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Introduction
This document provides the Minster of Finance and the Government of Malawi with a consensual and informed position from the perspective of the private sector of the Tax System and its Administration as a contribution to the Tax Reform process. Malawi Confederation of Chambers of Commerce and Industry (MCCCI), Economics Association of Malawi (ECAMA) and The Society of Accountants in Malawi (SOCAM), with input from the Bankers Association and facilitation from the National Action Group Forum Secretariat (NAG Secretariat) came together to provide one joint submission that broadly represents the views of their membership.1
This paper is based on an earlier document presented in February to the team from the US Treasury, but has since been modified to take greater account of the desire of GoM to maintain revenue neutrality as far as is possible and reasonable. It also formed the basis of the presentation to the IMF Tax Team in March 2005. This paper accommodates comments from our memberships on the drafts and further thinking on the issues based on feedback from the consultants, MoF and MRA officials. We believe that it represents a reasonable and balanced contribution to the debate on how to meet the needs of GoM for tax revenue, the needs of the people of this country to impact on poverty and the need to stimulate growth and development of the private sector as the source of our current and future prosperity.
Private sector argues that the key problem for the GoM in balancing its budget has been over-expenditure made worse by the loss of confidence by the donor community and the loss of their support through failure to meet the conditions set. This is how the deficit arose. The problem for GoM is therefore primarily one of expenditure management (and effectiveness of that expenditure) and not primarily of revenue raising.
In recent years it seems that the prevailing attitude has been to set expenditure budgets first and then find revenue from donors and the private sector to make up the gap. Imposing revenue increases on the private sector has been seen as an easy option to raise revenues. Over the last five years there has been a progressive and substantial increase in the amount of revenue gathered as a percentage of GDP, a disproportionate amount of which has come from the predominantly tax compliant formal business sector. Unless there is change of approach and emphasis, further increases in revenue raised will once again fall disproportionately on the tax compliant sector of the business community. This will further deplete their capital and further deter investment due to the low returns and the large share of net revenues already paid to government.
Unfortunately, whilst there is strong accountability to donors, this has not been the case in the past with taxpayers even though resources from businesses and individuals account for nearly half GoM revenues. However, the tax review announced by the Minister of Finance represents a welcome change and enabled the private sector to come together and offer some input from the perspective of what it is like to have to comply with the tax regime as it is. The private sector welcomes this and trusts that its contribution will be seen as constructive. In presenting these issues the private sector may appear to be too critical but it should be realised that without being direct on these issues they may never come to light.
It is realised that paying tax is never very popular and there will always be complaints, both legitimate and not legitimate. Individual or specific groups of taxpayers also tend to lobby for their own self-interests and seek special concessions. Because of this background, there is therefore a danger that as the private sector presents its contribution to the tax reform process decision makers in government may dismiss this as self interest lobbying instead of accepting that there are genuine problems to be addressed. In our process of wide consultation with private sector and dialogue with the consultants and GoM officials, we have tried to steer a middle path that balances the needs of the different stakeholders. The private sector would request government to give full and due consideration of the issues presented in this paper. So far the private sector is encouraged by the process and responses received from GoM officials and the consultants involved in the tax review process and hopes are high that the majority of the ideas will be taken into account.
The reality of operating a business in Malawi is very challenging. This has been acknowledged by the World Economic Global Forum's Global Competitiveness Report 2004/5 which ranks Malawi at 87th out of 102 countries on the Growth Competitiveness Index (down from 76th in 2003/4), 84th on the Business Competitiveness Index (down from 72nd in 2003/4) and of most concern, 100th on the macro-economic Environment Index, just three places from the bottom.2 Of course this does not reflect the improvements that have been initiated by the new GoM over the last 9 months, but it does highlight that the business community is facing a harsh operating environment that had progressively and significantly worsened over recent years.
Complying fully with the legislation and regulations that make up the operating environment is also very challenging. 100% compliance with all legislation and regulation is impossible given the complexity, breadth and scope for interpretation of the rules, but this paper refers to "predominantly tax-compliant businesses" as meaning those that seek to and are in the majority of situations tax compliant. This contrasts with a section of the formal business community that is persistently non tax compliant either deliberately or through ignorance. These are not the informal sector and micro businesses from whom the potential for tax revenue is relatively small3, but the small, medium and occasionally large businesses that are formally established with fixed premises. At present the burden of taxes is falling disproportionately on the predominantly tax-compliant businesses as these seem to be the easiest way for MRA Officers to meet their targets. This needs to change and doing so could yield significant additional revenues for GoM.
Any tax system needs to have the confidence of taxpayers, if it is to avoid serious disruption and breakdown. Tax systems only work if the majority of taxpayers collect and remit taxes on behalf of governments and broadly comply, of their own will. This enables the revenue authority to focus on those businesses and individuals that either choose to cheat or fail to comply through capacity weaknesses or lack of knowledge.
