This paper, therefore, looks at the 2023 taxation outlook in Kenya and discusses areas of change to the national tax policy and recommends adjustments that will reduce the country’s consistent deficit brought about by low tax collection. This paper further proposes some changes to the tax side of the budget that would help increase revenue collection and also reduce substantially, or even eliminate the budget deficit without necessarily increasing taxes. At the same time, these tax changes would be beneficial to the economy, not only due to the direct positive macroeconomic effects of deficit reduction and higher national savings but also through improved efficiency in how society’s resources are allocated. In this paper, I consider how to do this with a general strategy of first broadening and expanding the tax base, yielding a significant amount of revenue and a more efficient and neutral base without having to raise rates, and then adjust rates in a relatively efficient and equitable way in order to raise additional revenue.
Approved fiscal changes in the Finance Act, 2022
Increase of the capital gain tax rate: Capital gain subject to tax can be ordinarily defined as the difference between the purchase price (acquisition price) and the selling price of certain assets. Consequently, Capital Gains Tax (CGT) is the income tax payable on the gain/profit made on the sale (disposal) of a capital i.e it is the gain you make that is taxed, not the amount of money you receive. For financial assets, such as corporate stock, the basis generally is the price originally paid for the stock. For physical assets such as buildings, it is the difference between the sales price and the acquisition cost plus any improvement minus depreciation. For example, if you bought a painting for KES. 12, 000 and sold it later for KES. 24, 000, there will be a tax on the gain of KES. 12, 000. The gain is calculated as the difference between the cost at which the property was bought and the price at which the property is sold, this is after deducting any costs of improvement to the property and any incidental costs incurred o the transfer of the property, for example, loan/ mortgage interest, advertising costs, valuation costs, legal fees and enhancement. Capital gains occur in an economic sense regardless of whether they are realized. For example, if an individual were to buy a stock that appreciates in value there would be an accrued capital gain. However, the gain would be subject to tax until the stock was sold, at which point the gain would be realized.
CGT was introduced in Kenya in 1975 and suspended on June 13, 1985, when Kenya was seeking to spur growth in the mining sector, real estate market and deepening local participation in capital markets. The Finance Act 2014 amended the eight schedule of the Income Tax Act and as a consequence, CGT was reintroduced with effect from 1 January, 2015 at a rate of 5% of the net gain. The reintroduction of the CGT regime in Kenya was expected to widen the tax net and increase tax revenue collection for the government. CTG is chargeable on the net gain accruing to a company (interpreted widely) or an individual (resident or non-resident) on or after 1 January, 2015 on the transfer of property situated in Kenya, whether or not the property was acquired before 1 January, 2015. CGT is a final tax and cannot be offset against other income taxes. Property is defined by law (under the Eight Schedule of the Income Tax Act) and includes land, building and marketable securities. Marketable securities are termed as ‘securities capable of being sold and stock as defined in Section 2 of the Stamp Duty Act. CGT, therefore, applies to the transfer of unlisted securities. Listed securities have been excluded from the application of CGT. A transfer is deemed to occur when the property is sold, exchanged, conveyed or disposed of in any manner; or on the occasion of loss, destruction or extinction of property; or on the abandonment, surrender, cancellation or forfeiture of, or the expiration of rights to property. Further guidance is provided by KRA for instances where the acquisition cost is not available with additional guidance provided under paragraph 9 of the Eight Schedule
Capital Gains Tax Rate has been increased from 5% to 15% which took effect from 1 January 2023. The move to increase CGT, from a regional integration perspective, is a step towards bridging the differences in the fiscal and tax policies between East African countries by aligning Kenya to its neighboring countries that impose high tax rates on capital gains for example: Uganda; Tanzania (10% for non-residents) and; Rwanda’s rates of 30%. Kenya’s CGT of 5% was relatively low. Increasing the CGT rate is constrained as a way to raise revenue, based on official scoring, because of the larger realization response. The increase in the rate of CGT comes as no surprise as there have been numerous conversations surrounding the matter for a while. The current rate of CGT is determined based on the specific circumstances of the transfer. For example, if you invest KES. 10 billion in Kenya and transfer the investment after 5 years, the net gain will be subjected to the rate that was in effect at the time of investment. This means that if you made the investment before the CGT rate was increased to 15%, it would be subjected to a lower rate of 5% when the transfer is made. CGT is a transaction-based tax and should therefore be paid upon transfer of property but not later than the 20th day of the month following that in which the transfer was made. The tax is paid by the person transferring the property (seller). After the same is paid, the seller is under no obligation to pay other taxes and cannot be offset against other income taxes.
