Ending the War over VAT

SIMONKOLAWOLE!  BY SIMON KOLAWOLE

The evolution of Nigerian federalism has undergone major genetic variations in the last 20 years, but the war that has just broken out over the value-added tax (VAT) may become the turning point because of the potential impact on fiscal federalism and the political economy. On December 11, 2020, Justice Stephen Pam of the Federal High Court, Port Harcourt, Rivers state, had ruled — in a case brought by Mr Emmanuel Chukwuka Ukala, SAN, against the Federal Inland Revenue Service (FIRS) — that it is states, not federal government, that should collect VAT. He also held that the constitution lists the taxation powers of FG as covering only incomes, profits and capital gains.

Although I am a novice in legal matters, Pam’s judgment looks very sound to me. There is nowhere in the constitution where VAT is mentioned, and since it is linked to consumption, that appears to be in the terrain of states. The judge also held that there is no constitutional backing for the collection of VAT, withholding tax, education tax and technology levy in Rivers state, or any other state of the federation, by the FIRS. Based on the letters of the law, I do not expect any court to upturn his determinations. That is why I think the best way out of the impasse is a political, rather than legal, solution because of the likely negative impact on businesses, individuals and nation-building.

I want to draw out a few observations from what I consider to be the implications and complications of the VAT judgement. For those who may not understand much about VAT even though they pay it regularly when they make phone calls or drink Chivita, it is similar to a sales tax but is collected at the point of consumption in the value chain. Farm produce, medical services and educational materials are exempt. The FIRS, a federal agency, collects VAT and remits to a special account which is not part of the federation account. The revenue sharing formula is also different: federal government, 15%; states, 50%; and LGAs, 35%. For the states, there is a derivation payment of 20%.

Here are a few implications of the judgment, some of which many analysts have also pointed out. One, FG may be the biggest winners. In 2020, Nigeria earned N1.531tr from VAT. While local VAT was N763bn, foreign VAT — collected by FG — was N768bn. Therefore, rather than take just 15% (N230bn) from the N1.531trn, FG may now pocket the entire N768bn from foreign VAT since it does not go into federation account and may not be subject to the regular sharing formula. That would deprive the states, Rivers and Lagos inclusive, of about half of the total VAT revenue. This is HUGE. The FCT may also win as it generated N202bn in VAT last year but got only N34.6bn as its share.

Two, the general impression is that Lagos state will win massively from the judgement. I have my doubts. Yes, Lagos is the biggest beneficiary of the current arrangement: the state collected N216bn as VAT share in 2020. By comparison, Kano got N53bn and Oyo N45bn. This is quite a gap. Lagos also contributes about 60% to the VAT pool: that is why it is called “the goose that lays the golden egg”. This might have prompted the Lagos government to quickly pass a VAT law, even charging a rate of 6% — lower than the prevailing 7.5%. I hope Lagos state officials did their homework well because it looks like they are not seeing what I am seeing, except maybe some facts are not yet in the open.

You see, by the time every state enacts a VAT law, much of the derivation attributed to Lagos will reduce. Currently, all VAT incomes from telecoms and banking transactions are attributed to Lagos because the companies have their headquarters there. That means derivation on all phone calls made, bottles of Coke gulped and banking transactions done in 36 states and FCT are attributed to Lagos. That is why Lagos contributes about 60% to domestic VAT. That also explains why Lagos gets the lion’s share. Calls and transactions emanating from 35 states and FCT will no longer be attributed to Lagos — going by the judgment. That is why it looks like Lagos share of VAT may actually drop.

Three, will Rivers state win big? Again, I have my reservations, but they may not lose that much. Last year, Rivers got N40bn from VAT, but this includes their share of the N768bn revenue from foreign VAT. That also includes their share of the local VAT revenue generated in other states and FCT. Thus, if FG holds on to the foreign VAT, every state will be affected. This is contrary to the impression (even trepidation up north) that only northern states will suffer. In the meantime, states cannot make laws on import VAT as Lagos assumes it can do. The constitution is quite clear on who has the power to legislate on import: federal government. Devil is in the details but are we aware?

Four, it is argued that Sharia-compliant states cannot be breaking beer bottles and at the same time sharing the VAT revenue from alcohol. Fair point. However, beer contribution to VAT is not that much. The figures are not disaggregated by FIRS, but the NBS Living Standards Survey for 2018/2019 puts total annual spend on alcohol at N150bn. The VAT on N150bn is not heavy. Meanwhile, south-west topped consumption spending (both food and non-food) with N12trn; followed by south-south, N8.4trn; north-west, N6.8trn; north-central, N5.7trn; south-east, N4.8trn; and north-east, N2.5trn. And most are VATable expenses. The north may not lose as much as is being speculated.

Five, the biggest losers will be businesses — and that will further damage our fragile economy. There is a reason VAT collection is centralised in other countries, both unitary and federal. For practical purposes, if you produce soft drinks in Lagos and pay VAT to Lagos, you will still pay VAT to Oyo when you take your products there, and Oyo will have to calculate how may bottles you sold. Companies will now have to deal with 37 VAT regimes in 36 states and FCT, unlike now when you pay at once to FIRS. (By the way, the FIRS will be losers. That is why they are fighting day and night over the judgment. The agency gets a cool commission of 4% which I will touch on shortly.)

India used to do what we are about to do. Its 29 states had different VAT regimes. Inter-state commerce was hell. A truck carrying goods could wait for three days at a state border awaiting VAT inspection. When India finally decided to centralise VAT collection by enacting the goods and services tax (GST), it was a big relief for businesses. Brazil and Canada, which are federations like India and Nigeria, are currently trying to centralise VAT collection because of the complexity. But Nigeria is racing towards a different direction. Just imagine the nightmare of handling VAT stress all over the federation if you have to deal with 37 tax authorities, even though you are one company.

