Winston Churchill once contended that “for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle.”
This statement rings true in the Kenyan context where, despite myriad legislative and policy measures to squeeze more tax from Wanjiku, the state of the economy is not proportionately representative of the revenue collected by the exchequer.
The Finance Bill, 2021, as would be expected, has proposed a raft of tax legislative measures mainly geared to ensure that the government bridges its revenue deficit for the upcoming financial year.
One of the notable proposals under the Bill is to exempt exported taxable services from value-added tax (VAT). Such services currently enjoy a zero-rated status for VAT.
Exported taxable services have for a long time, under the VAT law and in line with generally accepted principles relating to international trade, been zero-rated.
Exemption means that the service is not considered taxable altogether while zero-rating means that the service is taxable but at zero per cent.
However, the underlying effect is different. Exemption disentitles a person who is registered for VAT from claiming a deduction of the VAT suffered on acquiring taxable business purchases (commonly referred to as input tax).
Zero-rating, on the other hand, entitles a person who is registered for VAT to claim a deduction on input tax.
This is on the basis that only persons making taxable supplies (which include zero-rated supplies) may claim a deduction (or offset) of input tax paid on purchases.
Non-recoverable input tax that arises due to exemption becomes a business cost to the registered person and may impact profitability.
International best practice stipulates that VAT should be a tax borne by the end user of either goods or services. Simply put, it is a consumption tax. Ordinarily therefore, businesses should not bear the burden of VAT.
In the case of goods traded across borders, the country of origin does not apply VAT on such goods; rather it is the destination country where the goods are consumed that has taxing rights on the goods.
This is to ensure VAT does not become a tax borne by business.
A good example is a Kenyan acquiring a second-hand car from Japan. At the port of exit in Japan, VAT is waived. However, on arrival in Kenya at the port of entry, VAT will be collected on the car together with other customs duties.
Similar treatment should apply for VAT on services traded across borders. However, this is complicated by the intangible nature of services. Unlike goods, the export or import of services does not ordinarily go through customs and the level of control by the government or Kenya Revenue Authority is far less.
Nonetheless, the application of VAT on international transactions, whether for goods or services, should not depart from the neutrality and destination principles that dictate the application of VAT on such transactions.
Kenya cannot tax its way into prosperity. Any tax changes should aim to create an enabling environment for business to thrive.
A move to exempt from VAT the export of taxable services is likely to be a deterrent to business and its gains may be disproportionate to the attendant losses.
The government’s proposed move is a departure from international best practice. It is also, at best, a simple solution to a complex problem.
- The writer is a tax manager at Deloitte East Africa. His views do not necessarily represent those of Deloitte. [email protected]