Hits and Misses of Finance Bill, 2023

The Government has proposed a raft of changes in 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 affecting agricultural produce in the year 2022. Kenyan businesses and wananchi need to be lauded for remaining resilient when the key macroeconomic fundamentals were not working in their favour. The work Bank published its Kenya Economic Update in May 2023 noting that real GDP expanded by 4.8 percent in 2022, a deceleration compared with the 7.5 percent 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 – hustlers, it is yet to be seen whether its policies will help redistribute wealth and reverse the worsening income inequality. It is said that less than 0.1 percent of Kenya’s population own more wealth than the bottom 99.9 percent. The pressure on the US dollar demand is an indication of high levels of imports compared to exports. Africa Development Bank Group (AfDB) notes in its Africa Economic Outlook 2023 that the current account deficit for Kenya widened to 6 percent of GDP in 2022 from 5.5 percent in 2021 driven by the low trade deficit. AfDB notes that the GDP is projected to marginally grow by 5.6 percent in 2023 and 6 percent in 2024 driven by services and household consumption. Inflation is projected to rise to 8.6 percent in 2023 and 5.9 percent in 2024 driven by food and energy inflation while monetary policy is expected to remain tight.

Ensuring business remain afloat in the midst of the above challenges depends on adoption of Government policies that support business operations including tax policies. The Government 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 capitalized businesses 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 of continued employment should the new owner opt to retain them. 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 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 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%. 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 to business process outsourcing. Businesses were shocked when exported services were subjected to VAT from July 2022 because it is contrary to globally accepted principle of taxation of internationally traded services. These services are usually taxed through 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 element or opted to seek such services from other jurisdictions without VAT on exported services. This reduced revenues to Kenyan businesses thereby resulting to lower income taxes to the Government. One would question whether there was any benefit in levying VAT on exported services at 16 percent in the grand scheme of things.

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

With the Kenya’s economy being predominantly agricultural, the Government should do everything possible to safeguard all policies that support agricultural output and even implement more policies to augment the current polices. It should not reverse any current polices 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 percent of GDP and 27 percent indirectly through its linkages with other sectors. It also employs over 40 percent of the total population and more than 70 percent of the rural populace.

Given the critical role the sector plays in providing livelihoods and a food basket for the Kenyan economy, one would question why the Government has proposed in this year’s Finance Bill, the change of VAT status of fertilizers 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 Government 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 fertilizers 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 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, social security while also expanding the tax revenue base, and increased foreign exchange earnings.

Kennedy Okoyo is Senior Tax and Legal Manager at Deloitte East Africa. The views presented are his own and do not necessarily represent those of Deloitte. He can be reached kokoyo@deloitte.co.ke