Finance Act 2023: Leveraging the National Tax Policy for Effective Tax Laws

Introduction

The publication of the National Tax Policy by the National Treasury in April 2023 marked a significant milestone in Kenya’s efforts to streamline her taxation system. The policy’s primary objective is providing a comprehensive framework for taxation and addressing key challenges that have hindered efficient tax collection and administration in the past. The policy addresses a key concern on the unpredictability of tax rates due to annual extensive revisions replaced by comprehensive tax law reviews every 5 years. This is expected to establish a stable tax regime, a predictable business environment for planning and a balance between an up-to-date tax system and minimal disruptions caused by frequent changes.

However, the proposal may be impractical due to the government's tight fiscal constraints that make a rigid 5-year review cycle difficult to adhere to. A balanced approach involves exploring alternative solutions, like adopting a staggered review process for specific tax aspects, perhaps every 2 years instead of waiting for 5. Making well-informed tax laws should be enhanced by actively considering and incorporating feedback from stakeholder consultations, rather than disregarding it, leading to laws lacking real public participation. Lastly, tax laws should include flexibility provisions for downward adjustments of tax rates based on adverse economic conditions.

Challenges Facing Kenya’s Tax System

The policy acknowledges that Kenya has made significant strides in transforming her tax system, but certain challenges persist, affecting revenue performance including:

1. Existence of Hard-to-Tax Sectors: The dominance of Kenya's large informal sector makes taxing it difficult and uneconomical due to poor record-keeping, cash-based transactions, and limited information. As an example, despite the agricultural sector's substantial 21.4% contribution to the GDP, its actual tax revenue fails to mirror this owing to limited formalization efforts.
2. Impact of Tax Incentives: Tax laws offering incentives, like exemptions, deductions, and concessional rates, promote investment and aid vulnerable groups. However, they erode the tax base, leading to substantial foregone tax revenue impacting revenue mobilization.
3. Low Tax Compliance: As of 2021, tax compliance levels for filing tax returns and timely payment were at 68% and 88%, respectively. Low compliance rates result from technical complexities, taxpayer apathy, high compliance costs, inadequate taxpayer education, and limited sharing of information among government agencies.
4. Complexity in Taxing the Digital Economy: The tax system faces challenges in addressing emerging digital economy business models that often fall outside the tax net, raising concerns about tax system equity and efficiency.
5. VAT Challenges: High tax expenditure and multiple VAT rates pose challenges to the VAT system, with estimated 2.2% of GDP tax expenditure in 2020 and multiple rates creating complexities and potential distortions.
6. High Rates of Excise Duty: Kenya's relatively high excise duty rates compared to other EAC partner states may lead to an increase in illicit trade through smuggling.
7. Customs Administration: The dynamics of international trade and increasing regional trade agreements present challenges in customs administration, with inadequate modern technological equipment, limited staff capacity, and collaboration issues among government agencies hindering effective customs management.
8. International Taxation and Tax Treaties: Multinational corporations are significant revenue sources but globalization has facilitated tax planning and profit-shifting practices becoming prevalent with some tax treaties lack provisions to address base erosion and profit shifting.
9. Tax Administration Challenges: A small percentage of individuals issued with KRA PINs pay taxes, and a high number of potential taxpayers remain unregistered, while inadequate tax education and information, and inadequate cooperation between national and county governments on tax matters further impact tax administration.
10. Dispute Resolution: The lack of independence in tax dispute resolution processes and appointment of facilitators by KRA, a party to such disputes, raises concerns about impartiality.

Policy Guidelines under the National Tax Policy

The policy outlined policy guidelines proposed to address the challenges identified above:

