of repair and maintenance services for passenger cars and minibuses; and

§ passenger car and minibus parts used in the manufacture or repair and maintenance of taxable goods;

§ vehicles specially designed or modified and primarily used for supply of taxable goods or services subject to prior approval by the commissioner.

2b. all motor vehicles (other than passenger cars and minibuses), bodies, parts and services for the repair and maintenance of such vehicles, except where the goods are used primarily for the supply of taxable goods and services.

3. furniture, fittings and ornaments of decorative items in buildings other than:

§ items permanently attached to buildings;

§ such goods for use in hotels and restaurants subject to the approval of the commissioner.

4. household or domestic electrical appliances other than those approved by the commissioner for use in the manufacture of taxable goods or the supply of taxable services;

5. entertainment services;

6. restaurant services;

7. accommodation services;

8. taxable supplies for use in staff housing and similar establishments for the welfare of staff.

The other thing that needs mentioning in connection with creditable VAT is the treatment of input tax deducted in respect of business premises that are later sold, disposed of or converted for use in making exempt supplies before the expiry of five years from the date the construction of the premises was completed. For such a case the tax, or the portion thereof relating to the construction of the sold, disposed of or converted premises, is legislated to be refunded to the Commissioner within thirty days of the sale, disposal or conversion. [14]

Apart from the above the legislation states that where a registered person supplies both taxable and exempted goods and services, the taxpayer can only deduct the part of his input tax, which is attributable to taxable supplies. The attribution method adopted by the registered person in this case should be approved by the Commissioner. It is also possible to use either of the following methods for the determination of the amount of deductible input tax without the approval of the Commissioner.

§ deductible input tax = value of taxable supplies

value of total supplies

§ -full deduction of all the input tax attributable to taxable goods purchased and sold in the same state;

-no deduction of any input tax which is directly attributable to exempt outputs, and

-deduction of the input tax attributable to the remainder of the taxable supplies, calculated with the above formula.

It is also stipulated that if the amount of input tax attributable to exempt supplies is less than five per cent of the total input tax, then all the input tax can be deducted.

In addition, the legislation states that if a person at the time of registration for VAT has in stock goods on which tax has been paid and which are intended for use in making taxable supplies; or has constructed a building or civil works or has purchased assets for use in making taxable supplies, the taxpayer may, within thirty days, claim relief from any tax shown to have been paid on goods in stock or on the construction of such buildings or civil works or the purchase of such assets. Such a relief is allowed only if buildings or civil works are constructed, or such goods or assets are purchased within twelve months immediately preceding registration, or within such period, not exceeding twenty four months, as the Commissioner may allow. For such claims for relief the Commissioner may authorize the registered person to make a deduction of the relief from the output tax on the next return if the Commissioner is satisfied that the claim for relief is justified.

4.6. VAT refunds and remission

When the amount of input tax exceeds the amount of output tax due, the amount of the excess is required to be carried forward to the next tax period. But, such excess is legislated to be paid to the registered person by the Commissioner if the Commissioner is satisfied that such excess arises from:-

§ making zero rated supplies and exports; or

§ physical capital investments where input tax deducted exceeds one million shillings and the investments are used in making taxable supplies.

In addition to the above, the VAT Act allows refunds for VAT on bad debts, VAT paid in error, and for those who are entitled to remission (or zero rating) but cannot produce documentary proof of the same at the time of purchase or importation. The tax paid under such circumstances is refundable if claimed by the person who paid it. Refund may also be given if, in the opinion of the Minister of Finance, it is in the public interest to do so. When a registered person has a refund because of any of the above circumstances, the taxpayer should lodge a claim[15] for the amount payable within twelve months from the date the tax became payable, or such longer period, not exceeding twenty-four months as the Commissioner may allow.

In addition, the Minister of Finance may allow full or partial remission of tax payable in respect of any taxable goods or taxable services, if he is satisfied that it is in the public interest to do so. According to the VAT Act and subsidiary legislations remission is applicable on: -

§ capital goods, excluding motor vehicles, of a total value of not less than one million shillings per investment, imported or purchased locally for new investments or the expansion of investments;

§ such other goods, including motor vehicles and computers (excluding passenger motor vehicles of a seating capacity of less than twenty six persons, building materials, audio and audio visual electronic equipment, spare parts, edible vegetable fats and oils, office furniture and other office equipment, stationery, textiles, new and used clothing and footwear, maize, wheat, sugar, milk and rice) imported or purchased locally for donations by any person to non-profit making organizations or institutions approved by the government for their official use or for free distribution to poor and needy persons, or for use in medical treatment, educational, religious or rehabilitation work;[16]

§ goods, including motor vehicles and aircraft, imported or purchased by any company which has been granted an oil exploration or oil prospecting license in accordance with a production sharing contract with the Government of Kenya and in accordance with the provisions of the Petroleum (Exploration and production) act; and

§ capital equipment and machinery imported or purchased solely for use in the manufacture of goods in a licensed customs bonded factory for export only; and

§ official aid funded projects;

§ taxable services supplied to projects approved by Government and funded through donations by any person for the benefit of poor and destitute persons;

Given the above discussions on the main features of VAT design in Kenya, the following section reviews the model VAT design, i.e., the design of goods and services tax in New Zealand.

