Reform agenda: Expected changes to the tax law

The country’s widening budget deficit and growing currency pressures seen since the uprising of 2011 have made the efficient use of revenues a primary concern of the Egyptian government. With Suez Canal receipts largely reliant on the fortunes of the global economy and the country’s tourism sector, Egypt’s other major revenue stream, suffering in the shadow of a challenging transition process which is unlikely to be fully resolved in the short term, revenue from taxation has emerged as an area where the government can make immediate changes.

HISTORY OF REFORM: One fact that will stand to the new government’s advantage as it pursues its tax agenda is a recent history of relatively successful tax reform beginning almost a decade ago. The cabinet sworn in during 2004 took office with a mandate to reform by creating a business-friendly environment and moving towards a knowledge-based economy. Addressing the bloated and inefficient tax regime was the centrepiece of the updated reform strategy.

The maximum rate of individual income tax, therefore, was reduced from 32% to 20%, with taxpayers earning less than LE20,000 ($3347) per year paying 15%, while those making LE5000 ($837) per year and under paying 10%. According to Ibrahim Sarhan, the chairman and managing director of e-Finance, a provider of electronic payment facilities, taxes account for 15% of GDP and currently the country appears an example of the 80-20 rule – the richest 20% of taxpayers pay 80% of the tax burden.

Corporate tax, however, saw the largest alteration. A top corporate tax rate of 42% was cut to a flat rate of 20%, and was applied to joint stock companies, companies with limited liability, companies limited by shares and foreign companies (including those with their head office or branches located overseas).

Coincident with the regulatory reform came strident efforts to improve the administrative capability of the country’s tax authority. To this end the first “large taxpayers’ office” was established during late September 2005, while in May 2006 the sales tax department and the income tax department were both merged into the Egyptian Tax Authority.

The results of the tax reform process were immediately apparent. Around a million taxpayers were added to the tax base in 2006 and income tax revenues as a percentage of GDP have grown steadily year-on-year despite the cuts in tax rates.

On the back of this reform, as well as the rationalisation of stamp duties and Customs tariffs, the Ministry of Finance (MoF) announced its intention to continue with its tax reform agenda, which by this time had evolved to encompass three goals: to make the tax administration more equitable and transparent; to increase tax revenues; and to improve the economic performance of the nation.

ONGOING PROCESS: The second phase of the ministry’s reform process has not come as quickly as it would have liked. The deteriorating economic situation during 2011 compelled the MoF to shift its focus from long-term reform and address the growing budget deficit in the short term. To do so, it raised the corporate income tax rate to 25% for companies with a turnover in excess of LE10m ($1.7m) – a move which Egyptian telecoms giant Orascom Holding cited as a contributing factor in its net loss for the three months ending in June 2011.

The wider tax reform agenda is now less clearly defined in both character and timing. A new real estate tax law has been in the legislative pipeline since 2008, but, despite being passed in 2009, has yet to be implemented. While the draft law outlined a modest level of contributions – annual tax on a property worth LE500,000 ($83,685) would be LE30 ($5), while tax on an asset worth LE1m ($167,370) would be LE660 ($110) – vocal opposition to the law came from property owners resistant to the idea of details regarding their assets being made public. The sensitivity of this issue stems from a tradition in Egypt of using property as a primary store of wealth, and the anxiety created by the proposal combined with the deteriorating economic environment in the wake of the global credit crisis persuaded the former regime to delay its implementation.

PROPOSED LAW EXPECTED IN 2013: In late 2011 Egypt’s interim rulers, the Supreme Council of Armed Forces, announced a further delay to the law’s implementation from January 2012 to January 2013, citing deficiencies in the draft law and the need to accommodate the social and economic needs of citizens in its directives. The MoF also revealed a number of amendments at this time, such as lifting the exemption limit for some homes from LE500,000 ($83,685) to LE1m ($167,370), and raising the exemption limit on annual rental income from LE6000 ($1004) to LE12,600 ($2109).

By early 2012, the latest iteration of the law was made public, including a complete tax exemption for private home owners on their principal property and a progressive rate on any additional properties over the value of LE500,000 ($83,685). Moreover, recognising the post-uprising demands for social justice, the proposed law stipulates that 50% of the revenue from the new property tax should be directed towards improving housing conditions in poorer areas.

Just as important as the revenue, perhaps, will be new tax’s contribution to the formalisation of the housing market and the potential unlocking of some of the underutilised capital within it, and for this reason the prospect of a real estate tax has been broadly welcomed in principle. The expansion of greater Cairo in particular has highlighted the current inefficiencies of the housing market, with many of the newly built properties vacant and not even rented out – their owners content with holding an untaxed asset that is appreciating in value.

However, some potential obstacles to the tax’s implementation remain. The introduction of such a broad-based tax represents a significant challenge to the Egyptian Tax Authority in terms of capacity. Most Egyptian taxpayers make their contributions through direct payroll deductions, with no annual tax filing requirement and therefore no direct contact with the Tax Authority. In its present form, the proposed property tax is expected to add around 40m taxpayers to the roughly 3m who currently deal directly with the authority to settle their tax affairs. This, combined with the large number of inspectors to be trained for the valuation stage of the new taxation process has led to scepticism regarding the authority’s ability to implement the proposed scheme.

THE VAT METHOD: The global financial crisis also stalled the government’s attempts to replace the current sales tax regime with a fully fledged value-added tax (VAT) system. Sales tax was introduced to Egypt in 1991, and applies to all non-exempt domestic goods, goods imported for commercial purposes and specific services stipulated by Law No. 11 of 1991. The law establishes a standard sales tax rate of 10%, a maximum tax rate of 25% on some luxury goods and a reduced tax rate of 5% on essential goods. However, the deficiencies of the sales tax system, such as the complicated audit and invoice trails involved with tax calculation and the inefficiency of extracting revenue at the transaction stage rather than at point of importation, convinced the government of the need to replace it.

Like the GCC, Egypt chose to adopt the VAT method, which brings with it a number of technical advantages: the elimination of double taxation through the dissemination of tax credit on goods and services necessary for the conduction of business; simplified tax calculation through the unification of tax rates into a single rate (the current proposal standing at 6%); and a reduction in collection cost by raising the tax threshold to exclude small taxpayers, which minimises the compliance costs.

In more general terms, the proposed VAT legislation has the potential to bring about a more efficient tax administration, address the shadow economy, and achieve tax equalisation between registered taxpayers and non-registrants (by increasing the tax rate by 2% on sales of goods and service by taxable individuals to non-registered individuals, except for sales made by retailers to the final customer). Just as importantly for the government, of course, is the increase in overall tax revenue that this broadening of the tax base will result in.

The political uncertainty that has prevailed in Egypt since 2011 has greatly disrupted the timetable of tax reform envisaged in the mid-2000s. The successful conclusion of the presidential elections promises a return of the early momentum, although the precise form of any new tax regime remains uncertain.

One principle of the original strategy that retains widespread support, however, is that tax rates alone are not the central issue that must be addressed by the process of reform. Increasing efficiency, tackling the problem of tax evasion and moving part of Egypt’s large informal economy into the tax net will be the primary concerns of the country’s new government.