The three Eastern Africa countries of Kenya, Tanzania and Uganda obtained their independence from Britain in the early 1960s and adopted the tax regime that was left by the colonial power. A customs union had been in place since 1917. The tax regime crafted by the British technocrats was largely borrowed from the U.K. tax laws. Prior to the British colonizing the three countries, the tax regime was based on Arabic and Portuguese practices in the coastal region where slave trade and trading took place.
The principal tax collection sources from independence have been pay-as-you-earn (PAYE), corporate tax, value-added tax (VAT), and customs and excise duty. This still is the case to date. Of these, VAT is the only one that has had some transformation, from a sales tax regime to a consumption tax which we now know as VAT. Sales tax was introduced in 1973 following the oil crisis and this was the source of government financing for the budget deficit. VAT was introduced in the 1990s in the region.
The three countries established an economic bloc known as the East African Community, which later collapsed in 1977. Kenya’s first own Income Tax Act was operationalized in 1974 after repealing the East African Income Tax (Management) Act. This paved the way for each country to create its own tax laws. The taxation principles in these countries have however largely remained the same.
In the case of Kenya, a significant tax change was the suspension of the capital gains tax in 1985, as part of the tax modernization program started in the late 1980s. It was reintroduced in 2015 and the tax modernization program has realized a shift from relying on direct taxes as a source of revenue to indirect taxes.
Recent Tax Developments
After the collapse of the East African Community, a second attempt has been made to forge a common Eastern Africa economic bloc. The treaty was signed in 1999 with additional countries joining the economic bloc, Rwanda, Burundi and South Sudan: this has brought the total membership to six nations.
Economic integration has not been fully achieved and requires political goodwill for full implementation of the treaty. The African Union has been advocating a free economic trade zone in Africa as a basis for increasing intra-Africa trade and supporting small businesses. Africa’s population of 1.3 billion, largely made up of young people who constitute 60% of the population, and with a growing middle class, is becoming an enviable economic base for any business.
Recent tax reforms in the East African countries have largely been about digitizing tax platforms. The era of filing manual tax returns has come to an end and tax returns and payments are now being done online. In Kenya’s case, this was fully implemented in 2014. Tax compliance and collections can now be monitored more efficiently using online portals.
Tax Objectives in a Modern Society
Tax measures are meant to ensure that every taxpayer contributes equitably towards tax revenues and the tax collected is used to address socio-economic issues such as infrastructure, healthcare and education. Income inequality in this region is significant and reforms are required to address this. Devolution of resources in Kenya to date is still a political battle and the impact in my view has been less than was expected.
Successes and Failures of Current Tax Regime in Eastern Africa
Questions may arise as to the effectiveness of the economic policies that have been instituted in the past 60 years: why are unemployment and income inequality still a major socio-political issue in the region?
Endemic corruption in the region has not helped in addressing the serious economic challenges that the citizens in these countries face. Even though all these countries have anti-corruption bodies and independent judiciaries, corruption appears to be eating away tax revenues that have been collected. The evidence of wastage and pilferage is readily valuable from the Kenya Auditor General’s annual audit reports, including investigative journalists’ reports.
Taxation measures are also required to encourage investment and spending in the economy. However, the exit of multinational companies from the region suggests that there may be other issues that governments need to address other than having attractive tax incentives for investment.
Tax measures need to be friendly, especially for newly established startups whose success rate is less than 50%. These are the institutions that will create employment and provide avenues for raising taxes in the future.
Tax incentives for a successful savings culture in any economy will ensure resources are available for investment in the economy. In addition to having tax measures that meet both monetary and fiscal policies of a country, the tax authorities need to be humane when dealing with taxpayers.
Tax in Kenya
Tax collections in Kenya have been on the rise in the past 20 years and have grown from $1.2 billion to the current estimates for 2020 of $17 billion. However, the current year’s collection will likely be impacted by the effects of Covid-19, as is expected globally.
A closer look at the collection statistics indicate that payroll and indirect taxes, in particular VAT, are the major sources of revenue. Corporate tax revenues have averaged at 20% of total collections. Corporate tax revenues have always been less than what is collected from PAYE for the data analyzed for the last seven years. PAYE has also been the leading tax revenue contributor in six of the last seven years. This implies that only a handful of Kenyans are paying their fair share of taxes.
Given that the economic nature of the countries in this region is largely informal, enforcing tax measures may not be easy. The recent introduction of a turnover tax for small and medium-sized entities (SMEs) at the rate of 3% on monthly turnover has not yielded much. A further reform was made this year to cushion SMEs against the effects of Covid-9 and the rate was reduced to 1%. SMEs that qualify for this elective tax regime are categorized as those that have a turnover of between 1 million Kenyan shillings ($9,200) and 50 million Kenyan shillings. The success of this is yet to be seen, as it is a newly introduced reform. My take on this is that if the previous 3% turnover tax did not yield much, how will this be a success? The introduction of a minimum tax of 1% on turnover this year irrespective of whether you make losses is likely to improve tax revenues from the corporates.
