INSIGHT: Kenya’s VAT Refund Scheme—Challenges, Developments and Outlook

Kenya aims to streamline the value-added tax (VAT) refund scheme in order to reduce instances of fraudulent claims, and fast track payments whilst making the refund verification process more efficient. Various measures have been put in place to ease the application process, verification, and essentially help boost compliance.

Current VAT Refund Scheme

The current VAT refund scheme in Kenya provides for VAT refunds in three instances, namely refund of tax on bad debts, tax paid in error and excess credits as a result of zero-rated supplies, the latter being the most common reason for VAT refunds.

Recently, however, amendments have been made to the VAT law to include refunds that arise from credits as a result of tax withheld by appointed withholding VAT agents. This was a move by the Kenya Revenue Authority (KRA) to address challenges in cases where VAT was withheld in advance at the point of payment for the supply, but the taxpayer was in a refund position at the point of filing and accounting for VAT.

Automation of Refund System

Taxpayers can lodge their VAT refund claims via Kenya’s online tax platform known as Itax. Refunds must be lodged within a year from when the tax became due and payable. Taxpayers are able to track the status of their refunds. This has eased the process of lodging and verifying claims as the claim details are drawn from VAT returns filed on the platform.

Procedural Challenges

Claims lodged on Itax are still however subject to verification before approval and payment, which tends to drag out the process. Ideally a refund is required to be processed and paid within 90 days of lodging the claim, more so when the refund relates to tax paid in error or overpaid taxes. Further, interest is payable by the KRA to the claimant on the refund, if left unpaid for up to two years from when the refund was lodged.

The introduction of interest on unpaid refunds is a welcome incentive for the claimant as it is meant to encourage timely processing and payment of the refund. However, a timeline of two years after lodging the claim is too long and tends to favor the KRA. This is unlike the case of an erroneous refund paid by the KRA Commissioner General (Commissioner) to a taxpayer, in which case a taxpayer is required to refund within 30 days of receiving a notification of the error, failing which a taxpayer is subject to interest on the amounts paid until the taxpayer refunds the amount fully.

Various measures have however been put in place to ease verification, such as the introduction of green channel status and use of automated verification systems. These measures are aimed at reducing the time taken to process a refund as well as improvement of the accuracy of the verification process.

Green Channel Status

The Green Channel Status is aimed at easing the processing and approval of VAT refunds for taxpayers operating in low-risk sectors. Taxpayers operating in low-risk sectors are encouraged by the KRA to apply for green channel status. Low-risk sectors as highlighted by KRA include horticulture, floriculture, fish products, dairy and milling products as well as pharmaceutical companies.

The status will enable taxpayers to obtain preferential treatment in terms of refund verification and payment processing as well increasing their tax status in terms of compliance. The catch however is that taxpayers are required to ensure that they maintain high levels of tax compliance and will be subject to arbitrary tax audits and reviews to ensure so.

Although the status currently limits other sectors, the model is welcome and has seen success in other tax areas such as customs clearance processes in Kenya and globally where taxpayers with preferential status are able to clear goods faster.

VAT Automated Assessment

The KRA has also adopted VAT Automated Assessments (VAA) to enable easy verification of inputs filed by buyers against output filed by sellers. The VAA system works by matching inputs filed against outputs declared and highlighting inconsistencies between the two. The VAA system enables the KRA to verify how taxpayers account for VAT and to weed out instances of fraudulent claims of inputs as well as non-compliance in terms of non-declaration of outputs by sellers. This system helps to verify both returns and refunds filed to ascertain the validity of the claims.

The KRA is also able to issue automatic assessments to taxpayers without physical verification of their records. Although the system appears to be redundant as taxpayers are allowed to object to the assessment essentially prompting a physical audit/verification to prove their case. If used correctly, VAA can ease VAT refund verification, by ensuring compliance before claims are lodged and enabling oversight in case a refund is overlooked and issued in error.

Challenges in VAT Legislation

There have been changes made in Kenya’s VAT laws to minimize instances of refunds due to zero-rated supplies. These changes include exempting supplies that were previously zero rated or introducing VAT incentives through exemptions as opposed to zero rating. The notion behind these changes is to ensure instances of zero-rated supplies and claims are reduced whilst maintaining the nil VAT effect through exemption. Examples include exemption of supplies made to official aid funded projects, supplies made to special economic zones, supplies used in local assembly of motor vehicles or construction of specialized hospitals.

