The difference between zero-rating and exempting Value Added Tax
The Sunday Nation
Nairobi,
06 June 2010
Peter Ndirangu (from last week) has a seemingly trivial question: “What is the difference between zero-rating and exemption of [value added] tax?”
At first sight, the two seem the same; after all, zero per cent of anything is zero. So, why say some products are zero-rated while others are exempt? To appreciate the difference, we need to understand how VAT is accounted for by traders.
Suppose you are a VAT registered business person. If you buy an item at Sh100+VAT, you will pay a total of Sh116 for it. If you then sell it at Sh120+VAT, you will charge a total of Sh139.20. The VAT is then accounted as follows:
You have collected Sh19.20 VAT from your customer; but you had paid Sh16 when you bought the product. Therefore, you pay only Sh3.20 (19.20 – 16) to the taxman.
This way, there is no double taxation and the taxman gets only 16 per cent of the final price. That is: Sh3.20 from you plus Sh16 from your supplier to make a total of Sh19.20.
The problem comes in when you use “VAT-able” inputs to produce a non-VAT-able final product. Maize meal is an excellent example. Since it is a basic food item, it is not VAT-able.
However, even though the major raw material (maize) is also not VAT-able, other consumables in the milling process do attract VAT. These include electricity for running the mill (at 12 percent VAT), transportation charges, etc (at 16 per cent VAT).
Now consider this: the producer price of a 90kg bag of maize is about Sh2,350. This works down to Sh26 per kilogram. The market price of a 2kg packet of maize flour is about Sh85, or Sh43 per kilo.
The difference between the price of maize and the flour is about Sh17. This amount takes care of the cost of milling and distribution and the profit margin of the miller. The greatest portion of this Sh17 pays for the electricity consumed by the mill. I don’t have a working figure, but I guesstimate it to be about Sh10.
The VAT on this Sh10 is Sh1.20 (12 per cent). Now if maize flour is exempt from VAT, the miller would not be able to recover the Sh1.20 per kilo from the taxman. Thus the price of the 2kg packet would go up by about Sh2.40. You might think this is a small amount, however, when you consider that this is our staple food, the magnitude changes.
On the other hand, if maize flour is zero rated; the miller will charge zero percent VAT (which equals zero!) and then, at the end of the month, he will file a VAT return showing nil tax collected and Sh1.20 [per kilo milled] paid to suppliers (input VAT).
Consequently, his return will show a negative value meaning that the taxman owes the miller Sh1.20 [per kilo milled]. Therefore, final price of the product will not include this Sh1.20 VAT. Unfortunately, however, this refund can be delayed forcing the miller to recover a portion of it from the consumers.
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