Egypt’s value-added tax, explained

With a new draft of the much-anticipated value-added tax law finally up for discussion in Parliament, Egypt’s tax policy has become a hot topic in the news.

While the government claims adopting a VAT will ease the deficit by increasing tax revenue, members of the public worry that a new tax regime will add another financial burden at a time when many Egyptians are already struggling to make ends meet.

Those fears were given added credence after Deputy Minister of Finance for Tax Policy Amr al-Monayer announced in a Tuesday press conference that the tax rate in the latest draft of the VAT law stands at 14 percent, compared to 10 percent in the current sales tax system. However, the government has tried to calm these fears by emphasizing that many basic goods will be exempt from the new tax, limiting its impact on the overall cost of living.

With so much at stake — the minister of finance suggests the VAT will bring in LE15-20 billion in additional revenue — the public is left with pressing questions about what VAT is, what changes a new law will bring, and why the government is so intent on passing it.

How does a VAT work, and how is it different from the current system?

“The current law is 85 percent VAT. The new law makes it 100 percent,” MP and former head of the Tax Authority Ashraf al-Araby told Mada Masr.

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 a raw material to a consumer product. In practice, this means a tax is charged based on the difference in price between an article of clothing and the textiles that were used to manufacture it, or the difference between the price a shop charges for a shirt and the wholesale price the shopkeeper paid to buy it. As a good moves up through the supply chain, each business has to pay taxes to the state but can claim a credit for taxes it paid when it purchased the cloth or shirt or other item. The same principle applies to imported goods, which are taxed when they arrive in the country and each time they change hands after that.

VAT also covers services, which are usually defined as any economic transaction in which a physical good doesn’t change hands — hotel stays, doctor visits, concert and train tickets, phone and internet service, education, financial and legal advice, etc. (Somewhat confusingly, restaurant meals are counted as a service). The same rules apply when it comes to taxing added value for services, although supply chains for services are usually less complex than for manufactured goods.

Value-added taxes are used all over the world, including in almost all OECD countries. Egypt’s current general sales tax already has many features of a value-added tax, including — since 2001 — collection of taxes throughout the supply chain.

When a VAT is adopted in Egypt, the procedures for paying taxes and claiming tax credits will change for businesses, but this isn’t something most consumers are likely to notice. In either case, the burden of the tax is ultimately passed on to consumers, most of whom will remain unaware of what’s happening behind the scenes.

How will switching to VAT affect prices?

“The significant difference is the change in the percentage of the tax,” explains Araby.

For most consumers, switching from a general sales tax (GST) to a VAT won’t, in and of itself, have a big effect. What matters are the specifics of the law — especially the tax rate and the any changes in the types of goods and services that are taxable.

Deputy Finance Minister Monayer said Tuesday that the draft VAT law sets the taxation rate of 14 percent, with some exemptions and exceptions. Clearly, increasing sales tax by 4 percentage points will make goods more expensive, but the government argues that by exempting basic commodities it can reduce the impact of the tax on vulnerable citizens.

A source at the Tax Authority, who spoke to Mada Masr anonymously, challenged this argument. “It doesn’t make sense. Items that are currently exempt will stay exempt under the new law, but a general increase in the percentage of the tax will definitely significantly increase inflation,” the source said.

The new tax rate will apply to all goods and services, except for those specifically exempted or assigned a higher or lower tax rate. The new tax tables haven’t been officially released, but local media claim to have obtained copies of them.

According to a report in Aswat Masreya, most basic goods will remain exempt from taxes. This includes infant formula and other dairy products, bread of all kinds, pasta, meat, poultry, fish, unprocessed processed agricultural products  as well as minimally processed goods like tahini and honey. The new law also exempts processed fruits and vegetables (except potatoes), juices and concentrates, pulses, cereals, table salt and spices.

Most printed materials will be exempt, as will raw petroleum and mineral products, including crude oil, natural gas, LPG, and raw gold and silver, according to Aswat Masreya. Civil aircraft, prosthetic devices, kidney dialysis machines and incubators are also exempt. Tea and sugar, which are currently taxed, will be VAT exempt, while changes in the taxation of cooking oil, formerly exempt, mean at least some edible oil products will be taxed at 1 percent. The tax on local medicine will remain at 5 percent. Despite calls to exempt fertilizer from taxes to support farmers, it will also remain at 5 percent.

