Kenya needs to review its policy on tax incentives

In the recent past, there has been renewed interest in the print and electronic media on the pros and cons of tax incentives. The latest round of interest was sparked off by revelations by KRA that Kenya was losing an estimated Sh478 billion per year in various tax expenditures, equal to 5.9 per cent of the country’s GDP.

Tax incentives are provisions in law that grant to any person or activity favourable conditions that deviate from the normal provisions of the tax legislation. These incentives take various forms usually involving one or more of the following: Reduction in tax rates, tax exemptions, allowable deductions to reduce tax liability and tax holidays.

Like many countries in Africa, Kenya has a comprehensive range of tax incentives incorporated in various statutes. They range from tax holidays, favourable depreciation rates, special deductions, tax rebates, preferential rates for Value Added Tax or remissions from the same, import duty exemption and an additional range of sector specific benefits. We provide these incentives to induce domestic investment, attract Foreign Direct Investment and promote exports.

We forego these tax revenues despite evidence tax incentives are not among the priority drivers of investment decisions. When International Financial Corporation carried out an investor motivation survey in 2012, they found tax incentives ranked number 11 in order of priority in terms of factors determining whether to invest in Kenya or not.

The first five were access to finance, access to land, labour costs, affordable skilled labour and proximity to the port. Further, 60 per cent of investors indicated they would have invested with or without the available tax incentives.

More recently, the 2018 World Economic Forum Global Competitiveness Report ranked Kenya number 93 out of 135 investment destinations. The principal challenges that undermined Kenya’s ranking were crime (especially organised crime and corruption), infrastructure (especially access to and quality of electricity and water), macro-economic management (with debt levels a prominent determinant), health and skills of the workforce, high tariffs, financial markets, (undermined by our non-performing loans portfolio) and business dynamism. In all these, Kenya ranked among the poorest 30 per cent worldwide. It is hard to argue tax incentives can be the ‘cure’ to the identified ills in these areas.

If tax incentives are a poor way to promote investment, then why are we so fixated on them? There appear to be two primary reasons: First, tax incentives seem critical in a limited number of areas and especially exports. The aforementioned IFC study found that exporters were particularly keen on tax incentives with 49-51 per cent of them indicating they would not have invested in the absence of these incentives.

Secondly, is that tax incentives, despite their lower priority ranking, are bankable. Our tax incentives are incorporated in various statutes and thus the investor has a degree of certainty they will benefit from them. The dynamics concerning improving infrastructure, labour markets, worker skills, security, reducing corruption and fiscal management make commitments in these areas less easy to guarantee. Thus, the investor focuses on what he can get, not what he needs.

So what should be the way forward? As we go through the process of reviewing our tax policy and tax legislation, we should consider the following: To begin with, in light of the high cost and debatable benefits of our incentive regime, we should seek to minimise tax incentives. As stated above, the only area that appears vulnerable to a removal of tax incentives is the export sector. Promoting exports is likely to be the exception to a roll back of the incentive regime.

Additional taxes

At the same time, cost benefit analysis should be carried out as we review the incentive regime. Essentially, tax incentives should only be provided if the additional taxes expected over the long term compensate for taxes foregone in the immediate or medium term, or if measurable externalities can be identified with equivalent effect.

Similarly, the policy framework should focus on tackling factors that undermine our investment climate directly rather than trying to compensate for them through tax reliefs. Ideally, the revenues mobilised through reduced incentives should be focused on the infrastructure, human resource and security shortcomings that undermine the country’s competitiveness.

Lastly, to minimise destabilisation of ongoing business activities and investments, already existing incentives should be ‘grandfathered’ through legislation allowing those already benefitting from an incentive to continue to do so while new entrants do not.

 

Mr Ogai is the Deputy Commissioner in charge of Research, Knowledge Management and Corporate Planning at KRA