Presumptive TAX: Equalizing the distribution of tax burden (I)
Taxation of the informal sector, particularly persons and businesses that are not properly structured or are unable to keep proper and detailed records of their business transactions, is a topical and challenging issue not only in Nigeria, but also in most developing countries. Almost every country in the world has at one time or the other been faced with the challenge of how to bring such businesses into the tax net.
The Nigeria tax system consists of three taxing levels – the federal, state and local governments – each with a large pool of taxpayers and potential taxpayers operating in the informal sector but not captured in the tax net. There is therefore, a great need to widen the tax net i.e. bring in more taxpayers into the tax net, and the key to achieving this is the simplification of compliance and ensuring that taxpayers are treated fairly and equally.
In dealing with the peculiar tax challenges in the informal sector, some countries leveraged on the experiences of others, while others decided to fashion out specific strategies. The Nigerian Government through the Federal Inland Revenue Service (FIRS) has opted to adopt a hybrid by developing a workable tax regime customized to suit the local circumstances – The Presumptive Tax Regime. The regime will be fully operational when the Presumptive Tax regulation is gazetted.
The presumptive tax regulation is based on the provisions of Section 6 of the Personal Income Tax Act, 2011 (as amended). A new sub-section 6 was added to Section 36 of the law. Specifically, the new sub-section states that: ‘’where for all practical purposes the income of the taxpayer cannot be ascertained or records are not kept in such a manner as would enable proper assessment of income, then such a taxpayer shall be assessed on such terms and conditions as would be prescribed by the Minister (of Finance) in regulations by order of gazette under a presumptive tax regime’’.
The presumptive method of taxation is understood to be effective in reducing tax avoidance as well as equalizing the distribution of the tax burden. It will grow the tax base across the three tiers of government and improve tax collection from non-oil tax revenue. A successful implementation of a presumptive tax regime will create an improved and easy access to the large pool of taxpayers in the informal sector.
Already operational in some developing economies like Ghana, Zimbabwe and a few others, the proposed regime is administered based on presumed, not actual, income of the taxpayer in a structured way that ensures fairness. It seeks to remove the challenges confronting the revenue agencies in their efforts to achieve a more effective administration of taxes for individual and corporate entities in the sector.
The term presumptive taxation covers a number of procedures under which the ‘desired’ base for taxation (direct or indirect) is not itself measured but is inferred from some simple indicators which are more easily measured than the base itself.
Presumptive income taxation is employed primarily in economies where ‘hard-to-tax’ taxpayers comprise the majority of the population and administrative resources are scarce. In these countries, most taxpayers lack the financial transparency that allows for effective taxation by the government. The result is that governments estimate or presume the appropriate income on which taxes should be levied.
In developed countries, the transition from presumptive to actual income-based taxation paralleled the shift from agricultural to industrial economies. Economic advancements replaced self-employment in farming and small-scale trade with concentrated employment in fewer and larger entities such as governments and large corporations. Whereas tax liability was formerly derived from indices such as estimated crop yield of agricultural lands, it gradually became a factor of actual income received from salary and wages. Movements towards more ‘modern’ forms of tax administration emerged as businesses became more sophisticated and financial transparency increased. As accounting practices became more prevalent, self-assessment of tax liability and withholding tax at source inevitably followed.
However, in developing countries, presumptive taxation may still be the most appropriate method of tax administration for specific groups of taxpayers. The economic transition from agriculture to industry has not occurred to the same degree as in industrialized nations. Nonetheless, most tax laws are written as if they had, assuming the tax is assessed on well-defined measures of income and well documented in transparent accounting records. The reality is that most taxpayers do not possess the administrative resources to maintain accurate books or navigate complex tax codes. As a result, tax evasion is rampant and authorities exert considerable effort locating and taxing small and medium enterprises (SMEs).
Presumptive taxation techniques may be employed for a variety of reasons. It could be for reasons of simplification, particularly in relation to the compliance burden on taxpayers with very low turnover (and the corresponding administrative burden of auditing such taxpayers). Another reason is to combat tax avoidance or evasion (which works only if the indicators on which the presumption is based are more difficult to hide than those forming the basis for accounting records). Third, by providing objective indicators for tax assessment, presumptive methods may lead to a more equitable distribution of the tax burden, when normal accounts-based methods are unreliable because of problems of taxpayer compliance or administrative corruption.
Presumptive methods can be rebuttable or irrefutable. Rebuttable methods include administrative approaches to reconstructing the taxpayer’s income, and may or may not be specifically described in the statute. If the taxpayer disagrees with the result reached, the taxpayer can appeal by proving that his or her actual income, calculated under the normal tax accounting rules, was less than that calculated under the presumptive method.
Rebuttable presumptions can encourage taxpayers to keep proper accounts, because they subject taxpayers to a possibly higher tax burden in the absence of such accounts. Also, presumptions that serve as minimum taxes may be justified by a combination of reasons (revenue need, fairness concerns, and political or technical difficulty in addressing certain problems directly as opposed to doing so through a minimum tax).
By contrast, irrefutable presumptive assessments are usually specified in the statute or in delegated legislation because they are legally binding. They must be defined precisely. Depending on the situation, irrefutable presumptions might be subject to legal challenge as unconstitutional. In some countries, the constitutional court (or Supreme Court) has been quite active in applying the principle of equality in taxation. Whilst in some other countries, tax law provisions that are seen as denying equal access to justice are particularly vulnerable to constitutional challenge.
Presumptive taxation can be used for any tax that is normally based on accounting records—income tax, turnover tax, and value added tax (VAT) or sales tax—although it is most commonly used for the income tax. A number of different types of presumptive methods exist in different countries.
Presumptive taxation is undoubtedly a ‘win-win’ technique given that it is an optimal method of curbing widespread non-compliance without employing excessive government resources because it addresses the concerns of both the taxpayer and the tax authority. Presumptive taxation provides taxpayers with a simplified option for tax compliance without requiring full financial transparency.
Without a doubt, SMEs employ the majority of taxpayers in any developing country. Yet, many SMEs remain in the informal sector because they lack sufficient resources, administrative infrastructure and accounting sophistication to comply with government tax regulations. The result is that many employers are ineligible to receive the benefits the formal sector offers, which inescapably compromises their financial viability. Small businesses are aware of the advantages that legitimate enterprises enjoy, and most would be willing to pay taxes but for the complex bureaucracy involved.
Presumptive taxation addresses these concerns by offering a streamlined method for moving from the informal to formal sector. Income is no longer assessed from accounting records but from indicators such as the value of a farmer’s land, gross turnover of the SME, or signs of individual wealth. This approach to estimating income on which tax is levied removes the administrative burden of financial transparency traditionally required for compliance.
Tax administrations are quite mindful of the burden which tax compliance places on individuals and businesses. However, non-compliance amounts to a lack of funds for the public works and social service programs that are central to national development. As a result, authorities spend a disproportionate amount of time tracking down non-compliant SMEs. Thus, governments often introduce presumptive taxation as a retribution-free method for providing incentives to citizens and businesses thereby bringing them into the tax net and increasing the country’s tax base.