THE EFFECT OF VALUE ADDED TAX ON THE NIGERIA TAX SYSTEM: A CASE STUDY OF REVENUE MOBILIZATION AND FISCAL ALLOCATION COMMISSION, ABUJA

CHAPTER TWO

REVIEW OF RELATED LITERATURE

2.1 INTRODUCTION

Country seeking to improve its revenue generation would opt for a concept enabling it to best realize its objectives with due regards to its peculiar socio-economic make-up. One of these ways is by Taxation. A tax can therefore, be defined as a means by which, a Government appropriate part of the private sector’s income. The accumulated revenue is used in meeting recurrent expenditure. Tax occupies a unique position, because it is an important part of government policies. The ability of a government to generate revenue from this sector affects services offered by such a government. A mean of improving internally generated revenue is through value added tax.

Value added tax was first introduced by France in 1954. It has been embraced by well over seventy countries all over the world. These include the entire organization for Economic Co-operation and Development of countries, Japan, Canada, the of Michigan in the USA and many African Countries.

In Nigeria, the March towards VAT system started with acceptance of the recommendation of a study group on indirect taxation in November, 1991. The decision to accept the recommendation was made public in the 1992 budget speech of the Head of . This resulted in setting up the Modified Value-Added Tax (MVAT) committee on 1st June, 1992 as recommended by the study group. The recommendation of the committee that VAT should be administered by an independent commission was rejected by the government. Tax administration was how ever given to revenue mobilization and fiscal allocation commission, abujas, which was already charged with the responsibility of administering most other taxes in Nigeria.

The introduction of VAT in Nigeria through Decree 102 of 1993 marks the phasing out for the Sales Tax Decree No. 7 of 1986. The Decree took effect from 1st December, 1993, but by administrative arrangement, invoicing for tax purpose did not commence until 1st January, 1994.

Value-Added Tax is tax on the supply of good and services which is eventually born by the final consumer but all collected at each stage of production and distribution chain. With VAT, government reasoned, it will be virtually impossible to evade tax.

2.2 THEORETICAL FRAMEWORK

Although, very few literature exist on the subject of value added tax in less developing countries by different groups of scholar academicians, tax experts and professionals commissioner by International Monetary Funds (IMF), World Bank, Organization of petroleum exporting countries (OPEC), Extensive studies have nevertheless, been done on the alternation prominence of Indirect Tax in developing countries is general and Nigeria in particular. The core function of taxation as revenue generating tool is developing countries has been studied by eminent scholars.

Naiyeju (1996) argued that the positive result received from any tax depends on the tax extent of how it is properly managed. The extent of how the tax law is interpreted and implemented as well as the publicity brought into it will determine how a particular tax is able to meet its objectives. Also, Naiyeju (1996) was looking at the relationship among interpretation of the tax laws, IE’s management between the success of tax system and tax justification using the issue of income tax in Nigeria where,government has administrative and operational jurisdiction. He argued that with the development in the Oil sector (declining/fluctuation in the international price) but, the lower chance of generating higher revenue from import duties there is need to revisit the jurisdictional issue of taxation in Nigeria.

Valve Added Tax is a consumption tax that has been embraced by many countries world-wide. Because, it is a consumption tax, it is relatively easy to administer and difficult to evade. The yield from VAT is a fairly accurate measurement of growth of an economy. Since, purchasing power which determine yield, increases with economy growth.

VAT is a self-assessment tax that is paid when return being rendered in-built in the new tax in the refund or credit mechanism, which eliminates the cascading effect that is a feature of the retail sales tax.

In Nigeria, the idea of VAT started with the acceptance of recommendation of the study group on indirect taxation in November 1991, Set up by the Federal Government. The Federal Government was however, not satisfied with the revenue yield from the sales tax whose base is regarded as norms and which covers only nine categories of good plus sales and services in registered hotels, motel and similar establishment. It is felt that the narrow base of the consumption negates the fundamental principles of consumption tax, which by nature is expected to cut across consumption of goods and services. Value Added Tax, in contrary has a broader base and includes most professional services and banking transactions that are high profit generating sectors, only locally manufactured goods were targeted by the sale tax Decree of 1986, although, this might not have been the intention of the law.

