The Ministry of National Treasury and Economic Planning (the National Treasury) has released the Medium–Term Revenue Strategy MTRS or the Strategy) for the financial years 2024/25 – 2026/27. The newly released MTRS is dubbed “An Approach for Enhancing Domestic Revenue.” The Strategy aims to boost Kenya’s tax revenues, specifically by raising Kenya’s revenue yield from the current 13.5% of the Gross Domestic Product (GDP) to at least 20% of the GDP by the end of the financial year 2026/27. This would be in line with the East African Community (EAC) target. The National Treasury has rolled out the Strategy at a time when there has been a decline in tax revenues as a share of the GDP and the increase in budget expenditure pressures has resulted in a rise in the fiscal deficit to 5.5% of the GDP in the financial year 2022/23.
The International Monetary Fund (IMF) estimates Kenya’s potential of tax revenue to GDP to be 25% and considers this achievable noting that in the financial year of 2022/23, the tax revenues to GDP ratio of South Africa was 27.3% and of Morocco was 22.5%. The National Treasury reckons that boosting revenue yield and reducing the fiscal deficit requires a holistic reform of the tax system as opposed to gradual and isolated reforms on one tax head. Accordingly, the MTRS proposes robust and coordinated reforms across all tax heads.
Despite the well-intentioned efforts of the National Treasury, the implementation of some proposed measures maintains the perception that Kenya's tax system lacks predictability and certainty. This unpredictability stems from the frequent annual amendments to tax laws, with certain provisions changing almost on an annual basis. Consequently, businesses and taxpayers struggle to make long-term plans and decisions with confidence. Addressing unpredictability and uncertainty was a central objective of the draft national tax policy. However, it seems that as long as the government faces a fiscal deficit, it will continue to adjust tax provisions each year in an attempt to boost tax revenues.
Some of the key revenue measures outlined in the Strategy include:
- reduction of the corporate income tax rate from 30% to 25%;
- the re-introduction of minimum tax, which would apply to companies in a tax loss position;
- the phasing out of preferential corporate tax rates such as those applicable to Special Economic Zones (SEZs) and Export Processing Zones (EPZs). This is a clear demonstration of the lack of predictability and certainty of the Kenyan tax system noting that the recently enacted Finance Act had just introduced additional tax incentives for SEZs. This measure will be quite concerning to investors who have set up in SEZs and EPZs since they would have been attracted by the available tax incentives including the preferential corporate tax rates;
- review of the non-resident withholding tax rates from the current rates to 30%, or if the corporate tax rate is reduced, to 25%, to align with the corporate income tax rate;
- the review of the Pay As You Earn (PAYE) graduated scale to expand the tax bands in a bid to enhance progressivity and reduction of the highest PAYE rate to 30%;
- the review of tax reliefs to eliminate those which are deemed counter-productive;
- review of the residential rental income tax rate to align it with the corporate income tax rate of 30% or progressively increasing the current rate. The residential rental income tax rate had just been reduced in this year’s Finance Act from 10% to 7.5% of the gross rental receipts;
- increase of the VAT standard rate from 16% to a possible 18% to harmonize it with the regional average;
- a review of the VAT registration threshold to increase it;
- review of the current VAT exemptions and zero-rated supplies with a view to zero rate only exports and retain exemptions only for unprocessed goods;
- increase in excise on alcoholic products, tobacco products and non-alcoholic beverages;
- review of excise duty on betting and gaming taxes; and
- introduction of the motor vehicle circulation tax paid annually by motor vehicle owners at the point of acquiring an insurance cover.
We analyze in further detail the key tax proposals in the Strategy:
Corporation tax
Reduction of the corporate income tax rate from 30% to 25%
This proposal is intended to yield increased revenues from this tax head on the basis that it would encourage foreign direct investments, and local compliance, discourage tax planning and lobbying for lower tax rates.
This would be a welcome proposal by all corporates.
