The prospect of increasing Value Added Tax (VAT) from 7.5% to 10% raises several important considerations for businesses operating in Nigeria. VAT is an indirect tax levied on the consumption of goods and services, with businesses acting as intermediaries in its collection on behalf of the government. Although the proposed increase might generate more revenue for the government, assessing how such a change could affect businesses, their operations, and the broader economic environment is essential.

One immediate outcome of a VAT increase is the rise in the cost of goods and services. As businesses adjust to the higher tax rate, the price of many everyday items and services will inevitably go up. For companies, this means recalculating their prices to reflect the new tax burden. Depending on the type of business and its industry, the higher cost may be passed on directly to consumers, who will pay more for the same goods and services.

This price increase can lead to reduced demand, particularly for non-essential or luxury items. Consumers, already facing inflation and economic pressures, may become more cautious in their spending, opting to cut back on purchases or seek cheaper alternatives. For businesses that rely on high consumer spending, especially in retail and hospitality, this reduced demand can result in lower sales volumes, directly affecting their revenue and profitability.

Also, not all businesses will be able to pass on the full VAT increase to their customers. In highly competitive industries, companies may be forced to absorb some or all of the extra tax to remain attractive to price-sensitive consumers. This can lead to a squeeze on profit margins, particularly for small and medium-sized enterprises (SMEs) that lack the financial resilience of larger firms. The impact could be even more significant for businesses already operating on thin margins.

To maintain profitability in the face of a higher tax burden, businesses may have to explore cost-cutting measures. These could include reducing their workforce, cutting back on investments in innovation or expansion, or renegotiating supplier contracts. While such strategies might help maintain short-term financial stability, they could also limit long-term growth opportunities and reduce the overall competitiveness of the business.

For many businesses, VAT represents a significant part of their tax obligations. An increase from 7.5% to 10% means a larger portion of their revenue will be tied up in VAT payments. This can create cash flow issues, particularly for businesses that operate on tight margins or have irregular income streams.

SMEs, in particular, may struggle to manage the increased cash outflow, especially if they have limited access to credit or other financial resources. Delayed payments from customers can further compound this problem, leaving businesses with insufficient funds to meet their VAT obligations promptly. Failure to pay VAT on time can lead to penalties and fines, adding to the financial strain.

In response to these challenges, businesses may need to reassess their financial management practices, including improving their invoicing and collection processes, renegotiating payment terms with suppliers, or securing additional lines of credit to manage cash flow fluctuations. However, these adjustments come with their own costs and challenges, particularly for smaller businesses with limited financial expertise.

Implementing the proposed VAT increase would require businesses to update their accounting systems, pricing strategies, and internal processes to reflect the new tax rate. For larger organisations with sophisticated accounting systems, this may be a relatively straightforward process. However, for SMEs and informal sector businesses, the administrative burden of updating systems and ensuring compliance with the new tax regulations can be significant.

Companies will need to invest in training staff, updating software, and ensuring that their accounting practices are in line with the new VAT rules. These changes may require external consultancy or legal advice, adding to operational costs. Businesses that fail to implement these changes correctly could face penalties from tax authorities, further straining their financial resources.

The administrative burden of collecting and remitting VAT also takes up valuable time and resources that could be better spent on other business activities, such as product development or customer service. For small businesses, which often have limited personnel and financial resources, this additional burden can be particularly challenging.

An increase in VAT could have a broader impact on consumer behaviour. As the cost of goods and services rises, consumers may become more price-sensitive, seeking out cheaper alternatives or cutting back on discretionary spending. This change in behaviour could disproportionately affect businesses that sell non-essential items or luxury goods, as consumers focus more on necessities.

In some cases, businesses may experience an uptick in demand for lower-priced alternatives or value products as consumers look for ways to save money. For businesses offering premium goods or services, this could mean a shift in market dynamics, where they may need to adjust their offerings to cater to a more cost-conscious customer base.

At the same time, businesses that are heavily dependent on imported goods could face additional challenges, as the VAT increase is likely to compound the effects of existing tariffs and import duties, further driving up costs. These businesses may need to rethink their supply chains or find ways to source more goods locally to mitigate the impact of rising costs on their customers.

An increase in VAT can also affect the overall competitiveness of businesses, particularly in the international market. Businesses already face significant challenges in the form of high operating costs, unreliable infrastructure, and a challenging regulatory environment. Raising VAT could make Nigerian goods and services more expensive compared to those of foreign competitors, reducing the country's attractiveness as a destination for investment.

For businesses that rely on exports, the VAT increase may reduce their competitiveness in global markets, particularly if they are unable to pass on the additional costs to foreign buyers. This could lead to a decline in export revenues and further strain the country's balance of trade.

From an investment perspective, the VAT hike could deter both domestic and foreign investors, particularly in industries that are highly price-sensitive or reliant on consumer spending. Investors may be hesitant to commit to new ventures in an environment where rising taxes are likely to erode profit margins and reduce consumer demand.

The proposed increase in VAT from 7.5% to 10% is likely to have a range of implications for businesses across Nigeria. While it may provide the government with much-needed revenue, the impact on businesses will be felt in higher costs, reduced demand, and tighter profit margins. SMEs are likely to be particularly vulnerable to these challenges, given their limited financial and administrative capacity.

At the same time, businesses will need to find ways to adapt to the new tax environment, whether through cost-cutting measures, pricing adjustments, or improved financial management. No doubt, the VAT increase presents both risks and opportunities for businesses, depending on how they respond to the changing landscape.

Research & Advocacy Department,
Chartered Institute of Directors (CIoD)
28, Olawale Edun Road, (Formerly Cameron Road), Ikoyi, Lagos.