4.7. Accounting for VAT

VAT charged on any supply other than exempted goods or services becomes due and payable at the earliest of the time when:

§ the goods or services are supplied to the purchaser; or

§ a certificate is issued, by an architect, surveyor or any person acting as a consultant or in a supervisory capacity, in respect of the service; or

§ an invoice is issued in respect of the supply; or

§ payment is received for all or part of the supply.

Similarly, the tax payable on services imported into Kenya is stipulated to be due and payable by the person receiving the taxable service at the earliest of the time when:

§ the taxable service is received; or

§ an invoice is received in respect of the service; or

§ payment is made for all or part of the service.

From the above points it can be noted that VAT on the supply of goods and services and on services imported into Kenya is due either on cash or accrual basis whichever comes first.

The accounting period, for VAT purpose, is legislated to be one calendar month. That is, registered persons are required to file VAT returns on monthly basis. A registered person may defer the payment of tax due to a date not later than the twentieth day of the month succeeding the accounting period in which the tax becomes due. This reveals that every taxpayer is required to file returns within twenty days from the end of the accounting period in which the tax is due and payable. Furthermore, the legislation stipulates that the Commissioner may require a registered person to pay tax at the time when the taxpayer collects that tax from customers as part of the price of a taxable supply.

The return filing process could be by going to the tax authority in person, or by sending the return through the post office provided that the envelope containing the return is sent on or before the 15^th day[17] of the reporting period.

5. Goods and services tax (GST) design in New Zealand

In New Zealand the value added tax is referred to as the good and services tax (GST). The GST was introduced in New Zealand for the first time in 1986. The legal basis for GST in New Zealand is contained mainly in the GST Act 1985 (as amended). GST is administered by the New Zealand Inland Revenue Department and Customs and Excise Authority. GST is imposed on the supply of taxable goods and services in New Zealand, which do not include:

· working for salaries and wages;

· hobbies or any private recreational pursuit;

· private sales of personal or domestic items;

· making exempt supplies

5.1. GST registration

In New Zealand, GST registration is required when the annual turnover[18] based on the value of supplies (including certain imported services that one receives) for the month and the last eleven months has exceeded NZ$40,000[19] or the annual turnover based on the value of supplies including certain imported services received for this month and the next eleven months is expected to exceed NZ$40,000. Those who have less than NZ$40,000 annual turnover can voluntarily register for GST. According to this criterion GST registration is required by businesses, local authorities and not-for –profit entities.

5.2. GST invoice

A tax invoice is a notice of an obligation which includes the GST on the goods and services provided. If taxpayers supply goods and services to another registered person, taxpayers must provide tax invoice within 28 days of purchasers ask for it. The information required in a tax invoice depends on the value of the goods and or services supplied. The following shows the three circumstances pertaining GST invoice.

1. For supplies of more than NZ$1000 (including GST), the tax invoice must clearly show:[20]

§ the words “tax invoice” in a prominent place;

§ the name (or trade name) and GST number of the supplier;

§ the name and address of the recipient of the supply;

§ the date the invoice was issued;

§ a description of the goods and or services supplied;

§ the quantity or volume of the goods and or services supplied;

The invoice must also have either:

§ the amount, excluding tax charged for the supply, the GST and the total amount payable for the supply; or

§ a statement that GST is included in the final price if it has been.

2. For supplies between NZ$50 and NZ$1000 (including GST), a simplified tax invoice is acceptable. The simplified tax invoice must clearly show:

§ the words “tax invoice” in a prominent place;

§ the name and GST number of the supplier;

§ the date the tax invoice was issued;

§ a description of the goods and or services supplied;

§ the total amount payable for the supply and a statement that GST is included.

3. A tax invoice is not needed for supplies of NZ$50 or less (including GST). However, it is suggested that taxpayers need to keep records (such as invoices, vouchers or receipts) for these purchases. As a minimum, record the date, description, cost and supplier of all purchases.

5.3. GST rates

GST in New Zealand is generally chargeable at 12.5 per cent and 0 per cent. 12.5 per cent is applicable for all taxable goods and services other than zero rated ones, whilst zero rate is for:

§ the sale of a “going concern”;

§ exported goods;

§ goods not in New Zealand at the time of supply;

§ duty-free goods;

§ exported vessels (ships);

§ exported aircraft;

§ goods and services that are directly connected with temporary imports;

§ transport of passengers and goods to and from New Zealand;

§ services performed outside New Zealand;

§ certain exported services;

§ the first sale by a refiner of pure gold, silver or platinum to a dealer in fine metal for investment purposes;

§ supplies of certain financial services to certain people; supplies of financial intermediation services (deposit –taking intermediation and brokerage services) may be zero rated to recipients that are registered for GST and 75 per cent or more of their supplies in a 12-month period are taxable supplies.

5.4. GST exemption

In New Zealand exempt supplies are goods and services which are not subject to GST and not included in GST returns. Exempted supplies include:

§ financial services (provision of financial services to recipients who do not meet the criteria to register for GST and whose taxable supplies in a 12-month period is less than 75 per cent);

§ donated goods and services sold by nonprofit bodies;

§ renting a dwelling for use as a private home;

§ the sale of a rental dwelling that was rented for at least five years before the sale;

§ residential accommodation under a head lease;

§ the supply of fine metals (gold with fineness of not less than 99.5 per cent silver with fineness of not less than 99.9 per cent and platinum with fineness of not less than 99.9 per cent), other than zero rated supplies;

§ penalty interest.

