Abstract
1. Lesotho possesses the core components of a modern tax system. While it has undergone important changes over time, there is still much room for improvement. Furthermore, the COVID-19 pandemic and the ongoing volatility in exogenously determined SACU revenues has reinforced the urgent need to improve domestic revenue mobilization.
An Overview of Taxation in Lesotho1
1. Lesotho possesses the core components of a modern tax system. While it has undergone important changes over time, there is still much room for improvement. Furthermore, the COVID-19 pandemic and the ongoing volatility in exogenously determined SACU revenues has reinforced the urgent need to improve domestic revenue mobilization.
2. The value added tax (VAT) provides the bulk of revenues, followed by the personal income tax (PIT) and corporate income tax (CIT), while excise taxes constitute a small yet nonnegligible portion with potential. Since its introduction in 2003 in replacement of a sales tax, the value added tax (VAT) has grown into the most powerful tax revenue-raising instrument, accounting for approximately 38 percent of tax revenues in the past decade (Figures 1 and 2). However, with several reduced rates and an economy characterized by high informality and significant cash-based transactions, the VAT has untapped potential. Contributing to nearly a third of total domestic tax revenue, the personal income tax (PIT) is another major source, due to the large number of salaried public servants employed by a government that dominates employment and consumption, overshadowing a weak private sector. As a result, PIT revenues are 2.5 times those from CIT, which have contributed on average 13 percent of the total domestic tax revenues over the past decade. Lesotho also levies excise taxes on specific goods and services such as fuel, cigarettes, and gaming. Furthermore, plans are underway to introduce a levy on alcohol and tobacco at 15 and 30 percent, respectively.
Breakdown of Domestic Tax Revenue by Source
(Percent of total)
Citation: IMF Staff Country Reports 2022, 162; 10.5089/9798400212918.002.A008
Source: Lesotho Ministry of Finance.Notes: PIT = personal income tax; CIT = corporate income tax; VAT = value added tax.Domestic Tax and Nontax Revenue
(Percent of GDP)
Citation: IMF Staff Country Reports 2022, 162; 10.5089/9798400212918.002.A008
Source: Lesotho Ministry of Finance.Notes: PIT = personal income tax; CIT = corporate income tax; VAT = value added tax.3. The collection of nontax revenue has been stable at 5 to 6 percent of GDP. Water and diamond royalties account for about three quarters of total nontax revenues (Figure 3), and there remains room for improvement in the mining sector. The government has proposed two new measures in the FY21/22 budget aimed at curbing perceived revenue losses from the mining sector. These include: (i) treating diamond royalties as a nondeductible expense for tax purposes; and (ii) eliminating the perpetual VAT refunds due to zero-rating of mining exports. While changing the zero-rating on diamond exports to exemption may save some money in the short term, it is ill-advised as this will distort the VAT system and impede the export competitiveness.
Royalties
(Percent of total nontax revenue)
Citation: IMF Staff Country Reports 2022, 162; 10.5089/9798400212918.002.A008
Source: Lesotho Ministry of Finance.4. In response to the COVID-19 pandemic, the government introduced temporary tax relief measures in 2020 to assist taxpayers to meet their obligations. Specific measures include:
Personal income tax payable by individuals engaged in the public transport business is remitted during the period of the COVID-19 lockdown.
Instead of following the regular quarterly schedule of CIT collection, the government deferred the CIT payment in 2020. The deferred amount and period vary depending on the size of the taxpayers, and the measures are more lenient towards MSMEs.2
For businesses closed during the national lockdown, the April, May, and June payments of VAT by the vendors and PAYE (pay-as-you-earn) by employers are deferred. The deferred amounts are payable from July 2020 to March 2021 in 9 equal monthly instalments.
5. Under the Income Tax Act 1993, the PIT is levied at progressive rates. Employment income is subject to a two-rate structure of 20 percent and 30 percent, while fringe benefits and passive income3 are taxed separately. Low income earners—with a monthly gross salary equal to or less than M4,200—are excluded from PIT by means of a non-refundable tax credit of M840 per month. Tax is withheld by employers through a pay-as-you-earn (PAYE) system and is remitted to the Lesotho Revenue Authority (LRA) on a monthly basis. Since the government is the largest employer in the economy, public servants account for the bulk of the PIT PAYE revenues.
