The government will review the value-added tax (VAT) rate in a move that will push up the cost of basic goods, but also says it will bring down corporate income tax in a bid to incentivise investors, according to proposed measures to grow revenues.
In a strategy that explains how the Kenya Kwanza administration plans to grow tax revenues between the 2024/25 and 2026/27 financial years, the National Treasury has proposed a raft of new tax measures that range from higher VAT to a carbon tax on petrol and diesel vehicles.
They also include a new tax on all motor vehicles, higher excise duty on alcohol, cigarettes and sodas as well as VAT on certain services offered by schools such as swimming.
The proposals come as Kenyans come to terms with higher taxes following the implementation of the Finance Act, 2023, which saw fuel prices rise to a historic high. This is now being felt as firms pass the higher transportation costs to consumers by hiking cost of essential products.
The National Treasury said it is considering increasing the VAT rate from the current 16 per cent to 18 per cent as it seeks to harmonise its rate to be at par with those of other countries in the East African Community (EAC).
In reviewing the VAT Act, the government will also limit the number of VAT-exempt and zero-rated products, a move that could see processed goods such as flour and processed milk subjected to the standard VAT rate.
This is even as it proposed to lower the corporate income tax to 25 per cent from the current 30 per cent as it seeks to attract firms to set up in Kenya.
“Currently, VAT rate in Kenya is among the lowest within the EAC member states. The EAC Common Market Protocol foresees harmonisation of taxes before the EAC Monetary Union. However, studies have shown that low VAT rates accompanied with rationalised exemptions promote compliance and improve revenue collections,” said Treasury in the Medium Term Revenue Strategy that aims to enhance domestic revenue collection.
“In this respect, the government will review the VAT rate as well as VAT exemptions and zero rating.”
In reviewing the VAT exemptions and zero rating, the government will remove all products from the zero-rated list save for exports while only leaving unprocessed products from the VAT-exempt list. The lists are found in the first and second schedule of the VAT Act.
It noted that local industry players have been abusing the zero-rating and exemptions to include products that should ideally not be in these lists, resulting in the underperformance of tax collections from vatable products.
The Treasury noted that VAT revenue as a percentage of GDP declined from 4.6 per cent in the 2013/14 financial year to 3.8 per cent in the 2022/23 financial year.
“This is largely attributed to tax exemption and zero rating of some goods that do not conform to the international best practices. In this respect, the first schedule and the second schedule of the VAT Act will be reviewed to rationalise the exempt and zero-rated supplies and align the VAT system to the destination principle as well as other international best practices,” said Treasury.
“The review shall limit zero rating to exports and remove all VAT exemptions except for unprocessed goods. However, the government will develop an appropriate strategy to address the tax burden on essential goods and services.”
The Treasury said it would reduce the corporate income tax rate from the current 30 per cent to 25 per cent. This, it said, would be in line with what many other countries charge – with the global average standing at 23 per cent – and in turn play a part in attracting multinationals to set up shop in Kenya.
“A comparative analysis shows that the Kenyan corporate income tax rate of 30 per cent is higher than the world average of 23 per cent and the African average of 29 per cent. Studies have shown that high rates of corporate income tax discourage foreign direct investments and encourage investors to lobby for lower rates or tax exemptions,” said Treasury, adding that high rates also contribute to reduced compliance among taxpayers. Locally, this has led to a decline in income tax as a share of GDP.
“To address the issue, the government will reduce the corporate rate of tax from the current 30 per cent to 25 per cent over the strategy period.”
The strategy also said the government would reintroduce minimum tax, which will see loss-making firms also pay taxes. Treasury noted that some companies have in certain instances prepared their numbers to depict a loss portion thus evading taxes. Previous attempts to impose the tax have ended up in courts. The latest attempt was in 2020 when through the Finance Act, it introduced a one per cent minimum tax but this was declared unconstitutional by the Court of Appeal.
“To ensure fairness in taxation of income, the government will redesign the minimum tax taking into account the issues raised by the court on previous minimum tax,” said Treasury.
