Nairobi: Prices of consumer goods are expected to rise steeply if Parliament passes an International Monetary Fund-sanctioned Bill to scrap all the tax rebates that the Treasury has been offering manufacturers. The proposals, contained in the Value Added Tax Bill 2011, seek to repeal tax laws by removing inputs which enjoy exemptions and those that are charged VAT at the rate of 12 per cent instead of the official 16 per cent. They also seek to phase out refunds for most of the intermediate goods.
The measures should have far-reaching impact on the consumers and could turn into a political as well as social time-bomb — especially in an election year.
Missing conspicuously from the new VAT exemptions list are the highly-sensitive flours — both maize and wheat — and animal feeds that will attract 16 per cent VAT if the law is passed. Textbooks, wooden coffins and charcoal are some of the most commonly used items that enjoy exemptions (VAT exclusion) but will be struck out under the new regime.
“Ultimately, all these costs will be passed on to the consumer with devastating consequences on retail pricing at a time of high level inflation,” said John Gikima, a tax associate at Ernst & Young.
Headline inflation rose rapidly from about five per cent in April to 18.91 per cent in October, a challenge that the Value Added Tax Bill 2011 can only exacerbate.
Finance minister Uhuru Kenyatta was initially expected to present the Bill to Parliament in his June Budget after his earlier agreement with the IMF to undertake the reforms in return for the Sh50 billion foreign exchange support deal. The changes aim at increasing tax revenues while simplifying taxation through the elimination of tax refunds.
Many, however, see them as the product of the IMF’s come-back to the centre of Kenya’s fiscal and monetary policy-making after nearly 10 years of strong growth that enabled the country to finance up to 90 per cent of its Budget through internally generated resources.
Kenya had promised in a letter of intent and a memorandum of understanding with the IMF to “review the VAT laws in the context of the 2011/2012 Budget to remove distortions introduced by a number of ad hoc exemptions and zero-rated goods that have undermined revenue collection.”
Manufacturing is particularly set to take a major hit as the six items that currently receive preferential VAT treatment at 12 per cent will no longer enjoy the preferential treatment.
Notable among the items that will be charged full VAT at 16 per cent are the electricity, furnace, diesel and other fuels used to drive machinery
Manufacturing growth decelerated to three per cent in the third quarter compared to 4.8 per cent in the second quarter partly because of high cost of production and inputs.
“In Tanzania these VAT measures are already in place and they are driving the cost of electricity and other things up,” said Athi River Mining CEO Pradeep Paunrana. “We understand where the government is coming from in terms of revenue requirement but the best thing is to negotiate with them and strike a good balance between our interests and theirs.”
Also set to be hit hard are tourism sector players whose services are currently exempt from VAT but will now bear the full cost, making it harder for them to compete with other destinations.
Tourism sector items earmarked for removal from the list of VAT exemptions include transport and services.
“We are also telling them that the revenue is not worth the administrative cost as we are just consolidators working with other industries including the hotel sector,” said the chief executive of the Kenya Association of Tour Operators, Fred Kaigua. The industry’s main concern, however, remains the effect of the tax measures on new hotels.
Currently, the permanent secretary in the Ministry of Tourism has the authority to propose approval of exemptions to the Treasury. The proposals can be made with regard to “all materials and equipment for use in the construction or refurbishment of tourist hotels, subject to the production of such evidence as the commissioner may require as to the quantity, quality and the type of good required from the project.”
This provision has been done away with.
Kenya Revenue Authority has been holding consultations with stakeholders on the proposed changes but the government has been firm in its commitment to the planned elimination of zero-rating of inputs and the resulting tax refunds that the IMF considers a fertile ground for rent seeking.
Mr Gikima said that moving the inputs from zero rating to the tax exempt category will considerably increase the tax burden on companies, which will in turn pass on the costs to consumers in the form of higher retail prices.
Zero-rating is a tax measure that allows manufacturers to get refunds for inputs used in the making of essential goods – a burden they will have to bear if the law is passed.
The list of products that have been enjoying the tax rebates includes machinery used in industrial production.
“This is a serious issue because the Bill does not indicate whether any taxes will be recoverable and how,” said Mr Gikima.
The list of potential losers if the Bill becomes law includes the President and the armed forces canteens. Only diplomats will enjoy tax-exemption for imported materials or machinery, according to the proposed law.
The current list items that qualify for exemptions and zero-rating runs into five schedules but that will come down to a restricted number that mainly targets agriculture, transport and health sectors.
Some tax experts, however, think this is a positive development despite misgivings about the possible negative socio-economic impact. “The Bill is easy to follow and implement as opposed to the current VAT Act which is complex,” said Mr Gikima.