6. The PIT regime features a sharp jump in marginal rates (Table 1). Although the top tax rate on employment income is near the mean level of the SACU region, the bottom rate (20 percent) is double the regional average of 10 percent (Figure 4).
Lesotho: Personal Income Tax
Lesotho: Personal Income Tax
| Employment income | Chargeable income (Maloti, per annum) | Tax credit (Maloti, per annum) | Tax rate (percent) |
| < 50,400 50,400 - 64,200 > 64,200 |
10,080 10,080 10,080 |
20% 20% 30% |
|
| Fringe benefits | 40% | ||
| Witholding tax | Resident contractors | - | 5% |
| Non-Resident Contractors | - | 10% | |
| Non-Residents (Technical services) (For RSA only) | - | 8% |
Lesotho: Personal Income Tax
| Employment income | Chargeable income (Maloti, per annum) | Tax credit (Maloti, per annum) | Tax rate (percent) |
| < 50,400 50,400 - 64,200 > 64,200 |
10,080 10,080 10,080 |
20% 20% 30% |
|
| Fringe benefits | 40% | ||
| Witholding tax | Resident contractors | - | 5% |
| Non-Resident Contractors | - | 10% | |
| Non-Residents (Technical services) (For RSA only) | - | 8% |
SACU: Personal Income Tax Rates
(Percent)
Citation: IMF Staff Country Reports 2022, 162; 10.5089/9798400212918.002.A008
Sources: Lesotho and Eswatini Revenue Authorities, IBFD.7. The CIT system is characterized by a relatively low standard rate in the Southern Africa region, and occasional concessional rates acting as tax incentives. The standard CIT rate in Lesotho is 25 percent, which is at the lower end relative to regional peers (Figure 5). A reduced rate of 10 percent is applied to manufacturing companies and commercial farming, including the textile manufacturing industry, one of the key growth engines of the economy. While this reduced rate may create some investment incentives in the short term, as a profit-based incentive, it is distorting activity and eroding the tax base. Although a unified CIT rate across sectors is generally advised, there are concerns that the largely foreign-owned textile companies are relatively mobile and may “pack and go” as soon as the preferential rate is removed. However, the credibility of these threats is unclear.
SADC: Corporate Income Tax Top Rates, 2020
(Percent)
Citation: IMF Staff Country Reports 2022, 162; 10.5089/9798400212918.002.A008
Sources: Lesotho Revenue Authorities, IMF Fiscal Affairs Department Tax Rate Database.Notes: The 10% reduced rate in Lesotho applies to manufacturing companies and commercial farming; SADC = Southern African Development Community; SACU = Southern African Customs Union; orange bars indicate SACU countries.8. The VAT is Lesotho’s revenue workhorse, providing 38 percent of total domestic tax revenues in the past decade, or 7.7 percent of GDP (Figure 6). The VAT regime has many features in line with best practices: it excludes small businesses with a minimum registration threshold on annual taxable turnover of M850,000, although there remains an option for voluntary registration; it is also destination-based, which means exports are currently zero-rated and it is advised to remain that way.
Value Added Tax Revenue
(Percent of GDP)
Citation: IMF Staff Country Reports 2022, 162; 10.5089/9798400212918.002.A008
Sources: Lesotho Ministry of Finance, IMF Fiscal Affairs Department WoRLD database, and IMF staff calculations.Note: The blue shadow excludes the top and bottom quartiles of the distribution.9. The standard VAT rate of 15 percent is in line with the region, and reduced rates, exemptions, and zero-ratings are applied to certain goods and services. The government intends to gradually eliminate the rate differentials and unify the VAT rate, and has just increased the rate on telecommunications from 12 percent to the standard 15 percent in May 2020. In addition, the rate on electricity is scheduled to increase from 9 to 10 percent starting from April 1, 2021—the authorities are justifying the slow rate increase on the grounds of limiting cost increases on the poorest. Medical, dental, financial, transportation and educational services are exempt from VAT, and basic food supplies are zero rated.4
10. The VAT C-efficiency is 0.56 in 2018, which—although above the SADC and SACU averages—suggests room for improvement if measures are taken to harmonize rates and improve tax morale and compliance to reduce evasion and informality (Figure 7). A sizeable amount of sales is cash-based and require no invoices, which increases the difficulty in tax administration and detecting evasion. In an effort to automate compliance, the LRA launched a Tax Modernization Project (LTMP), which aims to build a VAT invoice system along with a sector-specific custommade compliance approach. Under this system, the LRA pre-populates tax returns based on verified information in an integrated data system and simplifies the process for taxpayers.