I believe that the triple increase in CGT may result in: decreased demand for property, leading to a slowdown in the real estate market; decreased supply of property as some owners may choose to hold onto their property rather than sell and pay higher taxes; decreased investment in property as higher taxes may discourage new investors; negative impact on economic growth in Kenya, including potential consequences for the construction and real estate industries and related industries such as lending and insurance; decreased commission for property agent as some sellers may reduce commissions in response to the higher tax burden. The CGT rate increase will thus see property owners, developers and investors pay higher tax charges upon the sale of properties. Consequently, the government ranks as the main beneficiary due to an increase in revenue collected
However, there are certain property transactions that have been exempted from CGT which are inter alia: issuance by a company of its own shares/ debentures; transfer of machinery including motor vehicles; disposal when administering the estate of a deceased; vesting of property to a liquidator or receiver; individual residence occupied at least 3 years immediately before the transfer; sale of land by an individual where the proceeds are less than KES. 3 million; agricultural land that is less than 50 acres; transfer of securities by a body expressly exempted under the Income Tax Act.
Increase of the digital service tax (DST): Finance Act 2019, amended the Income Tax Act to include taxation of income accruing from the digital marketplace. A digital marketplace has been defined as a platform that enables the direct interaction between buyers and sellers of goods and services through electronic means. Effective 1 January 2021, the Finance Act 2020 introduced a 1.5% tax on income from services accrued or derived in Kenya through a digital marketplace. The tax is applicable on the gross transaction value of the services provided and is due at the time of payment. The responsibility to account for the tax is on the owner of the digital marketplace or an agent appointed by the Commissioner. The National Treasury issued DST regulations in December 2020 which extended the application of the DST to include: downloadable digital content such as mobile applications; over-the-top services including streaming television shows, music or podcasts; sale or licensing of, or any other form of monetizing data collected about Kenyan users; provision of a digital marketplace; subscription-based media including news; electronic booking or ticketing services; provision of search engine services, etc. Effective 1 January 2021, the Finance Act 2020 introduced a 1.5% tax on income from services accrued or derived in Kenya through a digital marketplace. The tax is applicable on the gross transaction value of the services provided and is due at the time of payment. The responsibility to account for the tax is on the owner of the digital marketplace or an agent appointed by the Commissioner
However, the Finance Act 2022 has increased the Digital Service Tax Rate from 1.5% to 3.0%. This move may discourage digital service transactions as the additional tax burden will be shifted to individual consumers. DST is only applicable to non-resident persons whose income from the provision of services is derived from or accrues in Kenya through a business carried out over the internet or an electronic network, including through a digital marketplace. Persons subjected to DST are required to submit a return and pay the tax due to the Commissioner on or before the 20th day of the month following the end of the month in which the digital services were offered.
E-books, Videoconferencing, Spotify, Netflix: There’s also an introduction of VAT (16%) for e-books, videoconferencing, Spotify, and Netflix which will lead to an increase in their prices as these additional tax costs will be passed on to consumers. Multinational tech firms have already issued notices to customers that they have started applying the standard 16% VAT on these electronically supplied services, as the taxman sets sights on the booming digital market in Kenya. This follows the introduction of the Value Added Tax (Digital Marketplace Supply) (Amended) Regulations, 2022.
Withholding tax on derivatives earnings by foreigners (15%): Foreign traders gaining from a local-based derivative contract will also start paying a withholding tax of 15%. Foreign traders in the derivatives market will therefore be among the biggest losers in the second phase of the government’s revenue-raising plan for the Financial year 2022/23.
Mobile to bank transactions and vice versa: High Court has however ordered Safaricom and the Central Bank to halt the re-introduction of charges on transactions made between mobile money wallets and lenders pending the determination of a suit involving financial consumer rights. The order by Justice Thande is expected to be in force until January 23 when the matter will be mentioned for further directions. Should the Court decide that the new transaction fees are legal, they will come with an additional tax burden of a 20% excise duty that will be levied on these transfers, affecting millions of Kenyans who had taken advantage of the waiver to send money cheaply. The charges had been suspended in 2020 due to COVID-19. However, should the Court decide that these transaction fees are illegal, it will steer Kenya into a new frontier, when it comes to how we view mobile money vs physical cash vs when we store in banks. It will mean a lot more gains to an economy that’s run on Mpesa; a lot more businesses will be able to freely accept such payments and people will no longer be charged fees when moving their own cash to their other accounts.
