Reassessing Kenya's VAT-Withholding Regime - Aligning Fiscal Policy with the Realities of the Digital Era

The Government of Kenya introduced the Withholding Value Added Tax (WHVAT) regime in October 2003 with the primary objective of addressing revenue leakages and enhancing Value Added Tax (VAT) compliance. Initially, the WHVAT framework targeted government institutions in addition to other designated entities, mandating them to withhold 16% of VAT on taxable supplies and remit directly to the Kenya Revenue Authority (KRA).

However, the system faced significant operational challenges including persistent VAT refund backlogs and negative cash flow implications for businesses which led to suspension of the regime in 2011. It was later reintroduced in September 2014 under the VAT Act, 2013 with a revised withholding rate of 6%.

Subsequently, the enactment of the Tax Procedures Act (CAP469B) (TPA) in January 2016 repealed Section 25A of the VAT Act, the enabling legal provision for Withholding VAT (WHVAT). This resulted in the temporary suspension of WHVAT until 2019.  The Finance Act, 2019 later re-established the WHVAT regime - through amendments introduced under Section 42A of the TPA with a reduced rate of 2% to alleviate the cashflow burden on taxpayers.

Since its introduction, WHVAT has contributed to a steady growth in VAT collection from KES 61,725 million in the Financial Year (FY) 2003/2004 to KES 314.157 billion in the FY 2023/2024 representing approximately 25% of total tax revenue as per the KRA annual revenue report. This growth reflects broader economic expansion, improved tax compliance and key policy reforms notably the implementation of the Electronic Tax Invoice Management System (eTIMS).

Notwithstanding its contribution to early tax collection, WHVAT has introduced inefficiencies that could hinder further VAT revenue growth if not reassessed. The recent deployment of the eTIMS, increased automation of tax administration processes, VAT special table and the emergence of digital tax compliance tools, have significantly diminished the initial rationale for WHVAT. A comprehensive review is therefore not only timely but necessary.

Fundamentally, VAT is a pass-through tax or otherwise a consumption tax intended to be borne by the final consumer. VAT operates on a multi-stage payment system where registered businesses act as intermediaries where they charge output tax on their taxable sales and remit to KRA and offset it against input tax incurred on their purchases. They are also entitled to credit for WHVAT deducted and remitted in advance by the appointed agents. As a result, the offset of WHVAT credits against output tax results in no incremental collection by the government.

Ultimately, while WHVAT does not increase total VAT revenue, it leaves an undesirable impact on cashflow for suppliers as its advance collection model requires businesses to be out-of-pocket prior to self-assessing their VAT position. As KRA gains from a cashflow perspective, businesses lose in delayed liquidity and constrained working capital due to delayed refunds. The impact is particularly pronounced for Small and Medium sized Enterprises (SMEs) and contractors which undermines the realization of the Bottom-Up Economic Transformation Agenda.

As of March 2025, Kenya Association of Manufacturers (KAM) reported outstanding WHVAT refund claims amounting to KES.15 billion owed to manufacturers.   This imposes an increased cost of doing business as businesses have to grapple with costly borrowing to sustain their business operations and meet vendor obligations.

Further, with the introduction of eTIMS in 2023 and the subsequent amendments to the Income Tax Act requiring eTIMS generated invoices to support deductible expenses, KRA now has enhanced capabilities to monitor real-time business transactions that are traceable and auditable. This enables the Authority to detect and curtail fictitious claims and fraudulent transactions thus enhancing VAT compliance. The recent introduction of pre-filled VAT returns that allow taxpayers to claim input VAT only on invoices that were relayed to KRA’s iTax portal through eTIMS reinforces transparency.

Given these developments, the foundational purpose of WHVAT was mainly to prevent fraudulent transactions and non-declaration which has been largely addressed through automation and eTIMS. The KRA now has full visibility over purchases and sales for businesses. Consequently, the WHVAT regime becomes a duplicative and administrative burden to both taxpayers and the KRA without necessarily improving compliance. Its initial gains are now realizable through the adoption of technology while its negative impact on cashflow for businesses persists.

In addition, the Finance Act, 2023 changed the previous framework of accounting for and payment of WHVAT from the 20^th day of the following month to within five working days of payment to the supplier. While the new change supports the government's cash flow requirements, it imposes significant compliance obligations on WHVAT agents. The increased frequency of WHVAT remittance has created administrative impediments which have necessitated additional human resources driven by the need to mitigate exposure to potential penalties and interest for failure to deduct and remit WHVAT on time.

Further complexity of what should be a straightforward system arises from reconciliation of withheld amounts in the VAT return involving manual tracking, record-matching, and ongoing follow-ups and communication with KRA.

It is further worth noting that the provisions of the VAT Act allow registered persons to seek refunds for WHVAT credits. The high volume of refund claims from WHVAT places a burden on the refund processing system and impedes broader revenue operations. It also contributes to tax expenditure, a fiscal area that the government is keen to streamline as evidenced by the gradual removal of items that are eligible for VAT refunds from the VAT law.

Kenya has entered a new digital era of tax management. With the integration of eTIMS and iTax, KRA possesses comprehensive oversight of taxpayer transactions enabling effective validation and early detection of irregularities. Therefore, to align the country’s WHVAT regime with modern tax administration practices, the KRA should implement an automated mechanism of verifying WHVAT refund claims and facilitating timely approvals for either direct refund settlement or offset against other tax liabilities.

In a digitally driven economy, enforcing WHVAT without a seamless real-time, refund mechanism undermines tax efficiency. It represents a mismatch between policy intent and technological capability hence attempting to address legacy challenges with present-day tools ineffectively.

With the available data, technology and infrastructure, Kenya needs a reassessment of the effectiveness of the WHVAT framework. Kenya must pursue implementation of a VAT system that reflects a modern economy and offers greater efficiency, equity, transparency and predictability in the tax landscape.

Maxwel Ambiro is a tax consultant at Deloitte East Africa. The views presented are his own and not necessarily those of Deloitte. He can be reached at mambiro@deloitte.co.ke.

This article was originially published on Business Daily here.