1. Hard-to-Tax Sectors such as Agriculture and Informal Sectors: To boost tax yields from these sectors, the government plans to enhance taxation methods including mandating farmers and informal sector players to register with sub-sector associations and co-operative societies. KRA will expand its presence and utilize tax collection agents to improve collection and undertake educational programs to raise tax awareness.
2. Management of Tax Expenditure: The government plans to develop a criteria for granting tax incentives, maintain a public record of all tax expenditures, and introduce sunset clauses for incentives where applicable. Regular reviews will align incentives with the development agenda and a centralized monitoring and evaluation framework, along with annual tax expenditure reports will ensure oversight. Guidelines for granting tax incentives will be regularly reviewed, with a comprehensive review every 5 years, and sector players will provide statistical data on the impact of incentives on business growth.
3. Increase in Tax Compliance Level: To progressively boost tax compliance, the government will continuously review mechanisms to detect and deter tax integrity issues. Modern information technology will be leveraged to enhance tax administration services and maintain accurate taxpayer data. Guideline issuance, taxpayer education, and structured engagement programs will be emphasized to improve compliance levels.
4. Taxation of Emerging Digital Economy: The government plans to leverage technology to address emerging business transactions and digital platforms effectively. Mechanisms will be established to optimize revenue collection from the digital economy, and continuous training of tax administrators in emerging technologies will be prioritized. Regular reviews of tax laws will ensure alignment with emerging technologies.
5. Personal Income Tax: Various policies will be implemented under income tax, including progressive maximum tax bands for personal income tax. All investment pooling vehicles will be treated as pass-thru, subject to regulations. Personal, mortgage, and insurance reliefs will be reviewed every 5 years to minimize bracket creep. Savings for retirement will be subject to exempt-exempt-taxed taxation, where pension contributions are deductible subject to a cap for improving progressivity. Investment income of contributed funds will be exempt from taxation, and withdrawals will be taxed at a progressive rate structure.
6. Corporate Income Tax: In the computation of taxable income from a business, deductions shall be allowed for any expenditures incurred solely and exclusively for generating that income. Allowable deductions for capital expenses shall not exceed 100% of the actual cost of the investment or asset. The corporate tax regime shall feature a single tax rate, without granting any preferential tax rates. In exceptional cases, where specific government policy objectives warrant a preferential tax rate, such rate shall not be lower than 50% of the general corporate tax rate. Repatriated profits for non-residents operating in Kenya through permanent establishments shall be subjected to tax charged similarly to dividends paid to non-residents. For eligible investments, the investment allowance shall be spread over the period specified in the income tax act. The method of calculating the investment allowance shall follow the straight-line method.
7. VAT: The VAT tax base will be determined by domestic consumption of all goods and taxable services, adhering to the destination principle. Any exemptions granted will be solely based on considerations of cost compliance and administration. VAT will be charged at every stage of production and distribution, including retail. A single general rate for VAT will be implemented, without any exemption or lower rates for distributional considerations. Exported goods and services will be zero-rated, while imported goods and services will be subject to VAT. The VAT registration threshold will be periodically adjusted, considering the cost-benefit analysis of collecting VAT from small firms. Additionally, all non-resident suppliers of digital services will be required to register for VAT.
8. Excise Duty: Excise duty will be imposed following the destination principle and shall apply to goods and services with negative externalities, discouraging harmful consumption, as well as luxury goods, communication services, and other items for revenue generation. The duty rate may be ad valorem, specific, or a combination, and in determining whether to impose either, consideration shall be made to ensure no undue advantage is conferred to any category of goods. Excise duty paid on raw materials used in manufacturing excisable products shall be offset against the duty payable on the finished goods. Regular studies will determine the optimal tax rates for different categories and manufacturing or supplying excisable goods and services must be done by licensed or registered individuals.
9. Customs Administration: Measures to detect and deter illicit trade will be enhanced, and intelligence-based risk management and post-clearance audits will be adopted. Modern technology will automate customs procedures, and increased border posts and one-stop border posts will be established. Customs-to-customs cooperation will ensure seamless and real-time information flow.
10. Tax Administration: KRA will enhance the registration of potential taxpayers, leveraging technology to facilitate the process. Continuous capacity development, automation of tax refund processes, and collaboration between national and county governments are among the key focus areas.
11. Tax Dispute Resolution: The government aims to streamline the tax dispute resolution process by reducing costs and time. To achieve this, a technical committee will be established to handle public and private rulings regularly. The out-of-court tax appeals tribunal will be made autonomous, along with the establishment specialized high court for tax matters with capacity enhancement for the judiciary to handle tax issues.
12. International Taxation and Tax Treaties: To address tax malpractices in cross-border transactions, the government will develop rules to tackle base erosion and profit shifting risks. Enhanced measures will detect and deter illicit trade and transfer pricing schemes. Partnerships with other tax jurisdictions will be established, and negotiations on avoidance of double taxation and fiscal evasion agreements will follow international best practices.

Conclusion

The National Tax Policy is poised to be a valuable guide for addressing challenges in Kenya’s taxation regime, exploring diverse revenue sources to optimize tax collections and ultimately contributing to fiscal stability. Key to note, prioritizing the implementation of stakeholder consultation feedback and undertaking tax impact assessments should be prioritized to result in more informed and efficient tax decisions and a responsive and economically rational tax system. As we adopt the National Tax Policy, it is vital for the National Treasury, Parliament and KRA to walk the talk and implement the policy proposals to establish a fair and stable tax regime that fosters economic growth and benefits businesses and consumers alike.