Simply called the Goods and Services Tax (GST), it is levied on the value added that results from each exchange. It is an indirect tax collected from someone other than the person who actually bears the cost of the tax (Ochei, 2010). It was invented by a French Economist, Maurice Laure in 1954 and was first introduced in France on April 10, 1954. Feldstein and Krugman (1990) were the first set of researchers to research on the international trade effects of Value Added Taxation. Their research was based on the widespread belief that VAT, because it is levied on imports and rebated on exports, acts as a combination of protection and export subsidy, giving the traded goods sectors of countries with VAT an advantage over the corresponding sectors of countries that rely on income taxation. The research used a simple model to show that this view is almost completely wrong. A VAT is not a protectionist measure; indeed, the allegedly pro competitive device of export rebates is necessary if the VAT is not to act as an export tax, which in turn is actually a protectionist measure that would reduce both imports and exports. It was also established that in practice, VAT would almost surely fall more heavily on traded rather than non traded goods, which would constitute a bias against both exports and imports. Different scholars had used different explanatory variables to attempt some empirical measurements of tax efforts in various countries. Such variables included agricultural output-GDP ratio, per capital income, mineral exports-GDP ratio, the degree of openness of the economy, money-GDP ratio, etc. Using mining-GDP, agricultural output-GDP ratio, and export – GDP ratio as determinants of tax share in GDP to measure tax efforts, Chelliah, Bass and Kelly (1975) showed that the agriculture share is negative while the mining share is positively related to tax share, and the export ratio is not significant. Using panel data on 43 Sub-African Countries for the period 1990-1995 to measure the determinants of tax-GDP ratio to construct an index of tax effort for these countries, Stotsky and Woldemariam (1977) found that the countries with a relatively high taxGDP ratio tended to have a relatively high index of tax effort, although the results varied across countries. Tait and Gratz (1979) later updated the work of Chelliah et al (1975) using the same sample of developing countries for the period 1972-1976. However, they did not find the agric-GDP ratio to be significant but their measure of tax effort indices yielded similar results to the initial study. Toder and Rosenberg (2010) worked on the effects of imposing a value added tax to replace payroll taxes or corporate taxes (in the US). The research work was conducted against the background that the United s is the only country in the developed world that does not impose a broad-based consumption tax. The typical form of broad-based consumption tax used worldwide is a credit-invoice Value Added Tax (VAT). The credit-invoice VAT, a subtraction –method VAT or Business Transfer Tax (BTT), and a Retail Sales Tax (RST) are all intended to tax the final consumption once at the retail level, but the collection mechanisms differ among the three taxes. The researchers found out that VAT has administrative advantages over both BTT and RST. Both VAT and BTT are easier to enforce than RST because under a tax collected at different stages of production, evasion by the final seller still leaves much of the tax in place. Compared with BTT, VAT makes it easier to exempt sales of categories of consumption goods, including export sales, but more difficult to grant preferences to selected industries. The distributional burden of VAT, it was found, is roughly proportional at the bottom of income distribution but regressive at the top. VAT was introduced by The Federal Government of Nigeria in January, 1993. It was believed by many Nigerians that the tax was introduced as a means of avoiding taking loans from international agencies (Ochei, 2010). According to analysts, the tax was intended to be a ‘super tax’ to eradicate completely many other taxes related on goods and services. VAT was then imposed on virtually all goods and services, whether produced or rendered in Nigeria or not. Exemptions however were granted in respect of medical and pharmaceutical products, basic food items, fertilizers, agricultural and centenary medicine, books and educational items, farming and transport equipment, etc. VAT effectively replaced the former sales tax, which, under the constitution, was supposed to be charged by s and not the Federal Government. Although very few literature exists on the subject of VAT in less developing countries, extensive studies have nevertheless been done on the alternation prominence of Indirect Tax in developing countries in general and Nigeria in particular. The core function of taxation as a revenue generating tool in developing countries has been studied by eminent scholars. Naiyeju (1996) argued that the positive result received from any tax depends on the extent of how it is properly managed. The extent of how the tax law is interpreted and implemented as well as the publicity brought into it will determine how a particular tax is able to meet its objectives. Ariyo (1997) in his study on productivity of the Nigerian tax system reported a satisfactory level of productivity of the tax system before the oil boom. The report underscored the urgent need for the improvement of the tax information system to enhance the evaluation of the performance of the tax system and facilitate adequate macroeconomic planning and implementation. Ajakaiye (2000) worked on the impact of VAT on key sectoral and macroeconomic aggregates, using a Computable General Equilibrium (CGE) model considered suitable for Nigeria. The study developed three scenarios. In order to approximate the presumed Nigerian situation, the study assumed that government pursued an active fiscal policy involving the re-injection of the VAT via increases in government final consumption expenditure in combination with a presumed non-cascading treatment of the VAT. Two other simulations considered an active fiscal policy combined with a cascading treatment of VAT and a passive fiscal policy combined with a non-cascading treatment. As it turned out, the scenario of a cascading treatment of VAT with an active fiscal policy not only had the most deleterious effects on the economy, it was also the one that most closely approximated the situation in Nigeria. VAT revenues under this scenario are more than 3% lower than the first scenario, the general price index increases by 12%, and wage and profit incomes fall by 8.54% and 12.27% respectively. Overall, the GDP declines by 11.34%. Such a situation, as observed by the researcher, poses a great threat to the sustainability of VAT. United Nations (2000) expert group d that tax revenue contributes substantially to development. The stark reality in most developing countries is that while there are several budgetary pressures as a result of ever increasing demand for government expenditure, there is a limited scope for raising extra tax revenues. Desai, Foley and Hines (2004) d that governments have at their disposal many tax instruments that can be used singly or in concert to finance their activities. These tax alternatives include personal and corporate income taxes, sales taxes, value added taxes, capital gains taxes and numerous others. In choosing what tax instruments to use and what rates to impose, governments are typically influenced by their expectations of the effects of taxation on investment and economic activities, including Foreign Direct Investments (FDI). The researchers d that there are extensive empirical studies that high corporate income tax rates are associated with low levels of FDI. VAT rate in Nigeria has been determined in a way that minimizes disincentive efforts on economic activities (Owolabi & Okwu, 2011). Musa (2009) opined that economic and social development laws and policies provide the basis for effectiveaction that lifts society from underdevelopment, improves the standard of living and facilities for the realization of the millennium development goals. Olaoye (2009) worked on the administration of VAT in Nigeria. The objective of the study was to seek ways of improving government revenue generation base in order to improve on the economy. The study among other things, recommended that more awareness was needed on VAT. Adegbie and Fakile (2011) worked on company income tax and Nigeria’s economic development. They used the GDP to capture the Nigerian economy and Petroleum Profit Tax (PPT), Company Income Tax (CIT), Customs and Excise Duties and VAT to measure Company Income Tax. Findings revealed that there is a significant relationship between company income tax and Nigerian economic development and that tax evasion and avoidance are the major hindrances to revenue generation. Owolabi and Okwu (2011) empirically evaluated the contribution of VAT to the development of Abuja economy. Development aspects considered included infrastructural development, environmental management, education sector development, youth and social development, agricultural sector development, health sector development and transportation sector development. Result showed that VAT revenue contributed positively to the development of the respective sectors. However, the positive contribution was statistically significant only in agricultural sector development.

