Ethiopia’s attempt to broaden tax base through VAT law faces pushback

Unclear regulation and potential impact on growth in the country’s insurance industry is a major concern, with experts saying new VAT law was hastily implemented.

Ethiopia’s new VAT law introduced on 4 July 2024 is facing pushback due to inconsistencies and a lack of clarity following the inclusion of traditionally exempt sectors – such as the insurance sector – which could hinder growth in the country’s nascent financial services industry.

Under the country’s initial VAT law, which has been in force since 2002, insurers in the country enjoyed a blanket exemption. The new law, however, only exempts life and health insurance policies and levies a 15% VAT on general insurance plans, which make up over 90% of policies in Ethiopia.

The new VAT law was hastily implemented, says Fekadu Yami, who serves on the legal technical team at the Association of Ethiopian Insurers. Announced initially in the form of a letter on social media, there remains uncertainty around whether this new law will affect premiums or the pay-outs.

“Who is going to buy insurance when they know that the compensation they get will have a deduction and as a result, will not be able to reinstate them to their previous status?” said Yami.

Grey areas on VAT deduction

VAT levied on premiums will also disproportionately impact those who are not registered as VAT payers and are unable to get refunds, further showing the discriminatory impact of the law, according to him.

“This will shrink the industry’s growth and reach and will create legal liability for insurers as policyholders expect full compensation,” he said.

One possible avenue insurers are exploring to tackle this dilemma is covering the 15% levy through contractual agreements with policyholders.

Whether the new tax position will have retroactive implementation is also open-ended, explained Yami. The process of insuring property damage is usually a long-winded one – the result of supply chain inefficiencies – which could create contention between policyholders who signed contracts before the new VAT law was implemented.

Additionally, re-insurers, who come into the picture on multi-million-dollar projects, like railroads, or airways, will also be expected to pay VAT but there are grey areas on how this VAT will be deducted.

Insurance industry penetration

In a country where there is a low level of awareness of insurance, reflected in penetration, this comes as bad news to an industry that has fallen behind its regional contemporaries.

Ethiopia’s insurance sector reaches less than 0.3% of the country, and its contribution to GDP is the lowest in East Africa.

“Nothing significant has changed over the past 20 years since the first VAT came into play, that now necessitates that insurers be included in this new levy,” says Yami.

While the Ethiopian government’s incentive to increase its revenue sources is clear, levying this VAT on an industry already struggling is not well-timed.

The VAT law applies to all players in the sector, explains Yami, but as experienced companies enter when the market opens up, they will have the edge over their local counterparts, potentially pushing local companies out of the business.

“Depending on the type of companies that enter the market, if they are efficient in their operation and have better service in terms of their capacity and they can snatch business away,” said Yami.

There is also the question of whether the country’s VAT law properly captures the value-added element.

Value is found between the payment that insurers collect and the payouts they make, and this VAT law doesn’t capture that, argues Dr Tadesse Lencho, a leading tax attorney in Ethiopia. “This is a technical problem faced by VAT. There needs to be a different kind of VAT system to capture this.”

Moreover, misunderstandings around the VAT law coupled with the recent change in forex policy and inflation make the time prime for disproportionate increases in prices, says Dr. Lencho.

Wider impact

Other industries previously exempted and will be hit by the new VAT law include services like water and electricity, as well as cotton traders.

A VAT tax on cotton sales could stifle an industry that relies significantly on an informal sector of smallholder farmers. While this move can potentially bring in new taxpayers to the system, the transition phase to formalise this sector has created fears of supply chain disruptions for textile and garment manufacturers in the country. Manufacturers are also worried that the VAT levies will freeze their much-needed working capital, as they do bulk purchases.

As such, the industry, which has been lobbying for a continued exemption among other requests, is hopeful for a positive response from the prime minister’s office.

In the case that they continue to be the new group of VAT payers, businesses are asking for clarity and uniformity in its application.

Source: theafricareport.com