In sum, I foresee fiscal crisis in many states. Why? The redistribution of VAT has been their saving grace. Some people are gloating and screaming “restructuring”, not knowing that it is not only one part of the country that will be affected. In 2020, only six states made more from IGR than they got from VAT allocation: Rivers, Lagos, Ogun, Kaduna, Delta and Edo. Akwa Ibom had parity: IGR, N30.6bn; VAT, N30.8bn. The other 29 states got more in VAT allocations than from IGR. On the average, VAT represents 33% of gross statutory allocations and 26% of total revenue for states. It is to address the imbalance between richer and poorer states that all federations, including the US, do fiscal transfers. That is the driving principle of fiscal federalism: stabilisation through redistribution.

With the VAT judgement, what is the way forward? For one, some states believe the present sharing formula is unfair. This is a legitimate concern. But the solution should not be pursued in ways that will make life more miserable for businesses and individuals, or cause further animosity in our severely challenged nationhood. We can create a win-win for all. That would require working out a robust political situation. Luckily, this is not a constitutional matter: the VAT Act can be amended in one week as along as the political authorities can reach a consensus on what is fair and just to all. Most importantly, this is a revenue issue: the states are under pressure to meet their needs.

Here are my suggestions. First, I believe FIRS should continue to collect VAT for ease of administration. The agency has built the capacity. However, its commission of 4% is too much. Customs also takes 7% as commission on foreign VAT. Both should get 0.5% each. This will increase the distributable amount in the VAT pool. Second, why does the North East Development Commission (NEDC) collect 3% from VAT? What’s the logic? The commission got N45.9bn from VAT last year. If it was a state, it would rank third behind Lagos and Kano. That money should go to the VAT pool. It even conflicts with the VAT Act, which clearly spells out the sharing formula.

Third, many items on the VAT-exempt list deprive us of good revenue. For instance, why should air tickets be exempt while train tickets are not? Why should aircraft be VAT-exempt while buses are not? What’s the sense in that? Fourth, VAT revenue can be disaggregated per state. Every state will be able to get derivation on items consumed within their territories. That way, alcohol VAT will not be shared with Sharia-compliant states because it is haram. Alternatively, we can abolish VAT altogether and allow states to charge and collect sales tax. We can also adopt or adapt the Indian or Canadan model on goods and services tax. There are so many options we can consider.

The National Economic Council (NEC), chaired by Vice-President Yemi Osinbajo and made up of the 36 state governors, need to burn the midnight candle over this. Actually, Nigeria is not raising enough tax revenue given the size of its economy. There are too many inefficiencies and leakages in the system. We need to fix that. Our tax revenue has gone up partly because of the crude oil crisis. We can do more without increasing tax rates or instituting extra handles. I propose we study other federations and see what we can learn from them. In the end, the VAT imbroglio may turn out to be a blessing in disguise and lead to a win-win outcome for all. Everything doesn’t have to be war.

AND FOUR OTHER THINGS…
DOLLAR RAGE
Sometimes I cannot but pity Mr Godwin Emefiele, governor of the Central Bank of Nigeria (CBN), as he battles tooth and nail to save the naira in the one-sided wrestling with the US dollar. As the naira fell to a record low against the dollar in the parallel market last week, you knew it was inevitable. The dollar in-flow is simply not there. Although oil is selling for $72/barrel, our production is 1.2mbpd (we were doing 2.2mbpd at a point in time). To make matters worse, the little FX gains we make mostly go back into paying for fuel subsidy as we keep pump prices at N162/litre. Emefiele insists CBN will meet all legitimate FX demands, but some fundamentals just have to change. Tight.

SCAM YARD
Thankfully, President Buhari has suspended his approval for the payment of $418m to “consultants” who said they helped states and LGAs “calculate” Paris Club refund as well as “contractors” who built invisible health centres. Presidents Obasanjo, Yar’Adua and Jonathan ALL refused to approve the suspicious payments when they were in office. That Buhari approved it is bewildering. He was apparently blackmailed or hoodwinked by those who might have been promised a cut. Imagine how far $418 million can go in combating cholera! Buhari would now do well to direct the anti-graft agencies to probe the whole affair. I would love to see some crooks behind bars. Filthy!

JUDICIAL ANARCHY
God bless the Court of Appeal for throwing out the case filed by a faction of the All Progressives Grand Alliance (APGA) and fining the two chieftains N10 million for abuse of court process. The faction had been doing everything in and out of the books to displace Prof Chukwuma Soludo as the governorship candidate of APGA in Anambra state. How can you appeal the ruling of the appeal court by going to another appeal court? Most recently, a high court overruled another high court in a case over the status of Chief Uche Secondus, the PDP chairman. While litigation is a fundamental human right, it is getting ridiculous. Politicians need to stop spitting on our democracy. Desperados.

CLARIFICATION & CORRECTION
In my article, ‘The Fallacy of Ethnic Homogeneity’ (THISDAY, September 5, 2021), I said Bangladesh broke away from India. That was inaccurate. The all-Muslim Pakistan was excised from India by British colonialists in 1947 while Bangladesh, known as East Pakistan, broke away from Pakistan in 1971 after a nine-month civil war. Thanks to my pal, Cheta Nwaze, I have also been made to understand that there are indigenous Igala communities in Anambra state. Ironically, I was aware but it somehow escaped my mind. Cheta further told me that there are communities that identify as Ibibio in Abia state. These put paid to my claim that the south-east is 100% Igbo. Apologies.