The KRA has also moved to the Supreme Court to challenge a ruling by the lower courts blocking the implementation of the mandatory 1% gross turnover minimum tax, as it lays the ground to hit the KES 2.1 trillion tax target. The Finance Act, of 2020, introduced a minimum tax of 1% on gross turnover. The minimum tax was not to be applicable to employment income, residential/rental income, capital gains, persons undertaking mining or upstream oil gas activities, persons subject to turnover tax, insurance business, and any business whose retail price is regulated by the government. The minimum tax was intended for taxpayers who are carrying out business and thus earning revenue, but their tax payable is lower than 1% of their gross turnover. The minimum tax was to be a final tax and payable in installments that are due on the same date as the current installment tax obligations. Should the Supreme Court reverse the rulings by the High Court and the Court of Appeal, loss-making businesses that do not pay the standard 30% corporate tax will take the biggest hit.
Can increasing taxes reduce the budget deficit?
Developing countries are struggling to recover lost income despite the tax reform measures that they implement to bridge tax gaps. This situation has given rise to budget deficits and Kenya, just like every other developing country, also experiences a budget deficit due to low resources owing to low tax revenues, low salaries and savings. If government expenditure surpasses its revenue, then the country has a budget deficit. In other words, the budget deficit negates the amount of public savings. A budget deficit can also be triggered by s government spending more than the taxes it raises. Budget deficits have attracted a great deal of attention over the past few decades.
In spite of its various attempt to widen the tax base and the numerous austerity measure to cut down on its recurrent expenditure, the Kenyan government has over the years been a perpetual casualty of s budget deficit. Historically, the government of Kenya has suffered budget deficit since independence which is mainly attributed to expenditures falling short of government revenue due to limited budgetary resources brought about by low economic performance such as high inflation rates and over-indebtedness, among other ills.
Deficit reduction cannot all come on the spending side of the budget; some changes to tax policy are necessary to bring budget deficits under control. For Kenya to reduce/eliminate the budget deficit, its imperative that it widens its tax base. for instance, the VAT system in Kenya is still an unexplored goldmine that can generate billions of shillings in revenue if well structured. New sources of revenue will be needed to fund rapidly increasing government spending. The projected increases are huge and unavoidable as they stem from the steeply growing population, impacts of the Covid-19 pandemic and ravaging drought throughout the country. It is thus unrealistic to expect that government spending as a share of the economy will remain at its historical average, so taxes as a share of the economy will have to increase as well. Exactly how much depends on the priorities of Kenyan society – once we decide how much we are willing to spend, we have to be willing to pay for that spending with more revenue.
New revenue would thus make it easier to address the deficit sooner rather than later so that reckless policies and the curse of compound interest stop digging the fiscal hole deeper. While fundamental reforms to the long-run entitlement programs are necessary, they will not come quickly enough and it will be difficult to accomplish such reforms in a revenue-neutral, let alone a revenue-increasing way. Potential cuts to discretionary spending might be an easier way to chip away at the budget, but these changes are just too small to have much of an effect on the deficit and are more difficult to monitor over the longer run.
How else can Kenya raise revenue without increasing taxes? How can we overcome the existing loopholes in the current taxation regimen?
To collect more taxes KRA doesn’t need new taxes, or higher rates but can adopt the following measures:
Improving the collection of taxes that are (already) legally due, that is, pursuing strategies to reduce the ‘tax gap’ is one way to increase revenue without changing tax rates. There are ways that the KRA could use its current level of funding more efficiently to increase compliance and the revenue yield but additional resources may be necessary and could produce substantial not increases in revenue. The magnitude of owed taxes that are not collected, the tax gap, is staggering. The gross tax gap is the difference between the taxes that are lawfully owed for a given time period and the taxes that are voluntarily reported and contributed. Citizens and framers should be concerned about the tax gap not only from an inefficiency or loss-of-revenue standpoint, but because it’s an unfair feature of the tax system. For instance, non-compliance creates a substantial degree of horizontal inequity across taxpayers- between those who comply and those who do not. In addition, the distribution of non-compliance across income categories implies a vertical inequity-with higher- income households hiding (intentionally or not) larger fractions of their income from the KRA. The perceived unfairness of the tax gap may in fact contribute to its size. Public perception of rampant tax evasion might induce a downward spiral of decreasing compliance, as honest taxpayers become frustrated with the inherent injustice of a tax system with substantial non-compliance and imperfect enforcement. Thus, this in turn would potentially necessitate more aggressive and invasive enforcement efforts and thus promote further distaste for the KRA. Addressing the tax gap requires first acknowledging the fact that the gap exists because of both intentional tax evasion and unintentional non-compliance. A general strategy to address willful evasion is to pursue policies that increase taxpayers’ perceived or actual marginal cost of evasion (such as increasing audit activities and penalties) and decrease the taxpayers’ perceived or actual marginal benefit of evasion ( such as decreasing marginal tax rates). To increase compliance among taxpayers who unintentionally fail to pay their tax bills, the costs of compliance need to be reduced for example by making the tax law simpler and easier to understand, or by providing more information.
