The low hang­ing fruit in tax col­lec­tion

The Star Early Edition - - BUSINESS NEWS - Bongu­musa Makhathini Bongu­musa Makhathini is the di­rec­tor of le­gal and ex­ter­nal af­fairs at Bri­tish Amer­i­can Tobacco South­ern Africa.

AREAL ques­tion mark hangs over the 2017/18 tax sea­son tar­get of R1.265 tril­lion, not­with­stand­ing the con­fi­dence ex­pressed by the SA Rev­enue Ser­vice ear­lier this month in its abil­ity to col­lect this sum.

Since the Fe­bru­ary Bud­get, the eco­nomic out­look has de­te­ri­o­rated fur­ther as a feared rat­ings down­grade ma­te­ri­alised and the coun­try en­tered a tech­ni­cal re­ces­sion.

Although there are indi­ca­tions of an im­proved global out­look, South Africa’s abil­ity to cap­i­talise on this re­mains in ques­tion, given de­pressed busi­ness con­fi­dence and sus­tained po­lit­i­cal up­heaval.

Record high un­em­ploy­ment is likely to curb rev­enue from per­sonal in­come tax – the big­gest com­po­nent of tax rev­enue – and, bar­ring an un­ex­pected res­o­lu­tion of ma­te­rial pol­icy un­cer­tainty and sub­se­quent re­bound in con­fi­dence, yields from cor­po­rate taxes may also dis­ap­point.

As it is, cus­toms du­ties fell short of the tar­get last year by R6.5 bil­lion, thanks to a con­trac­tion in real terms of im­ports, VAT sim­i­larly un­der­per­formed by R11.3bn and per­sonal in­come tax by R15.2bn.

For the first time in many years, tax rev­enue col­lec­tions lagged rel­a­tive to gross do­mes­tic prod­uct (GDP) growth last year, in­di­cat­ing that the buoy­ancy in col­lec­tions which has come to the Trea­sury’s res­cue so of­ten in the past can no longer be re­lied upon.

It hardly needs em­pha­sis­ing that a short­fall in rev­enue col­lec­tions can­not be plugged by in­creased bor­row­ing, with to­tal gov­ern­ment debt sit­ting at around 50.7 per­cent of GDP and in­ter­est pay­ments mak­ing up an ever greater share of ex­pen­di­ture, ex­ac­er­bated now by a credit rat­ing down­grade.

Fur­ther cuts in ex­pen­di­ture tar­gets, with po­ten­tially se­vere so­cial con­se­quences, would seem to be the only op­tion in the event that a short­fall in rev­enue col­lec­tions in­deed ma­te­ri­alises.

Yet there are low-hang­ing fruits avail­able to the SA Re­serve Ser­vice (Sars), which would go a long way to­wards im­prov­ing tax rev­enue per­for­mance. One of these is im­proved tax com­pli­ance, specif­i­cally re­lat­ing to the trade in il­licit cig­a­rettes.

Ev­ery year, this il­licit trade de­frauds the gov­ern­ment of an av­er­age R5bn in lost tax rev­enue, while con­ser­va­tive es­ti­mates sug­gest that more than R26bn has been lost to the Trea­sury over the past five years due to il­le­gal trade.

The il­le­gal mar­ket is huge, ac­count­ing for around 24 per­cent of the to­tal tobacco mar­ket in South Africa (or 5.4bn cig­a­rettes) and putting us among the top five coun­tries in the world in terms of the size of the il­le­gal mar­ket, in the com­pany of Malaysia, Iraq, Brazil and Pak­istan.

Sars it­self ac­knowl­edges the ex­tent of the prob­lem, stat­ing last year that South Africa is los­ing an es­ti­mated 10 per­cent of its GDP, or R178bn a year, to the il­licit econ­omy.

It listed il­licit tobacco prod­ucts, coun­ter­feit tex­tiles, drug man­u­fac­tur­ing and smug­gling, il­licit min­ing of gold and di­a­monds, ivory smug­gling and the poach­ing of en­dan­gered species like abalone and rhino as the ma­jor com­po­nents of this un­der­ground econ­omy.


Even more dis­turb­ing is that the bulk of the il­licit cig­a­rettes – in­de­pen­dently ver­i­fied re­search puts the fig­ure at more than 80 per­cent – are man­u­fac­tured in South Africa, by man­u­fac­tur­ers who are based or have a pres­ence here, and who are ei­ther fail­ing to prop­erly de­clare their pro­duc­tion vol­umes and are thus dodg­ing taxes due on these vol­umes, or who are pro­duc­ing cig­a­rettes covertly.

The over­whelm­ing ma­jor­ity of these il­le­gal prod­ucts are con­cen­trated in a hand­ful of brands, man­u­fac­tured by a small num­ber of lo­cal tobacco man­u­fac­tur­ers.

