Hits and misses in this year's Finance Bill as economy hurts

The government has proposed a raft of changes to the Finance Bill 2023 which has elicited a countrywide debate on whether the Bill supports recovery initiatives of businesses that have been affected by depressed economic growth, coupled with the high inflation rate, the weakening Kenya shilling and delayed rainfall. 

This affected agricultural production in 2022. Local businesses and wananchi need to be lauded for remaining resilient when the key macroeconomic fundamentals were not working in their favour.

The World Bank’s Kenya Economic Update in May 2023 noted that real gross domestic product (GDP) expanded by 4.8 per cent in 2022, a deceleration compared with the 7.5 per cent annual growth in 2021.

Whilst the current government campaigned on a platform of helping alleviate the economic situation of the people at the bottom of the wealth pyramid or hustlers, it is yet to be seen whether its policies will help redistribute wealth and reverse the worsening income inequality.

 Trade deficit

It is said that less than 0.1 per cent of Kenya’s population own more wealth than the bottom 99.9 per cent.

The pressure on the US dollar demand is an indication of high levels of imports compared to exports.

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Africa Development Bank Group (AfDB) notes in its Africa Economic Outlook 2023 that the current account deficit for Kenya widened to six per cent of GDP in 2022 from 5.5 per cent in 2021, driven by the low trade deficit.

AfDB notes that the GDP is projected to marginally grow by 5.6 per cent in 2023 and six per cent in 2024 driven by services and household consumption. Inflation is projected to rise to 8.6 per cent in 2023 and 5.9 per cent in 2024 driven by food and energy inflation while monetary policy is expected to remain tight.

Ensuring businesses remain afloat in the midst of the above challenges depends on the adoption of government policies that support business operations including tax policies.

The State seems to have had these challenges in mind when preparing the Finance Bill and proposed some tax policy measures to address them.

For example, the challenges above may force some smaller businesses to sell off their operations to well-capitalised entities as a going concern. This transaction is widely referred to as a Transfer of Business as Going Concern (TOGC).

This way, employees may be guaranteed continued employment should the new owner opt to retain them.

Input VAT

Currently, value-added tax (VAT) is chargeable on the assets transferred to the new owner. Most tax jurisdictions provide relief for TOGCs either by zero-rating or exempting such transactions for VAT purposes.

The merit of zero-rating over exemption is that the former allows the seller and buyer to claim the input VAT incurred in the TOGC.

The latter does not allow claiming of input VAT but is nevertheless better than the standard rating as is currently. From experience, TOGCs are normally occasioned by distress - either from an operational efficiency perspective or from a cash flow perspective.

Levying VAT on TOGCs only exacerbates the pain being experienced, making the business being sold more expensive and requiring the buyer to look for more funds to finance the VAT element. Therefore, the proposal to exempt TOGCs from VAT is timely and responsive to the current business environment and aligns with most VAT jurisdictions globally.

However, the Parliament’s Departmental Committee on Finance and National Planning (Finance Committee) has proposed for the Bill to be amended to make TOGCs taxable at 16 per cent.

This may make these distressed businesses unattractive to potential buyers and impede efforts to rescue them through buyouts.

Similarly, the proposal to exempt exported services from VAT is a positive move from the current situation where businesses that export services are required to charge non-resident customers VAT at the standard rate unless the services are in respect of business process outsourcing.

Businesses were shocked when exported services were subjected to VAT from July 2022 because it is contrary to the globally accepted principle of taxation of internationally traded services.

These services are usually taxed through the Destination Principle, where the country with the taxing right is the country in which the consumer of such services is located.

Non-residents who were not willing to absorb the Kenyan VAT either negotiated for lower prices of the services purchased from Kenya to cater for the VAT or opted to seek such services from other jurisdictions without VAT on exported services.

This reduced revenues to Kenyan businesses, thereby resulting in lower income taxes to the government.

One would question whether there was any benefit in levying VAT on exported services at 16 per cent in the grand scheme of things.

The State’s proposal of reverting exported services to VAT exemption as was the case prior to July 2022 is therefore a welcome move and will make such services competitive compared to the current scenario.

 Global practice

It is even better that the Finance Committee has proposed to amend the Bill and zero-rate these services to allow claiming of input VAT associated with providing these services and also align it with global practice.

It is hoped that the amended Bill clearly provides for zero-rating of all exported taxable services and is not restricted to the services with respect to business process outsourcing.

With Kenya’s economy being predominantly agricultural, the State should do everything possible to safeguard all policies that support agricultural output, and even implement more policies to augment the current policies. It should not reverse any current policies that support agricultural output.

The Central Bank of Kenya (CBK) notes in its Agricultural Sector Survey that the agriculture sector plays a critical role in Kenya, accounting for 22 per cent of GDP and 27 per cent indirectly through its linkages with other sectors.

It also employs over 40 per cent of the total population and more than 70 per cent of the rural populace.

Given the critical role the sector plays in providing livelihoods and a food basket for the economy, one would question why the State has proposed in this year’s Finance Bill, the change of VAT status of fertilisers and agricultural pest control products from zero-rating to exemption.

Changing the VAT status from zero rating to exemption will definitely increase the prices of these products. This is contrary to the State’s promise to lower food prices by incentivising food production.

The Finance Committee seemed to have appreciated the critical role played by the agricultural sector in Kenya’s economy and proposed to amend the Bill to retain the zero-rating status of fertilisers and agricultural pest control products.

Indeed, given the significance of agriculture’s contribution to the economy, one way of increasing employment and redistributing wealth is by supporting players in the agricultural sectors to increase their output.

This is espoused in the 2023 Budget Policy Statement where the government intends to place special focus on increased employment, more equitable distribution of income, and social security while also expanding the tax revenue base, and increasing foreign exchange earnings.

-The views presented are his own and do not necessarily represent those of Deloitte. He can be reached [email protected]

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