Phasing out of preferential corporate income tax rates such as those applicable to Special Economic Zones (SEZs) and Export Processing Zones (EPZs) which currently enjoy reduced corporate income tax rates in the first twenty (20) years of their establishmentThis proposed measure is a clear demonstration of the mantra that Kenya's tax system lacks predictability and certainty. The Finance Act 2023 has just introduced additional tax incentives for SEZs including removing withholding taxes on payments made by SEZ operators, developers and enterprises to non-resident persons, only for this proposal to phase out preferential corporate income tax rates. If implemented, this proposal is likely to significantly adversely affect entities that have set up long-term projects in the preferential zones based on tax incentives, as well as to disincentivize further investment in preferential zones.
Review of the non-resident withholding tax rate
The Strategy proposes a review of the non-resident withholding tax rates to 30%, and if the corporate tax rate is reduced as proposed, to 25% to align them with the corporate tax rate.
While this proposal is meant to ensure fairness in the taxation of residents and non-residents, it is likely to be challenged on two limbs:
a) certain incomes derived by non-residents from Kenya are subject to further income taxes in the non-resident’s country of residence and may not enjoy tax reliefs; and
b) most contracts with non-resident persons contain gross-up clauses which means that the payments made to non-resident persons would be uplifted to cover for any amount payable as withholding tax. The withholding tax is then borne by the resident persons, which means that the economic impact of the payment is on the resident person. This would be counterproductive.
Review of residential rental income tax
In a bid for the government to realize the expected revenue targets from the residential rental income tax, the Strategy proposes to:
a. tax the residential rental income at the corporate rate of tax (30% or 25% (if reduced to that rate)) and allow for expenses. The rate of tax for residential rental income tax was just reduced in the Finance Act 2023 from 10% to 7.5% of the gross rental receipts; and/or
b. retain the simplified tax regime but progressively increase the rate and allow the deduction of at least 40% of the revenue as expenses.
Further, the Strategy proposes that the government enhances the registration of property agents, mapping of properties and leveraging technology to address compliance challenges.
This proposal is another example of the unpredictability of the Kenyan tax system, noting that the residential rental income tax rate has just been reduced from 10% to 7.5%. The proposal if implemented will be frowned upon by most taxpayers (landlords as well as tenants) unless the increase is implemented gradually. Landlords would aim to pass the tax to residential tenants through higher rental charges.
Re-introduction of minimum tax
Minimum tax at the rate of 1% has previously been successfully challenged in the Kenyan courts as unconstitutional, mainly on the basis that it goes against the cannons of taxation. It is not clear why the Treasury is of the view that the proposed minimum fate would not face the same fate.
It is possible that unlike previously, the Treasury may in this turn, seek to have minimum tax apply to the businesses that have been loss-making for a specified number of years. This is meant to ensure that all businesses pay their fair share of taxes as well as ensure that companies do not engage in creative accounting which would lead to massive losses.
One key consideration that should be made is that companies which are genuinely in a loss position as a result of capital investment claims (such as investment deduction allowances), should be exempted from the application of minimum tax as their losses stem from investment activities which contribute to economic development.
Personal Income Tax
Review of the PAYE tax bands and pension structure
a) The Strategy proposes a revision of the PAYE tax bands to improve their progressivity and harmonize the personal income tax top rate with the corporate tax rate applicable during the strategy period (30% or if the corporate tax rate is reduced, to 25%); and
b) The Strategy also proposes a review of the structure of taxation of pension benefits to eliminate the taxation of pension withdrawals even when these are done before attaining the age of 65.
This proposal comes at a time when the Finance Act 2023 has just revised the tax bands to introduce two new layers with additional taxes at 32.5% and 35%.
If implemented, this proposal would cushion low-income earners since the bands would be expanded making a wider range of incomes subject to the lower income rates. Further, the elimination of the newly introduced tax rates on the graduated scale by harmonizing the highest PAYE rate with the corporate income tax rate will be a welcome proposal and is likely to reduce tax planning measures.
With respect to pension, the intention is to change the current pension tax regime (exempt-exempt-tax) which exempts contributions to pension schemes from tax, exempts from tax investment incomes earned from the pension scheme but taxes withdrawals made from the pension scheme before attaining the age of 65. The proposal is to structure the taxation of pension benefits as exempt-exempt-exempt which would exempt contributions to pension schemes, investment incomes from the pension schemes and withdrawals made from the pension schemes from tax.
