Govt short on answers as fiscal crisis looms

In September 2023, Uganda’s national treasury reported a significant shortfall of Shs134.44 billion in tax revenue. This spanned all major tax categories, including direct, indirect, and international trade taxes. The international trade tax category topped the pile, falling short of its target by Shs90.36 billion. This was primarily due to lower-than-expected imports on which Value Added Tax (VAT), withholding tax, and import duties are levied.

The Uganda Revenue Authority (URA) identified the construction sector as the hardest hit, contributing a mere 5.52 percent or Shs7.75 billion to the tax revenues. This decline was primarily attributed to a decrease in revenue from the construction of roads and railways, as well as building completion and finishing, amounting to Shs21.18 billion and Shs1.05 billion, respectively.

As a result of this dwindling tax revenue, the government was compelled to cut its expenditure by a staggering Shs305.38 billion, affecting developmental projects, which achieved only 63.5 percent of its goals for the month. Disbursements from development partners fell short of expectations, further exacerbating the fiscal strain.

In an attempt to offset the revenue gap, the government conducted two treasury bill auctions and one treasury bond auction in the domestic market in September, raising Shs1.291 trillion. Bills contributed the majority of this amount, totalling Shs901.11 billion. An additional Shs390.2 billion was raised from bonds. 

Domestic debt crisis
These actions were taken as a response to the ballooning domestic debt crisis. Uganda’s financial woes stem from the need to finance its substantial Shs52 trillion Budget for the 2023/2024 fiscal year. This budget represents a 9.5 percent increase from the previous year, with the tax authority aiming to raise tax revenues by a lofty 16 percent, from Shs25.6 trillion to Shs29.7 trillion.

The country’s heavy reliance on taxing the income of its relatively small registered population is problematic, particularly given the economic challenges that have diminished returns on investments, particularly in the construction sector.

The economic landscape is further burdened by factors such as declining corporate profits, soaring inflation, global supply chain disruptions, and high borrowing costs. Corporate tax revenues suffered a considerable decline, with some of the top taxpayers recording significant reductions in their contributions.

Low profitability was cited as a primary factor, with one undisclosed major contributor experiencing a Shs3.22 billion decline in corporation tax paid due to the availability of alternative competitive products and services. A Shs1.68 billion reduction attributed to reduced sales and increased manufacturing input costs has hardly helped matters.

Even the tax revenue from the casino sector, which contributed Shs18.60 billion between July and September 2022, saw a significant drop.

“For instance, Intel-world, which had remitted Shs17.19 billion mainly from arrears recovery in the previous year, failed to meet that amount this year. Consequently, the expected windfall was not factored into the target for the 2023/24 financial year,” said, URA Assistant Commissioner and spokesperson, Bbosa Ibrahim.

Uganda’s economists argue that some companies are now borrowing to pay their wage bills as a result of low returns on investments in the country’s revamping economy.

“Companies that sell are making low profits on goods and services as people have reduced disposable incomes to increase their spending, which is totally not good at all,” said Fred Muhumuza, a Ugandan macroeconomist.

Paye to the rescue?
To address its mounting financial crisis, the Ugandan government is increasingly relying on Pay As You Earn (Paye) tax revenues, the only source of tax revenue that experienced a surplus in September 2023. Paye revenue is primarily derived from specific key sectors that have expanded their workforce and increased wage bills, most notably the burgeoning oil and gas sector.

Official data from the taxman reveals that the public administration sector saw the most substantial growth, experiencing an 81.77 percent increase. Other sectors that displayed significant growth included the oil and gas sector with a 66.34 percent uptick, education with a 38.04 percent increase, as well as financial and insurance with a 14.88 percent rise.

Notable organisations such as TotalEnergies EP Uganda, CNOOC Uganda, Centenary Bank, and Stanbic Bank significantly increased their staff numbers, leading to a substantial boost in Paye collections.

The improved Paye performance can also be attributed to arrears management initiatives, which resulted in recoveries totalling Shs104.99 billion.

These recoveries included Shs3.65 billion from Strabag International Uganda, Shs5.74 billion from the Civil Aviation Authority after a TID (Tax Investigation Department) assessment, Shs1.98 billion from Kansai Plascon after an audit, and Shs1.14 billion from Uganda Management Institute due to an audit for March 2010 to August 2021, among others.

Paye fragility
Despite the improved performance in Paye tax collection, it remains a somewhat fragile source of income, highly susceptible to audits that are not conducted frequently.

