Sticky VAT thresholds create ‘economic distortion’

The 16-year-old threshold for mandatory value-added tax (VAT) registration creates “economic distortion”, can potentially render small businesses uncompetitive, and may even prove to be a “gross disincentive” for them to expand.

The registration threshold has been R1 million since 2009, while the threshold for the submission of monthly VAT returns has remained R30m since the introduction of VAT in 1991. If the thresholds had been adjusted for inflation, they would be closer to R2m and R200m, respectively.

Several VAT experts recently unpacked the possible reasons the thresholds have remained stagnant, and the unintended consequences for keeping them where they are.

ENSafrica executive Charles de Wet says it is well known that the South African Reserve Bank wants to target an inflation rate of 3%. The effect when a small business crosses the VAT threshold is it becomes 15% more expensive. If the inflation target is 3%, it means the business will introduce five years of increases in a single year.

A small business can opt to reduce its profit margin by 15% to remain competitive, but De Wet expresses doubt whether many small businesses are achieving double-digit margins.

The policy thinking behind increasing the threshold from R300 000 to R1m in 2009 was to allow businesses to grow without being bogged down by an administrative burden.

De Wet calls for proper engagement with National Treasury and other stakeholders to determine the “right number” for a realistic threshold, given the state of the economy.

He also notes that the minimum threshold for voluntary VAT registration has remained R50 000, the threshold when providing commercial accommodation has remained R120 000, and R30m for companies that can file VAT returns monthly.

Cost of doing business

Severus Smuts, a partner and VAT specialist at Deloitte, suggests a registration threshold of around R3m to allow businesses to grow. Once they have sufficient infrastructure (proper inhouse skills and accounting systems), they can be pulled into the net.

“The thinking at the time (when the threshold was increased) was for the small business to focus on their business and to reduce the cost of doing business. Small businesses generally do not have the expertise to deal with VAT issues or with SARS. They have to appoint experts and that increases costs.”

Smuts says VAT is nuanced and making mistakes has led the South African Revenue Service to disallow some input costs. If a small business enters into a dispute with SARS, it is not only costly, but also time-consuming.

A major issue with VAT accounting is the impact on the cash flow of a small business. Smuts says the business is obliged to pay the VAT charged to SARS once an invoice is issued. This is despite the business not having been paid by its clients.

Staying below the threshold

Economic distortion comes into play when a close competitor is just below the threshold. “The playing field for the VAT-registered vendor just becomes less level,” says Leonard Willemse, a director at specialist tax firm AJM.

The effect is that many businesses prefer to remain under the threshold, which is counterproductive to the initial policy objective, he adds.

“One must consider that to have a turnover of R1m, a company like a coffee shop, plumbing business, or laundromat will earn a monthly income of R83 000.” In today’s terms, this equates to a very small business.

He adds that South Africa is relatively on par with comparable countries such as Namibia and Kenya. Even countries such as Germany, Canada, and Australia have registration thresholds ranging between R500 000 and R1m.

On the other hand, countries such as France, Japan, and the United Kingdom have registration thresholds closer to R2m. Outliers such as Chile, Turkey, Colombia, and Mexico require all corporate entities to register for VAT.

Willemse says any Minister of Finance who touches VAT becomes unpopular, as Enoch Godongwana experienced earlier this year when he tried to increase the VAT rate from 15% to 17%.

Willemse is of the view that the government will keep the thresholds unchanged. The inability to raise the VAT rate left the government with a significant revenue shortfall. The thinking may be that it will lose even more from VAT collections if the thresholds are increased, even if there is no data to indicate what portion of VAT collections is derived from small and medium enterprises, he adds.

Smuts notes that there is growing VAT tax gap – mainly because of non-compliance and fraud. If SARS reduces its VAT register by eliminating small companies, it will have more resources available to focus on the “big fish” and close the growing gap.

De Wet says he generally has two bets during the annual Budget – one is that the zero-rated list will be expanded to include chicken, and the other is that the VAT thresholds will increase. Given the current economic climate and the need for growth, it may be opportune to give small businesses breathing space to expand and create much-needed employment.

Amanda Visser is a freelance journalist who specialises in tax and has written about trade law, competition law, and regulatory issues.
Disclaimer: The views expressed in this article are those of the writer and are not necessarily shared by Moonstone Information Refinery or its sister companies. The information in this article is a general guide and should not be used as a substitute for professional tax advice.