New tax reliefs good for cushioning investors but need scrutiny

The Tax Laws Amendment Bill published last week seeks to effect the tax proposals announced by President Kenyatta on March 25 to cushion Kenyans against the negative economic impact of Covid-19. 

The amendment Bill contains a host of proposals including some that Mr Kenyattta did not directly mention in his speech. Particularly significant one is the repeal of the tax provision relating to capital allowance on investments. This was replaced with a new schedule on capital allowance.

The schedule provides for the removal of a popular incentive allowing for investment deductions of 150 per cent of the expenditure incurred in the first year (for qualifying investments).  

This popular incentive was replaced with a provision for an initial claim of 50 per cent in the first year and further deductions in the following years subject to a maximum of 100 per cent.

Removing this incentive is counter-productive, especially at this time when investors are grappling with the Covid-19 pandemic.

Of specific concern is that this shift in policy acts as a disincentive to investments during this tough economic environment. The effectiveness of tax incentives in promoting investment has been the subject of intense debate among economists and tax experts. While such incentives tend to increase the return on investment, they may not always attract more investments.

In addressing this question, policy makers are more inclined to decisions that are likely to generate the most beneficial economic activity in the long run.

For instance, should the government forego a shilling in taxes given away as an incentive or spend it on a public service or on infrastructure?

Market failure

According to a study by James Sebastian and Van Parys 2009, the answer depends on the level of public goods and services that is already present in a country.

It may be better for government to spend a shilling on infrastructure so as to benefit many investors than spend it on incentives that benefit only a few.  However, there are instances where tax incentives result in positive impact in the economy including incentives designed to address specific market failures such as lack of investment in specialist health facilities.

It makes economic sense if a particular tax incentive that benefits a few investors is replaced with an incentive that benefits most if not all taxpayers.

Key proposals in the amendment Bill may compensate for the removal of the popular investment deductions.

These include reduction of income tax top rate from 30 per cent to 25 per cent and the lowering of the corporate tax rate from 30 per cent to 25 per cent.

Also, reduction of the VAT rate from 16 per cent to 14 per cent and the turnover tax rate from three per cent to one per cent would serve this purpose. These measures have the potential to cushion businesses in a depressed economy. They have the effect of retaining extra liquidity that can be used to sustain economic activity.  

Removal of the investment allowance allowing qualifying investors to deduct up to 150 per cent of their capital expenditure in certain cases, and substituting it with the reduced tax rates - income tax, corporation tax, VAT and turnover tax - is a good tax policy, immediate effects notwithstanding.

Increasing upper threshold of turnover tax applicable to small business from Sh5 million to Sh50 million needs consideration. The Sh50 million threshold is high and may rope in businesses that can easily comply with regulations.

The writer is an advocate of the High Court