“The unpredictability of these revenues from audit technicalities introduces an element of uncertainty into the government’s revenue projections,” said a tax expert who sought anonymity.

Economic analysts stress that Paye does not reflect the good performance of the economy. It’s also independent of a company’s performance due to being pegged on people’s employment contracts, which only fall when workers are laid off.

“Paye is not even easy to adjust but sometimes firms even go to banks to borrow money for people’s salaries, however, they remain hopeful that the economy will revamp. Times like this are seasonal though,” said Dr Muhumuza.

Uganda has undertaken various measures to boost tax revenues from its roughly one million taxable individuals, although the population engaged in economic activities is considerably larger, per URA’s 2021 data.

To meet its targets, the government leveraged its reformed tax policies in 2012/13, raising the tax-free lower threshold and increasing tax rates for higher-income earners.

An additional tax band was introduced for the top one percent of income earners. However, heterogeneity analysis revealed that high-income workers in firms under ordinary (as opposed to medium or large taxpayer) offices reported lower incomes following the reform.

This was partly due to the government’s decision to increase the highest marginal tax rate from 30 to 40 percent.

Digital tax stamps
In an effort to enhance the enforcement of tax collection, Uganda implemented the Digital Tracking Stamp technology solution. This technology was introduced to mitigate revenue losses and address existing deficiencies in tracking and tracing locally manufactured and imported products.

Effective November 1, 2019, manufacturers and importers of specific products, including beer, soda, bottled water, wines, spirits, and tobacco, were required to affix digital tax stamps to their products.

In addition, as of April 1, 2021, producers and importers of sugar and cement were also mandated to use these stamps.

Subsequently, as of February 1, 2022, cooking oil, fruit and vegetable juices, other non-alcoholic beverages, other fermented beverages, and other alcoholic beverages were added to the list of products requiring digital tax stamps.

While the introduction of digital tax stamps was a move towards modernising tax enforcement, the collections under Local Excise Duty (LED) for September 2023 fell short of the target, totalling Shs184.73 billion, an Shs9.70 billion deficit, resulting in a performance rate of 95.01 percent.

“In comparison to September 2022, LED collections have grown by Shs24.65 billion (15.40 percent) in September 2023. Between July and September of FY 2023/24, a total of LED worth Shs528.77 billion was collected, however, this falls short of the target of Shs557.01 billion by Shs28.24 billion, resulting in a performance rate of 94.93 percent. Nonetheless, compared to July-September 2022, LED collections have grown by Shs77.01 billion (17.05 percent),” Mr Bbosa noted.

Notably, Nile Breweries and MTN Uganda Limited emerged as the most significant contributors to LED tax revenue between July and September 2023/24, exhibiting a 25.03 percent growth in their respective tax revenues.

INCOME SHIFTING
Research findings from the United Nations University World Institute for Development Economics titled ‘Taxpayer response to greater positivity’ suggest that part of this income reduction may stem from income shifting, with firms where the earned income for top-income earners decreased the most increasing their dividend payments more than other firms of similar size.
    
While not conclusive, this suggests that income reduction among top earners may have been influenced by income shifting between earner income and capital income.
   
“We dig deeper into the potential mechanisms and find that firms where the earned income for the top-income earners dropped the most also increased their dividend payments more than other firms of similar size,” a 2023 working paper on taxpayer response notes, adding, crucially, “While not causal, this finding could indicate that a part of the income reduction among the top earners stemmed from income shifting between earner income and capital income.”
    
The tax policy reform led to a modest reduction in after-tax income inequality but also resulted in a reduced tax base for URA to collect revenues.
     
Large taxpayers are defined as those with a turnover of Shs15 billion and above or average annual tax contributions exceeding Shs4 billion, an indicator that is likely correlated with the firm’s number of employees but not forcing so.

According to tax experts, the tax rates for government securities like bonds are higher for securities with a maturity of 10 years or less at 20 percent and lower for securities with a maturity of 10 years or older at about 10 percent, which significantly reduces the government’s potential tax revenues.
     
Additionally, they argue that capital gains are not taxable unless there is a cash transaction of assets and that’s why high-income individuals prefer the asset gains that appreciate overtime which even enable them to attract more shareholders and grow their wealth.

“The sale of these firms and the exchange of assets does rarely happen, and that’s where URA could have gotten additional tax revenue because the growth in these assets needs to be taxed. It even lessens income inequality,” said a tax expert from a reputable auditing firm in the country that sought anonymity.

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