Taxpayers had been holding their breath and crossing their fingers, ahead of Finance Minister Malusi Gigaba’s Budget Speech today (21 February 2018), worried about potential VAT increases.  The news is in: VAT is increasing from 14% to 15%, with effect from 1 April 2018; and the VAT zero-rating on fuel will not be removed. 

There is no doubt that the 1% increase in the VAT rate will be a cost to all taxpayers, with some concerned that the lowest income earners will be hardest hit.  However, given the availability of exempt and zero-rated items, the impact of this change may not be as large as is feared, particularly for the more vulnerable lower income consumers.  The good news is that removing the VAT zero-rating on fuel is not currently on the cards, which should come as a very substantial relief. 

Background to the VAT increase

VAT increases have been discussed for several years, despite being politically sensitive.  The urgency for an increase in the VAT rate escalated towards the end of 2017 when Finance Minister Malusi Gigaba announced in the Medium Term Budget Policy Statement that there would be a ZAR 50.8 billion tax revenue shortfall in the 2017/ 8 year.  This excludes the cost of free tertiary education for low-income households, announced late last year, and the cost of National Health Insurance (NHI), both of which are critical to mitigate the structural inequalities in South Africa.  It is accordingly clear that the fiscus will need to collect a substantial amount of additional revenue to cover the current shortfall and provide free tertiary education, and NHI in due course.

Government’s need to raise funds takes place against a background of exceptionally high unemployment, and South Africans are reeling from substantial job losses throughout 2017.  Lower income households are struggling to make ends meet, and cannot afford any significant tax increases.  For this reason, many people have been very outspoken against increasing VAT. 

VAT increase may not be a critical blow for low income consumers

It is noteworthy that South Africa’s VAT rate is below the average for both OECD countries and African countries.  In addition, on its own, an increase in the VAT rate may not hit lower income consumers as hard as is feared.  If one looks at the average spend of households that Statistics SA categorises as “poor households” in the 2017 Poverty Trends publication, various categories of expenditure are not subject to VAT.  If the VAT zero-rating on fuel were to stay, the average transport cost of ZAR 3 957 per year would not be impacted by VAT rate changes, and neither would the average yearly housing costs of ZAR 6 966 (bond repayments and rent are both exempt from VAT). 

Basic foodstuffs, too, are zero-rated for VAT purposes.  Such items include, among others, brown bread, dried beans and other legumes, maize meal, milk, amasi, rice, fresh fruit and vegetables, eggs, vegetable oil and tinned pilchards.  These items make up at least 46% of the normal food purchases of the average poor household, according to Statistics SA.

Essentially, then, changes to the VAT rate would, on average, affect approximately 54% of poor households’ yearly food spend of ZAR 9 487, and spend on “Other” of ZAR 8 150.  A 1% VAT increase would equate to approximately ZAR 133 of extra costs per year for households with an average annual income of ZAR 46 624.    

No removal of the VAT zero-rating on fuel: a relief for lower income earners

The removal of VAT zero-rating on fuel, as was proposed in Budget Review 2017, would have been a far greater VAT blow to lower income consumers. 

If this had happened, the cost of petrol and diesel would have risen by 14% with knock-on effects on the prices of goods that are transported.  Consumers would also have been hit hard, especially commuters making use of public transport and the taxi industry. 

Relative impact of VAT on fuel versus VAT increase

The impact of VAT on fuel is much more substantial than an increase in the VAT rate.  Based on average transport spend of ZAR 3 957 per year for poor households, the tax impact would be
ZAR 554 per year.  For poor households, then, the VAT charge on fuel would be approximately four times as severe as increasing the VAT rate by 1%. 

The situation is more severe for households that Statistics SA categorises as “non-poor households” (average annual income ZAR 199 267, so definitely still lower income earners).  On an estimated annual Vatable spend of ZAR 45 000, the impact of a 1% VAT rate increase is ZAR 450 per year.  By contrast, 14% VAT on transport spend of ZAR 25 415 per year is ZAR 3 558 per year.  The VAT charge on fuel would be almost eight times as severe as increasing the VAT rate by 1%.

Article by Hermann Marais, associate in our Tax Practice.