Although the incentive of reducing the VAT burden on inputs is enjoyed by the consumers, suppliers are unable to recoup input VAT incurred in providing these supplies hence having to expense the VAT cost.

Another key challenge in terms of VAT legislation lies in interpretation of VAT provisions relating to zero-rated supplies. This is such that a refund claim can be disallowed or rejected if the outputs are considered not to fall within the zero-rated regime, a case in point for supplies such as exported services which are zero rated. The interpretation of what constitutes an exported service based on the current legal provisions lies squarely on whether the service was used or consumed outside Kenya.

The definition of use and consumption has taken different meanings and interpretation for both taxpayers and the KRA. As a result of this various claims have been disallowed for not qualifying as an exported service, ergo not being a zero-rated supply. This has resulted in objections and essentially cases at various levels of Kenya’s judicial system with varying outcomes which have further created uncertainty. It would be pertinent for these laws to be clearly defined in order to ensure there is no ambiguity and that taxpayers and the KRA are able to apply the laws correctly and uniformly.

Kenya’s Tax Procedures Actoutlines procedures to be followed for administration of tax laws. One of the provisions relating to refunds enables the KRA to offset existing tax liabilities under VAT and other tax laws before issuing any funds resulting from refunds. This therefore means that businesses will most likely have their refunds utilized in offsetting tax liabilities including historical taxes owed as well as penalties and interest accrued. This will essentially affect cash flows and may even result in businesses not having their refunds fully paid.

Outlook of Kenya’s VAT Refund System

Taxpayers have been affected by various challenges including procedural challenges such as backlogs in verification of refunds, processing and payment of refunds, challenges in legal interpretation and changes in VAT status of their supplies. This has resulted in cash flow issues and a need to re-evaluate the cost of input VAT in a case where exemptions are applied on outputs.

Although there are various challenges, Kenya is making strides in easing the VAT refund process and essentially streamlining it. The KRA aims to clear out backlogs, ease the refund processes and ensure compliance and reduced claim fraud. There are various changes that the KRA is set to implement in order to achieve a more efficient VAT refund management system which include;

• Integration of Itax platform with customs’ online platform, Integrated Customs Management System (ICMS) which will ease linking of records related to filing and accounting VAT especially records related to exports included in claims.
• Rolling out Tax Invoice Management System (TIMS) that will reduce instances of issuance of fraudulent VAT tax invoices and accountability in terms of filing. The TIMS system will enable automatic reconciliation of VAT invoices issued as the KRA will be able to get real time information on tax invoices issued. This will help deal with fraudulent claims and help authenticate filed VAT returns.
• Categorization of claimants into various green, amber and red channels based on their risk profile in order to determine how best to process and pay claimants’ refunds. This is a welcome move given it has worked for Customs procedures, although it will be crucial to determine how risk profiling shall be done and measures applied under each category. The KRA is however yet to fully roll out the model to include both red and amber channels, but has started identifying and registering green channel taxpayers.
• Proposals to have taxpayers pay VAT net of refunds will essentially ease the burden of cash flows for businesses and refund processing for Revenue.

Planning Points

It is important for businesses to take note of the current refund system, its challenges, measures adopted to mitigate challenges and various proposed changes. We recommend the following is considered:

• Taxpayers should take note of various changes in VAT status of their supplies in order to ensure that they apply the correct VAT treatment and check if they qualify for VAT refunds.
• Taxpayers eligible for green channel status can take advantage and apply for green channel status as it will ease refund processing and payment.
• Taxpayers should ensure to account for VAT correctly and ensure compliance under VAT as it will ease the VAT refund verification process.
• The KRA is adopting technological measures such as VAA, TIMS and linking various platforms to ensure compliance. Taxpayers should therefore be vigilant in terms of filing and customize their accounting and filing systems to comply with the KRA systems.

Lynnet Mwithi is Manager, Samuel Njoroge is a Partner and Martin Kisuu is the Managing Partner at Taxwise Africa Consulting LLP, Kenya.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.