The low hanging fruit in tax collection
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.
Disturbing
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.