5.5. GST credit

GST on all purchases and expenses is allowed to be credited against the output GST provided that the taxpayer is in possession of invoices or details for supplies of NZ$50 or less. There is no need for tax invoices to claim a GST credit for GST on imported services. However, one must be able to show that he or she has accounted for GST on any imported services received and are entitled to claim the GST on imported services. If a taxpayer cannot claim GST on purchases and expenses now (for example no invoice), the taxpayer can claim the credit in the future. But, since April 2005 taxpayers can only claim their GST late on expenditures incurred in the previous two years. The following, however, are exceptions from the two-year rule:

§ disputed payments for expenditure;

§ inability to obtain tax invoice;

§ mistakenly treating a supply as non-taxable;

§ clear mistakes or simple oversights.

5.6. GST refunds

In New Zealand, refunds of GST are allowed when the GST a taxpayer has paid is greater than the GST that the taxpayer has collected in the relevant accounting period. Furthermore, if a taxpayer changes the accounting basis and the tax authority finds that the taxpayer has paid too much GST, the authority will make a refund. But, refund monies can be withheld in situations where a refund (or part thereof) may be used to pay any other taxes the taxpayer owes, for example, PAYE deductions or income tax. In addition, if the taxpayer has not filed a return for any taxable period, the tax authority may hold the refund until the taxpayer sends the overdue return; and if the tax authority is not satisfied with taxpayer’s return the authority will not release the refund until they have checked any problems.

In addition, if a taxpayer’s refund claim is under NZ$1, the taxpayer will only receive a cheque if the claimant applies in writing within six months after filing the return. The tax authority usually sends out refunds within 15 working days of receiving a correct return. The tax authority pays interest on refunds and overpayments of GST in excess of NZ$100.

In general, the discussions so far present the main design features of GST in Ethiopia, Kenya and New Zealand focusing on such issues as registration, rate structure, exemptions, credits, refunds and accounting for GST. The following section makes a comparative analysis of the GST designs in these countries with respect to the above mentioned design features.

5.7. Accounting for GST

In New Zealand, there are three bases of accounting for GST namely invoice basis; payments (cash) basis and hybrid basis. Under invoice basis taxpayers account for GST when they issue an invoice or receive a payment whichever comes first and they claim GST when they receive an invoice. Under payment (or cash) basis taxpayers are required to account GST in the taxable period in which they make or receive payment. Under hybrid basis taxpayers account for GST on their sales (income) using the invoice basis, and claim GST on their expenses (purchases) using the payment basis.

The payment basis may be used by any registered person if the total value of taxable supplies for the last 12 months was NZ$1.3 million or less, or the total value of taxable supplies is not likely to exceed NZ$1.3 million in any period of 12 months beginning on the first day of any month. However, on written application a taxpayer may be allowed to use the payments basis if they expect to exceed $1.3 million in any 12 months period taking into account the nature, value and volume of taxable supplies, and the type of accounting systems used. For example, a retailer accounting for purchases and sales on a cash basis, with a high volume of sales at a low unit price and a turnover higher than $1.3 million may be allowed to use the payments basis. Non-profit bodies can use the payments basis, even if they don’t meet any of the above criteria. The hybrid basis can be used by any registered person who requests for it.

The accounting period for GST in New Zealand may be for a period of one, two or six months. Any registered person whose taxable supplies[21] exceed (or are likely to exceed) NZ$24 million in any 12 months must have a one-month taxable period. The two-month taxable period is the standard taxable period and can be used by those who have annual turnover between NZ$250,000 to NZ$24 million. The six month reporting period is allowed to be used by mainly small businesses if the total value of their taxable supplies has not exceeded NZ$250,000 in the last 12 months, or is unlikely to exceed NZ$250,000 in the next 12 months. Therefore, at the time of registration each taxpayer is required to choose the accounting period applicable for it. But, if there are taxpayers who do not choose the accounting period, they would be automatically assigned a two month taxable period, unless they are required to use a one-month period.

Once registered for GST, one has to periodically file returns with the tax authority. Whether a taxpayer is a one-month, two-month or six-month period user, the taxpayer is required to file GST return within the due date shown on the return, which is the last working day of the month following the end of the accounting period used by the taxpayer. That is, taxpayers are required to file returns within a month from the end of the accounting period. Taxpayers are allowed to file their GST returns either manually (though the post office) or online and are also allowed to effect payments electronically.

6. Comparative analysis of VAT/GST design in Ethiopia, Kenya and New Zealand and some lessons to be learnt

Sections three to five examined the main design features of GST in Ethiopia, Kenya and New Zealand. In this section, the design features of the Ethiopian VAT focusing on registration and threshold, rate structure, tax invoice, exemptions, credits and refunds will be compared to VAT/GST designs in Kenya and New Zealand. Therefore, the following presents a broad overview of the differences and similarities between the Ethiopian VAT design and that of Kenya and New Zealand. It also identifies eight lessons to be learnt from the experiences of Kenya and New Zealand.

