Value Added Tax (VAT) - Ep4

Transcript

Titus Mukora

So welcome again to our ongoing series of the Finance Act on PwC Kenya’s Tax Talks podcast. Really, really excited to have two guests here, specialists in their field, Job Kabochi and Priya Shah. I’m going to ask them to introduce themselves first before we continue with this conversation. Job? 

Job Kabochi

Thanks Titus. So Job Kabochi is my name. A tax partner with PwC in Kenya. I’ve been in this field of VAT for the last 22 years or so, both as an in-house practitioner for one of the big US conglomerates looking after VAT for their Middle East as well as Africa region. And I’ve had the privilege of leading the VAT team, or the indirect tax team, at PwC Africa for the last eight years. So pleasure being here today with you, Titus.

Titus Mukora

Priya?

Priya Shah

Thank you, Titus. My name is Priya Shah. I’m a senior manager with PwC Kenya. I’ve now been with PwC Kenya for almost four years, specialising in VAT. Before I moved to Kenya, I was working in London for almost 15 years, again specialising in VAT. I am very delighted to be here to talk about the VAT implications of the Finance Act. So thank you for having me.

Titus Mukora

Welcome, welcome. So Job, lots and lots of changes in this Finance Act. But before we just drill down to the specifics on this Finance Act, give me maybe your overall thoughts on this, on what you think about the trends or whatever is coming out from the Finance Act in respect of VAT. 

Job Kabochi

I think, similar to many other governments out there, we’ve seen the government of Kenya focus on targeting indirect taxes. And when you think about indirect taxes, think about VAT, think about customs and excise as a way of collecting taxes. One of the topical ones that has been commented on by many thought leaders is the one around the increase of the VAT rate from the 8% to 16% on fuel products — and that clearly talks to the government that is looking at VAT as a way of enhancing its revenue collection.

You have had changes like a focus on VAT, on insurance compensation, for instance. That’s just talking to the collection of additional revenue for the government. But I’d say we’ve also seen VAT being used as a way of cushioning the cost of living for the mwananchi. So if you think about the change that the government has introduced around the LPG gas, for instance, which has then been moved from the 8% VAT to a zero rate VAT. That’s talking to making it a bit more affordable for the common man when it comes to access to energy. 

We’ve then also seen changes that are then aimed at the environmental agenda. So when you see a government that is talking about zero rating electric vehicles, then that talks to a government that is then thinking about the environmental impact that, say, fossil fuels have on our environment.

But at the same time, I would say we’ve seen a government that then is grappling with whether to exempt or zero rate when it comes to basic commodities and basic services. So we’ve seen an oscillation between exemption and zero rating when it comes to things like medicaments. We’ve seen several of those products now, again, finding themselves in the exempt schedule as opposed to the zero rated schedule.

But I would say one of the things that we’ve also noted is that, whilst in the last two to three years, we’ve seen a lot of focus on the digital economy, this year, I think that economy is getting a break. I think that’s because, just leading up to the Finance Act, we’d seen sudden changes being introduced by the VAT on digital market regulations.

So I guess the government is almost then saying, let’s wait and see how that plays out before we introduce more changes in that sector. 

Titus Mukora

I just want to pick up on one thing that you’ve spoken about. I mean, driving past a petrol station one can’t avoid but see the eye-popping price for fuel. What’s going to be the impact of that increase in VAT from 8% to 16% on fuel? 

Job Kabochi

So if you think about it, the bigger impact is going to be for the bigger macro element. If you think about the manufacturing sector and you then are looking at, say, industrial fuel. Now attracting VAT at a rate of 8%, that quickly just means that the cost of production has gone up.

If you then think about sectors like agriculture, where you’re using diesel for your tractors, quickly, then, the cost of production from an agricultural perspective is bound to go up. So at the end of the day, what you then expect is that the ripple effect of that is access to food, access to transportation. It just means a higher cost of production, a higher cost of living for the mwananchi. One could then sit back and ask: what could the government have done differently?

What we’ve seen in other economies is that key sectors — if you think about it, Kenya is still heavily dependent on thermal electricity production — certain sectors could have been ring fenced from the impact of the VAT at 8%. Either working around a rebate, for instance, for say, their electricity production, whereby they would then be able to get their VAT back, and therefore then that means that that additional 8% does not need to be passed on to the common mwananchi, or as well as the manufacturing sector, which is then heavily dependent on electricity.

Titus Mukora

Let me bring Priya into this conversation here — and Priya, I hope there’s something more uplifting that you have to talk about here in respect of the Finance Act and the changes for VAT. Is it all doom and gloom or is there anything positive that we can talk about? 

Priya Shah

No, so there’s been a lot of positive things as well with this Finance Act.

The one important one is export of services. Now, export of services has been a very contentious area for the last few years. The VAT rate has changed from zero rated to exempt to standard rated for certain services which are not considered to be business process outsourcing. And now back to zero rated again. So this is a very welcome move.

