Before this year’s Budget, requests were made to Minister of Finance Trevor Manuel for the abolition of value-added tax (VAT) on books — again raising the question of whether the VAT system should be used to meet certain social objectives. In the case of abolishing VAT on books, the aim is apparently to improve the literacy rate in South Africa.
The abolition of VAT, or the increase of the VAT rate on a specific item, can have a material impact both on the relevant industry and competing industries. Those calling for VAT to be scrapped on certain goods, including books, should know exactly what they are asking for, and the consequences of their demand.
If an item is exempted from VAT, no VAT is levied on the sales consideration. However, VAT exemption also means the seller cannot claim VAT on expenses. The VAT Act provides that a vendor may only claim VAT on expenses incurred in the course of taxable activities.
In the case of books, exemption from VAT would mean the supplier is not entitled to claim VAT on printing costs, distribution costs, advertising costs or any overheads. It would also mean that a retailer who sells both VAT-exempt books and other taxable items may only claim VAT on overhead costs to the extent that it relates to taxable income.
Apart from increased expenditure, exemption also results in additional administration costs for the supplier.
It is, therefore, doubtful whether VAT exemption of an item would result in material savings.
However, where an item is taxed at the zero rate, the supplier would levy VAT on the sales price at 0%, while the VAT on expenses could still be claimed as an input tax deduction.
The call should, therefore, be for zero rating, rather than exemption.
However, one should warn that if the request for zero-rating succeeds, there is no certainty or control that traders will pass the full price reduction on to the public.
A case in point is the South Africa Revenue Service’s experience with the zero-rating of illuminating paraffin a few years ago. Very few traders reduced their prices and many consumers were unaware of the amendment of the VAT Act. It was the traders that mainly benefited from the zero-rating, not consumers.
A further implication is the effect of exemption or zero-rating on competing products. How does one determine which publications promote literacy and which do not, and where to draw the line for publications that qualify?
If books or printed media qualify, why not also the electronic media? The application of the guidelines could degenerate into a nightmare for both the South African Revenue Service and suppliers.
The contrary argument could also apply to undesirable publications. Why not increase the VAT rate on pornographic publications to limit their distribution?
The real question is whether the abolition of VAT, or the increase in the VAT rate on certain publications, will have any material effect on their sales. Will the zero-rating of books really lead to a material increase in book sales to that segment of the market where there is a compelling need to promote literacy?
Because of the implications that abolishing or raising the VAT rate may have on an industry or its competitors, the VAT Act is not an ideal mechanism for achieving social goals such as the promotion of literacy.
It is far more effective to direct a portion of tax collected, including VAT, to specific programmes with those social aims, where funds are spent under strict control.
Gerhard Badenhorst is tax director of corporate law firm Sonnenberg Hoffmann Galombik