Presumptive tax not a new animal, but has struggled in Zim

In many economies worldwide, informal businesses play a significant role in the economic landscape and Zimbabwe is not an exception.

These informal enterprises, often unregistered and operating outside the formal regulatory framework, contribute to employment, income generation, and the provision of goods and services.

However, they also pose challenges for governments in terms of tax collection and regulation enforcement.

One mechanism used by authorities to address these challenges is ‘presumptive taxation’. The Minister of Finance, Economic Development and Investment Promotion, Prof Mthuli Ncube reconfigured his presumptive tax, much to the outcry of the population.

Hence, this week we delve into the concept of presumptive taxation, its functioning, rationale, and its effectiveness in compelling informal businesses to formalise their operations.

To begin with, presumptive taxation is a simplified method of assessing and collecting taxes from businesses, primarily targeting those operating informally or whose income is difficult to ascertain accurately.

Instead of requiring detailed accounting records and financial statements, presumptive taxation relies on certain presumptions or estimates to determine tax liabilities.

Under presumptive taxation, tax authorities establish predetermined bases for calculating taxes based on factors such as turnover, assets, or location.

These bases are often applied to specific sectors or types of businesses. For example, a common approach is to tax businesses at a fixed percentage of their turnover or gross receipts, regardless of actual profits or expenses incurred.

Rationale behind presumptive taxation

The rationale behind presumptive taxation is multi-faceted. Firstly, it simplifies the tax compliance process for small businesses, reducing administrative burdens and compliance costs. By eliminating the need for complex record-keeping and accounting, presumptive taxation makes it easier for informal businesses to fulfil their tax obligations.

Secondly, presumptive taxation addresses the challenges of tax evasion and underreporting prevalent among informal enterprises.

Since these businesses often operate in cash-based economies and lack formal accounting systems, accurately determining their income for taxation purposes is challenging.

Presumptive taxation provides a pragmatic solution by imposing taxes based on easily verifiable proxies such as turnover or assets.

Thirdly, presumptive taxation aims to broaden the tax base by bringing informal businesses into the formal tax net.

By providing a simple and transparent tax regime, authorities incentivise informal businesses to register and formalise their operations to avail of the benefits of formalisation, such as access to credit, Government services, and legal protection.

Effectiveness in encouraging formalisation

The effectiveness of presumptive taxation in encouraging formalisation depends on various factors, including the design of the presumptive tax regime, enforcement mechanisms, and broader socio-economic conditions.

Firstly, the design of the presumptive tax regime plays a crucial role. The tax rate, thresholds, and criteria for applicability must be carefully calibrated to strike a balance between revenue generation and compliance incentives.

Excessive tax rates or overly burdensome requirements may deter informal businesses from formalising or drive them further underground.

Secondly, effective enforcement is essential to ensure compliance with presumptive taxation rules. This requires adequate monitoring and oversight by tax authorities to detect and deter tax evasion and underreporting.

Leveraging technology, such as digital payment systems and data analytics, can enhance enforcement capabilities and reduce opportunities for tax leakage.

Thirdly, broader socio-economic factors influence the effectiveness of presumptive taxation.

Factors such as access to formal markets, business support services, and the overall business environment shape the incentives for informal businesses to formalise.

Policies that promote entrepreneurship, access to finance, and market integration can complement presumptive taxation efforts by creating a conducive environment for formalisation.

Challenges and limitations

Despite its potential benefits, presumptive taxation faces several challenges and limitations.

One challenge is the risk of overtaxation, particularly for small businesses operating on thin profit margins. Imposing taxes based on turnover or assets may disproportionately burden businesses with low profitability, hindering their growth and sustainability.

Another challenge is the risk of distorting market incentives and competition. Presumptive taxation can create disincentives for businesses to expand or invest in productivity-enhancing activities since taxes are levied irrespective of profitability.

Moreover, differential tax treatment across sectors or business types may distort resource allocation and hinder economic efficiency.

Additionally, presumptive taxation may inadvertently incentivise informal businesses to remain underground or engage in tax planning strategies to minimize tax liabilities.

In the absence of robust enforcement mechanisms and complementary policies, informal businesses may opt to evade taxes rather than formalise their operations.

Presumptive taxation is a pragmatic tool for taxing informal businesses and broadening the tax base in economies with significant informal sectors.

By simplifying tax compliance, addressing challenges of tax evasion, and incentivising formalisation, presumptive taxation aims to enhance revenue mobilisation and promote economic formalisation.

However, its effectiveness depends on careful design, effective enforcement, and supportive policy measures to address challenges and foster an enabling environment for formalisation.

Ultimately, striking the right balance between simplicity, fairness, and compliance incentives is essential for the success of presumptive taxation in shaping the behaviour of informal businesses and promoting broader socio-economic development.

In Zimbabwe, the new presumptive taxes could have forced businesses to formalise, but that will not be the case as the formal sector is over regularised and over taxed which makes companies want to remain small.-ebusinessweekly