If one looks at taxable supplies in Ethiopia and Kenya, taxable supplies are goods and services supplied by businesses, while in New Zealand taxable supplies are goods and services supplied by businesses, not-for profit entities and local authorities. Such a difference reveals that the VAT base in Ethiopia and Kenya is narrower than that of New Zealand. Broadening the VAT/GST base is unquestionable in making the VAT revenue productive and leveling the competition ground. In this light it is sound to bring not-for-profit organizations and local authorities into the tax net. However, from developing countries' perspective, where tax administration is relatively weak and the level of poverty is high, bringing not-for-profit organizations and local authorities to the tax net would have its own adverse impacts.
Regarding VAT/GST registration in Ethiopia like in New Zealand there are compulsory and voluntary registrations. But in Kenya there is only compulsory registration. Examining compulsory registration requirements in Ethiopia in relation to that of New Zealand shows that like New Zealand, in Ethiopia compulsory registration is based on annual turnover. That is, persons with annual taxable transactions (turnover) more than ETB 500,000[22] are required to register for VAT. Similarly, in New Zealand persons who have annual turnover exceeding NZ$40000 or who expect their annual turnover to exceed NZ$40,000 are required to register for GST. In the case of Kenya, nevertheless, the registration threshold is categorized into four categories as shown in section 4.1 earlier. Examining Ethiopia’s VAT registration threshold in relation to those of New Zealand and Kenya (taking the annual turnover level only) evidences that Ethiopia has the highest registration threshold.[23] It is, therefore, worth learning from the experiences of New Zealand and Kenya (considering the annual turnover only) and reducing the Ethiopian VAT registration threshold. Reducing the registration threshold would help in reducing the unfair competition that might arise between registered and unregistered traders.

In addition, in less developed nations like Ethiopia and Kenya, considering the awareness of taxpayers and the capacity of tax administrators in bringing taxpayers into the VAT net, putting sector selected registration requirement is desirable. Accordingly, unlike New Zealand, Ethiopia and Kenya have compulsory sectoral registration requirement. The list of sectors required to be in the VAT net under the sector selected registration requirement is longer in Kenya than in Ethiopia. It would, hence, be worthwhile to learn from the experience of Kenya in expanding the list of sectors that could possibly be brought into the VAT net. Moreover, like in New Zealand, taxpayers in Ethiopia are allowed to register for VAT voluntarily. However, the voluntary registration provision, in Ethiopia, unlike in New Zealand, is restrictive in that voluntary registration is allowed only for those who regularly supply or render at least 75 per cent of their goods and services to registered persons. This is likely to discourage persons who are willing to be part of the VAT net. It would, hence, be wise to learn from the experience of New Zealand and to abolish the 75 per cent transaction with registered taxpayers requirement for voluntary registration in Ethiopia.

Comparison of the three VAT designs in terms of the requirement to issue tax invoice shows that like in Kenya and New Zealand, in Ethiopia, taxpayers are required to issue tax invoice. Like New Zealand and Kenya, information to be contained in the standard tax invoice is clearly stated in the Ethiopian VAT proclamation. But unlike Kenya and, especially, New Zealand, in Ethiopia the information to be contained in the simplified invoice is not known. Moreover, in Ethiopia the relevant directives legislated to be issued by the Minister of Revenue to waive a registered person’s obligation to issue a receipt or tax invoice for cash sales if the total consideration for the entire supply does not exceed ETB 10 are not issued. Such a problem has led to the incurrence of unnecessary compliance costs[24] by taxpayers, that is, taxpayers, regardless of the nature and volume of their operations, are issuing VAT invoice. Furthermore, there is no consistent procedure in dealing with invoice issuance, some use bills (their own type) while others use cash registers and at the end of each business day they issue VAT invoice.

In addition, taking the waiver of the obligation to issue VAT invoice in particular, in Kenya and New Zealand to be entitled for such a waiver the value of supplies by a registered trader must not exceed KSh500 (US$7.24) and NZ$ 50 (US$34.25) respectively. But in the case of Ethiopia the maximum value of supplies for a registered trader to be waived from the obligation of issuing VAT invoice, i.e., ETB10 (US$1.13), is very small. Requiring taxpayers to issue tax invoice (standard or simplified) for each supply in excess of ETB10 is likely to have its own bearing, among others, on VAT compliance costs of taxpayers.

Concerning invoices, the Ethiopian government could learn from the experiences of Kenya and New Zealand. First, in determining the information to be contained in the simplified VAT invoice and who should use it, the Ethiopian government could use the information contained in the simplified VAT invoice and who are allowed to use this invoice in Kenya and New Zealand as a starting place.[25] Secondly, in order to reduce the burden of compliance costs that might arise in connection with the obligation to issue tax invoice, it would be better to increase the minimum value of supplies needed for the issuance of tax invoices, at least, as high as that of Kenya (ETB 80). And the Ethiopian government has to determine the details of the conditionalities for taxpayers to meet in order to be waived from the issuance of tax invoice.

Comparison of VAT designs in terms of rate structure reveals that like New Zealand but unlike Kenya, Ethiopia has two VAT rates. In Ethiopia and New Zealand the standard VAT/GST rates are 15 per cent and 12.5 per cent respectively. They are both chargeable on taxable transactions and imports of goods and services other than zero rated ones. In Kenya there are three rates: 14 per cent, 16 per cent and 0 per cent. The taxable activities chargeable with 14 per cent and 16 per cent are shown in section five earlier. The use of one standard and zero rates is likely to reduce the complexity that might arise in administering the tax. In this light, in Ethiopia like the model VAT design (GST in
New Zealand) using one standard rate and zero rate is worthwhile.

