TOPIC 1 TAXATION THEORIES. Taxation scheme simply means a complete set of tax options, rules and conditions.

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1 TOPIC 1 TAXATION THEORIES Tax or taxation is a compulsory contribution to the state revenue, levied by the government on personal income and business profits or added to the cost of some goods, services and transactions, at fixed rate mostly proportionate to the amount on which the contribution is levied. Taxation scheme simply means a complete set of tax options, rules and conditions. Characteristics of Taxes Taxes are mandatory charges; not contributions, donations or gifts to the state, they are legally imposed, and therefore non-compliance will result into statutory civil and criminal penalties. Only government or other taxing body has power to levy taxes, therefore other non government bodies like sports clubs, churches, political parties can not charge taxes. There is no quid pro quo relationship. Tax payers should not expect equal returns from the tax paid. Taxes are usually paid and collected in monetary terms either coins or paper money. The government does not have any an obligation to provide to an individual account of how tax is utilized, however in most cases the government account to parliaments on behalf of the taxpayers. Objectives of Taxation: An appraisal of a tax system must be predicated on a widely accepted set of goals or objectives that the nation is seeking, and on knowledge of the potential role that a tax system can play in the achievement of these goals. Every tax jurisdiction can have a set of objectives which may be different from those in other jurisdictions. But there are several objectives which at least every tax system seems to seek. (a) Need for financing reasons: In ancient times taxes were mostly for financing wars. The very existence of a nation requires that its citizens through their government must be able to defend themselves against aggressors, and maintain law and order. In recent times governments have taken more responsibilities. In addition to defence and maintenance of law and order, governments provide a wide range of public services. The number, size and coverage of government programmes have increased tremendously. This trend has emphasized the need for expanding sources of revenue in order to finance government expenditure. There are several sources of government revenue. These are basically non-tax sources and the tax sources of which the

2 latter have gained prominence due to disadvantages which arise from reliance on the non-tax sources as briefly discussed below. The tax sources include all the taxes, indirect or direct such as the personal income tax, excess profits tax, capital gains tax, estate duty, sales tax, excise taxes, customs duties, road tolls, development levies, registration fees and the like. (b) Mobilization of Capital for Capital Formation To forge economic development a country must possess sufficient capital for purposes of investment. In this regard, taxation plays the role of mobilizing and accumulating capital from the general public and concentrating the same to the disposal by the government through investments in enterprises that are considered to be of high economic priority. Taxation collects the residue of income from individuals whose purchasing power is thereby reduced. Individual savings are thus transferred to the government capital accumulation fund. This is a free enterprise system has an effect of debilitating the growth of the private sector of the economy, but, services a crucial purpose in a centrally planned economy. (c) Allocation of Resources Taxation can be used to allocate resources to ventures or geographic areas that are considered underdeveloped. For example, by offering liberal expense deductions in respect of agricultural and mining businesses, investors may be attracted to invest in such enterprises. The tax factors, however, should not be emphasized because investment decisions take count of a horde of other factors as well. Also by allowing a tax holiday in the proposed new capital city i.e. Dodoma by the Dodoma Special Investment Area Act, 1989 the government attempts to direct resources to that particular geographical location. (d) A tool to regulate the Economy (e) Distribution of Wealth In this respect, taxation is used as a means of redistributing wealth, for instance, by taking away from the wealthy and providing services to the people. Often this is achieved through the use of progressive rate structure. There are many other specific objectives of taxation. Perhaps Fuller makes the best assessment when he says that taxation is a legal maid for all work. (f) Protecting the economy

