Budget teaser – reducing tax rates in restaurants

The dilemma facing restaurant owners is a real one and has been fearlessly exposed by Julian Sammut, managing director at Kitchen Concepts. He has identified a sclerosis in the system that blinded operators to make hay while the sun shines regardless of the long term sustainability of the industry. This may well be anathema and continuing in such an unbridled fashion may lead to tomorrow’s demise.

This article explains how burning the candle at both ends will cause the sector to implode if and when the economic cycle turns from boom into bust. For this and other reasons PKF approached the Malta Hotels and Restaurants Association (MHRA) to obtain statistical data concerning the profitability of its members and to agree to join in an island-wide survey concerning all categories in the restaurant sector. MHRA is sponsored by Bank of Valletta, which in turn supports a quarterly study of the hotel market trends. No such study is conducted in the restaurant sector.

PKF offered to prepare on a complimentary basis such a study, having obtained details of revenue from restaurant declarations for past years. It asked for permission to approach the MHRA’s members to conduct a confidential study of their operating structures. The MHRA, which does not hold financial data on members, acquiesced to our request, demanding a payment of a €5,000 token fee as a pre-condition to endorse the study.

Naturally, PKF in turn wrote to BOV for sponsorship but to date the matter is still under consideration. Attempts to meet Julian Sammut and discuss a quantitative questionnaire on the subject have not been successful. Having checked what other countries charge on food sales one is surprised to note that Luxembourg charges only 3%. At the peak of the Greek financial crisis, in September 2011, the VAT rate for non-alcoholic restaurant sales increased from 13% to 23%, and subsequently was drawn back to 13% in August 2013.

This helped correct a heavy trend of under-declaration. If a study in Malta proves that if the VAT rate is reduced then one expects the level of under-reporting to decrease for two reasons: first it reduces the motive to evade, as the proceeds from under-reporting decline; and second it lowers the VAT ratio for a given level of reported sales, implying a higher probability of detection.

Therefore there is scope for a scientific study to be conducted to guide the finance minister contemplating a revision in VAT rates for budget 2018. PKF acknowledges the pioneering work in the sector by Julian Sammut (a fervent restaurant owner and successful businessman) who was recently interviewed exclusively at the Sunday Independent about the future of the industry. He stands as a colossus in the restaurant sector and is managing more than 10 outlets at Kitchen Concepts Ltd, part of the giant food wholesaler and import firm Alf Mizzi & Sons.

In his candid interview, he did not mince words and shoots from the hip at the problems besetting the eateries. In his opinion, these chronic problems, unless remedied, may lead to a cataclysmic downfall of the tourist industry. The root of the problem lies in the tax evasion both on VAT and corporate taxes while a good proportion of kitchen and waiting staff are employed at low rates or paid under the table. This tomfoolery continues notwithstanding the heavy endowment allocated to the Malta Tourism Authority to promote quality tourism and subsidize low cost carriers – the budget now exceeds €36 million annually.

The MHRA, the union for hotels and restaurant owners, was also contacted by the Independent newspaper and its president, Tony Zahra, said that the association is willing to take a proactive approach to tackle the issue of human resources abuse. In my opinion the MHRA should conduct an econometric study to discover in a scientific way why some of its members are tempted to continue breaking the rules.

The practice of papering the cracks will not solve the issue. Julian remarked that certain owners (excluding his company Kitchen Concepts, which is fully compliant) are facing increasing rents, a severe lack of entry-level staff and last but not least –personal greed. These combined factors push owners to either abuse the system or trade on low margins and face failure.

It appears that located in the entertainment mecca of Paceville there exists a well planned system of accounting and reporting structures based on templates commonly used to compute the expected rate of return on investment. It is either this or in extreme cases businesses have to shut down. One doubts if the landlord is earning far more than the operator who risks so much time and energy to meet all the health and safety requirements and retain an adequate number of qualified staff. This compares to a monster that raises its head above the water to devour start-ups which do not play the game.

The game leads to laundering of money by way of undeclared sales, thus evading VAT and corporate taxes. Such surplus is the only way they can afford paying higher undeclared wages and salaries, necessary for staff retention. It goes without saying that such abuses will create a two-way structure – those who abide by the fiscal rules and suffer a lower return on capital and all the others who abuse the system and continue to employ non-EU workers at low wages.

This abusive practice is a double-edged sword since while it pleases the workers yet in the long term it prejudices their future claim for pension and welfare payments.  Naturally the finance minister is well aware that abuse exits. He is reported to have exclaimed that “this is a continuous struggle.  Abuse can be limited, but never eliminated. What we need to do is address the black economy and treat it as a beast on its own. It creates unfair competition and loss of revenue.”

Even though business seems promising yet restaurant owners struggle to retain quality staff. When foreigners are employed to fill the gaps, patrons complain that they cannot communicate properly. Equally there is a problem with untrained locals attending the early stages at ITS, as they are often unreliable. Readers may disagree with such arguments. Some accuse restaurant owners who charge high menu rates when most of the time they do not pertain to the Michelin stable even though they promote themselves as providing a silver service experience.

Many disagree, saying restaurants are always full, especially the good ones, and business is brisk pushing you to book in advance for a good table. This bonanza comes not only as a result of the increase in tourist arrivals and full employment levels but more so due to the deep pockets of ex-pats employed with Igaming industry sporting attractive expense accounts. Surely this extra affluence generates more entertaining sprees at good restaurants.

The million dollar question is the lack of a level playing field – is the trickle-down effect working? Are owners being forced to take additional risks due to cutthroat competition, compounded with an unrelenting increase in property rents – a result of gentrification, particularly in the Eldorado area of Sliema/St Julians. Ideally a scientific study as proposed by PKF can shine a light on this dilemma. Pray that BOV comes to the rescue.

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George Mangion is a senior partner of PKF, an audit and consultancy firm. He may be contacted at [email protected] or on +356 21493041