As shown in sections three to five, zero rating in the three countries is mainly for exports. In the case of Kenya, unlike Ethiopia and New Zealand, zero rate applies to various types of transactions on top of the export of goods and services. For instance, goods imported or purchased before the imposition of tax by privileged persons and institutions such as aid agencies are zero rated. Some of the zero rated supplies or institutions in Kenya are exempted from VAT in Ethiopia. For example, in Ethiopia such institutions as NGOs and Embassies are exempted from VAT.

The exemption of these and other institutions has revenue advantage from the side of the government. But on taxpayers’ side, it has its own implication in that when taxpayers have supplies to persons and institutions with exemption entitlements they have to build new prices consisting of the input tax as a cost. Furthermore, such suppliers must go through the difficulty of apportioning the input tax between taxed and exempted supplies. In this regard, it is worth learning from the experience of Kenya, in that, although it would have its own implications on the revenue position of the government, in order to reduce the burden of being partially exempted from VAT, it would be better to zero rate supplies made to aid agencies and other institutions which are currently being given exemption entitlement through letters written by the revenue authority.

Furthermore, in New Zealand zero rate applies to supplies more or less similar to those of Ethiopia. For instance, like New Zealand but unlike Kenya, in Ethiopia a supply by a registered person to another registered person in a single transaction of substantially all of the assets of a taxable activity or an independent functioning part of a taxable activity as a going concern is zero rated. Unlike in Ethiopia and Kenya certain financial services in New Zealand are zero rated.

Examining VAT exemption in the three countries exhibits that in Ethiopia some of the exemption entitlements are either not clear or pending the issuance of directives. For example, even though the pertinent directive does not clearly make a difference on enjera, milk and bread[26] in practice it is only bread (at bakeries level), enjera without sauce (in Amharic “dereke enjera”) and unprocessed milk (in Amharic “terie wotet”) that are exempted from VAT. Furthermore, unlike Ethiopia, Kenya exempts wheat flour, maize (corn) flour, other cereal flours and fruits (including banana, pineapples, avocados, guavas, mangoes, oranges and apples) among others. In poor nations like Ethiopia the imposition of VAT on goods such as flour is likely to exacerbate the living conditions of citizens. It would, hence, be better to reconsider the treatment of goods such as flour. In this case, lesson could be learnt from the experience of Kenya. Furthermore, clearly delimiting the scope of exempted items such as enjera, bread and milk would reduce the variation in treating such items among taxpayers.

VAT credit in Ethiopia is allowed for domestic transactions and imports that occurred either during the current or preceding accounting period. But, in New Zealand taxpayers can claim their GST late on expenditures incurred in the previous two years although there are exceptions as stated in section five earlier (giving longer credit claiming period). Similarly, in Kenya, input tax is claimable within 12 months (or a longer period if it is approved by the commissioner) from the time it is due and payable. Both the Kenyan and New Zealand VAT/GST systems give taxpayers a period of at least 12 months to claim credit for input VAT. But in Ethiopia as per the legislation taxpayers can claim credit either in the current or succeeding period which cannot entertain cases like delays in getting invoices, mistakes, disputed supplies and others. It is, hence, desirable to learn from the experiences of Kenya and New Zealand and increase the time for taxpayers to claim input VAT credit.

In New Zealand refund is made within 15 days, from the date of filing the correct return, to those taxpayers who have excess input tax. In Kenya excess input tax is required to be carried forward to the next period or refunded[27] to taxpayers if the excess arises from zero rated transactions or from physical capital investment. Examination of the refund provisions of the Ethiopian VAT in relation to those of Kenya and New Zealand reveals the following. Unlike the GST in New Zealand, in Ethiopia, at least in the law, any excess credit is allowed to be refunded within 2 months (and not 15 days) from the date of application for refund, if the taxpayer has more than 25 per cent of the value of taxable transactions zero rated. Otherwise, the excess credit has to be carried forward to the next five accounting periods. There is some form of similarity on the refund provisions of the Ethiopian and Kenyan VAT. They both require the carry forwarding of the excess credit if it does not arise from the provision of zero rated goods and services. Furthermore, unlike the Kenyan VAT, the Ethiopian VAT puts a level (25 per cent) to be entitled for immediate refund (within two months) of the excess as indicated above.

The Ethiopian VAT does not make any distinction between capital goods and merchandise items. As discussed earlier, it treats capital goods in the same way as merchandise items. However, the Kenyan VAT allows taxpayers to get cash refund if the credit arises from the acquisition of physical capital goods with value more than KSh1million. The other thing to be noted is that the Kenyan VAT allows refund to be given to taxpayers for excess VAT erroneously paid to the tax authority, however, in Ethiopia this is not the case.

Moreover, in Kenya, taxpayers may get either full or partial remission of tax payable in respect of any taxable goods or taxable services, if the Minister of Finance is satisfied that it is in the public interest to do so. As presented in section four capital goods are among the goods on which remission is allowed to be applied. Remission of VAT on capital goods and refund of excess credit arising from the acquisition of capital goods are likely to ease the strain that VAT might have on investments.