3 A theory is an idea or set of ideas that is intended to explain facts or events Therefore, the following are the theories of taxation in relation to their application in Tanzania and their respective criticisms thereto. BENEFIT THEORY : According to this theory, the state should levy taxes on individuals according to benefit conferred on them. This mean that, the more benefits a person derives from the activities of the state, the more he should pay to the government. This theory seeks to ensure that each individual s tax obligations are as far as possible based on the benefits that he or she receives from the enjoyment of public services.the application of this theories in Tanzania is such that there are various taxes(levies) that are collected in the local jurisdictions example, in market, bus stands which are collected by various local government authorities, at the end this fund is further used to develop various social facilities which results to social benefit to the society members. However, this theory faces various critics such as: Firstly, if the state maintains a certain connection between the benefits conferred and the benefits derived, it will be against the basic principle of the tax. A tax, as known, is compulsory contribution made to the public authorities to meet the expenses of the government and the provisions of general benefit. There is no direct quid pro quo in the case of a tax. Secondly, most of the expenditure incurred by the state is for the general benefit of its citizens. It is not possible to estimate the benefit enjoyed by a particular individual every year. Thirdly, if we apply this principle in practice, then the poor will have to pay the heaviest taxes, because they benefit more from the services of the state. Thus, if we get more from the poor by way of taxes, it is against the principle of justice. ABILITY TO PAY THEORY : This is the most popular and commonly accepted principle of equity or justice in taxation, that is, citizens of a country should pay taxes to the government in accordance with their ability to pay. It appears very reasonable and just that taxes should be levied on the basis of the taxable capacity of an individual. For instance, if the taxable capacity of a person A is greater than the person B, the former should be asked to pay more taxes than the latter. It seems that if the taxes are levied on this principle as stated above, then the justice can be achieved. In Tanzania this principle is well applicable by virtue of Section4 and 6 of the income tax Act on which tax is charged on basis of each person s income from business,

4 employment or investment. However, there are still some difficulties putting this theory in practice. The trouble arises with the definition of ability to pay. Thus, the main viewpoints (assumptions) have been advanced in connection with the ability to pay which are as follow: Ownership of Property: Some economists are of the opinion that ownership of the property is a very good basis of measuring one s ability to pay. Tax on the basis of Expenditure: Some economists assert that ability to pay tax should be judged by the expenditure which a person incurs. The greater the expenditure the higher should be the tax and vice versa. Criticisms Ownership of Property-This idea is out rightly rejected on the ground that, if a person earns a large income but does not spend on buying any property, he will then escape taxation. On other hand, another person earning income buys property; he will be subjected to taxation. So, the question here may arise, is this not absurd and unjustifiable that a person earning large income is exempted from taxes and another person with low income is taxed? The basis of Expenditure-The point of view seems unsound and unfair in every respect; for example, a person having a large family to support has to spend more than a person having small family. Therefore, if we make expenditure as a test of one s ability to pay, the former person who is already burdened with many dependents will have to pay more taxes than the latter who has a small family. So this is unjustifiable Income as the basics: Most of the economists are of the opinion that income should be the basis of measuring a man s ability to pay. It appears very just and fair that if the income of a person is a greater than that of another, the former should be asked to pay more towards the support of the government than the latter. That is why, in the modern tax system of the countries of the world, income has been accepted as the best test for measuring the ability of a person to pay. THE DIFFUSSION THEORY According to diffusion theory of taxation, under perfect competition, when a tax is levied, it gets automatically equitably diffused or absorbed throughout the community. Advocates of this theory, describe that: "When a tax is imposed on a commodity by state, it passes on to consumers automatically. Every individual bears burden of tax according to his ability to bear it".

5 For instance, a specific tax is imposed on say, cloth. Manufacturer raises prices of commodity by the amount of tax. Consumers buy commodity according to their capacity and thus share burden of tax. In the words of Mansfield: "It is true that a tax laid on any place is like a pebble falling into a lake and making circles till one circle produces and gives motion to another". This quotation has been given to explain to readers that just as a pebble gets diffused in a lake, similarly a tax imposed on a commodity is also absorbed and its burden is felt equally among various sections of community. Assumptions: Advocates of this theory assume perfect competition in the market but in world of reality, it is imperfect competition which prevails. If tax gets automatically diffused through the community, then most of worries of finance minister will be over. He will simply impose tax and collect money from people without worrying about final resting place of a tax. In actual practice we find that taxes do not get distributed equally. Some taxes remain where they are imposed first and some are partly or wholly shifted on to me consumers. Let us consider now some important taxes and see who ultimately pays it. Criticism: Diffusion theory of taxation has never gained any importance in the world of reality. It has never been seen that a tax gets automatically equitably distributed among people. It is true that in some taxes, diffusion or absorption does take place but that too is not throughout the community. Accordingly, the reason for rejecting theory of taxation is that there are few taxes like income tax, toll tax in which there is no absorption at all. How can this theory state that tax burden is automatically spread throughout the community? (Assignment no.1) THE SACRIFICE THEORY :