It’s something that we as a firm have quite invested heavily in to lobby for this. When the Finance Bill actually came out, it suggested that export services should be exempt from VAT. Now, what that would have meant is that whilst, yes, no VAT is charged on that supply, any VAT that that Kenyan supplier has incurred in making that supply, they won’t be able to recover that.

So this would have made Kenya very uncompetitive in the international scene. Luckily, or rather thankfully, our lobby efforts paid off. The Finance Act has confirmed that, effective from 1 July 2023, export services will be zero rated. What does this mean for our Kenyan suppliers? Provided that the service that they’ve exported is consumed offshore, they’re able to zero rate the services. So that means charge no VAT. But on the other side, they can recover all the VAT that they’ve incurred — obviously subject to normal VAT rules.

Now, there’s still this big debate about, even if the Kenyan business is able to zero rate the services and if, depending on the VAT profile, if they are in a VAT refund position, would they actually be able to get these refunds back from Kenya Revenue Authority?

This is something taxpayers have grappled with over the last few years, but we have new sets of rules. Once your VAT refund has been approved, you can then apply to either have this VAT refund set off against other tax liabilities for that period, or even future tax liabilities for the same legal entity. So all in all, VAT on exported services being zero rated is a very welcome move.

And in fact, it’s actually in line with what we’re seeing around the world.

Titus Mukora

And it’s not only exported services which was zero rated in this Finance Act. I think there’s a whole range of other goods and services. 

Which ones are those? 

Priya Shah

That’s right. So actually there’s been a lot of goods that have now been included in the zero rating schedule.

And if you look at the theme of goods, there’s a wide range, but it generally covers agriculture, manufacturing, cleaner energy and environmental issues, pretty much in line with the government’s agenda. So even though Job said that fuel prices are going up, they have tried to cushion that by bringing in a lot more goods as zero rated.

So electric bicycles and electric busses will now be zero rated from a cleaner energy perspective. That would work for them. We then have bioethanol vapour stoves, which would promote cleaner cooking. From a manufacturing perspective, it’s going to be the supply of locally manufactured and assembled mobile phones — which should be a big industry for Kenya.

We also have local purchase of tea and coffee that would help with the agriculture side. These are only a few of the items, but it gives you an idea of where the government’s headed.

Titus Mukora

Excellent. Let me bring you, Job, back into this conversation. Job, I think there was some short-lived joy from the Finance Bill whereby transfers of business were going to be exempt from VAT.

But then when the Finance Act came, that proposal seems to have been dropped. One: what happened? And two: what’s going to be the consequences of that? 

Job Kabochi

Yeah, I guess — what happened? I guess it’s just a normal lawmaking process. It was an indication of the policy direction the government wanted to go. And I guess keeping with what Priya is talking to, just keeping with international norms, that there was this relief that had been proposed around business restructure.

But I guess the parliamentarians then have that right to actually then interrogate the draft proposal — and end up with where we’ve ended up, where that proposal has actually been left out of the Act. Now I would say, for a government that is looking to attract investors into the country, maybe this is one that could have received a different kind of a consideration.

Because what this actually means is that, if you think about a disposal of a business or restructuring of a business — and let’s take an example, say like the telco sector, where the regulators are then pushing for a separation of the core telecom activity and the financial services part of all the services offered by telco companies in Kenya  — if you think about that separation, what the law currently is providing is that each and every asset or service that is going to be transferred as part of such a reorganisation would then have to be assessed on its own merit, whether it attracts a VAT or not.

It’s likely that most of the assets will then attract VAT. So it’s making a business restructure transaction 16% more expensive. And one could then argue that it’s only a cash flow cost. But in some of these transactions it actually ends up being an absolute cost. 

Priya was talking about the ability to recover your VAT as an input tax deduction. The fundamental rule is, to the extent that you are then making exempt financial services or exempt services, you are not entitled to your recovery of input credits.

So if you then have, say, the financial services part of a business transferred and which attracts 16% VAT, that VAT then is a total trapped, sticking VAT in such a business transaction. So an unfortunate one. We thought that, yes, the government had eventually listened to stakeholders that are interested in this space, but unfortunately one that did not pass and one that we then expect will continue being a point that causes investors to ponder whether investing in Kenya is actually as lucrative as the government is presenting it to be.

Titus Mukora

Yeah. Definitely adds to the exit taxes that one has to consider when they’re disposing of a business. I think maybe I’ll bring this conversation to an end, unless you have anything else that you wanted to say. But let me thank you very much, Job and Priya, for joining us on this — and VAT being what it is, such an important tax, I’m sure that we’re going to be having more discussions as there are more developments throughout the year on this. So thank you very much and welcome back. 

Job Kabochi

Thank you Titus. 

Priya Shah

Thank you.