How to tax vendors and service providers, operating informally, is a difficult question. This is the informal sector, a hard to tax sector. Unfortunately, tax systems are largely designed to work with formal businesses or those transacting with formal businesses. Transactions between operators in the informal setting are difficult and sometimes impossible to identify and tax. So, how to tax the informal sector is largely a question of how to formalise the informal sector.
The tax administration law (The Tax Administration Act, Cap 438) was amended through the Finance Act, 2017 to require TRA to recognise and register small vendors and service providers conducting business in the informal sector (“Machinga”). Under this scheme, TRA were to issue identification cards to the machingas. Subsequently, however, the President through the LGAs also started a separate initiative to issue identity cards to the machingas at a ‘fee’ of twenty thousand shillings per annum.
Earlier this year, the Minister for Finance and Planning issued regulations to govern the registration of small vendors and service providers (The Tax Administration (Registration of Small Vendors and Service Providers) Regulations, 2020). The regulations formalise the recognition and registration initiative that was done through the LGAs and put in place a structure of how TRA and LGAs can work together. However, there are potential challenges.
Low threshold
The regulations refer to the First Schedule to the Income Tax Act for a minimum income tax threshold eligibility. The regulations could have been more specific on which part of the First Schedule they refer. Nevertheless, the ‘minimum income tax threshold’ under paragraph 2 of the said First Schedule applies where an individual’s annual turnover from business does not exceed four million shillings. In this case, no income tax is payable. The tax administration law defines small vendors and service providers to include hawkers (machinga), caterers, event managers, masters of ceremony and such other small vendors or service providers. The four million annual threshold is probably too low, practically, for some of these targeted vendors and service providers. Think of mama-lishe selling 20 plates of rice a day at 2,000 shillings per plate for 240 days a year (assuming they don’t operate on some weekends and public holidays).
Informal sector challenge
The regulations also may not fully address the challenge of taxing the informal sector. The small vendors and service providers intended by the regulations are exempt from income tax. Registering them will be helpful if they later graduate to higher turnovers. Shouldn’t TRA then focus more on those with turnover above 4 million? The regulations, currently, require those not eligible for registration as small vendors and service providers to pay their taxes as required under the relevant tax laws. But since they still operate in informal settings, both enforcement and voluntary compliance will still be a challenge. Some formalisation (also through LGAs) shsould precede taxation. The laws could be reformed, and the regulations improved so that the ID system (now at plat fee of 20,000 shillings) or a similar simple system is taken as an alternative (income) tax and accommodate those with turnover higher than four million and below 100 million operating informally. A tiered ID system, for example. Akin to the ‘patent system’ of taxation used in Russia. The biggest advantage of the system is in its simplicity – both in compliance and administration.
By Shabu Maurus, Tax Partner, Auditax International.