6 TERMINOLOGIES IN TAXATION Taxable capacity This is the maximum amount which a nation can contribute towards the support of the government without inflicting damage on the power and willing to produce or it is the maximum amount of tax burden which the citizen of the country are ready to bear. Factors determining Taxable capacity Quality of tax system A good tax system might increase taxpayer s perception of fairness and probably compliance might increase and accordingly increase the taxable capacity. Purpose of taxation The taxpayers are more willing to pay taxes when their taxes are used in improving public goods than when taxes are misused. Psychological factor When the taxpayers trust their government are likely to pay their share of tax band easily thus improve taxable capacity Living standard of citizens Inflation Tax Base: This relates to the question, what is taxed and what is not. Choice of a tax base is perhaps the most important yet contentious issue in taxation. Under tax base we have two common categories:- Tax on income earned or received by tax payers at specific period e.g corporate tax or PAYE Wealth accumulated by taxpayers e.g capital gain tax and property taxes. Effective tax rate The effective tax rate is the average rate at which an individual or corporation is taxed. The effective tax rate for individuals is the average rate at which their earned income is taxed, and the effective tax rate for a corporation is the average rate at which its pre-tax profits are taxed.

7 ERT= Total tax paid Total income Marginal tax rate A marginal tax rate is the tax rate an individual would pay on one additional unit of income. Thus, the marginal tax rate is the tax percentage on the last unit earned. Mathematically MRT= Change in tax paid Change in income Average rate of tax The average tax rate is the total amount of tax divided by total income Mathematically ART= Total tax paid Total income Class illustration Fromm the following table compute the marginal rate of tax and average rate of tax year Income (Tshs.) Tax paid (Tshs.) , , , , ,000, , ,200, ,000

8 Tax avoidance Is the deliberate action/technique used by taxpayer to minimize his/her tax liability or not to pay tax at all without contravene the tax laws. It is not punishable under the law. How does avoidance exist? Through the tax deductions Abusing the tax incentives Using ambiguous tax provisions Other loopholes in the tax laws Tax evasion Is the deliberate action used by taxpayer to minimize his or her tax liability or not to pay at all by contravening the tax laws. It is punishable under the laws. How does evasion exist? By declaring less income Not filing the required tax returns Overstating the expenses/deductions Documents not properly kept. Tax Planning This is the techniques of arranging the business transaction so as to realize tax savings. The process aimed at minimizing tax burden through tax avoidance. The process start from the process of formulation of the business and is the continuing process to remain within the ax laws and minimize the tax What re the techniques for tax planning? Distribute the income among several taxpayers Transform ordinary income into capital gain income i.e. they mostly prefers owning shares or stock at discount instead of cash so as to avoid normal tax rate Take full advantages of exemptions and deductions Choose investment that provide tax shelter

9 Causes of Tax frauds High tax rate Multiplicity of taxes Misuse of the public fund Inefficient staffs Poor working tools Complicated tax laws and regulations Week penalties and fines The habit of the society Low tax morale TAX ARREARS Is the balance of un paid tax due from the taxpayers The taxpayers may pay part of the assessed tax and the remaining portion be paid on the other days due to the various causes Reasons for Tax Arrears Objectives and appeals In efficient tax administration Death Bankruptcy Untraceable taxpayers

