The Imposition of Value-Added Tax (VAT) by the Somali Government

1. Introduction to Value-Added Tax (VAT)

When discussing this type of tax, it’s essential to define it clearly: Value-Added Tax (VAT) is an indirect tax applied to goods and services at every stage of production and distribution, up to the point of sale. Recently, the Somali government introduced VAT, which has sparked significant public debate, particularly in Mogadishu, where many residents feel especially burdened by the tax. While most people oppose the new tax, a small group sees its potential benefits. The controversy has not been limited to the general public; some politicians have also expressed their disapproval of the implementation of the tax.

A common question among the public is whether this tax is entirely new. According to the Ministry of Finance, VAT is not new; rather, the method of its collection has been updated. The Ministry has adopted a more advanced and efficient approach, utilizing modern technology to simplify the tax collection process.

VAT is crucial for any government because it helps increase domestic revenue through various tax systems. To provide essential public services, the government needs to collect sufficient taxes to cover the significant costs associated with these services.

2. Sales Tax or VAT Law

Sales Tax Law No. 2, enacted on January 7, 1984, established that the tax would be applied to imported goods, wholesale businesses, hotel bills, and goods produced within the country. However, with the introduction of VAT, there has been a shift in the tax system. VAT now applies to every transaction between consumers and businesses, including transfers from mobile wallets to business merchant accounts.

3. Benefits of Implementing VAT in Somalia

VAT implementation in Somalia brings several key benefits:

• Revenue Generation for the Government: Effective VAT collection will greatly enhance domestic revenue, which is crucial for Somalia, especially after the recent debt relief that eliminated $5.4 billion in national debt. As international financial aid decreases, the Somali government is prioritizing the generation of adequate domestic revenue to fund operating expenses, such as salaries and development projects.
• Reduction of Tax Evasion: The new tax collection system, which leverages merchant accounts, will help reduce tax evasion. By directly deducting VAT from transactions, the government can more effectively track business activities. Non-compliance will result in substantial fines or even imprisonment, thereby discouraging tax evasion.
• Promoting Formal Business Practices: VAT will encourage informal businesses to register and obtain the necessary permits or licenses, thus increasing the formalization of the Somali economy. Formal businesses benefit from access to investments, potential financial support, and subsidies. Furthermore, a more formal business environment will enhance the quality and reliability of market research and data collection.

4. Challenges in VAT Collection in Somalia

Despite the benefits, there are significant challenges in collecting VAT in Somalia:

• Administrative and Logistical Difficulties: Somalia’s weak institutions hinder effective tax administration, and there is widespread public distrust in how tax revenues are managed. The government’s limited control over large parts of the country further complicates VAT collection, making it difficult to ensure compliance across the nation.
• Public Awareness and Compliance Issues: There is a general lack of awareness about VAT among the public. Many are unclear whether VAT is a new tax or simply a modification of an existing one. The Somali culture of tax resistance exacerbates compliance issues, making it challenging to enforce tax laws effectively.
• Resistance from Businesses and Consumers: Businesses and consumers have shown resistance to the new VAT system, particularly the use of merchant accounts. Many have reverted to using private mobile wallets like EVC-Plus and e-Dahab, which are not subject to VAT, in an attempt to avoid the tax. The government has responded by threatening fines and arrests for non-compliance.

5. VAT Calculations

Many people have misconceptions about VAT, especially when it comes to calculating it. A key question that often arises is: How exactly is VAT calculated? Let’s consider an example. If you purchase goods from Hayat Supermarket costing $100 before VAT, Hayat will add a 5% VAT, bringing the total cost to $105. Another question you might ask is whether the government taxes the original $100 or the total $105, and who actually bears the burden of the tax. The system that collects VAT uses an automatic formula to ensure accuracy. To determine the original price before VAT, the total amount in this case, $105, is divided by 1.05, which gives us $100. The VAT amount is $5, not $5.25 as some might mistakenly calculate. Thus, the full burden of the VAT falls entirely on the consumer.

6. Comparative Analysis: Somalia and Kenya

Many African countries, particularly those in the East African Community (EAC), collect Value Added Tax (VAT) at varying rates. For instance, Kenya imposes a 16% VAT but exempts non-industrialized food products, education, and healthcare from this tax. On the other hand, Somalia charges a lower VAT rate of 5%, but there are no exemptions; all sectors, including non-industrialized foods, healthcare, and education, are taxed.

To illustrate, imagine a Somali citizen with a budget of $100 who buys 10 kg of potatoes for $10, mangoes and bananas for $20, books for $20, and spends the remaining $50 on a health check-up. In Somalia, a 5% VAT would be applied to each transaction, resulting in a total VAT of $5.

In contrast, a Kenyan citizen with the same budget who purchases the same items would not pay any VAT, as these sectors—food, healthcare, and education—are exempt from VAT in Kenya.

7. Recommendations for Enhancing VAT Collection

To improve VAT collection in Somalia, the following recommendations are proposed:

• Improving Public Awareness and Education: The government should launch an extensive public education campaign to raise awareness about tax laws and the benefits of VAT. Teams from the Federal Member States (FMS) and the Banaadir region could be deployed to engage with the public, explaining the importance of taxation for the country’s development. Large-scale events featuring experts in taxation and economics could also be organized to further educate the populace.
• Strengthening Enforcement Mechanisms: The government needs to enhance its enforcement mechanisms to ensure greater compliance and achieve its revenue targets. This could involve stricter penalties for non-compliance and more robust monitoring of business transactions.
• Providing Incentives for Compliance: Offering incentives to the best taxpayers could encourage greater compliance with VAT regulations. Recognizing and rewarding businesses that adhere to tax laws could foster a culture of tax compliance and increase overall revenue collection.

8. Conclusion

The recent introduction of Value-Added Tax (VAT) by the Somali government represents a crucial step in modernizing the country’s tax system and boosting domestic revenue. Despite significant public debate and resistance, especially in Mogadishu, VAT offers notable benefits, including increased government revenue, reduced tax evasion, and the promotion of formal business practices. However, the implementation faces challenges such as administrative difficulties, public mistrust, and resistance from both businesses and consumers.

To ensure the success of VAT, it is essential for the Somali government to address these challenges effectively. This includes launching comprehensive public education campaigns to improve awareness and understanding of VAT, strengthening enforcement mechanisms to ensure compliance, and providing incentives to encourage adherence to tax laws.

Future research should focus on the long-term economic impacts of VAT on critical sectors like healthcare, education, and food, as well as on the experiences of small and informal businesses. Comparative studies with other countries in the region could offer valuable insights into effective VAT implementation practices and strategies.