Expanding the base: Recent policy reforms and technological advances should help boost the percentage of revenue from tax collection

Several changes are under way in Kenya’s tax landscape for 2017. The Kenya Revenue Authority (KRA) is in the midst of implementing long-term and multi-pronged strategies to collect more revenue, and politicians are continuing to tweak the legal environment to serve the same goals. County-level politicians have joined the discussion as well in the last several years, with the early stages of devolution impacting the revenue collection process.

Tax Base

Tax revenue in the FY 2014/15 budget year reached an estimated KSh958.2bn ($9.3bn), up 12.5% from KSh851.8bn ($8.3bn) in FY 2013/14. Expressed as a percentage of GDP, however, the total slipped from 16.9% to 16.8%.

Like most countries in sub-Saharan Africa, Kenya struggles to collect revenue from the vast majority of its citizens, who typically earn too little and interact mostly in the informal economy. Of its urban populations, approximately 30% are subject to direct taxes. An estimated 80% of revenue comes from large and medium-sized taxpayers. Though the country has implemented a value-added tax (VAT), a study from the Institute of Certified Public Accountants of Kenya found that the country remains highly reliant on income taxes for revenue. Figures from the IMF show income tax comprising 53% of all tax revenue, and VAT at 27%. Kenya does, however, have a high degree of tax buoyancy — a measure of how responsive revenue collection is to fluctuations in GDP — suggesting that the government is not missing out on additional revenue opportunities that come with economic growth.

Aggressive Growth

Kenya’s government has had a habit of setting ambitious targets for revenue collection, which can be challenging to meet. According to the Kenya Institute for Public Policy Research and Analysis (KIPPRA), at the halfway point in the FY 2015/16 cycle collections had reached KSh581.1bn ($5.7bn) overall, 15% short of the six-month target of KSh678bn ($6.6bn). In the 2014/15 period KIPPRA found that tax collection fell short of targets in all categories save for local VAT.

Given these trends it came as a surprise when the KRA in February 2017 announced a boost to the forecast for FY 2016/17. The tax-revenue expectation was hiked 8.7%, from an initial target of KSh1.4trn ($13.7bn) to KSh1.5trn ($14.6bn). Economists had previously expected revenue to miss expectations based on concerns about a slippage in the overall GDP growth rate, but the KRA said revenue collection in the first seven months of the fiscal period, from June 2016 to January 2017 exceeded expectations, at KSh687.4bn ($6.7bn).

Competition For Resources

However, it is unlikely that any pressure on the KRA will be lifted, given the country’s current and capital spending. The high level of expenditures is occurring not only at the national but also at the county levels, where Kenya’s devolution process has created an ongoing public debate over how revenues are shared between the state and its county-level governments. In addition, public sector wages are climbing as a proportion of expenses, creating another pressure point. Wages and salaries rose to 8.5% of GDP in FY 2015/16, according to KIPPRA’s figures, up from 6.9% in the previous period. This budget item is expected to drop in FY 2016/17, to 7.8%.

Given the state’s efforts to boost capital spending for public housing and infrastructure under the country’s Vision 2030 economic development strategy, reducing outflows for recurrent wages are crucial. Capital spending in the current decade peaked at 8.3% of GDP in the FY 2011/12 budget cycle, and have since declined to 6.4% of GDP in the current period, and to a projected 5.7% in FY 2016/17, although some of the reduction can be explained by the steep increase in spending earlier this decade with the $3bn Standard-Gauge Railway project.

The outlook for tax collection in the current and next cycle could be clouded by several factors, including the August 2017 election. As is frequently the case in African markets in the lead-up to national elections, uncertainty over the outcome is temporarily dampening investor and business sentiment. Profitability at Kenyan banks could also be an issue because of a law capping the amount of interest they can charge their customers. “The financial sector has traditionally been a strong taxpayer, but on account of statutory and regulatory changes, unless they innovate, there could be some challenges this year and fewer taxes paid,” Christopher Kirathe, executive director of transaction tax for EY in Nairobi, told OBG.

Until costs are reigned in, however, or GDP jumps, official revenue targets are likely to remain ambitious. According to the IMF figures, tax revenue as a percentage of GDP climbed from 16.8% to 17.3% in FY 2015/16, and should only rise from there; to 17.6% in FY 2016/17 and up to 17.9% by FY 2018/19. The state’s financial forecasts are also reliant on increased foreign aid in the form of grants. These are expected to reach 2% of GDP in FY 2016/17, the highest proportion in at least a decade.

Making The Grade

Solutions to the revenue challenge could come from several sources. The KRA is focused on increasing the enforcement of compliance with tax law, and has developed a multi-pronged strategy. For example, new systems such as iTax, an online tax filing system, are being implemented and promise to boost compliance among taxpayers while improving the efficiency of audits. “Without a doubt, the financial services sector is seeing a trend of increasing compliance on the back of greater enforcement of existing regulations,” Fredrick Ngatia, managing partner at Ngatia & Associates, told OBG.

VAT implementation is one example of a challenge. An estimated 70% of government suppliers are not in compliance, which will require greater enforcement. Estimates indicate that KRA targets could be met and exceeded if it were able to boost the overall tax compliance rate to 63%, from 43% as of March 2017.

An updated system for processing imports through Customs has been implemented, reducing scope for delays and corruption. The new approach enacts a number of changes, perhaps the most obvious of which is the establishment of an automated system in which the value of goods is benchmarked to norms. This reduces corruption by eliminating the ability of Customs agents to declare the value of goods at artificially low prices in order to help importers pay lower taxes in the process.

“Tremendous amounts of data are being aggregated by the new electronic systems, which will help us improve the efficiency of Kenya’s trade,” Amos Wangora, CEO of KenTrade, told OBG. The system will also be integrated with the Regional Electronic Cargo Tracking Platform, which will be used by Kenya, Uganda and Rwanda to track goods from the Port of Mombasa inland to final destinations.

The KRA is looking to digitise the entire tax process, a move that has been lagging in sub-Saharan Africa in part due to lower levels of internet usage. However, moving to online platforms for filing tax returns and providing other documentation, such as VAT receipts, improves the level of service for taxpayers. They have more options to interact with the KRA remotely, rather than going to tax offices, and allow workers to ensure that their employers are remitting tax deductions from payrolls properly.

Digitisation also helps improve transparency and governance for the KRA. It has allowed it to create databases and electronic taxpayer profiles, and this information can be leveraged to make better choices. KRA officials can compare tax returns against norms and averages, which helps in spotting anomalies that could provide clues on tax evasion. The overall impact is an improved process for determining which taxpayers should be audited, and greater efficiency as a result, said EY’s Kirathe.

Policy Options

The government has announced that the country’s Income Tax Act is under review, but has also been in the process of tweaking other tax laws and rules. The main theme common to all reform efforts is to broaden Kenya’s tax base, and to consider moving from a reliance on direct taxation, a system in which most Kenyans are not impacted because they do not work in the formal economy, to indirect taxation. This could better capture the value of informal economic activity.

Recent changes include reintroducing a capital gains tax in 2015, which applies to the transfer of property at a rate of 5%. In the Finance Act of 2016 the government has offered a tax amnesty, in which money repatriated from overseas will be returned to the country and taxed on a no-questions-asked basis, preventing the KRA from investigating potential illegalities. At least KSh124bn ($1.2bn) in Kenyan assets are estimated to be held outside the country, according to a forensic study by Kroll Associates.