Costly compliance to tax laws and out-of-reach incentives offered by the government are choking small enterprises out of business, a new study reveals.
These barriers have also denied county governments the much-needed revenue as traders would collude to pay less than the required amount which is pocketed by the county revenue officers.
According to the study by The Institute for Social Accountability (TISA) released on September 26, the country’s tax policy and structure is disadvantageous to micro, small and medium enterprises (MSMEs).
The advocacy body has decried an uneven playing field for large corporates and MSMEs saying some of the incentives only benefit those with the financial muscle in the economy.
It also criticised the country’s tax structure noting the heavy reliance on indirect taxes like Value Added Tax (VAT) as compared to direct taxes like Pay As You Earn (PAYE).
The study titled Small Biz, Big Tax, cites Kenya Revenue Authority (KRA) 2021/2022 figures that show approximately 62 per cent of total tax revenue came from indirect tax while VAT is the largest contributor accounting for 42 per cent.
This is compared to personal income tax, as a direct tax, that contributed 24 per cent during the same period.
“This imbalance in the tax structure has led to economic injustices and tax inequalities,” the study says.
“The overreliance on indirect taxes disproportionately impacts MSMEs, youth, women, and persons with disabilities (PWDs) entrepreneurs in the informal sector.”
It adds that indirect taxes like VAT have a regressive impact as they take up a larger proportion of the income of the lower-income population compared to those of higher-income individuals. This results in a heavier tax burden on those who can least afford it hence reducing sales of goods and services of businesses in the informal sector. This is despite the crucial role businesses play in revenue numbers for both levels of government.
“In Nairobi City County, single business permit is the second largest source of revenue after land rates underscoring the place of businesses in the county,” the study.
TISA states that while Kenya has tax incentives that would benefit formal MSMEs, many are not eligible as they operate under the radar of the government. There are some which do not have the financial muscle to benefit from these incentives either.
For example, incentives for research and development(R&D) which allows companies to claim a deduction for the costs they incurred on R&D activities. This incentive, TISA explains, is meant to encourage formal sector companies to invest in activities that improve their products and services.
“This incentive is widely out of reach of MSMEs and informal sector businesses, as they may lack the capacity to engage in significant research and development activities,” the study says.
Another incentive that MSMEs are eligible for is an investment deduction that encourages capital injection into equipment, machinery or buildings.
“For instance, the deduction rate for machinery and equipment is 100 per cent while that for buildings is 25 per cent. While there is no explicit exclusion of MSMEs, this incentive does not benefit most of them due to informality, and low awareness levels amongst MSMEs,” the study states.
The study adds that formal sector companies can also take advantage of tax holidays, which are periods during which they are exempt from paying income tax.
“These tax holidays are often offered to new businesses to encourage investment and growth, and they can last up to five years,” it adds.
From the focus group discussions and sessions held by TISA when collecting views on the tax regimes, compliance was a key issue at the national level. This was particularly due to the multiple tax returns ranging from turnover tax, excise tax, VAT, and also how to claim VAT returns from the taxman.
At the county level, the study exposed the continued revenue leakages due to corruption where for daily market access fees and even some licenses, traders collude with county enforcement officers to pay less than the specified amounts which is pocketed.
“This takes away the revenue need for service delivery to the traders,” the study notes.
TISA states that the tax exemptions and incentives available to the formal sector in the country do create a significant advantage over MSMEs and other small businesses in the informal sector. This then builds an uneven playing field that disadvantages MSMEs and the informal sector, which often lack the resources and capacity to compete with formal sector companies.
“As such, there is a need to review the current tax policies and exemptions to ensure that they are fair and equitable, and that they support the growth and development of all businesses, including MSMEs and the informal sector,” the advocacy group points out.
TISA states that as the government moves to seek greater enforcement by deployment of paramilitary (enforcement officials), there are concerns from small businesses that the exercise will be brutal and harmful as opposed to being educative, affirming and building the needed patriotism.
“The overreliance on indirect taxes to expand the tax base, has proven detrimental to the wellbeing of MSMEs, youth and women operating within the informal sector,” the study states.
“These taxes have contributed to increased product prices, lowering the profit margins.”
Moreover, it adds, the inflationary pressure of these indirect taxes has significantly contributed to higher cost of living posing a challenge to entrepreneurs.
“The asymmetry in tax treatment of MSMEs in the informal sector compared to the formal sector puts them together with youth and women entrepreneurs at a disadvantage, undermining their financial viability,” the study indicates.