Kenya Needs To Review Its Policy On Tax Incentives

In the recent past, there has been renewed interest in the print and electronic media on the pros and cons of tax incentives. The latest round of interest was sparked off by revelations by KRA that Kenya was losing an estimated Kshs.478 billion per year in various tax expenditures, equal to 5.9% of the country’s Gross Domestic Product (GDP).

Tax incentives are provisions in the law that grant to any person or activity favorable conditions that deviate from the normal provisions of the tax legislation. These incentives take various forms usually involving one or more of the following: reduction in tax rates, tax exemptions, allowable deductions to reduce tax liability, and tax holidays.

Like many countries in Africa and other partner countries in the East African Community (EAC), Kenya has a comprehensive range of tax incentives incorporated in various statutes. They range from tax holidays, favorable depreciation rates, special deductions, tax rebates, preferential rates for Value Added Tax (VAT) or remissions from the same, import duty exemption and an additional range of sector-specific benefits. We provide these incentives to induce domestic investment, attract Foreign Direct Investment (FDI) and promote exports.

We forego these tax revenues despite evidence that tax incentives are not among the priority drivers of investment decisions. When the International Financial Corporation (IFC) carried out an investor motivation survey in 2012, they found that tax incentives ranked number 11 in order of priority in terms of the factors determining whether to invest in Kenya or not. The first five were access to finance, access to land, labor costs, affordable skilled labor and proximity to the port.  Furthermore, 60% of investors indicated that they would have invested with or without the available tax incentives – indicating that 60% of the time the foregone revenues were an unnecessary loss.

More recently, the 2018 Global Competitiveness Report of the World Economic Forum (WEF) ranked Kenya number 93 out of 135 investment destinations.  The principal challenges that undermined Kenya’s ranking were crime (especially organised crime and corruption), infrastructure (especially access to and quality of electricity and water), macro-economic management (with debt levels a prominent determinant) health and skills of the workforce, high tariffs, financial markets, (undermined by our non-performing loans portfolio) and business dynamism. In all these areas, Kenya ranked among the poorest 30% worldwide.  It is hard to argue that tax incentives can be the ‘cure’ to the identified ills in these areas.

If tax incentives are a poor way to promote investment then why are we so fixated on them? There appear to be two primary reasons:

First, tax incentives seem critical in a limited number of areas and especially exports. The aforementioned IFC study found that exporters were particularly keen on tax incentives with 49-51% of them indicating that they would not have invested in the absence of these incentives.

Secondly, and probably a more fundamental reason is that tax incentives, despite their lower priority ranking, are bankable. Our tax incentives are incorporated in various statutes and thus the investor has a degree of certainty that they will benefit from them. The dynamics concerning improving infrastructure, labor markets, worker skills, security, reducing corruption and fiscal management make commitments in these areas less easy to guarantee. Thus, the investor focuses on what he can get, not what he needs.

So what should be the way forward? As we go through the process of reviewing our tax policy and tax legislation, we should consider the following:

To begin with, in light of the high cost and debatable benefits of our incentive regime, we should seek to minimize tax incentives. As stated above, the only area that appears vulnerable to the removal of tax incentives is the export sector. Promoting exports is likely to be the exception to a rollback of the incentive regime;

At the same time, a cost-benefit analysis should be carried out as we review the incentive regime. Essentially, tax incentives should only be provided if the additional taxes expected over the long term compensate for taxes foregone in the immediate or medium-term, or if measurable externalities can be identified with equivalent effect;

Similarly, the policy framework should focus on tackling the factors that undermine our investment climate directly rather than trying to compensate for them through tax reliefs. Ideally, the revenues mobilized through reduced incentives should be focused on the infrastructure, human resource and security shortcomings that undermine the country’s competitiveness;

Lastly, to minimize destabilization of ongoing business activities and investments, already existing incentives should be ‘grandfathered’ through legislation allowing those already benefitting from an incentive to continue to do so while new entrants do not.