Understanding VAT and its implication on prices

By Nikhil Hira

In this year’s budget expectations list, one thing I felt was sure to come was the enactment of the VAT Bill 2012.

 Well, I wasn’t entirely right but then again I wasn’t wrong either.  What the Cabinet Secretary for Finance Henry Rotich did was to announce that the VAT Bill would be re-tabled in Parliament meaning we can expect the VAT Bill 2013 (having already had the VAT Bills 2012 and 2011).

Indeed it has come to be. The VAT Bill is currently before Parliament and by all accounts, there may be some significant changes in the offing.

The key worry about the first two Bills that were tabled was the attempt to bring basic commodities in to the standard rated VAT bracket.  Indeed it was more than just the basic commodities. 

It would seem that the VAT Bill 2013 continues along this line.

 Our current law has in excess of 800 zero rated items and exempt items all of which came in to being from various forms of lobbying over the years.

Unsustainable law

 The consequence of this was a tax that did not actually achieve what it was meant to and so the bid to make virtually everything taxable.  I for one agree that the existing law is not sustainable but I do feel that we are moving from one extreme to the other at the expense of the poor in our society. 

That middle ground still needs to be found. VAT is in fact a great form of taxation to raise government revenues, as it is a consumption tax which the end consumer bears, but this is the cause of all the heated debate.

 I guess the issue here is to understand what VAT is all about – other than it being a ‘Very Annoying Tax’ – and thus a VAT 101 course follows!  VAT is a consumption tax, meaning every time you spend you pay the tax.

Tax claims

 If one is a registered business, subject to certain limitations, one can claim back the tax they are charged by the supplier (commonly known as input VAT) against the tax they charge the customer (commonly known as output VAT).

  As a registered business, you in essence act as a collection agent for government and do not bear much of the VAT.  The end consumer – generally individuals – bears the tax in its entirety.

Basically, VAT is a tax on business transactions at every step of the production or economic value chain.

To the extent that an individual buys something in cash with the supplier not accounting for the VAT, not all the tax will have been lost since at earlier points in the cycle tax, it would have been charged and accounted for.

In Kenya, there are basically two types of supply for VAT: taxable supplies and exempt supplies.

Taxable supplies

 Depending on the type of goods or services one is supplying, one will likely fall into one or the other category.  Taxable supplies are further sub-divided into supplies at the standard rate (16 per cent), the zero rate (0 per cent) and a special rate for power and fuel (12 per cent).

The critical difference between taxable and exempt supplies is the ability to recover input VAT by the registered business.

 Indeed, it is because of the ability of businesses in the value chain to recover input VAT on taxable supplies that we are faced with VAT refunds in excess of Sh25 billion for businesses that predominantly make zero rated supplies (exporters for one).

It is important to remember that VAT is a domestic tax and will only apply on supplies made in or imported into Kenya.

Tax differentiation

  Perhaps the easiest way to demonstrate the difference between the two types of supply and how VAT works is to use a simple example.

At the very simplest level, let us assume that all transactions in the value chain are subject to standard rated VAT of 16 per cent. The final VAT that the consumer bears is 16 per cent of 600 or 96.

 This amount has been paid by the businesses in each stage of the chain to the KRA and recovered by the next step in the change until one gets to the final consumer. So what is the effect on the price of products assuming different types of VAT supplies?  Again a simple example is probably the best way to demonstrate it.

Let us assume that a manufacturer buys inputs that are exempt from VAT, converts the raw materials, incurs overheads and includes a margin.

He will end up with a product that could be subject to VAT either as an exempt supply (no tax), a zero rated supply (0 per cent) or a standard rated supply (16 per cent).

The table below illustrates the final price of the product in each of these scenarios: Clearly the best option from the point of view of the consumer, though not the KRA and the State, is for the product to be zero rated for VAT.

 However, there is no need for everything to be zero rated. The current debate stems around basic food commodities that the mwananchi rely so heavily on and to my mind they should be zero rated or exempt.Let us now see where Parliament takes it.