The government also said it would review the excise tax on alcoholic beverages with the result being an increase in “excise duty on spirits and other higher alcohol content production to discourage their consumption, as they pose higher health risks”.
It added that it would harmonise excise duty on cigarettes and have uniform excise duty rates across filtered, non-filtered and other tobacco products that are currently charged duty at different rates.
“Given the negative health externalities of these products, the rates will be based on the extent of the externalities as well as recommendations of the ongoing EAC partner states study.”
It will also review excise duty on sugar-based nonalcoholic products such as sodas and juice to discourage consumption and prevent obesity and diet-related non-communicable diseases.
“The government will review the tax regime for sugar-sweetened non-alcoholic beverages to base taxation on sugar content,” said Treasury.
Treasury also noted that the implementation of some of the proposed tax measures might lead to a shortfall in revenue collection in the short term. To address the challenge, it noted that might have to resort to surcharge tax (tax on tax) as a temporary measure.
The government is also planning a motor vehicle circulation tax as a form of wealth tax. This will be an annual tax paid by motorist when they are acquiring an insurance cover.
“There will be a minimum tax amount payable by all motor vehicle owners in addition to a graduated amount based on the engine capacity of the vehicle,” said Treasury.
Kenyans planning to buy vehicles powered by diesel and petrol are likely to pay more as the government considers a carbon tax.
The Treasury strategy said there would be a gradual increase in excise taxes on vehicles that use fossil fuels, a move that will also be used to phase out imported vehicles.
It will also introduce excise duty on fossil fuel power tractors, forklift, excavators, earthmovers and other such equipment.
It will at the same time reduce taxes on electric vehicles.
Treasury will also do away with some of the personal reliefs that employees in formal employment enjoy, which tends to reduce their tax burden.
“During the strategy period, the government will review the tax reliefs with a view to eliminate the reliefs that are counterproductive. The current reliefs include: personal, insurance, medical and housing.
“However, with the removal of personal relief, the low-income earners will be cushioned in line with the adjusted tax bands by creating a zero-rated tax band,” said Treasury.
In the revenue strategy, the government is seeking to grow tax revenues to Sh3 trillion over the current financial year and Sh4 trillion over the medium term. The Kenya Revenue Authority (KRA) collected Sh2.4 trillion over the year to June 2023.
Treasury noted that while tax revenues have grown over the past decade, the tax to GDP ratio has been on the decline.
“Kenya’s total revenue collection has tripled from Sh800 billion in the 2013/14 financial year to Sh2.4 trillion in the 2022/23 financial year. However, this revenue collection has been consistently below the Medium Term Plan targets,” said Treasury.
“Kenya has witnessed a declining trend in ordinary revenue collection as a share of GDP since the 2013/14 financial year. The ordinary revenues declined from 18.1 per cent of GDP in the 2013/14 financial year to 15.4 per cent of GDP in the 2018 /19 financial year.”
“This is attributed to various challenges, including growing of the hard-to-tax sectors such as the informal sector, and the digital economy that adopts virtual business models. In addition, there has been a proliferation of tax expenditure over the years.
“The emergence and the spread of Covid-19 pandemic worsened the revenue performance from the 2019/20 financial year and the 2020/21 financial year. Ordinary revenue as a percentage of GDP declined ... to 14.8 per cent in 2019/20 financial year and 13.7 per cent in the 2020/21 financial year.”
Revenue, however, improved slightly to 15 per cent in 2021/22 as the economy started picking up after easing of Covid-19 restrictions. It would dip again to 14.1 per cent over the 2022/23 financial year owing to the Russia-Ukraine conflict that led to disrupted supply chains and partly to blame for a global economic slowdown.
Treasury expects this to improve to 15.8 per cent of GDP in the current financial year as it embarks on major revenue mobilisation.
The International Monetary Fund (IMF) has estimated Kenya’s potential of tax revenue to GDP to be 25 per cent.