Black market to thrive as Ruto tax plan suffers blow

Traders wait for tomatoes to be offloaded from lorries at Daraja Mbili Market in Kisii County. [Sammy Omingo, Standard]

Kenyans are bracing for tax increases as the William Ruto government seeks to bridge its budget deficit. 

However, the proposals are stirring concerns about the underlying consequences, raising questions about the effectiveness of such measures.

Proponents of higher taxes in the Kenya Kwanza regime argue that increased revenue is essential to fund vital government services like infrastructure and social programmes. 

However, critics warn that excessive taxation could kill already struggling businesses, while pushing others to the informal sector, ultimately harming the economy.

As tax rates under the Ruto administration go higher, traders and individuals are devising ways to evade.

This hidden marketplace, where transactions happen in cash and receipts vanish, threatens to rob the government coffers and distort the very economic picture it tries to tax, experts warn.

With the Finance Bill, 2024, proposing taxes on critical services like mobile money, some businesses are dumping formal payment systems.

“We are also not using mobile money any more. You have to withdraw money and pay hard cash,” says John, a hardware trader in Kiambu County.

The businessman says he offers customers an opportunity to buy goods on the cheap as long as the Kenya Revenue Authority (KRA) electronic receipt (ETR) is not issued.

“The compliance burden is so huge the statutory contributions have gone up significantly we can no longer afford to be legitimate businessmen under this taxation regime,” he says.

John is not alone in this underground economy. June, a pharmacist along Thika Road, says she no longer uses the money wallets of leading telecommunication companies.

“We heard they want to track our transactions. We don’t want trouble so we are preparing ahead,” she says, amplifying a sense of fear among many small-scale traders who had embraced mobile channels for ease of commerce.

Such moves could reduce government revenue needed for essential services and create unfair competition for businesses that comply, experts say.

“A large shadow economy undermines tax collections; reducing the shadow economy is associated with higher tax collections,” says tax expert Paul Karanja.

“Greater tax complexity imposes heavier compliance burdens on taxpayers, disincentivizes tax compliance, and encourages taxpayers to move into the shadows. Receipt-free cash transactions for goods and services increase the risk of tax evasion.”

Kenya’s vibrant jua kali sector, known for its informal micro-enterprises, thrives partly due to the high costs and complexities associated with formal operations.

Parts of the public transport sector, particularly the matatu industry, are known to have a significant informal component, where some operators might under-report income to avoid taxes.

Bankers and financial inclusion advocates are also expressing concern about the proposed implementation of Value Added Tax (VAT) on various banking services contained in the Finance Bill, 2024.

The Kenya Bankers Association (KBA) says the proposal, if passed, would put more financial burden on customers. 

The Bill proposes a VAT on transactions like foreign exchange (forex), money orders, telegraphic transfers, credit card issuance and cheque processing, which were previously exempt.

The Bill is also seeking to increase excise duty on financial services from the current 15 per cent to 20 per cent.

“Consequently, a customer will pay a total of 39.2 per cent on fees charged by banks as tax if the proposals are enacted to law,” says Raimond Molenje, KBA acting chief executive officer.

“For example, if a bank charges a customer Sh100 for money transfer, the Bill proposes an additional Sh39.20 to be paid by the customer to cater for taxes (Excise Duty at 20 per cent and VAT at 16 per cent) bringing the total cost to Sh139.20,” he said.

Bankers warn this is likely to push customers to transact in cash outside globally recognised leading financial ecosystems with adverse loss in taxes.

“We urge the National Assembly to reconsider these proposals and maintain the current status of exempting financial services from VAT and sustaining the 15 per cent Excise Duty,” says Molenje. 

A section of bank bosses are also cautioning that the proposed taxation measure would hurt Kenya’s status as a financial hub and eradicate gains made by East Africa’s largest economy. 

Tax experts and banking industry players reckon that these new VAT charges will make banking more expensive for Kenyans, potentially discouraging them from using formal financial services. 

“There will be VAT on forex transactions, money order, telegraphic transfer, issue of credit cards, cheque processing. All of this was exempt from VAT so far,” says Kunal Ajmera, chief operating officer of Grant Thornton Kenya, a consultancy firm. 

“This will make banking more expensive and Kenya as an uncompetitive jurisdiction. Those fintech companies who are based outside Kenya and facilitates such transactions will benefit from this at the cost of local banks.”

The debate over taxation highlights the delicate dance between raising revenue and fostering economic growth.  

By addressing the concerns of potential underground activity, the government can craft tax policies that are both effective and fair, ensuring a thriving formal economy that benefits all Kenyans, say experts.

This could hinder progress towards financial inclusion, a key goal for developing economies like Kenya, bankers have warned.

“The scrapping of VAT exemptions for banking transactions….will make basic banking expensive, raise cost of credit, and drive people to the black market,” NCBA Chief Executive John Gachora posted on X.

The concern is that higher costs might push people back towards informal financial systems, which are often less secure and transparent, bankers say.

Additionally, Kenya’s competitiveness as a financial hub in the region could be affected if banking services become more expensive compared to neighbouring countries.

“Kenya has been a leading light in financial inclusion globally. An unnecessary tax on banking transactions will make us uncompetitive. Large FX transactions will be offshored. Completely unnecessary,” argued Gachora.

He asked legislators to reject the proposed tax measure to save Kenyans the economic pain. 

In a bid to step up surveillance on tax evaders, the government plans to amend the Data Protection Act to allow the KRA to identify tax discrepancies by analyzing bank and mobile money transactions.

This is part of Ruto’s grand plan to broaden the country’s tax base by catching tax evaders and raising revenue at a time when the taxman has been missing targets.

The Data Protection Act sets out restrictions on how personally identifiable data obtained by firms and government entities can be handled, stored and shared.

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