Another way to increase to collect more taxes is by broadening the tax base by reducing tax expenditures. Tax policy is used not just to raise revenue but also to forgo revenue through subsidies that take the form of exclusions and exemptions deductions and credits, and preferential tax rates. Tax expenditures are a much less obvious form of government spending than direct expenditure because they reduce the revenue the government might receive rather than appear as a cost on the spending side of the budget. Tax expenditures, therefore, influence the budget deficit in the same way that spending programs do, and represent a huge amount of spending. Government should thus reduce its tax expenditures which will in turn broaden the tax base.
Also, tax administration is an attractive sector open to damaging corruption as the opportunities and incentives to engage in the illicit activity are numerous. For tax officials, tax and revenue collection opens opportunities to take bribes and embezzle funds. Private businesses and individual taxpayers may corruptly influence tax officials to evade tax obligations and save larger sums of money. Corruption in taxation is thus always to the detriment of the State coffers and leads to reduced revenue collected. A multitude of public financial management reforms have been tried, over and over again but many of these reforms have had little or no impact on corruption whatsoever, as they have only tried addressing the technical and fiscal levels and left the drivers of corruption untouched. Without the political will to curb corruption in the tax administration, there are few changes that reforms and safeguards will succeed. However, if there is a political will to curb corruption, possible approaches include measures to enhance the autonomy and capacity of KRA and also ensure high salaries for tax collectors, training, and better facilities; reduce taxpayers’ interaction with tax officials; improved internal control, audits and oversight of tax administration; encourage informants to report corruption and; use credible penalties for non-compliance of tax subjects.
In addition, in the Report on the Finance Bill 2022 by the Departmental Committee on Finance and National Planning, a majority of stakeholders proposed that the CGT rate of 15% be reconsidered to a lower value of 10% citing that Kenya is yet to adopt a mechanism to address inflation adjustment in the increased CGT rate. Furthermore, the stakeholders argued that the increased CGT rate would have a negative impact on Kenya’s competitiveness as an economic hub and investment destination. The Committee rejected the proposal by stakeholders to reduce the CGT rate to 7.5% citing that this would have a negative impact on revenue allocation. Notwithstanding that, it agreed and recommended that the CGT rate be revised from 15% to 10%. Despite the recommendations from the Committee and stakeholders, the Finance Act adopted a CGT rate of 15%. Owing to the significant change made, the government could have considered a gradual increase, say a 10% increase that was proposed by some stakeholders. This would have cushioned investors in the region who will be massively affected and from whom the 200% increase is likely to elicit strong reactions as a significant portion of capital gains on disposal of properties is often attributed to a general increase in prices because of inflation. The increase should, therefore, have considered an inflation adjustment (indexation) to arrive at an equitable value. In the present context, indexation refers to an adjustment of the asset value to eliminate the effect of inflation using the consumer price index.
Although taxes are not responsible for the enormous long-run fiscal challenges facing our nation currently and, in the years, to come, tax policy can certainly work to either exacerbate the problem or alleviate it. This paper has described many opportunities to raise revenue that can be pursued fairly immediately. Adopting some combination of these justifiable national tax policy changes could easily eliminate deficits within 5-10 years. Therefore, if the National Tax system is formulated well, it will indeed be vital in optimizing revenue generation by the National and County governments. It will further come in handy in facilitating socio-economic development and enhancing income re-distribution within the various sectors of the economy.
The writer is a law student at JKUAT-Karen Campus. He’s passionate and particularly interested in Tax law, corporate law, Public International law, Administrative law and Environmental law.
The writer is a law student at JKUAT-Karen Campus. He's passionate and particularly interested in Tax law, corporate law, Public International law, Administrative law and Environmental law.