- Traders Forced to Evade VAT to Stay Competitive in Shadow Economy
Across Merkato and throughout Ethiopia, widespread VAT evasion thrives as traders and tax collectors engage in a ongoing game of cat and mouse. Facing pressure to meet collection targets, officials at times aggressively fine businesses even on minor suspicions. Traders in turn employ various strategies to avoid oversight and leave sparse paper trails. An underground economy has grown with unreported transactions, inflated costs claimed on imports, and off-the-books dealings -- all of which severely reduces tax revenues that could support important development programs. Experts estimate Ethiopia loses over a billion birr annually due to VAT avoidance in Merkato and similar informal markets. Yared Seyoum of BirrMetrics provides more insight on this issue.
Abdella Ahmed seemed annoyed as he sat waiting at the Teklahaimnot Branch of the Addis Ababa Tax Office. He had come to complain about the large fine of 25,000 birr that had been imposed on him for allegedly not collecting VAT from consumers. To Abdella, this fine represented over a week's worth of profits during good times at his shop. According to Abdella, a team of tax officials from the office had been conducting inspections of shops in the Merkato area of Addis Ababa.
During their rounds of the market, one of the tax officials entered Abdella's shop in the Military Tera area. While in the shop, the official noticed a customer leaving without an invoice. Upon questioning, the customer revealed that she had actually purchased an item from another shop just moments prior, but had wandered into Abdella's shop afterwards. Despite Abdella's protests that the customer was not his, the official fined him 25,000 birr on the spot for not collecting VAT.
Abdella felt the penalty of 25,000 birr was unfair and too severe, since it equated to around a week’s profits, especially since the customer and sale did not involve his business at all. He wanted to file an official complaint at the branch to try and have the steep fine revoked. However, he knew overturning these types of decisions made in the field would be difficult.
It was well known that traders and tax collectors in Addis engaged in an ongoing game of cat and mouse in busy markets like Merkato. With so many intermingled shops and customer traffic, it was easy for businesses to conceal goods and money during spot checks. Likewise, customers moving between storefronts made it hard to determine where transactions originated.
Under pressure to hit revenue targets, tax officials aggressively fined establishments even on minor suspicions of wrongdoing. Meanwhile, traders employed various tactics to avoid oversight and leave minimal paper trails for the authorities. It had become a constant struggle between the two sides trying to outmaneuver each other.
As Abdella watched several other aggrieved merchants before him contest apparently unjust penalties that day, he began to doubt any fair hearing at the branch. Whether penalties stood seemed to depend more on whether inspectors believed traders' stories than solid evidence. It was a system that bred mistrust between the revenue collectors and collected.
Abdella could only hope one day the endless game of hide and seek might cease and be replaced by reasonable, legitimate policies on both ends. But for now, he steeled himself for yet another frustrating round with the system.
Sprawling over 250 acres on the outskirts of Addis Ababa, Merkato Market is the largest open-air market in Africa. On any given day, over 200,000 people converge in its bustling alleys to engage in trade. The range of goods sold is enormous, from clothing and electronics to food items and construction materials. Nearly anything can be found amidst the lively hustle and bustle.
However, not all commercial activities are openly disclosed. Over three days, this reporter investigated underground practices of tax avoidance within the market's informal economy. On the first morning, Beryihun, a 15-year veteran plastic goods supplier, was approached. "So how does VAT impact your business?" asked the reporter casually. He smiled knowingly and said, "Let's just say VAT and I don't see eye to eye."
Further conversations revealed other strategies traders use to slip under the VAT radar. Some try to report earnings below the registration threshold. Cash payments also limit paper trails in such cases. Widespread evasion thrives due to lax monitoring and penalties.
Across the market, unmarked stalls and nameless shops weekly receive shipping containers from Djibouti's free trade zone. Imports like electronics, phones, toiletries and clothing visibly bear duties and taxes not fully accounted for on forms.
A seller privately noted, "Wholesalers undervalue invoices to retailers. If retailers paid the actual wholesale price, profits would decrease. So receipts are avoided to boost earnings." He blamed importers and middlemen for passing the costs of avoided VAT down the chain.
Many wholesalers in Merkato purchase goods in foreign currencies like dollars from the parallel market, where exchange rates are much higher than the official rate. For example, dollars may cost twice as much on the unofficial market.
To account for these inflated procurement costs but still show competitive prices to retailers, wholesalers undervalue the goods on invoices. While retailers pay a far higher price than stated, wholesalers can report smaller profits for tax purposes.
However, this creates a dilemma for retailers. If they record the actual prices paid to wholesalers, which reflect the exchange rate premium already built into costs, their profit margins appear artificially high when calculating VAT. This increases their overall tax liability owed to the government.
To avoid this, retailers choose not to issue receipts at all for many transactions, instead making payments in cash off-record. They know recording the true transaction value on invoices submitted to the tax authority would cut significantly into profits due to higher taxes owed.
After three days of covert observations, Merkato's VAT losses were startling. Estimates say unreported taxes could exceed a billion birr annually, severely undermining social financing needs.
Despite the widespread issue of VAT evasion in markets like Merkato, the Addis Ababa Revenue Office managed to collect 108 billion birr in taxes for the fiscal year - achieving 98.5 percent of its collection target. However, experts note this figure likely still falls far short of the actual VAT owed.
The majority of traders continue operating largely under the radar and under-collecting VAT from customers. Transactions are rarely if ever properly documented and reported. As a result, large sums of potential revenue go uncollected each year even as tax authorities meet targets.
In response, the Ministry of Finance has started new efforts to widen the VAT base by bringing more businesses into the formal system. "The legal loopholes are not the primary reason for low tax collection rates,” commented legal expert Tadesse Lencho.
“The real problem lies in the wide collection gap. Authorities have been unable to effectively monitor economic activities and collect owed VAT, especially in informal sectors." Tadesse believes the lax oversight and weak penalties have allowed a culture of non-compliance to take hold.
If the revenue body hopes to significantly boost collection, Tadesse says serious administrative reforms and increased enforcement are needed. “Fines for evasion must be high enough to truly deter unreported transactions. Inspections have to become more robust and unexpected. Only then will we start to close the collection gap and dependence on other tax streams.”
Without concerted efforts to formalize underground commerce and strengthen tax administration, Tadesse warns ongoing shortfalls will undermine the state’s capacity to fund critical development initiatives.