10 ASSESSMENT Is a notice given to the taxpayers notifying them about their tax liability, repayment of overpaid tax in a particular year of income Classified in self and non self assessment SELF ASSESSMENT It is the scheme whereby taxpayers pay tax according to their own declarations in the tax returns. Responsibilities are placed to the taxpayer to calculate their own tax liability. It is a modern system based on the voluntary compliance with tax laws. The system requires proper maintenance of records and books of accounts. Characteristics of self assessment Tax payer is presumed to be honest, and the tax declared shall be final discharged of his tax liability Tax consultant shall have an important role on their clients tax affairs. All players will strive for high standard tax knowledge. Excellent customer service based on the clear or specified delivery standards, which are adequate taxpayers information and effective information. Simplification of forms, procedures and laws. Effective data processing. Impartial and efficient mechanism of resolving tax disputes. Advantages of Self Assessment Steady flow of revenue on due dates. Taxpayers will be aware with the provision of the tax laws because they are empowered to make their own assessment and instill more confidence and responsibility. Facilitate book keeping improve accountability Speed up the relationship between taxpayers and tax authorities Reduce administration cost Objections and appeals would be reduced at maximum as tax payers make their own assessment.

11 Evasion technique might be reduced disadvantages Low quality of assessment-there could be a possibility of a tax payer to lower his/her taxable income. Revenue loss-not all return for a particular period can be audited, thus high risk of losing the revenue. Non Self Assessment The responsibility of conducting assessment lies on tax administrators. The most assessment mostly based on standards kept by tax administrators or average proposed since no proper records kept by businessmen Advantages Collection base is widened because those who keep records and those who do not keep records are included in the system Eliminate the backdoor or evading tax Disadvantage Increases the administration cost Encourages the taxpayers not keep proper records hence hide their actual turnover

12 TOPIC: 2 CANONS OF A GOOD TAX SYSTEM/TAX STRUCTURE Adam Smith in The Wealth of Nations promulgated certain criteria for evaluating taxation systems. He said there are four canons of taxation: 1) Equity that is, the subject of every state ought to contribute towards the support of the government as nearly as possible in proportion to their respective abilities, i.e. in proportion to the revenue which they respectively enjoy under the protection of the state. Traditionally equity is divided into two suitsa) Horizontal equity, which means that those in equal circumstances should pay an equal amount of tax, or similar individuals, should be treated similarly. This requires that administrative arrangements should ensure that the tax does not impinge heavily on some transactions while exempting others and the system ought not to create a bias such that the tax is paid by the honest and those without effective tax advisors or those reluctant to reorganize their affairs so as to minimize their tax liabilities. b) Vertical equity, which is concerned with the burden imposed by the tax rates. This is the principle that those in unequal circumstances should pay different amounts of tax, or person with different financial capabilities should be treated differently. In distributing the tax burden the rate structure has to ensure that persons with comparatively high income pay more in taxes than those with low incomes. 2) Certainty (clear) This simply means that the scope of the tax should be clear. The tax which each individual is bound to pay ought to be certain and not arbitrary. The time of payment, the manner of payment and the amount to be paid, ought all to be clear and plain to the contributor and o every other person. 3) Convenience According to this canon every tax ought to be levied at the time, or in the manner in which it is most likely to be convenient for the contributor to pay it. For example, collection of income tax from employees through the PAYE system and the withholding tax system on dividend and interest income earned by residents of Tanzania as well as on other payments made by residents to non-residents. 4) Economy This is, every tax ought to be so contrived as both to take out and to keep out of the pockets of the people as little as possible, over and above what it brings into the public treasury of the state. Other principles can be

