By Tamer Hafez

“We are going ahead with reforms and will never look back,” said house speaker Ali Abdel Aal, announcing the passage of Egypt’s value-added VAT Sept. 7. President Abdel Fattah el-Sisi ratified the VAT the same day, capping months of wrangling between MPs and officials over the details of the new tax law, which is supposed to broaden Egypt’s tax base—nearly doubling tax revenue within the first year—helping to ease the country’s yawning budget deficit. A key part of the government’s fiscal reform program, VAT is levied at each stage in the production chain of goods and services, making it harder to evade taxes.

Many, however, worry that a new tax regime will add another financial burden at a time when many Egyptians are already struggling to make ends meet. Critics argue that rather than representing reform, the VAT is a convoluted process riddled with loopholes and inconsistencies. Businesses do not have much time to sort the process out. The VAT went into effect Sept. 8, and companies have three months to amend their contracts, pricing and books. “A lot of businesses will be thrown into chaos,” predicts Nady Azzam, a finance professor at Ain Shams University. “This law will hurt the economy at large.”

The International Monetary Fund has been pushing since the 1990s for Egypt to switch to a VAT, which is a key condition of the $12-billion financing package the IMF has tentatively agreed to loan Egypt. Since 2013, officials have said the switch was imminent. For the last three years, the government has been on a VAT road show, trying to explain the new tax structure to industry groups and other members of the business community. Four different drafts of the VAT law went before parliament before it was finally approved at a rate of 13 percent for the first year compared to the old 10-percent general sales tax.

Finance Minister Amr el Garhy argues that VAT—which is used by virtually every major economy in the world, with the notable exception of the United States—allows for fairer taxation. “We are not inventing the wheel with this VAT law,” he said at press event last month. The legislation also paves the way for the approval of the three-year loan package by the IMF’s executive board in the coming weeks.

During fiscal 2016/17, officials project that the VAT will bring in an additional LE 26-27 billion in tax revenue, while the subsequent year—when the rate will rise to 14 percent—is expected to yield an extra LE 32 billion, according to officials, who argue that Egypt has been undertaxed for years. “Under the outgoing GST tax, revenue as a percent of GDP was very small compared to the global average,” says Amr el Monayer, a deputy at the finance ministry. In most advanced economies, tax revenue amounts to around 20 to 25 percent of GDP. In Egypt, by contrast, tax revenue in recent years has totaled less than 13 percent of GDP. “With the VAT, we aim to increase tax revenue by 1 percent of GDP every year until fiscal 2021/22, when it will be 18 percent,” said Monayer at an AmCham breakfast late last month. 

Executives voiced concerns at the event that certain aspects of the law—such as a clause granting tax exemptions for items that are “necessary for production”—are ambiguous and open the door to corruption. As its name indicates, a VAT is an attempt to tax businesses at each stage of production on the value added each time a good changes hands as it goes up the chain, from raw material to consumer product. Businesses can claim a credit for taxes they paid earlier in the supply chain. The same principle applies to imported goods, which are taxed when they arrive in the country and each time they change hands after that. Because the VAT has a higher revenue threshold at which businesses are subject to tax, the Tax Authority estimates that 120,000 small local businesses that were subject to sales tax under the old system won’t have to pay VAT. On the other hand, some 200,000 service providers—which weren’t subject to the general sales tax—”are now eligible to pay VAT,” says Mohamed Shawky, head of central operations at the Tax Authority.

Like the old general sales tax, the VAT involves a complex formula for what is and isn’t supposed to be subject to tax. Products that are totally exempt include so-called essentials including baby food and pasta, sesame-based desserts and fruits and vegetables. Natural and butane gas, gold and paper used to print books and magazines are also exempt, as is tuition for international schools and the construction of mosques and churches. Certain products, meanwhile, including plant-based oils and flour-based baked goods and fertilizers will continue to be subject to a flat excise tax rather than the value-added tax. So-called luxury products, like mobile telecom services and carbonated beverages, are subject to both taxes.