However, when a system is judged to be unfair, excessively burdensome or discriminatory in its rules or in the way it operates, progressively more and more of the previously compliant taxpayers stop co-operating and cease playing by the rules or choose not to invest further or liquidate their investments. Malawi has not reached the point where its tax system will collapse, but over the last five years taxpayer relations have deteriorated significantly due to the pressures on the MRA to collect revenue, which has often been implemented by MRA with little regard to the rules, precedents, agreed practices or acceptable methods. At the same time the rules are getting ever more burdensome and extracting a greater share of the available returns to tax compliant investors. Coupled with a deteriorating macro-economic performance through to mid 2004, with its impact on profits (triggered by government overspending and borrowing), businesses have faced a harsher operating environment, deteriorating relations with the MRA and lost a higher share of their earnings to government, with little to show in return.
It is time for Malawi to decisively change course and to establish the conditions for economic and business growth that will bring prosperity to businesses, people and government alike. As any business knows, balancing the books is crucial, as is ensuring that borrowings are manageable within the revenue surpluses available. Revenues can be pushed up so far and have probably reached the point in Malawi where further increases cannot be sustained just from the current sources. New sources of revenue are there, particularly the non-compliant business and NGO sectors. These are discussed in the following sections. But the quickest way for GoM to reduce its deficit is to cut costs, painful as that will be - Malawi simply cannot afford to keep increasing spending as it has done over the last five years.
In terms of its broad strategy, GoM must therefore:
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Make more realistic projections for domestic revenues and donor inflows than in the past and base its expenditure budget on these, not set the expenditure budget first and find ways to bridge the gap as appears to have been the case in the past.
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Reduce the domestic debt as quickly as possible by cutting expenditure in real terms and as a percentage of GDP, paying down the debt with the savings to reduce interest payments and make more funds available to GoM in subsequent budgets.
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Make a decisive shift in compliance efforts by MRA towards the persistent and deliberate formal sector offenders - this will require stronger and perhaps independent capacity to be made available to the new leadership of MRA.
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Support MRA to regain the trust of the majority tax compliant community by treating tax compliant businesses fairly, taking a more focused risk based approach and rewarding compliance.
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Take the first steps to restructure taxation to remove the most obvious problems in the system - setting a new course and taking the first steps will be a significant boost for private sector confidence in the new government and encourage investment.
Whilst any agenda is difficult to prioritise, the following probably represent the priorities of the broader tax compliant private sector (not in priority order):
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Ensure the excessive amount of tax refunds currently due are paid within the statutory/ regulatory periods, particularly surtax and withholding taxes.
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Separate the assessment and adjudication functions of the MRA as a means to restore confidence in the tax administration system.
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Redirect compliance efforts to those that are clearly cheating at a significant scale with more adoption of risk based approaches towards broadly compliant firms and sectors.
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More appropriate treatment of capital through more realistic capital allowances, shift to straight-line methods for taxation purposes, more appropriate time periods (shorter) and less exclusions (particularly non-manufacturing commercial property) that recognise the reality of the depreciated cost of capital in a high inflation economy.
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Automatic indexation of allowances and thresholds (and fees charged for GoM services) with catching up where these have fallen in real terms.
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Revise Capital Gains Tax to ensure inflationary changes in the value of investments are not taxed, and the rate of tax is revised to be appropriate to an investment not as if it were income.
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Significant review of Withholding Tax to reduce its scope, simplify its categories, introduce more appropriate rates in certain categories and increase thresholds to meaningful and efficient collection levels for both businesses and MRA to make efficiency savings. Exemption certificates need to be more widely available for the proven tax compliant. This would allow a more serious compliance effort once the rules are more appropriate.
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Urgently review the operation of surtax, with appropriate exemptions, zero rating and removal of anomalies. This would underpin more serious enforcement of the rules, particularly in the trading sector.
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Automatic indexation of thresholds for PAYE, with an immediate up lift of the tax free allowance to MK 72,000 p.a. and bring down the highest rate from 40% towards harmonisation with the corporate tax rate to encourage enterprise, marginal efforts to earn more and better compliance.
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Remove the duty on spare parts for capital goods and extend the coverage of what capital items can be brought in duty free. Shift from a system of paying and then seeking remittance of duty and surtax as this is an unnecessary inefficiency.
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PSI needs to be applied on a more risk based approach targeting sectors of the economy which have highest rates of non-compliance, such as trading. Anomalies such as PSI on duty free materials and capital goods need to be resolved. Excessive delays by the contractors that hold up shipments need to be reduced and if necessary penalised if they are outside agreed reasonable times. There needs to be a deliberate requirement in the next contract to build MRA capacity because the longer PSI is out-contracted, the less capable MRA is of doing it and the more we become dependent on the contractors.
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Investment incentives need to be transparent and automatic, ideally built in as improved capital allowances available to all businesses whatever their size, instead of discretionary and often delayed without clear qualifying criteria.
Footnotes:
- There has been considerable consultation based on previous submissions/ideas from members, circulating drafts/proposals and pre-budget consultations in Blantyre, Lilongwe and Mzuzu.
- Reported in Daily Nation 14th April 2005.
- Though these are primarily not tax compliant, we would not direct compliance efforts onto this group
for efficiency and poverty reasons.
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