13 5) Flexibility-Tax policy is a primary tool of macroeconomic policy (i.e. economic stabilization). To be able to respond quickly to address potential difficulties in the economy, tax authorities must be able to change tax liabilities easily and quickly and those changes must quickly be felt throughout the economy Tax Structure in Tanzania Types of taxes Basically there are two types of taxes. Each type is classified according to the legal and effective incidence to the final payer. These two types are direct and indirect taxes. Direct taxes These are taxes levied directly on people s income from employment, business or ownership of property and an investment. The impact and incidence of the tax falls on the same person i.e. incidence cannot be shifted to another person e.g. corporate tax, Pay As You Earn (PAYE) and withholding taxes. Corporation Tax This is a tax, which is paid from corporate profits. Companies or entities have to prepare final accounts, which must be approved by authorized Auditors, and Accountants recognized by both NBAA and TRA. These accounts are submitted to TRA on the prescribed accounting date. All companies whether resident or non-resident are required by the Income Tax laws to file an estimate of income within three months after the start of its accounting year. The firm is supposed to pay tax based on four installments. Six months after the accounting period, the firm must file a final tax return to TRA. The current corporation tax rate is 30%. Individual Income Tax Individuals include sole traders and salaried people who are taxed at progressive individual income tax rate, which varies from the lowest marginal rate of 9% to the top marginal rate of 30%. However, for a non-resident individual the applicable rate is 20%, which is charged on the total income. The table below shows the current resident individuals tax rates.

14 Resident Individual tax rates for 2014/15 Financial Year [Source: Income Tax Act, 2004 (As amended)] Monthly Income Tax Rate Where total income does not exceed Tshs. 170,000/=. Nil Where total income exceeds Tshs. 170,000/= but does not exceed Tshs. 360,000/= Where total income exceeds Tshs. 360,000/= but does not exceed Tshs. 540,000/= Where total income exceeds Tshs. 540,000/= but does not exceed Tshs. 720,000/= 9% of the amount in excess of Tshs. 170,000/= Tshs. 22,800/= plus 20% of the amount in excess of Tshs. 360,000 Tshs. 58,800/= plus 25% of the amount in excess of Tshs. 540,000/= Where total income exceeds Tshs. 720,000/= Tshs. 103,800/= plus 30% of the amount in excess of Tshs. 720,000/= Taxation of small traders with and without complete record (Presumptive cases) Small traders, who operate mostly without keeping proper business records, are charged income tax based on the annual turnover of their business. There are four turnover bands with their taxes as per the table below: Tax Rates for Presumptive Cases [Source: Income Tax Act, revised 2008] TURNOVER PER ANNUM TAX PAYABLE WHERE INCOMPLETE OR NO RECORDS ARE KEPT TAX PAYABLE WHERE RECORDS ARE KEPT Tshs. 3,000,000 or less Tshs.35,000/= 1.1% of the turnover Tshs. 3,000,000 7,000,000 Tshs. 7,000,000 14,000,000 Tshs. 14,000,000 20,000,000 Tshs.95,000/= Tshs.291,000/= Tshs.520,000/= Tshs. 33,000/= plus 1.3% of turnover in excess of Tshs. 3,000,000/= Tshs. 85,000/= plus 2.5% of turnover in excess of Tshs. 7,000,000/= Tshs. 260,000/= plus 3.3% of turnover in excess of Tshs.

15 14,000,000/= The above bands which are legally enforceable by TRA are mere estimates and they are not a substitute for the requirement for keeping business records. All taxpayers whose turnover exceeds Tshs 20,000,000 are required to prepare and submit to TRA the audited financial statements together with the return of income of the year of income. Indirect taxes These are taxes, which are based on consumption. Examples of such taxes are like Import Duty, Excise Duty, and Value Added Tax (VAT), etc. By definition the legal incidence of the tax falls on the trader who acts as a collection agent of the government while the effective incidence falls on the final consumer of goods or services who eventually pays the tax. TOPIC: 3 THE RELATIONSHIP BETWEEN THE EXECUTIVE, PARLIAMENT AND JUDICIARY IN LEVYING TAX The Executive The Executive of the United Republic comprises of the President, The Vice-President, President of Zanzibar, the Prime Minister and Cabinet Ministers. The President of the United Republic is the Head of State, the Head of Government and the Commander-in-Chief of the Armed Forces. The President is the Leader of the Executive of the United Republic of Tanzania. Normally, the executive organ of the government is the initiator and administrator of all financial issues of the country, this includes setting the budget proposal of the country. The national budget comprises of revenue and expenditure of the government for different financial years. It is from the revenue part of the budget where by the government proposes charging and collection of tax liabilities from different sources of income owned by persons in a country in order to run its governmental expenditures.