2.3 CONCEPTUAL FRAMEWORK

VAT is a consumption tax levied at each stage of the consumption chain and borne by the final consumer of the product or service. Each person is required to charge and collect VAT at a flat rate of 5% on all invoiced amounts, on all goods and services not exempted from paying VAT, under the Value Added Tax Act 1993 as amended. Where the VAT collected on behalf of the government (output VAT) in a particular month is more than the VAT paid to other persons (input VAT) in the same month, the difference is required to be remitted to the government, on a monthly basis, by the taxable person (Oserogho and Associates, 2008). Where the reverse is the case, the taxpayer is entitled to a refund of the excess VAT paid or more practically, to receive a tax credit of the excess VAT from the government. All exports are zero rated for VAT, i.e. no VAT is payable on exports. Also, VAT is payable in the currency of the transaction under which goods or services are exchanged. Every person, whether resident in Nigeria or non resident in Nigeria, who sells goods or renders services in Nigeria under the VAT Act (as amended) is obligated to register for VAT within six months of its commencement of business in Nigeria. Registration is with the Federal Board of Inland Revenue (FBIR). The VAT Act (as amended) provides that a foreign non-resident person or company that carries on economic activities in Nigeria is also obligated to register for VAT, using the address of the person with whom it has a subsisting economic activity for purposes of correspondence with FBIR and for compliance with the VAT Law. The foreign non-resident person or company is required upon registration for VAT to include in its invoice VAT at 5% with instructions to the receiver of the goods or services to remit the VAT in the currency of the transaction to the Nigerian government on behalf of the foreign nonresident person. A taxable person, whether Nigerian resident outside Nigeria, who fails or refuses to register for VAT administration within six months of engaging in any economic activity in the territory of Nigeria is liable to pay a penalty of $67.00 for the first month that the failure occurs and a further penalty of $34 for each subsequent month in which the failure continues. In addition to the fines for non registration, Section 32 of the VAT Act (as amended) authorizes the FBIR to seal up the premises from where the economic activity in question is being carried on within the territory of Nigeria.

