The Cabinet Secretary responsible for the National Treasury read his budget statement on 10th June 2021. This follows the publication of the Finance Bill, 2021 on 30th April 2021. In this alert, we summarize some of the proposed tax changes that are set to take effect in the 2021-2022 fiscal year.
National Tax Policy Framework on the way…but will it help?
In his budget statement, the Cabinet Secretary indicated that he has initiated a process for developing a National Tax Policy Framework that will ‘… not only enhance administrative efficiency of the tax system but provide consistency and certainty in tax legislation and management of tax expenditure.’
Whilst these overall goals are commendable, it is difficult to predict what exactly the policy framework will achieve. After all, policy is not law nor can it override tax legislation.
Expanded definition of a permanent establishment (PE)
The Cabinet Secretary proposed to widen the definition of a PE to align it with the international best practice. It is expected that the expanded PE definition will borrow from both the OECD Model Tax Convention and the UN Model Tax Convention. Worth noting is that the UN Model Tax Convention contains a service PE concept. If this is adopted, it will result in the creation of a PE for non-resident persons providing services in Kenya through employees or other personnel engaged by the non-resident person where the services continue for a period or periods exceeding in the aggregate of ninety one (91) in any twelve (12) month period commencing or ending in the year of income concerned as envisaged in the Finance Bill, 2021.
If passed into law, this expanded definition of a PE will result in Kenya having taxing rights in a larger number of instances.
Widened scope of services subject to Digital Service Tax (DST)
The Cabinet Secretary proposed to expand the scope of the recently introduced DST to cover all traders who use a digital marketplace platform to transact their businesses. Currently, DST covers platforms facilitating ‘direct interaction’ between buyers and sellers electronically. It is expected that the widened DST scope will cover all platforms enabling online sale of goods/services. This will increase the cost of goods sold or services rendered electronically.
Earlier this month, the G7 advanced economies reached what they have termed a ‘historic agreement’ to stop companies shifting profits to low tax jurisdictions and ensure the largest multinationals pay a minimum corporate tax in the countries where they operate. As part of the agreement, the G7 is working towards removal of all Digital Service Taxes although no agreement has been reached on this issue. It will be interesting to see how Kenya’s recently introduced DST evolves in the long run.
More restrictive thin capitalization rules underway
A more restrictive approach to thin capitalization has been proposed. Currently, thin capitalization rules are based on a 3:1 debt to equity ratio. If the proposals are passed into law, thin capitalization will be based on a ratio of earnings before interest, taxes, depreciation and amortization (‘EBITDA’). This will result in any interest paid in excess of 30% of a company’s EBITDA being disallowed for corporate tax purposes.
These tighter rules will limit the extent to which entities may be financed through debt.
Perpetual carry forward of tax losses
The Finance Bill, 2021 proposes to allow the perpetual carry forward of tax losses beyond the currently allowed ten-year period. The proposed amendment may mitigate against the stifling effect of the minimum tax provisions which would result in taxpayers losing their entitlement to offset tax losses against future tax liabilities beyond the ten-year period even where such taxpayers pay minimum tax.
Increased withholding tax (WHT) rate on service fees payable to subcontractors in the extractive sector
The Cabinet Secretary proposed to harmonize the WHT rate on service fees paid to subcontractors with the rate applicable to other services. The rate is therefore set to increase from the current 5.625% to 10%. This will result in increased cost of doing business for petroleum and mining companies in Kenya.
Capital allowances to be on a straight-line basis
The Cabinet Secretary proposed to do away with the reducing balance method of calculating Capital Allowances and instead have these apply on a straight line basis in order to provide for definite timelines for claiming the deductions. These changes have been included in the Finance Bill, 2021 but no transitional guidelines have been provided for items currently qualifying for capital allowances on a reducing balance basis.
More rebates for taxpayers
The Cabinet Secretary proposed a rebate allowing employers engaging a minimum of ten graduates from Technical and Vocational Education and Training Institutions as apprentices to deduct an extra 50% of the costs of the apprentices’ emoluments from their taxable income.
The Cabinet Secretary also proposed a tax relief on contributions made by taxpayers to the National Health Insurance Fund at the rate of 15% of the contributed amount.
Value Added Tax (VAT)
Exported services to be VAT exempt
Finance Bill, 2021 proposes to exempt exported services from VAT. This begs the question as to why exported services should be treated differently from exported goods. This is a blow to Kenya’s competitiveness as a service hub.