However, to curb tax planning, the Strategy proposes to restrict exempt contributions made to the pension scheme to a capped amount.
Review of exemptions on personal income
The Strategy proposes to review and rationale exemptions on personal income, including exemptions granted on a reciprocal basis and exemptions granted to staff of international Non-Governmental Organisations.
This is intended to expand the tax base so that more people who are currently exempt from tax can be subject to personal income taxes.
Review of tax reliefs
The Strategy proposes the review of tax reliefs on personal income tax to eliminate those which are counterproductive. Currently, tax reliefs include personal relief, insurance relief, and mortgage relief among others.
The removal of the tax reliefs is likely to further burden taxpayers who are currently labouring under heavy personal income taxes. However, if the government then adjusts the tax bands to improve their progressivity, the effect may not be felt as harshly by individual taxpayers.
Value Added Tax
Review of the VAT Threshold
The Strategy proposes an upward adjustment in the VAT registration threshold.
The upward review of the VAT registration threshold from Kenya Shillings five million (KES 5M) is meant to factor in the effects of inflation given that the last review was conducted in 2007. This is a welcome proposal since, if implemented, it will relieve smaller taxpayers from the burden of complying with VAT.
Review of VAT exemption and zero rating
The Strategy proposes to limit the zero-rating of taxable supplies (supplies subject to VAT) to exports and remove all VAT exemptions except for unprocessed goods. The Strategy indicates that the government will find a way to address the tax burden on essential goods and services.
This proposal appears to be in line with the current government’s policy to incentivize production as opposed to consumption. However, the exclusion of certain essential items such as medical and agricultural inputs from the list of exemptions as proposed is likely to make access to medical care as well as agricultural inputs expensive, which would not augur well with the government’s agenda on agriculture and affordable health care.
Phasing out of VAT preferential rates
The Strategy proposes to adopt a standard rate for all taxable supplies.
The phasing out of preferential rates comes at a time when some of these rates have been eliminated such as the previous preferential rates on petroleum and petroleum products which were subject to VAT at the preferential rate of 8%. Currently therefore there are no products that enjoy preferential VAT rates.
Review of the VAT rate to 18%
The Strategy proposes to review the VAT rate to harmonize it with the current EAC rates.
The revision of the VAT rate is likely to weigh heavily on consumers since VAT is an indirect tax which is eventually passed down to the consumer.
Imposition of VAT on certain services provided by schools and on insurance services
The Strategy proposes to impose VAT on services provided by schools, but which are not related to education as well as on insurance services.
If implemented, this proposal is likely to further drive up the price of insurance as well as auxiliary educational services which will in turn affect consumption.
The imposition of VAT on insurance services is likely to raise the cost of insurance and potentially decrease insurance penetration in Kenya, which currently stands at only 2.8% of the GDP.
Excise Duty
Review of excise duty on petroleum products and introduction of excise duty on coalThe review of excise duty on petroleum products and the introduction of excise duty on coal is intended to be in line with the Government’s vision to promote the transition to clean energy. However, this will make both petroleum products and coal quite expensive, which will be passed on to consumers through higher costs of goods.Review of excise duty on alcoholic products, tobacco products and non-alcoholic beverages
The Strategy proposes to:
a) review the basis of taxation of alcoholic products to the alcohol content and increase excise duty on spirits and high-content alcoholic products;
b) harmonize excise duty rates across filtered and non-filtered cigarettes as well as other tobacco products;
c) review the tax regime for sugar-sweetened non-alcoholic beverages to base taxation on sugar content.
The increase in excise duty rates on alcoholic products, tobacco products and non-sweetened beverages is meant to discourage consumption. It however remains to be seen whether such an increase in taxes will yield the desired effect or will achieve the desired revenue targets.
Other proposed tax measures include:
- The review of excise duty on betting and gaming to make it more punitive;
- Introduction of a motor vehicle circulation tax paid annually by motor vehicle owners at the point of acquiring an insurance cover; and
- The possible introduction of a carbon tax based on the carbon content of fossil fuels.
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