Indirect taxation of the underground economy:

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Indirect taxation of the underground economy
IFC
Internatinal Finance Corporation

• The potential and limits of Withholding Taxes

Presentation by Sebastian James FIAS, World
Bank Group
Africa Tax Conference, April 22, 2009, Kigali
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Capturing taxes from the underground economy

• What constitutes the underground economy?
• underground economy includes unreported
  income from the production of legal goods and
  services, either from monetary or barter
  transactions - hence all economic activities
  which would generally be taxable were they
  reported to the state (tax)
• Estimated at approximately 40 of GDP in Africa

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Withholding Taxes

• Enables continuous flow of revenue to government
  coffers
• Reduces cost of collection for Tax Administration
• Useful tool to tax transactions that are likely
  escape taxation
• Transactions earning income for foreigners
• Transactions earning income for evasion prone
  businesses

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How it works

• On any payment arising from transaction with
  specified businesses
• Tax has to be withheld and provided
• directly to government
• The amount of Tax withheld
• is close to the
• estimated
• tax liability

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How it works

• Withholding applicable to transactions with
  businesses
• Which are likely to under report
• Which are known to be cash based (construction
  contracts, catering contracts, etc)
• Which are unregistered for tax purposes
• Such businesses could then file tax returns and
  claim refund if applicable
• Purpose is to increases the cost of non-compliance

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Efficient Withholding Taxes

• Withholding Rate should not be excessive
• But, close to estimated tax
• Otherwise, causes cash flow problems for business
• Taxpayers should be refunded any excess tax paid

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Efficient Withholding Taxes

• Manageable number of Withholding agents
• Danger of agents retaining government money
• Limit withholding agents to those where large
  number of transactions originate
• Best not to include individuals as withholding
  agents

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Limits of using Withholding Taxes

• Not a simple solution
• If used too liberally could result in lower
  overall compliance
• For those not taxable, might result in excessive
  compliance burden

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Examples

• Sierra Leone
• Tenants are to withhold tax on rent paid to
  landlords
• Creates serious compliance issues
• Creates discomfort between tenants and landlords
• Burkina Faso
• Liable to withholding tax for any transaction
  with unregistered taxpayers
• Creates large number of withholding agents
• How could these problems be avoided?

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Thank you