Whoever is in charge of the Ethiopian economy will have to work under strict budgetary constraints. In most years, the budget deficit amounts to less than two percent of the GDP. Even as the economy expanded, government revenue remained relatively constant at around 10 percent of the GDP. While such difficulties are not uncommon, the effects of the war in northern Ethiopia and the coronavirus pandemic-driven global economic slowdown on government revenue over the past two years have made them rather different. This is in addition to the sharp decline in external financing, a common method of financing deficits.
Expanding the tax base is seen by policymakers as a means to increase tax revenue. This is evidenced by their rush to amend major tax laws in an effort to maximize taxation. In particular, this year has been a busy one for Ministry of Finance officials, who have introduced property tax, revised excise tax, and are currently amending the value-added tax (VAT). At his June 2022 address to the House of Peoples’ Representatives (HPR), Finance Minister Ahmed Shide expressed confidence that the government’s revenue would increase as a result of the implementation of three reform measures to the tax regime. Yet, implementation has been sluggish thus far this year.
In January, the House of Federation (HoF) and the HPR adopted a joint resolution delegating the responsibility for collecting property tax to the respective regional administrations. However, a proclamation to regulate this type of tax is still in the works. The Ministry has not yet issued the updated VAT proclamation, and the HPR has not yet approved the revised excise tax proclamation.
“For the coming fiscal year, we planned the revenue taking into account the introduction of the property tax, the updated excise tax, and the value-added tax,” Ahmed stated in his address to the Parliament. Revenue forecasts for the fiscal year totaled 477.8 billion birr, with taxes expected to bring in 400 billion birr of that total. Revenue versus the planned budget of 786.6 billion birr caused the deficit to soar to a record 309 billion birr.
Each new tax that the Finance Ministry put in place raised eyebrows, but the draft VAT proclamation is getting the most attention currently. Several people have expressed surprise at several aspects of the proposed VAT proclamation. The new proclamation still has a value-added tax of 15 percent, but it taxes ride-hailing services, telecom services, and those provided by financial institutions, as well as those related to the provision of energy services.
The Finance Ministry spent the last four days holding consultative meetings with key stakeholders that would be affected by the move after making the draft proclamation available for public comment in the middle of last month. On the first day of the meeting, February 27, 2023, representatives from firms in telecommunications, agriculture, mining, and associated services participated and forwarded their feedback. The next day, banking institution management met with Wasihun Abate, the Ministry’s tax affairs advisor.
Wasihun elaborated on how the new proclamation will put an end to the practice of various businesses receiving VAT exemption rights over the past two decades. The inclusion of financial institutions in the list of VAT-paying firms is one of the most significant changes made by the proclamation. “The National Bank of Ethiopia views money transfers as part of a bank’s services, but we consider it not a service of banks since there are other firms doing it,” he said in an effort to encourage banks to charge VAT on money transfers.
He was also critique of the salary payment services banks offer to their corporate clients, including government offices. Wasihun believes VAT should be imposed on such services. A value-added tax will be added to the costs associated with providing letters of credit and other services for which banks receive commissions. The inclusion of insurance claims into the VAT system was another hotly contested topic during the session.
Wasihun, the advisor, explained to the attendees that a 15 percent VAT will be imposed on all insurance paid-claims to policyholders other than life. It will be up to the insurance firms to collect these taxes and transfer payment to the government within the required time frame. Insurance industry representatives present at the meeting voiced their concern that the rule would have a negative impact on their business.
Abraham Mersha, CEO of Lion Insurance, stated that this regulation will have a significant impact on businesses since it will scare away customers. He says that the main reason people buy insurance is to protect their possessions in the event of an accident, so cutting their payouts by 15 percent wouldn’t be in line with the spirit of the service.
Wasihun’s reaction to Abraham’s worries was that insurance companies should sign contracts reflecting this change and figure out how to include the 15 percent from the start.
This allows businesses to provide their customers with comprehensive insurance protection while also lowering risk, according to Wasihun. VAT will also be imposed on electricity and water supplies as a result of the proclamation. But the amount of monthly use that will be subject to or exempt from VAT will be determined by a directive issued at a later date.
“It was to benefit society that such supplies were excluded from the existing proclamation, yet everyone was making use of it,” Wasihun said, referring to commercial entities. He explained at length about ride-hailing services, which were another topic of interest to the attendees.
Considering the impact on inflation and the administrative burden, he argued that transportation services should be exempt from VAT. In spite of this, he claimed that ride-hailing services should be charged because they are the preferred mode of transportation for people with disposable income.
After the proclamation is put into effect, the government’s primary source of revenue will be the value-added tax (VAT) on prepackaged telecommunications services and products.