SADC: Value Added Tax Rates and C-efficiency
Citation: IMF Staff Country Reports 2022, 162; 10.5089/9798400212918.002.A008
Sources: IMF Fiscal Affairs Department.Notes: The value labels indicate the year when VAT became effectivel SADC = Southern African Development Community; SACU = Southern African Customs Union; orange bars indicate SACU countries.11. Recently-approved tax policy changes risk undermining the integrity the VAT. As of April 2022, Parliament approved amendments to the 2001 Value Added Tax law to remove zerorating for the exports of the mining sector to curb what is seen as “perpetual refunds” to the mining sector. This can be harmful to the functioning of the VAT and introduce unintended distortions in business activity:
For the mining sector, it usually takes several years to expand upfront capital investment before production, therefore, zero rating and refunding VAT on a timely basis are generally accepted policy measures. A non-creditable input VAT on capital assets will prevent the companies in the mining sector from improving modernization of plant and machinery, and will be passed through increased output prices, lower dividends to investors, and reduced wages and employment.
In general, by removing zero-rating of exports, i.e., denying refunds of input tax credits, cascading will arise and the VAT would translate into a tax on exports or productive investment.5 Cascading also encourages vertical integration of businesses to minimize the VAT burden, which erodes competition. As the input VAT on capital becomes a tax burden on exports, this would commensurately reduce Lesotho’s international competitiveness. Broad exemptions of inputs of raw materials and capital equipment is also a bad policy for a consumption-based VAT.
Net refund positions are common. Appropriate VAT refund policies preserve the integrity of the VAT and render most exemptions unnecessary.
Lesotho could instead consider a more targeted approach such as the import VAT deferral mechanism, to reduce the cash flow impact and potential refund claims from import VAT, or targeted VAT exemptions during the mining development phase.
12. The tax regime for MSMEs is still in its primary development stage, and the authorities have started laying the groundwork to bring more MSMEs into the tax net. At present, there is a presumptive tax system in place for the retail and transport sectors—the latter is based on the size of vehicles. To widen the tax net coverage, the LRA has proposed a turnover-based tax, with the aim of introducing it in a phased approach, starting with the transport sector. In the meantime, the new Business Licensing and Registration Act, 2019 (“the Act”) was developed and took effect on November 17, 2020, aiming to automate the business registration and licensing system and facilitate the inclusion of businesses into the formal sector. The Act makes provisions for online license application and payment of various fees, streamlines the procedures, and limits the application processing period to five business days.
13. The diamond mining sector took off in the early 2000s but is viewed by many as not paying its “fair share” of taxes. The revenue sources from the mining sector are the government’s equity interest, royalties, corporate income tax, and the withholding tax on dividends.6 The royalties on diamond exports constitutes roughly 21 percent of the total nontax revenues. However, the capital structures of most mines—characterized by loans from parent companies—means that profit shifting has undermined CIT revenues over time. As a result, it is possible that changes in the VAT are being used to address problem of international corporate income tax avoidance.
14. There remains considerable potential to improve the revenue-raising capacity of the mining sector. The authorities have also proposed the enforcement of an export sales tax.
The diamond mining companies are subject to the standard CIT rate of 25 percent, which is significantly lower than regional peers (Table 2). However, under the current CIT regime, indefinite carry-forward losses allow the mining companies to only start paying CIT when enough profits are generated to cover the perpetual losses. This not only results in lower taxable corporate income but can also create direct losses in already limited dividend income from the government’s shareholding. While loss carry-forward reduces asymmetries in corporate taxation and supports risk-taking, it can be overly generous and risk abuse. Therefore, a time-bound loss carry-forward would be preferable: the period where losses can be carried forward could be longer than for ordinary economic activities given the capitalintensive nature of mining, resulting in a longer investment recovery period.