The underlying problems need to be addressed: why a majority of Kenyans in the informal business sectors do not want to pay their fair share of taxes. This would be a good study point for both academics and the political class. Word on the street is that the extent of waste and level of corruption in the public sector may be the primary cause of reluctance over tax compliance in the country. As such, only a small number of taxpayers have been left with the burden of financing government revenues. This also appears to be a significant problem in the rest of Africa.
A growing fiscal deficit in Kenya, which currently stands at $13 billion, has put pressure on the Kenya Revenue Authority to collect more taxes. The tax collection rate as a measure of gross domestic product (GDP) in Kenya has averaged at 18%, compared to the sub-Saharan average of 17%. The collection rates for South Africa, Morocco, Tunisia and Seychelles have averaged 28%, 27%, 31%, 31%, respectively. A high tax collection rate would translate into the Kenyan government being able to effectively provide more goods and services to the population. I have traveled to the four countries mentioned above and seen tax monies being put to good use on infrastructure at least.
Lower collection rates may also point towards tax leakage and/or evasion.
Corporate tax needs to be reformed based on the statistics on its contribution to the national economy. Corporates should at least pay more than payroll taxes. Group tax measures have not been incorporated in the region as a means of encouraging investment and spending. Currently each component of a group is treated as a separate taxable entity. A reform in this area would be useful in encouraging investment by group companies, which tend to be large and would invest given these incentives.
The corporate tax rate is also due for a reform. The rate has stagnated at 30% for several decades and only a temporary reprieve of 25% has been introduced as a tax support for businesses during the Covid-19 pandemic. A tax rate for different sizes of companies needs to be introduced to enhance equity in taxation. There is a major difference in Africa between a formal SME and an informal SME.
A reform of entrepreneur taxes needs to be introduced. Most startups struggle with financing, and burdening them with tax compliance without incentives usually kills these enterprises.
The capital gains tax regime needs to be reformed, as no provision for inflation is factored in when computing the capital gain. This would enhance equity and lead to a better compliance level.
Agriculture accounts for 25% of Kenya’s GDP and is the largest employer in the country outside the public sector. You would logically expect this sector to contribute a similar percentage in taxes. Unfortunately, this is not the case, as the majority of farmers fall under the informal sector. A tax reform is required in this sector to enhance tax collections. Farmers have been vocal in asking for more assistance from the government to provide infrastructure and market linkage which is funded from taxpayers: they should also pay a fair share in direct taxes.
With the advent of mobile money, a simplified and innovative platform may be used to collect some revenue from Africa’s largest employer.
Employment taxes have also stagnated for decades and only employees in the formal sector appear to be paying payroll taxes. A reform is needed in this sector to reflect the realities of the cost of living in the country and have those who earn more pay more for social equality in the country.
The savings, pensions and charities culture needs to be embedded in payroll taxes as tax incentives. Currently only pensions have been addressed in payroll taxes. Lower tax rates and taxpayer education in the informal sector may yield more taxes in collections if a reform is instituted. We have witnessed a succession of cases in Kenya last for as long as 40 years in the courts.
The public sector such as the public universities and county governments have billions of Kenyan shillings in unremitted statutory deductions. This is largely due to cash flow problems. These institutions receive most of their funding from state coffers and they have not been successful in generating their own revenue to finance their budgets. This problem has been there for decades and a reform is required to address this dire situation in the public sector as it affects pensions and tax compliance.
It is also perhaps time to introduce an inheritance tax and increase revenue collection.
The Way Forward
In conclusion, the pace of economic growth in Eastern Africa, which has averaged over 5% in the last 10 years, as well as the socio-economic needs of the continent, have outpaced the taxation policies and measures that are in place in most of the region. The tax laws and policies in Eastern Africa have largely been unchanged over the past six decades after independence.
Tax measures need to be innovative and tailored to suit our circumstances in Africa. The informal sector is the largest employer in most African countries and innovative tax measures need to be put in place to enhance tax compliance.
A total overhaul of our taxation regime would be necessary to improve tax collection rates. Improved tax collection rates will in turn reduce significant public borrowing and free up resources for the private sector for investment. As Africa moves towards having a Free Continental Trade Area, now is the time to start overhauling our tax regimes and encourage intra-Africa trade.
Africa has the resources and with proper governance, we do not need to have Africans risking their lives crossing dangerous routes to look for gainful employment opportunities in Europe or elsewhere in the world.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Cephas Osoro is Partner, Head of Corporate Services, with Crowe Kenya.
The author may be contacted at: email@example.com