Increased VAT exemptions
In his budget statement, the Cabinet Secretary proposed to expand the list of supplies subject to VAT exemption to include:
- Medicaments used in health facilities including decongestants and food supplements.
- Diagnostic and laboratory reagents, artificial respirators including therapeutic respiration apparatus, breathing appliance, gas masks as well as medical equipment and technologies used in the provision of medical services.
- Inputs used in the manufacture of medical ventilators and breathing appliances.
These three exemptions should serve to reduce the cost of the proposed VAT exempt supplies and cushion Kenyans from the impact of Covid-19.
- Goods for exclusive use in geothermal or oil exploration and mining prospecting; and, equipment for generation of solar and wind energy. This exemption is geared towards promoting the exploration and mining sector in the country.
- Equipment for generation of solar and wind energy. This is a shot in the arm for the country’s developing green energy sector.
- The transfer of assets into Real Estate Investment Trusts and Asset Backed Securities. Hopefully this reduces the cost of securitization in the country.
Transitional provisions for projects carried out under Power Purchase Agreements (PPAs)
The Cabinet Secretary proposed transitional provisions for projects under PPAs signed before April 2020 to allow these to continue benefiting from the VAT exemption in respect of taxable goods used in the projects. This transition will expire upon completion of the projects.
One word that summarizes the proposed customs duty amendments is ‘protectionism’; all of these are geared towards protecting local industries from cheaper foreign imports. In summary, the proposals include:
- Raw materials and inputs for the manufacture of masks, sanitizers, ventilators and personal protective equipment will continue to enjoy customs duty remission for another year.
- Imported iron and steel products shall be subject to 25% for an additional year.
- Vegetable products including potatoes, peas, tomatoes, and other will attract import duty at the rate 30% for one year pending finalization of the review of the EAC Common External Tariff.
- Raw materials for the manufacture of baby diapers will continue to be duty free under the Duty Remission Scheme.
- Imported products for the manufacture of leather and footwear products maintained at 25% and a further specific duty rate is to be introduced to guard against undervaluation.
- Import duty on imported furniture has been maintained at 35% for an additional year.
- Raw materials for the manufacture of roofing tiles will continue to be duty-free under the Duty Remission Scheme.
Re-introduction of excise duty on betting
The Cabinet Secretary proposed a re-introduction of excise duty on betting, which will be charged at the rate of 20% on the amount wagered. The re-introduction of this tax will be an additional burden to an already heavily taxed industry.
Introduction of excise duty on products containing nicotine or nicotine substitutes
To bring products containing nicotine or nicotine substitutes that are currently not subject to ‘sin tax’, the Cabinet Secretary proposed to introduce excise duty on these products at a specific rate of KShs. 5.0 per gram. This is likely to increase the cost of these products but whether this results in a drop in consumption remains to be seen.
Rebates on excise duty paid on internet data
The Cabinet Secretary proposed rebates on excise duty paid on internet data by persons purchasing data in bulk for resale. The intention of the proposed amendment is to reduce the cost of internet accessibility to end users.
Tax Administration Procedures
Incorporation of mutual administrative assistance in tax administration
The Cabinet Secretary proposed amendments to facilitate implementation of the Multilateral Convention for Mutual Administrative Assistance in Tax Matters which was ratified by Kenya in July 2020. This will facilitate automatic exchange of tax information between the Kenya Revenue Authority and agencies in other jurisdictions. This is expected to result in increased data driven audits and compliance checks of offshore activities by individuals and organizations.
Tattle tales to get paid
The Cabinet Secretary proposed to increase the reward payable for information leading to the identification of unassessed taxes or duties. Currently, a person who provides information leading to identification of unassessed taxes is 1% of the duties or taxes so identified or KShs. 100,000/-, whichever is the less. The upper limit has been increased to KShs. 500,000/-.
The Cabinet Secretary also proposed to increase the reward payable for the information leading to the recovery of unassessed taxes or duties. Currently, a person who provides information leading to recovery of unassessed taxes is 5% of the taxes or duties so recovered or KShs. 2,000,000/-, whichever is the less. The upper limit has been increased to KShs. 5,000,000/-.
The proposals will encourage voluntary sharing of information with the Kenya Revenue Authority thereby bolstering tax compliance and revenue collection.
Most of the amendments proposed through Finance Bill, 2021 have an effective date of 1st July 2021. In order for this to actually happen, this must be passed into law on or before this date.
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