Lower VAT rate works better for economy than an exemption

VAT as a consumption tax is meant to be borne by the final consumer in a supply chains. FILE PHOTO | NMG 

By JOB KABOCHI AND IMELDA MUTISO

Summary

• Taxation Kenya would have been the first East African country to impose VAT on petroleum products.

When tax is imposed on essential commodities, it may have far wide reaching implications beyond the intended policy measure of revenue collection. Essential commodities include items that consumers require for their day-to-day living as well as critical inputs in the production value chain. These inter alia include pharmaceuticals products, medicaments, clothing and foodstuffs such as bread, unga, milk and cereals. Key to the production value chain include electricity and petroleum products.

Had it not been for Parliament’s two-year extension, the transitional Value Added Tax (“VAT”) exemption on various petroleum products, including diesel and petrol, would have lapsed on September 1.

VAT at the standard rate of 16 per cent, would have kicked in, making Kenya the first East African country to impose the levy on petroleum products. We note that this exemption was to lapse in 2016 but the government extended it by two years.

The push to levy VAT on fuel is not an isolated case of fiscal policy shift as the government has come under pressure from among others, development partners to manage public debt and opt for innovative ways of raising revenue. Other recent fiscal measures include the evolution of excise duty from the traditional ‘sin tax’ to becoming a mainstream transactional tax and a preference for VAT exemption over zero rating, in an effort to ease the government’s VAT refund challenge.

VAT as a consumption tax is meant to be borne by the final consumer in a supply chain. In this regard, while it may appear that exemption and zero rating have similar effect of reducing the cost of supplies, this is not the case.

Under zero rating, all VAT incurred by the supplier is recoverable as cash refunds from the government. On the contrary, in an exemption regime, the suppliers are not entitled to refunds of VAT incurred in the production chain.

All the unclaimed VAT is therefore passed on to the consumer as part of the price for goods or services. In essence, VAT exemption merely presents a false impression of cost reduction.

With the above backdrop one may hasten to question why the heightened attention to the lapse of transitional VAT exemption on petroleum products? Is levying VAT at 16 per cent the only option available to government and is it a lesser evil vis-à-vis VAT exemption? Is further extension of the VAT exemption better than permanent exemption?

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Various commentators have painted VAT at 16 per cent as the greater evil. With this narrative etched in the Mwananchi’s mind, it is perhaps time the government presented a more positive alternative narrative with regards to its fiscal policy. For instance, it is our view that zero per cent VAT would be the ideal rate for petroleum products for a country keen on enhancing financial inclusion and its manufacturing capacity. This said, we are also awake to the VAT refund challenge posed by zero rating which remains a pain for government. Additionally, some policymakers argue that zero rating should be a preserve for exports.

With this in mind, is it not time to consider reintroducing a reduced VAT rate for essential commodities? The repealed VAT Act, Cap 476, provided for a lower rate of tax at 12 per cent on the supply of certain items. Similarly, the current VAT Act, 2013 allows the National Treasury CS, subject to Parliament’s approval, the discretion to vary the rate of VAT by either decreasing or increasing the rate by four percentage points.

Accordingly, it is our view that the existing VAT rates may be varied from zero to four per cent, a reduction from 16 per cent to 12 per cent or an increase to a maximum rate of 20 per cent.

The reduced rate, would in our view be a halfway between the adverse effects of the 16 per cent rate and the zero rate – such a rate would inter alia guard against a high inflationary effect and the VAT refund challenge associated with zero rating whilst ensuring increased revenue for the government.

The concept of reduced VAT rates would not be unique to Kenya. Most of the European Union member countries have adopted a reduced rate on certain essential commodities.

Examples include the United Kingdom with a standard rate of 20 per cent and reduced rate of five per cent on items such as children’s car seats and home energy and, Austria with a standard rate of 20 per cent and reduced rates of 13 per cent and 10 per cent on foodstuffs and pharmaceutical products.

Closer home, Egypt has a standard rate of 14 per cent and a five per cent reduced rate on machinery and equipment, Algeria with a standard rate of 19 per cent and a reduced rate of nine per cent on supplies relating to agriculture, Ghana with a standard rate of 12.5 per cent and three reduced VAT rate on schemes for small entrepreneurs.

Mr Kabochi is a partner while Ms Mutiso is a manager at PwC Kenya’s Tax practice.