Ethiopia could learn a lot from the experiences of Kenya and New Zealand as far as refunds and treatment of capital goods is concerned. First, like New Zealand, it is vital to shorten the time needed to make cash refund from the date of making application for a refund by the taxpayer. It would also be worth if the Ethiopian government reduces the number of accounting periods to which excess credits are required to be carried forward to at most three accounting periods.

Secondly, like in Kenya, it is worth making a distinction between capital goods and other merchandise items, in that, giving remission to taxpayer for the VAT on the acquisition of capital goods (for both new investments and expansions) for more than a certain amount. Or refund (without being carried forward to the next five accounting period) should be allowed to be paid to taxpayers who have excess credits arising from the acquisition of capital goods in excess of a certain amount.

8. Unlike New Zealand, in Ethiopia and Kenya the accounting period for VAT purpose is one calendar month. In New Zealand, the accounting period could be a period of one-month, two-months or six-months taking into account the size of taxpayers and, of course, their choice. In the case of the reporting period, Ethiopia and New Zealand have one-month period of reporting while in Kenya the reporting period is 20 days from the end of the accounting period.

Looking at the time that GST/VAT is due and payable and hence is accounting in those countries shows that in Kenya and Ethiopia VAT is due and payable and is accountable at the earliest of the issuance of invoice, or payment, or delivering goods and rendering services. But, in the case of New Zealand, GST is accountable either under invoice, cash or hybrid bases depending on the size, nature and choice (given some conditions) of taxpayers. In sum, with respect to the accounting period and the time that VAT/GST is considered to be due, New Zealand’s system is more flexible[28] than those in Kenya and Ethiopia. It would, therefore, be better for Ethiopia to learn from the experience of New Zealand concerning the accounting period and the time VAT is due and accountable. Accordingly, the Ethiopian VAT design would better consider the size of taxpayers and the accounting system in use. That is, for smaller VAT payers, for instance, with annual turnover less than ETB 500,000, it would be better to allow them to use cash basis of accounting in which they account for VAT at the time of collection and payment. Furthermore, for these taxpayers the government could consider allowing them to report VAT on quarterly basis. These measures would help smaller taxpayers in simplifying the accounting for VAT, reducing working capital shortage that might come due to paying VAT to the government before collecting it on credit sales and also the compliance cost that might arise due to the reporting of VAT monthly.

In addition, examining the three VAT/GST systems in terms of the process of filing returns exhibits that in New Zealand taxpayers can file returns online or through the post office while in Kenya the return filing can be by going to the revenue authority’s premises in person or sending returns through the pose office. In the case of Ethiopia, nonetheless, to file returns taxpayers have to go to the tax office in person. This is especially a problem for taxpayers who are in remote areas where there are no Federal Inland Revenue Authority’s (FIRA’s) branch offices for the administration of VAT and are required to come to Addis Ababa or to the nearby cities where the FIRA has a branch office. This is a costly procedure for taxpayers. In this regard, lesson could be learnt from Kenya in that the government could see the possibility of using post office in the process of VAT reporting. The possibility of having branch offices at several locations is also the other thing that the government could consider in alleviating the prevailing problems.

7. Conclusions

The GST/VAT has spread over many countries though out the globe. One of the reasons for the proliferation of GST/VAT is its revenue productivity. With the vision of increasing government revenue and enhancing economic growth, Ethiopia has introduced VAT as replacement of sales tax. The introduction of VAT was reported by the Ethiopian Revenue Authority to have contributed to the increment in government revenue. But, as stated earlier, the revenue claimed to be raised by VAT was determined without taking facts such as the failure of the government to make cash refund into account.

In order to achieve the intended objective of increasing government revenue and enhancing economic growth, it would be worth to closely examine the Ethiopian VAT system and identify main areas in the design and administrative procedures that need reconsideration. This paper focuses on the design of the Ethiopian VAT. In order to identify the problematic areas in the VAT design a comparative analysis was made and based on the lessons learnt from the experiences of Kenya and New Zealand the following concluding remarks and recommendations could be drawn.

Regarding the registration of taxpayers, it is concluded that Ethiopia has registration threshold higher than that of Kenya and New Zealand. It is, hence, worth looking at the possibility of reducing the threshold level on top of improving the administration capacity of the tax authority in order to reduce the uneven competition that might exist between registered and unregistered traders. In addition, in poor nations like Ethiopia, considering the awareness of taxpayers and the capacity of tax administrators in bringing taxpayers into the VAT net, putting sector selected registration requirement is desirable. It would, hence, be worth examining the volume of business that could be carried out in other areas and check if they could be brought into the VAT net. In this regard, consideration could be given to suppliers of automobile parts and accessories and to those who are engaged in such services as accountancy services (including any type of auditing, bookkeeping or similar services); management consultancy services; computer services of any description, including systems analysis and design, and software development; services supplied by architects and consulting engineers; and advertising services. It is also worth relaxing the restriction on voluntary registration and attracting taxpayers into the VAT net instead of limiting the voluntary registration to those who transact at least 75 per cent of their transactions with VAT registered persons.