GENERAL STRUCTURES OF VAT IN NIGERIA

Value Added Tax is a consumption tax on economic operations, which includes imported goods and services. It originated from the Rome treaty signed by the European Union countries in the late sixties. VAT is computed at a flat rate of 5% of price of goods and services and at zero rates for export (Seyi, 1993).

Aims of VAT:

Taxable goods and services and rates: VAT covers manufactured goods and imports as well as professional and Banking Services. Though, the list of affected goods and services published by FIRS is still subject to amendment. Table 2 shows some of the goods and services and specific rate chargeable.

Goods and service exempted: VAT exempts essential goods such as all medical and pharmaceutical product basic food, books and educational material, news papers and magazines, baby products, fertilizer agricultural and veterinary medicine, farming transportation equipment. While, services exempted include medical services, services rendered by community bank’s, people’s bank and mortgage institution as part of learning. All diplomatic items are exempted as covered by international agreements and airline tickets for international travel.

Administration of VAT: The VAT system in Nigeria is administered by the Revenue mobilization and fiscal allocation commission, abuja (VAT Directorate). The board is charged with the function of assessment and collection of the tax and shall account for all amounts so collected in accordance with the provision of the decree. Although, it is administered and controlled by the federal government using the existing tax machinery of the revenue mobilization and fiscal allocation commission, abujas in close co-operative with the Nigeria custom service and theinland Revenue Service. The net proceeds from VAT are shared among the federal, s and local government in the ratio 45:35:20.

Thy prospective VAT payer obtains and completes VAT from 002 and returns to the nearest VAT office. Once, registered the the VAT proceeds is expected on monthly basis to be paid to the VAT office.

Remitance of VAT: Every vatable person is to remit to the relevant local VAT office the net. VAT payable, which is the excess of the output tax over the in put tax while filling the VAT return. Remittances are supposed to be made together to the VAT returns filed. The VAT carries a single rate of 5% on vatable goods and services. Zero rate is assumed for export while there are goods and services exempted from the tax.

Accounting for VAT: Since, VAT introduction was long ago, there is need to emphasis, the peculiar aspect in accounting that relates to it. These are:

Offences and penalties of registered person: There are various offences with every stiff penalty under the VAT system some of the offences are:

There are swift and automatic penalties differentiated by the types of transgression. Some of the penalties are as follows:

being evaded, whichever is greater, or imprisonment for a term not exceeding 3 years

Collections and computation of VAT: The collection of VAT is not different from the current system of collecting withholding taxes operated at all levels of government. Essentially, the withholding tax requires the payer too withhold (deduct) percentages. Specify by law from his payment and to remit this withhold amount to the government. The law imposes the liability for the underling obligation being paid is that of the year.

Computation: Value-Added Tax is calculated by deducting from the value of goods or services the cost of input of other goods or services that were used up in process of the production of the goods or delivery of the services.

Problems of VAT administration: Although, It is agreeable that, there is need for VAT to replace the formal sales tax because of the progressive nature, government’s ability to adequately and effectively retrieve the proceeds from companies and other agent of collection remains a problem. It does not appear as if there is adequate machinery for effectively monitoring the remittance of tax withheld to the relevance tax authority. The Revenue mobilization and fiscal allocation commission, abuja (FIRS) lacks logistics support for effective administration of VAT.

The further problem of VAT administration present composition and functions of the tax authorities, which weaken effective tax administration in the country. Nigeria’s perform only technical functions and not the needed management functions. The non-performance of management functions given the increasing complexity of the tax administration largely explains the ineffectiveness of tax administration in Nigeria. Basically, the performance of only technical function leads to large declaration, refusal to complete tax return form, fraud, declaration, refusal to complete tax return form, fraud inflation and deductible expenses, smuggling, default, illegal bunkering, etc.