While everyone agrees that the value-added tax will make things more expensive, the government argues that exempting basic commodities will cushion the impact on Egypt’s poorest citizens. Even products that are ostensibly tax exempt however, may go up as a result of the VAT, as a result of increasing taxes on manufacturing inputs and services that go into making them. For example, packaged organic fruits and vegetables might get more expensive because although the produce isn’t taxed, the packaging is.

What the overall effect of switching from a general sales tax to a VAT will have on consumer prices remains to be seen. Since early September, when the new tax system went into effect, certain mobile telecom services have gone up, subject to a 22.2-percent levy compared to 15 percent previously. The price of prepaid mobile calls, texts and 3G internet has jumped by around 10 percent across the board. “This will affect a huge proportion of mobile users because around 80 million lines are prepaid subscriptions, and they usually belong to low-income individuals,” says Ehab Said, head of the telecom division at the Cairo Chamber of Commerce. He notes that landline telephones and ADSL internet service are exempt from VAT, however. “The bills will remain the same as before,” says Said.

Meanwhile, tobacco went up by 20 percent to as much as 40 percent for certain flavored products. The price of steel—critical for the real estate and construction sectors— increased by around 5 percent under the new system.

However, the taxes on imported passenger cars, traditionally considered a luxury item subject to high taxes, have decreased slightly under the VAT—with vehicles taxed anywhere from 15 to 44 percent depending on the engine capacity. Locally made passenger cars will now enjoy the advantage of being taxed at a maximum rate of 29 percent compared to 44 percent for their imported counterparts. Air conditioners, refrigerators under 16 feet and TVs with smaller than 32-inch screens also enjoy a slight reduction in tax.

Many analysts are still puzzling over which products and services the government has chosen to tax at a higher rate under the new system. “In many cases, we don’t see any distinction between the tax rate for the smallest and the biggest consumers,” Atef Yacoub, chairman of the Consumer Protection Agency, told Al Watan News last month. Yacoub points out that this is not just illogical but unconstitutional, as Article 38 of Egypt’s constitution explicitly states that tax systems must be progressive—in other words, the rich are supposed to pay more than the poor.

Meanwhile, even experts are confused about whether certain services, such as health and education, are taxed under the new law. Products and services related to health care, a basic right, are exempt, for example. However, pharmaceutical factories use packaging and other products that are subject to higher taxes. “I expect that 50 percent of locally made medicines will go up due to the VAT,” says Ahmed al-Ezaby, chairman of the pharmaceutical section at the Federation of Egyptian Industries. Hospital fees themselves are tax exempt, but doctors and nurses—whether in public hospitals or private clinics—must pay VAT every time they treat a patient. In one of the more mystifying facets of the new VAT law, multinational firms doing business in Egypt must now pay tax on loans or services from their parent companies. Online purchases, even from companies located outside Egypt, are liable to pay VAT in Egypt—a rule that may be virtually impossible to enforce.  

Finance minister Amr El-Garhy predicted in July that the VAT would cause overall price hikes ranging between 0.5 percent for low-income Egyptians to 2.3 percent for the upper class—though widely varying forecasts have been thrown around by officials.

This overall sense of confusion doesn’t bode well for consumers—especially given that one of the main arguments for instituting tax reform in general and the VAT in particular over the years was to simplify Egypt’s labyrinthine sales tax structure, which had evolved in an ad hoc fashion to satisfy the demands of businesses and consumers and included a confusing array of special tax rates. But far from simplifying things, the VAT has so far left consumers more bewildered than ever. “We are now entering into a world of unprecedented pricing chaos,” says Mohamed el Sadat, an MP who is leader of the Development and Reform Party. “We have seen prices of a lot of things go up in the past week or 10 days, yet no one can determine whether these increases are because of the greed of traders or the dollar crisis or because of the application of VAT.”

Good, bad or ugly, the new tax is here to stay, however. “The government promised the IMF that Egypt will have a VAT,” says Adel Amer, director of the Egyptian Center for Legal, Economic and Social Studies. “And we definitely need their money.”

© Business Monthly 2016