It would also be worth to make the legislation complete to deal with the problems discussed in connection with invoices. That is, determining the information to be contained in the simplified VAT invoice, increasing the maximum value supplies that is used to waive taxpayers from the issuance of invoice to ETB 80 and determining the conditionalities that a taxpayer should fulfill to be waived from the issuance of invoices should be given due consideration.

Although, it would have its own implications on the revenue position of the government, in order to reduce the burden of being partially exempted from VAT, it would be better to zero rate supplies made to aid agencies and other international institutions.

In poor nations like Ethiopia the imposition of VAT on goods such as flour is likely to exacerbate the living conditions of citizens. It would, hence, be better to reconsider the treatment of food items such as flour. In this case, exemption of such items could be one possibility.

With regard to accounting for VAT, the government could consider the possibility of allowing taxpayers especially small ones (with annual turnover less than ETB 500,000) to use cash basis of accounting and quarterly reporting. As mentioned earlier, this would reduce the burden the tax may have on taxpayers’ working capital and compliance costs.

It is also worth making a distinction between capital goods and other merchandise items. Taxpayers should be given remission of VAT on capital goods in excess of a certain amount or immediate refund should be allowed for the same. In the case of input VAT on construction in progress, it is worth allowing taxpayers to credit the input VAT while the construction is in progress instead of holding the resources of taxpayers (for a very long time) and waiting until the construction is completed. The government could allow taxpayers to credit the input VAT while the construction is in progress (provided that the building is going to be used for a taxable service) and then later if the building is converted to be used for exempted services the government could ask the taxpayer to refund the VAT credit obtained earlier.

In general, the above proposed changes in the VAT legislation should be supported by enhanced administration. Without improving the administrative capacity of the tax system, the above recommended changes would not be able to achieve their intended objectives and even they might have adverse impacts on the entire system. The improvement on the administration capacity of the tax system would help in putting not only the above proposed changes into practice but also some of the provisions in the existing law which are not being properly implemented. For instance, in the case of refund, it is legislated to make cash refund for those who have excess credit after carrying it forward to the next five accounting periods. In practice, however, the tax authority as mentioned earlier made the first cash refund to this group of taxpayers in February 2007. Furthermore, the tax authority takes very long time in processing refund claims. These delays in making cash refund to those who are entitled is partly because of the weakness in administering VAT. Therefore, it would be better to strengthen the administrative capacity of the tax system and to put the various provisions into practice. Doing this, especially, making cash refund to entitled taxpayers, in due time, would build the trust of taxpayers on the system and would contribute to the change in taxpayers’ mentality[29] and increase in taxpayers’ voluntary compliance.

References

AfDB/OECD (2004) ‘African Economic Outlook’, OECD, Paris.

African Economic Research Consortium,(2004) ‘Financing pro-poor growth in Africa’

AERC Senior Policy Seminar papers VI, Kampala, Uganda.

Cheeseman, Nicholas & Robert Griffiths (2005), ‘Increasing tax revenue in sub-Saharan

Africa: The case of Kenya’, The Oxford Council on Good Governance

Council of Ministers- Federal Democratic Republic of Ethiopia, (2002) ‘Value Added Tax Regulations, Council of Ministers Regulations no. 79/2002, Federal Negarit Gazeta, Addis Ababa, Ethiopia.

Domestic Tax Department (Kenya Revenue Authority) (2004) ‘The Value Added Tax

Act (CAP. 476) and Subsidiary legislations’ viewed in 2006, http://www.kra.go.kt/vat/pdf/VATAct2004.pdf.

Federal Democratic Republic of Ethiopia (2002) Value Added Tax Proclamation no. 285/2002, Federal Negarit Gazeta, Addis Ababa, Ethiopia

G/Ezgihabher (2005) ‘An assessment of Value Added Tax Design and Revenue Performance in Ethiopia: A comparative analysis wit Sub-Saharan African Countries’, Addis Ababa University, MSc Thesis.

Kenya revenue authority (no date) ‘Value added tax’ viewed in 2006, <http://www.kra.go.ke>.

Ministry of Revenue (no date), ‘Assessment on the implementation of value added tax in Ethiopia’, working paper, viewed December, 2006, <http://www.mor.gov.et/workingprinciples.html>.

National Bank of Ethiopia (2003/04) Annual Report, A/A., Ethiopia.

National Bank of Ethiopia (2004/05) Annual Report, A/A., Ethiopia.

New Zealand Goods and Services Tax Act 1985 (Reprint as at 24 July 2006) viewed

2006, <http://rangi.knowledge-basket.co.nz/gpacts/reprint/text/2006/an/020.html>.

World Bank (2005) World development report, Washington, USA

Appendix

Table 1 Summary of General Government Revenue by component

(In Millions of Ethiopian Birr)

Fiscal year Particulars	2003/04	2004/05
Total revenue and grants	17918	19873
Total revenue¹	13917	15466
Tax revenue Tax revenue as a % of total revenue	10906 78%	12265 79%
Direct tax revenue Income and profit taxes Rural land use fee Urban land use fee Direct taxes as a % of tax revenue	3431 3131 114 186 31%	3940 3569 140 221 32%
Indirect taxes Domestic taxes Foreign trade taxes	7476 2200 5276	8335 2589 5746
Non-tax revenue	3010	3202
Grants	4002	4407

Source: National Bank of Ethiopia Annual report 2004/05, and own computations.