Actions are also needed to eliminate the royalty rate negotiability in mining agreements. The statutory royalty rate is 10 percent according to the Mines and Minerals Act 2005, and the government had proposed in the FY21/22 budget to further increase it to 15 percent. However, in practice the rate can be negotiated on a case-by-case basis between the Ministry of Mining and mines. Despite efforts to eliminate the rate differentials, some mines are still operating under reduced rates as low as 4 percent.
The LRA needs improved tax expertise and regulations on transfer pricing. Such measures would effectively detect tax avoidance behaviors, including mining companies changing ownership without paying tax on capital gains.
There is no sector specific profits tax. Introducing an export tax would for all practical purposes be equivalent to increasing the royalty rate. The staff recommend reviewing the royalty rates instead of introducing an export tax, and removing the immediate expensing of capital expenditure under the CIT, which is a more common policy measure in the mining sector.
Lesotho: Mining Sector: Revenue Sources
Lesotho: Mining Sector: Revenue Sources
| Lesotho | Botswana | Namibia | |
|---|---|---|---|
| Government shareholding (equity interest) | *25% Liqhobong Mine *30% Letšeng Mine *20% Lemphane Mine *25% Kao Mine *20% Kolo Mine *25% Mothae Mine |
*50% in Debswana, jointly owned with De Beers *15% in De Beers *50% Diamond Trading Company Botswana *80% indirect beneficiary shareholding in Morupule Colliery |
*50% in Namdeb *De Beers Marine Namibia owned 30% by Namdeb and 70% De Beers |
| Royalty rate | Statutory royalty rate is 10%; increased to 15% in recent proposal. In practice the mining companies can negotiate lower rates. | 10% | 10% |
| Corporate tax | Standard 25% | 22-55% | 55% |
| Withholding tax on dividend | 15% | 7.50% | 10% |
| Taxation on Downstream Processing | - | 15% | - |
Lesotho: Mining Sector: Revenue Sources
| Lesotho | Botswana | Namibia | |
|---|---|---|---|
| Government shareholding (equity interest) | *25% Liqhobong Mine *30% Letšeng Mine *20% Lemphane Mine *25% Kao Mine *20% Kolo Mine *25% Mothae Mine |
*50% in Debswana, jointly owned with De Beers *15% in De Beers *50% Diamond Trading Company Botswana *80% indirect beneficiary shareholding in Morupule Colliery |
*50% in Namdeb *De Beers Marine Namibia owned 30% by Namdeb and 70% De Beers |
| Royalty rate | Statutory royalty rate is 10%; increased to 15% in recent proposal. In practice the mining companies can negotiate lower rates. | 10% | 10% |
| Corporate tax | Standard 25% | 22-55% | 55% |
| Withholding tax on dividend | 15% | 7.50% | 10% |
| Taxation on Downstream Processing | - | 15% | - |
Prepared by Qiuyan Yin and Zhangrui Wang.
For large taxpayers, 60 percent of the first quarter instalment and 80 percent of the second quarter instalment are deferred to June and September 2020, respectively; the deferred amounts of 40 and 20 percent are payable from October 2020 to March 2021 in 6 equal monthly instalments. For small and medium taxpayers, 100 percent of the first quarter instalment is deferred, while 80 percent of the second quarter instalment is deferred to September 2020; the deferred amounts of 100 and 20 percent from the first two quarters are payable from October 2020 to March 2021 in 6 equal monthly instalments.
For example, interest, dividends, royalties, management charge, patent fees, and trademark fees.
Basic food supplies include maize meal, maize, beans, agricultural input, paraffin, milk, bread, peas, animal feeds, lentils, sorghum meal, unmalted sorghum grain, wheat grain, and wheat flour.
A destination-based VAT relieves exports from VAT by zero-rating exports and allowing exporters to reclaim all input tax. In jurisdictions with weak revenue administrations or governments facing revenue constraints, refund requests tend to build up, which is especially problematic during extraction firms’ start-up phase. It effectively turns the VAT into a tax on investment or on exports.
Central Bank of Lesotho, The Scope of Government Revenue Mobilization in Lesotho, 2017.