Alcohol taxes are set to rise as well, with the new law upping the tax rate to 250 percent, with a minimum of LE500 per hundred liters, compared to 200 percent with a minimum of LE400 per 100 liters.

After substantial public controversy, the Finance Ministry released statements saying that the new law will not increase the tax burden for passenger cars, and that changes to cigarette taxes are still being discussed.

On the services end, Aswat Masreya says mobile telecommunications will be taxed at 8 percent, on top of the general tax rate, although landline based internet will be VAT exempt for a year. In one of the most controversial provisions of the new tax, fees at international schools and universities — formerly tax exempt — will be subject to a 5 percent tax.

According to Mada’s source at the Tax Authority, even experts are confused about what services will be taxed under the new law. “Health, education, security are all services and it’s not clear if they are subject to the law,” the source said.

Over all, the minister of finance said in a Tuesday press conference that he estimates that the VAT will add 1.3 percentage points to inflation, due to the overall increase in tax rates as well as the incorporation of informal businesses into the tax system. However, he stressed that this added burden will not exceed 0.5 percentage points for the lowest income segment, while adding 2.3 percentage points to the cost of living for higher-income Egyptians.

Why VAT, and why now?

The government said for years that it intends to impose a VAT instead of its current general sales tax.

Switching to a VAT is, in part, an attempt to streamline Egypt’s tax system and to reduce tax evasion. The system is often described as self-policing. Businesses can’t claim tax credits unless they have tax paperwork for the transactions with both their suppliers and their customers, and the paperwork filed by all parties has to match up. If businesses will only work with suppliers and re-sellers who can provide proper tax documentation, it makes tax evasion more difficult and provides small operators with an incentive to get into the system.

The government is counting on these technical changes to curb tax evasion, but Araby is skeptical. “This law won’t fight tax evasion alone. It all depends on strong implementation by the Tax Authority,” he says.

It’s also likely that the current push for VAT is connected to the government’s desire cover its fiscal deficit by obtaining a number of loans from international donor institutions. For the most part, applying for these loans requires adopting an economic reform plan, including tax reform.

The World Bank explicitly made adopting a VAT a condition of a US$1 billion loan agreement signed in December 2015, according to a leaked copy of the agreement published by Mada Masr.

Egypt is also reportedly exploring the possibility of taking out a loan from the International Monetary Fund (IMF), potentially for as much as US$10 billion dollars. Al-Masry Al-Youm newspaper on Tuesday reported that an IMF technical mission including two tax experts was visiting Cairo in conjunction with the Parliamentary debate on the VAT law.

Sources in the Ministry of Finance reportedly told Al-Masry Al-Youm that the mission focuses on providing technical support and assistance for tax system reform.

Egypt’s 2016-17 budget is also highly dependent on an increase in tax revenue, with a target of LE201 billion in taxes on goods and services compared to a goal of LE184 billion in the previous year’s budget. In a phone call with the program Hona Al-Aasema, Finance Minister Amr Garhy said he expects adopting the VAT will increase revenue by LE25-30 billion.

In a Tuesday press conference, Garhy said the government is depending on this tax increase to cover the budget deficit, which he said stood at 11-11.5 percent in the last fiscal year, while public debt reached 97-98 percent of GDP.

What’s next?

With the draft law approved by the Cabinet, parliamentary approval remains the final hurdle before the law can be officially implemented via presidential decree and publication in the Official Gazette. This could still take some time though — there is likely to be debate in Parliament on many provisions of the law, including the overall tax rate.

Translated by Isabel Esterman

Mohamed Hamama 

You have a right to access accurate information, be stimulated by innovative and nuanced reporting, and be moved by compelling storytelling.

Subscribe now to become part of the growing community of members who help us maintain our editorial independence.
Know more

Join us

Your support is the only way to ensure independent,
progressive journalism