Make VAT law for free promotional items

Shoppers at a Nakumatt outlet. file photo | nmg 

By JOSEPH THOGO

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Summary

• Under the previous regulations, where taxable goods with a value of less than Sh200 were distributed as free samples to fewer than 30 persons in any given month in furtherance of a business, then such goods would not be liable to VAT.
• Unfortunately there are no similar provisions in both the main VAT Act and the new regulations, which potentially means that such taxable goods (and services) when distributed as free samples will be subject to VAT.

A few weeks ago a telecoms company ended up with egg on its face when it experienced network outage.

To redeem itself after the incident, it offered not to charge its customers for money transfer transactions (which it would otherwise have) undertaken within a specified window of time.

It is the same thing that you will probably witness with a retailer which might decide to bundle some of their merchandise with a give-away item.

Therefore, if you buy a 500ml yoghurt, you get a free 100ml pack, or if you buy a one-kilogramme of washing powder you get another product (often cheaper) made by the same company as a give-away.

With the current VAT being silent on how such should be, the question that remains unanswered is how these give-aways should be treated for VAT purposes.

It was hoped that the recently published VAT regulations that were enacted in late March would offer guidance but they did not.

Under the previous regulations, where taxable goods with a value of less than Sh200 were distributed as free samples to fewer than 30 persons in any given month in furtherance of a business, then such goods would not be liable to VAT.

Unfortunately there are no similar provisions in both the main VAT Act and the new regulations, which potentially means that such taxable goods (and services) when distributed as free samples will be subject to VAT.

Of course, there is the potential argument that since such supplies are given as compliments, then 16 per cent of free-of-charge is zero and, therefore, there would be no VAT to pay.

However, is that really the case and, more important, does the lack of consideration extinguish VAT liability?

Businesses are set up for profit purposes and do not ordinarily give away their inventory. However, there are many commercial reasons for doing that - to reward their customers, to introduce new products.

At the moment the most appropriate pigeon-hole that would accommodate such is to characterise them as discounts.

While the current VAT legislation does mention discounts or rebates, it does not offer much guidance on how buy-one-get-one-free programmes or bundling free merchandise should such be considered. Why is all these important anyway?

While one is required to account for the VAT on the supplies that he makes, he is allowed a deduction of the VAT that he incurred on his purchases.

So if you are in business and you purchase inventory for Sh1,000 (upon which you incur Sh160 as VAT), and you subsequently sell it for Sh1,500 (on which you collect Sh240 as VAT), your margin in Sh500 and you owe the Government Sh80 as VAT (Sh240 less Sh160).

It is for this reason that the issuance of these freebies distorts this VAT equation above and means either Caesar collects less VAT or no VAT at all.

While such arrangement maybe supported under the discount argument, there is the school of thought that argues that the discount should relate to the Sh500 margin above and not the Sh80 VAT.

If a number of retailers or manufacturers run such schemes simultaneously, the reduction of VAT in the taxman’s hands will certainly be cause for concern, especially since it often comes with penalties and interest as ‘give-aways’.

What is needed is specific VAT legislation that addresses complimentary merchandise during sales promotions and perhaps, more important, in instances one is seeking to introduce a product into the market using give-away freebies under buy-one-get-one-free arrangements.