VAT tussle: Does the road look wet on hot days?
It is a mirage. There is no water on that road. The same may apply to some of the states generating high VAT revenue. When the rubber meets the road, the result may shock you. Let’s respectfully discuss VAT.
Before we discuss why the State may not be in a position to implement VAT at the moment and how the expected outcome of State VAT collection may surprise many, let us define VAT with an example.
So what is VAT? Simply put, it is a consumption tax that is charged on the “value-added” at each stage of production or each value (supply) chain. The best way to explain VAT is by using an example of a product and how the tax is generated through the value chain.
VAT is not generated at the point of sale to the final consumer but during the supply (or value) chain process. It may be paid at the point of sale. Perhaps, this is why many are confused about the amount generated by each State.
For the purpose of this analysis, we will assume that the traded goods are leather bags and shoes and also assume that the three states involved are Lagos, Kano, and Abia in the production process. Remember, this is purely an academic exercise done to explain a complicated issue.
I will introduce a VAT table that we will use for the analysis. The numbers are made up. (NOT REAL) H&S = Hide and Skin. Please, not hide and seek o. Now let’s go.
The H&S dealers aggregate the hide or skin from the farmers and animal processors big or small and sell to the tanneries. The value added by the H&S dealer is the effort to aggregate the products from varieties of producers. This is what VAT is paid on.
The State where the H&S dealer added the value to the hide is the state where the VAT is generated but not necessarily where it will be collected. So who should be credited with this amount, the State that generated it or the State that collected it? Confused? Let’s continue.
The H&S dealer buys the hide for ₦800 apiece and sells to the tanning industry for ₦1200 thereby adding a value of ₦400 to the hide. The ₦800 purchase is the original value added by the farmer or producer of the hide. At this point, Kano already generated ₦90 in VAT (based on 7.5% National VAT).
Fast forward to when the leather goods reached the final consumer. Lagos earned VAT of ₦600 for the full price of ₦8000 even as we know that it added only ₦3800 in value which amounts to ₦285 in VAT. Lagos may have generated ₦600, part of it belongs to other States. See chat below:
Therein lies the mirage with the state collecting VAT. Also, States don’t yet have the mechanism to properly work together in order to avoid double taxation. Only the FGN has that capability and it is doing a good job.
It will take a while for the States to be able to build and run a VAT system that does not lead to double taxation. So in the meantime, expect to pay more for goods and services. Why? Simple! Expect Kano and Abia to collect VAT at the source. ₦600 become ₦1065. Don’t rush it.
The seller will have to claim the input tax paid in other jurisdictions from Lagos State to avoid double taxation. If you think dealing with two to three States is complicated, wait until it involves dozens of States. More jobs for tax accountants and lawyers though.
Currently, agricultural products are mostly exempt from VAT. The exemption creates an unfair disadvantage for States that are predominantly food producers. They can’t charge VAT on their major source of income and yet we blame them for not being able to generate enough VAT.
The 2021 Q2 GDP figure released by the NBS showed that while crude oil only contributed 5.8% (₦2.27 Trillion ) to the GDP (current price), Agriculture recorded 22.1% (₦8.6 T) and manufacturing 14.3% (₦5.55T).
In the same period that Agriculture contributed almost ₦9 T (22%) to the GDP, it only contributed ₦760M (0.2%) to VAT while crude oil GDP = ₦2.2T (5.8%) and VAT = ₦9.5B (1.8%). This is happening by design. Nigeria does not allow VAT on most agricultural products.
Some strategies States may adopt: 1. Reach a reciprocal VAT reparation agreement with other states. 2. Promote VATABLE production activities 3. Replace VAT with sales and use tax 4. Abolish the exemption of VAT on food and other agricultural products.
One of the immediate solutions to the challenges posed by having 37 jurisdictions collecting VAT will be to have a reciprocal agreement between them. The agreement will deal with the reparation of input VAT back to the source state. This is required to avoid double taxation but very complicated to accomplish. Secondly, a state may create a strategy that promotes manufacturing that employs locally available resources.
Using our example, Kano could decide to create a conducive environment for the manufacturers of leather goods to set up factories in Kano Kano’s advantage is the raw material and lower labor cost. Remember, this is just a simulated example. But the idea is that VAT collection by states may actually improve competition. This is why I have always sided with states on this issue but it should not be rushed.
An increase in local manufacturing will lead to an increase in IGR through PAYE and additional VAT for the state. States can even decide to be VAT-free in all LGA or in LGA close to financially buoyant States to encourage consumption and cross-border buyers. For example, Ogun State and Kogi could allow VAT-Free items to attract Lagosians or Abuja consumers.
The issue of the exemption of agricultural produce from VAT will have to be dealt with. The states may, in the long run, seek to abolish the exemption. This is a legal matter.
This brings me to ask this question. Assuming that the supreme court decides in favour of Lagos and Rivers, will other states need to go back to court or do they automatically earn the right to charge tax on the currently exempted products and services? If they need to go back, when is the best time? Now or after the supreme court decides. Keep in mind that if the decision favors Rivers, other States will need to instantly put their collection strategies together to avoid a sudden cash crunch.