In other words, it should be a rel­a­tively sim­ple ex­er­cise to put a stop to this prac­tice and col­lect the R5bn-odd in tax due on these cig­a­rettes.

This is be­cause South Africa em­ploys an ad­min­is­tra­tive method to col­lect tobacco ex­cise tax, based on a “Duty at Source”. This means that ex­cise is paid and reg­u­lated at the point of man­u­fac­ture.

What­ever leaves your fac­tory is taxed at a fixed rate per thou­sand cig­a­rettes.

Man­u­fac­tur­ers of il­licit cig­a­rettes get around this sys­tem by fraud­u­lently mis­rep­re­sent­ing the vol­umes they have pro­duced, but it should be a rel­a­tively sim­ple mat­ter to stamp out this prac­tice.

There are two pos­si­ble so­lu­tions that ex­ist to ad­dress the prob­lem. The first is to leg­is­late the min­i­mum price based on the min­i­mum col­lectable tax (VAT and Ex­cise), man­u­fac­turer costs and trade mar­gins.

One other po­ten­tial so­lu­tion to the wide­spread tax fraud in the tobacco in­dus­try is to in­tro­duce dig­i­tal tax ver­i­fi­ca­tion.

This sys­tem – which has been suc­cess­fully adopted by Mozam­bique, among many oth­ers – uses dig­i­tal cod­ing tech­nol­ogy to print a unique code di­rectly on to packs at the point of man­u­fac­ture. This se­curely en­crypted 12-digit al­phanu­meric code makes it easy to au­then­ti­cate ev­ery pack of cig­a­rettes man­u­fac­tured in the coun­try, any­where along the sup­ply chain.

It also au­to­mat­i­cally feeds in­for­ma­tion on pro­duc­tion vol­umes di­rectly into a gov­ern­ment-con­trolled, cen­tralised data­base, mak­ing it easy for tax of­fi­cials to de­ter­mine the cor­rect ex­cise tax due on prod­ucts man­u­fac­tured.

Cus­toms of­fi­cials should also be lo­cated at fac­to­ries to au­dit prod­uct vol­umes, as­sisted by ma­chine coun­ters and bet­ter rec­on­cil­i­a­tion sys­tems for im­ported leaf and fin­ished prod­ucts des­tined for ex­ports.

This tech­nol­ogy can also be used in other highly reg­u­lated in­dus­tries, such as al­co­hol and phar­ma­ceu­ti­cals.

The in­vest­ment re­quired to im­ple­ment it is neg­li­gi­ble, rel­a­tive to the huge sums in lost tax rev­enue that could be re­couped and BAT South Africa stands ready to work with other le­gal tobacco man­u­fac­tur­ers and the author­i­ties to do so.

Not only are the sources of il­licit cig­a­rettes easy to iden­tify, but the prod­ucts them­selves are more of­ten than not sold at a price well be­low the pre­scribed ex­cise tax and VAT amount of R15.10 per pack, some­times for as lit­tle as R7, which would be im­pos­si­ble if the cor­rect taxes had been paid.

Law-en­force­ment of­fi­cials should be in­ves­ti­gat­ing all in­stances of this kind of pric­ing, which patently stems from the il­le­gal trade.

Job pro­tec­tion

We be­lieve this would be in the in­ter­ests not only of help­ing to meet the tax col­lec­tion tar­gets for 2017, but also in the in­ter­ests of pro­tect­ing the jobs, in­vest­ment and taxes paid by le­git­i­mate tobacco man­u­fac­tur­ers, of which we are the big­gest in the coun­try.

BAT South Africa con­trib­uted R10.2bn in ex­cise – 27 per­cent of all ex­cise in South Africa – and R14.5bn in to­tal taxes (in­clud­ing sales, cor­po­rate and other taxes) to the fis­cus in 2015.

We em­ploy more than 2 400 peo­ple and in­di­rectly sup­port more than 72 000 jobs across the tobacco value chain, many of which are in small- and medium-sized busi­nesses in the re­tail and agri­cul­ture sec­tors.

The level of our con­tri­bu­tion to tax and to job cre­ation is un­der threat from the il­licit tobacco trade, which un­der­mines our busi­ness and has al­ready forced us to shed 690 jobs over the past three years.

The means to put an end to this are read­ily avail­able, sim­ple to im­ple­ment and highly se­cure, and they could help solve a huge rev­enue headache for the gov­ern­ment.

We should act now to plug the hole, be­fore more dras­tic mea­sures are re­quired to bal­ance the Bud­get.

Bongu­musa Makhathini says that it is time plug the hole of il­licit tobacco prod­ucts.

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