The dishonest practices by some tax officials also, pose a serious threat to effective tax administration in Nigeria especially, when such practices are capable of having demoralizing effect on the honest tax payers in the same vain, consumers still want to know how much of this tax these companies are collecting from VAT, more especially when such tax is not even duly reflected in their invoice. It is believed that VAT is just another way of inflecting economic hardship on consumers to the advantages of manufacturers and companies. Tax exports are of the opinion that seminar and workshops so far organized on the issue are narrow scope and design. Another problem is that Nigeria. Se VAT as an excuse to raise price of goods arbitrarily-inadequate and lack of information also makes VAT administration difficult.

Agenda for the effective management of VAT: The good tax system according to Musgrave should be designed so as to meet the requirement of equity, effective and ease of administration, while it is admitted that our tax system should strive to achieve those three ES f taxation, it is additionally important that a cardinal objective of our tax system is to provide resources for the development of the national economy to achieve the three ES if the system cannot, in the end, generate sufficient reason for the realization of the nations development objectives. In the Nigeria context, VAT was introduced to help boost the government revenue, which has been dwindling for many years. VAT has started yielding positive results for instance, in its first month of operations; yielded over N 500 million. This is an indication that if it is properly managed, the projected N6 billion revenue to be generated by VAT will be exceeded. However, for the Revenue mobilization and fiscal allocation commission, abuja to hit that target of 6 million, the performance of the management function of taxation in the country in veritable. However, to discharge this management functions, the FIRS must be set granted full autonomy (Anonymous, 2003).

An internal audit section should also be set up in each tax zone to carry out periodic assessment and monitoring of the performance of the FIRS and also audit the record of each vatable person or organization. As sharp practices by tax officials do not enhance the public image of the tax authority and are capable of having deteriorating effect on the willingness of honest citizens to pay tax, no case involving fraud, loss of tax revenue and the printing and use of tax revenue receipts should be expeditiously handled while appropriate. Sanctions be imposed and nicely publicized to serve as a deterrent machinery should also be set up to hear cases of abuse against consumers.

The absence of the tax payer’s voluntary compliance give rise to enforcement and for penalty, the test of whether or not tax administration is a toothless bulldog is in the process of enforcement, in an effective system, the tax administration created an impression through its action that it can bark and bite, if need be. Effective sanctions as contained in the VAT Decree must be promptly taken against VAT defaulters as the needs arises, but within the limits of the law.

2.4 EMPIRICAL REVIEW

Value Added Tax (VAT) has become a major source of revenue in many developing countries. In sub Saharan Africa for example, VAT has been introduced in Benin Republic, Cote d’Ivore, Guinea, Kenya, Madagascar, Mauritius, Niger Republic, Senegal, Togo and Nigeria. Evidence suggests that in these countries, VAT has become an important contributor to total government tax revenues (Ajakaiye, 2000). Shalizi and Squire (1988) found out that VAT accounted for about 30% of total tax revenues in Cote d’Ivoire, Kenya and Senegal in 1982. The oil producing countries are not excluded from the list of countries introducing this tax hurdle. Tait (1989) showed that VAT has been in effect in Ecuador and Mexico since at least 1973 and by 1983 accounted for 12.35% and 19.71% of total government revenues in these counties respectively. Indonesia introduced VAT in 1983 and by 1988; the ratio of VAT revenue to GDP had risen to 4.5% (Bogetic and Hassan, 1993). This impressive performance of VAT in virtually all countries where it has been introduced, according to Ajakaiye (2000), clearly influenced the decision to introduce VAT in Nigeria in January 1994. VAT is a consumption tax that is relatively easy to administer and difficult to evade and it has been embraced by many countries world-wide (Revenue mobilization and fiscal allocation commission, abuja, 1993). Evidence so far supports the view that VAT revenue is already a significant source of revenue in Nigeria. For example, actual VAT revenue for 1994 was N8.189 billion, which is 36.5% higher than the projected N6 billion for the year. Similarly, actual VAT revenue for 1995 was N21 billion compared with the projected N12 billion. In terms of contributions to total federally collected revenue, VAT accounted for about 4.06 % in 1994 and 5.93% in 1995. As much as N404.5 billion was collected on VAT (5.1% of total revenue) in 2008. While the performance of VAT as a source of revenue in Nigeria is encouraging, it remains difficult to find attempts to systematically assess the impact of VAT on the economy. Recent research works on the impact of taxation on the Nigerian economy lumped up all the various taxes together without isolating VAT. How and in what direction has VAT been affecting the Nigerian economy, proxy by Gross Domestic Product (GDP)? Is there any causality between the two economic variables? Finding answers to these and other similar questions is the main trust of this paper.