1. It does not include privatization proceeds.

Table 2: Selected Macroeconomic indicators

Fiscal year	1995/96	1996/97	1997/98	1998/99	1999/00	2000/01	2001/02	2002/03	2003/04	2004/05
GDP at current market price (Mn. ETB)	37937.6	41465.1	44840.3	48803.3	53189.8	54210.7	51932.8	57077.3	69195.7	74506
Total revenue including grants (Mn. ETB)	8062.9	9381.5	9686.2	11215.2	11222	12805	12833	15703	17187	19873
Total revenue excluding grants(Mn. ETB)	6966.2	7877.4	8412.9	9453.1	9498	10177	10409	11149	13185	15466
Tax revenue (Mn. ETB)	4723.3	5358.2	5268.7	5591.6	6782	7440	7926	8243	10520	12265
Tax revenue as % of GDP	12.5	12.9	11.7	11.5	12.8	13.7	15.3	14.4	15.2	12.7
Total expenditure as % of GDP	27.2	24.2	25.3	29.8	32.3	29.1	34	35.9	29.4	-
Budget Deficit (excluding grants) as % of GDP	8.9	5.2	6.5	10.5	14.4	10.3	13.9	16.4	10.4	-
Budget Deficit (including grants) as % of GDP	6	1.5	3.7	6.8	11.2	5.5	9.3	8.4	4.6	-

Source: National Bank of Ethiopia Annual report 2004-2005,

[1] Such a decline was mainly due to the decrease in interest payments in the mentioned period.

[2] Such a rise in expenditures was in the face of an increase in GDP (at current market price) from ETB 37937.60 million in 1995/96 to ETB 56958 million in 2002/03 (G/Ezgihabher 2005).

[3] Tax to GDP ratio for other selected African countries in the year 2001 is Namibia 29.9%, South Africa 26.5%, Swaziland 26.6%, and Uganda 107%.

[4] This is allowed a notice in writing signed by the transferor and transferee is furnished to the authority within 21 days after the supply takes place and such notice includes the details of the supply.

[6] is defined as a road vehicle designed or adapted for the transport of eight or fewer seated persons, including a double cap vehicle (VAT Proclamation No. 285, p. 1848).

[7] means the provision of food, beverages, tobacco, accommodation, amusement, recreation, or hospitality of any kind by a registered person whether directly or indirectly to any person in connection with a taxable activity carried on by the registered person (VAT Proclamation No. 285, p. 1848).

[8] Especially capital goods that are not used in connection with zero rated supplies of goods and services.

[9] At the time of filing returns, input VAT on construction in progress is reported in a separate form.

[11] In-house supplies means supplies which are either made from own resources; or brought in from third parties but materially altered so that the supply made is substantially different to that purchased.

[12] The VAT is proclaimed to be a liability of the person making the supply and import and is due at the time of supply and import into Kenya respectively. In the case of VAT on services imported into Kenya, the payment is required to be made by the person receiving the taxable service.

[13] According to legal notice no 95 motor vehicle means a self propelled vehicle intended for use on roads but does not include a tractor.

[14] Where the premises are sold or disposed of, the input tax refundable by the registered person is required by the ACT to be the output tax.

[15] Application for refund and relief from the tax office of an amount exceeding one million shillings shall be accompanied by all the necessary documents including an auditor's certificate that the application or claim is true and that the amount is properly refundable under the Act.

[16]As per the legislation, remission in respect of all goods may be granted subject to the approval of the Minister and in the case of maize, wheat, sugar, milk, edible vegetable fats and oils, rice, textiles, new and used clothing and footwear imported or purchased locally during periods of civil strife, national calamity or disaster declared under any law for the time being in force, or where they are intended for use in officially recognized refugee camps in Kenya.

[18] For the purpose of GST in New Zealand turnover is defined as the total value of the entities’ sales and income, including any grants or subsidies received and barter transactions and imported services.

[19] Exchange rate NZ$1 = ETB 6.085 and US$1 = NZ$1.46

[20] If the invoice covers a number of supplies which add up to more than NZ$1000, all the details listed under “1” are needed.

[21] If the business operates in a group, or in branches, the taxable supplies of all members or branches must be added together to get the total taxable supplies.

[22] Exchange rate US$1=ETB8.88; US$1= NZ$1.46; US$1 = KSh70

[23] The annual threshold levels in US dollars in Ethiopia, Kenya and New Zealand are US$56,306, US$42,857 and US$27,397 respectively.

[24] The compliance cost may arise in terms of time spent in the process of getting permit to print VAT invoices, preparation of VAT invoice at least once in a day for transactions recorded in a cash register or for which bills are already issued. Compliance cost may also arise in the form of stationery cost, that is the cost of getting VAT invoice printed.

[25] The information to be contained in simplified VAT/GST invoice in New Zealand and Kenya are clearly stated in the respective legislations as shown in section 4 and 5 of this paper.

[26]The directive issued in this case states that enjera, bread and milk are exempted from VAT.

[27] The length of time that the refund process would take is not clearly stated in the legislation.

[28] Flexible in the sense that it gives the chance to tax payers to choose from alternative ways of accounting bases and the accounting period.

[29] In Amaharic “menegist kazena ye geba genzeb ayemelesem”