16 In relation to tax matters, the executive makes different policies relating to taxes and administer all other tax laws, rules and regulations to ensure that they are smoothly implemented. In administration of tax the executive under the supervision of ministry of finance (MOF) delegated the authority of handling all issues relating to tax administration to a government body known as THE TANZANIA REVENUE AUTHORITY (TRA). This is the government body established in order to implement different government revenue policies and laws e.g. Fiscal policies. It is administered by the Commissioner General who is the Chief Executive of the Authority. Some of the commissioner s responsibilities are:- Day to day operations Management of funds of the authority Administration, organization and control of other officers and staff in the authority. OBJECTIVES OF TAX ADMINISTRATION (TRA) To assess, collect and account for government revenue. To administer the tax laws fairly, uniformly, impartially as well as with diligence and efficiency. To facilitate and encourage voluntary compliance. To detect and counteract all forms of frauds including tax avoidance and evasion. To maintain the public confidence in the integrity of the tax requirements of tax system. To advise the government on all matters relating to fiscal policy. To provide for trade statistics and publications The Legislature The Legislature, or the Parliament of the United Republic of Tanzania, consists of two parts, i.e. the President and the National Assembly. The President exercises authority vested in him by the Constitution to assent to bills by Parliament in order to complete the enactment process before they become law. The National Assembly, which is the principal legislative organ of the United Republic, has authority on behalf of the people to oversee and the accountability of the Government of the United Republic and all its organs of their particular duties. The Parliament is headed by the Speaker, who is assisted by the Deputy Speaker, and the Clerk as the head of the Secretariat of the National Assembly.

17 The executive must obtain the consent of parliament for both the levying of taxes and the appropriation of funds, and this fact is fundamental to the influence of parliament over government. The power of the purse flows from the basic constitutional principle that government expenditure must be authorized by legislation This forms the basis of requirements of financial control and accountability. In this sense parliament holds the supreme power over government finances: without the consent of parliament the government can neither raise new taxes nor undertake expenditure. The relationship between parliament and government on the matter of financial control is, however, not so one-sided or so straightforward as it first appears. While the government depends on the parliament for its ability to tax and spend, and therefore for its viability as an administration, parliament itself has no means of independently spending public funds to carry on its own activities and is reliant on the government for its own budget. That parliament holds ultimate control over government finances but cannot direct resources towards its own operations come about because only members of the executive are able to bring appropriation legislation before the parliament for its consideration. Thus, the parliament s control over public finances is by way of a veto or limited power to amend proposals put to it by the government, rather than by way of initiating appropriations or authorizing new taxation measures of its own design. The financial control parliament exercise over government is reactive in nature. In a direct connection with levying of tax, the legislature plays a very important role of making sure that all tax objectives put forward by the executive are achieved. This is done by formulation of various tax laws and rules where by all persons will be required to obey voluntarily. The legislature enacts laws regarding:- The amount of tax liabilities that tax payers shall pay depending on their levels of income The time or due dates of paying the tax liabilities The modes of paying tax liabilities together with consequences of various failures of paying taxes including fines and penalties.

18 The Judiciary The judiciary is formed by the various courts of judicature and is independent of the government. Tanzania adheres to and respects the constitutional principles of separation of powers. The Constitutional makes provision for the establishment of an independent judiciary, and the respect for the principles of the rule of law, human rights and good governance. The Judiciary in Tanzania can be illustrated as follows. The Judiciary in Tanzania has four tiers: The Court of Appeal of the United Republic of Tanzania, the High Courts for Mainland Tanzania and Tanzania Zanzibar, Magistrates Courts, which are at two levels, i.e. the Resident Magistrate Courts and the District Court, both of which have concurrent jurisdiction. Primary Courts are the lowest in the judicial hierarchy. In relation to charging of taxes in any country, this part of the government acts as the law enforcers where by all tax failures that are criminal in nature will be handled by the courts of law. In case of any criminal act a tax payer can be fined, jailed or face both punishments up on conviction.