Indirect taxation taking centre stage in State revenue measures

The world has, over the last few decades, seen a shift from direct to indirect taxes – essentially a move from taxing spending rather than income. 

Many countries have decreased direct tax rates, particularly for corporates, and increased VAT rates. This change should, in theory at least, increase collections and make enforcement easier. In practice there is perhaps someway to go, but the ball has started rolling.

Kenya has to an extent been no different, but in my mind not as effective. Until the early nineties, direct tax rates were as high as 65 per cent for both individuals and corporates.

With the introduction of value-added tax (VAT) in 1990, these high direct tax rates were lowered to the 30 per cent top rate we have today.

While this certainly saw a rise in revenue collection, the reality was that this came from income and corporate taxes rather than VAT. If the intention was to tax spending rather than earnings, the change was probably a failure!

Given that VAT is payable on virtually everything one buys, you would expect this to be the major contributor to tax revenues. However, VAT has not exceeded 27-30 per cent of total collections and direct taxes continue to be the largest proportion. Much of this is probably as a result of over-complex VAT legislation and a plethora of exempt and zero-rated items.

The Value Added Tax Act, of 2013 attempted to address this by significantly reducing the number of non-taxable items. However, over the years, this trend has reversed, and we are headed back to the bad old days.

So where does the government go next? Indirect taxation is probably still the right way to go, and VAT has been preforming better as enforcement improves, but there is still work to be done. Excise duty seems to be the current target with numerous new items being subject to it since 2015; what was traditionally known as “sin tax” - taxing all the things one enjoys but have health repercussions.

Kenya has started to introduce excise on services as well such as airtime, mobile money charges and bank charges, among others.

Much as one would expect in an election year, even though the incumbent is not contesting, there were very few changes to the tax legislation in the Budget Speech read on April 7. Overall, the Cabinet Secretary said his proposed tax measures are expected to raise Sh50.4 billion, a drop in the ocean in a collection target of about Sh2.4 trillion.

It is important to also remember that Kenya, like may parts of the world, had a terrible 2020 with Covid-19 lockdowns and supply chain disruptions, but a somewhat better 2021, with growth forecast at 7.6 per cent, which may be a trifle optimistic. This year may be tougher with the ongoing war in Europe and an election.

On the indirect tax front, VAT and excise duty exemptions for the pharma industry on plant and machinery was a clear sign of the panic that the pandemic caused during its peak.

Local manufacture of such item should benefit from this, which should contribute to the manufacturing pillar of the Bid Four agenda.

Similar exemptions for the local assembly of motor vehicles and spare parts were introduced, an industry that already benefits from a lower corporation tax rate. Both these industries will also benefit from exemption from Import Declaration Levy and Railway Development Levy.

The Commissioner General is being granted the power not to impose inflationary excise duty adjustments on products that have a social impact. But the Cabinet Secretary did not just give exemptions for excise duty, he also introduced a 15 per cent tax on advertising by the gambling, gaming and alcohol industry.

Another move to expand excise duty by taxing services and this is something we are likely to see in the future, too. There were minor amendments to the Income Tax Act including allowing deduction of cash donations to charities even if they are not registered.  Gains on financial derivatives by non-residents will now be taxed to ensure fairness and equity. It is not clear how this will impact the Nairobi International Financial Centre.

Perhaps the proposed amendment with the most far-reaching impact is an amendment to the Tax Appeals Tribunal Act.

Under the proposal, if one loses at the tribunal and wishes to appeal to the High Court, there will be a requirement to deposit into a special account 50 per cent of the disputed tax.

This could well be a substantial sum that may impact the taxpayer’s ability to continue in business.

If the taxpayer wins the matter at the High Court, the sum will be refunded in 30 days, although it must be said that the State’s record on payments and refunds is far from exemplary!

The speech did not say whether the special account will be interest bearing and there is no time limit for determination of the matter in the courts.

The author is partner at Kody Africa LLP. The views in this article are the author’s and not necessarily those of the firm