Egypt's tax reform set to help bring in more public revenue

The government has scored some minor successes in the area of taxation over the past two years. The introduction of the long-awaited real estate tax in 2014 was a victory in principle, given its complicated gestation since it was first proposed in 2008.

The new levy encountered some public opposition and it took until 2011 for the Supreme Council of the Armed Forces (SCAF), which assumed power after Hosni Mubarak’s ouster, to revisit the law and propose a number of modifications with a view to promulgation by January 2013. In December 2012 the successor to the SCAF, President Mohamed Morsi, brought forward fresh legislation as an alternative to the SCAF proposals, which he aimed to have in place by July 2013. However, this in turn was made redundant with the nation’s change of leadership later that year. Public opposition and associated political turbulence over the subsequent period combined to make the already complex issue of tax reform even more challenging still, but by 2014 a state of relative calm had been established by the administration of President Abdel Fattah El Sisi, opening the door to tax reform once again.

Real Estate

The real estate tax’s final implementation was, in this context, an important victory in principle for the government’s tax policy, but its impact on the balance sheet has been limited by generous exemption levels and challenges surrounding its implementation, particularly with regard to the time-consuming valuation process and collection.

Other parts of the government’s tax reform agenda have faced similar difficulties. A capital gains tax promulgated in July 2014 and implemented in April 2015 had been postponed for two years as a result of objections from traders and brokers – a decision that prompted the IMF to publicly state its disappointment. The dividends component of the proposed tax has, however, been retained, and in October 2016 the IMF stated that Egypt intended to include the capital gains tax in its economic reform programme, a fact the IMF welcomed as a channel through which the wealthy can contribute revenue.

Sales Tax To Vat

Progress on tax revenue enhancement has been slow, but the government is currently preparing for what will be a major step in Egyptian tax reform. The replacement of the current general sales tax (GST), which was first introduced in 1991, with a value-added tax (VAT) is the keystone of a new strategy that aims to widen the tax base and boost state revenue.

The government is now moving its VAT plans forward, a development that has been given further impetus by the IMF linking it to a $12bn, three-year loan facility, which is considered to be crucial to Egypt’s efforts to plug its fiscal deficit. The government has been keen to reassure citizens regarding the implementation of the new tax, pointing out that they will notice little difference from the current framework. “The current [GST] law is 85% VAT. The new law makes it 100%,” Ashraf Al Araby, a member of Parliament and former head of the Tax Authority, told the local business press in July 2016. In August 2016 the country’s Parliament discussed and approved the new law, which was published in the Official Gazette and scheduled to take effect in September 2016. The VAT rate at introduction has been set at 13%, which was a compromise between the 14% the government had sought and the 12% preferred by Parliament.

While this is a significant increase on the 10% level of the old sales tax, proponents of VAT argue that the government’s exemption list will mitigate the effects of the rise by exempting basic food items. Other goods and services that are exempt from the new tax include medicines, food sold through non-touristic restaurants and shops, natural gas and butane, the production and transfer of electricity, land and building sales, banking transactions and non-banking financial services under the supervision of the Egyptian Financial Supervisory Authority. Some products and services, such as soda, certain categories of televisions and refrigerators, air conditioners and communication services through mobile networks will be subject to a schedule tax, as well as VAT, applied at varying rates depending on the item. Others will be subject to only the schedule tax, including tobacco, gasoline, kerosene, diesel, manufactured products and professional services.

Benefits

There are clearly a number of very strong economic arguments for VAT. According to a November 2015 IMF paper on tax reform in the Gulf region, the VAT system has “proven highly effective in mobilising tax revenue and avoiding the distortion to production and trade association with the cascading of indirect taxes”. The report added that it has been implemented in more than 150 countries, and that VAT revenue has the potential to contribute 3-10% of GDP.

At a July 2016 press conference, Amr Al Monayer, the deputy minister of finance for tax policy, suggested that Egypt’s new framework would bring in an additional LE15bn-20bn (equivalent to $795m-1.1bn as of December 2016) in revenue.

Beyond the obvious revenue gain, Egypt also stands to benefit in less tangible ways. The new framework will see the end of the complex audit and invoice trails associated with the GST, as well as the inefficiency of extracting revenue at the transaction stage rather than at the point of importation.

The broad-based nature of the tax, and the fact that it targets consumption, reduces opportunities for tax evasion that a simple sales tax is vulnerable to. VAT’s burden on consumers is also mitigated by the fact that it is collected in small fragments at numerous stages of production and distribution.

Furthermore, by not taxing business inputs VAT avoids cascading – by which a good is taxed more than once as it progresses from production to final retail – thereby removing the incentive for businesses to vertically integrate in an attempt to avoid paying taxes on inputs for the production process.

Challenges

With the implementation date of VAT following so quickly after its approval by Parliament, Egyptian businesses face a challenging transition to adjust to the new framework. According to international tax consultancy EY, larger companies operating enterprise resource planning (ERP) frameworks will have to revise their systems to enable them to charge and recover VAT, while those without ERP systems will be compelled to implement manual VAT accounting processes. This will include everything from ensuring that invoice templates contain the relevant fields necessary for VAT accounting, to altering the business structure to avoid unnecessary cash flow or absolute VAT costs arising, particularly on inter-company transactions.

Moreover, all companies will need to revise the terms of business with clients to make sure that VAT correctly becomes a cost to customers and not suppliers. Most of Egypt’s businesses will face a relatively straightforward transition.

According to a September 2016 news alert on the VAT introduction by PwC, companies and importers registered under the GST law will automatically be considered registered for VAT purposes, provided that their annual turnover exceeds the registration threshold of LE500,000 ($26,500). Furthermore, all such businesses do not need to notify the Egyptian tax authorities and will keep the same taxation number. A more problematic area for the government is the large cash economy that traditionally has not kept records of transactions.

Economic Effects

Another concern is the effect the introduction of VAT will have on inflation. While many basic goods have been established as VAT-exempt, they are likely to be indirectly affected by rising transport costs and higher fees for services, as well as the recent currency flotation. In July 2016 Al Monayer stated that VAT may lead to price inflation of between 0.5% for low-income Egyptians and up to 2.3% for higher earners.

Should this turn out to be the case, the government’s success at structuring the exemption list in such a way as to place the larger burden on wealthier households will be broadly welcomed.

However, even a modest rise in the cost of living can be a challenging proposition at a time when an estimated 27.8% of the population subsists beneath the poverty line – which is currently defined as an income of LE482 ($25.55) per month – according to information released by the Central Agency for Public Mobilisation and Statistics.

As a consequence of these initiatives, 2017 is likely to see both the government and the private sector making a series of careful adjustments to their taxation systems and processes in order to best mitigate the potentially disruptive effects of these changes to Egypt’s taxation framework.