Explainer: Tracing VAT monster in Kenya

Effective July 1, Kenyans are bracing for higher prices at the pump following Parliament’s June 21 endorsement of the proposal to standard rate Value Added Tax (VAT) on fuel from the current eight per cent to 16 per cent.

On average, the price per litre of product is expected to go up by at least Sh10.62, driven by the change in VAT as well as a reduction in Import Declaration Fee from 3.5 per cent to 2.5 per cent and the reduction in Railway Development Levy from 2.5 per cent to 1.5 per cent.

But how did we get here? 

The journey towards the standard rating VAT on fuel is not a Finance Bill 2023 affair.

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It goes back as far as the mid-1980s and starts with two programmes adopted in 1986 – the Tax Reforms Programme and the Budget Rationalisation Programme.

• Tax reforms under Sessional Paper No.1 1986

The Tax Reforms Programme and the Budget Rationalisation Programme were designed to ensure that Kenya, then faced with widening revenue shortfalls, ramped up its revenue collection and also trimmed its annual expenditure to align with revenue collection.

The Tax Reform Programme would form a pivotal pillar of the Sessional Paper No.1 of 1986 on Economic Management and Renewed Growth.

Among the targets set in the sessional paper were increasing Kenya’s tax revenue to gross domestic product growth to 24 per cent.

• January 1990: Kenya introduces VAT

This proposal paved the way for the introduction of VAT in Kenya which materialised courtesy of the June 15, 1989 and took effect on January, 1990 at a rate of 17 per cent.

“Mr Speaker, VAT is a tax on consumer expenditure collected on business transactions and imports. It differs from sales tax in that it is not limited to manufactured goods and can be imposed on any type of goods or services. The way it operates allows anyone registered for VAT to operate in practical terms with tax-free goods and materials because the tax is ultimately passed on to consumers”, then Finance Minister, Prof George Saitoti, said in his June 15, 1989 budget speech.

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It was in his July 1, 1990 budget speech that Prof Saitoti would revise the rate of VAT from 17 per cent to 18 per cent.

The setting up of the Kenya Revenue Authority (KRA) in 1995 through Musalia Mudavadi’s June 15, 1995 budget speech was yet another milestone in the journey towards VAT in Kenya, and the standard rating of the same on fuel products.

The development now placed the collection of taxes under KRA as opposed to the previous Tax Policy Unit under the National Treasury.

The next major step in the evolution of Kenya’s VAT regime came in 2003 under the Kibaki administration.

In his June 12, 2003 budget speech, Finance Minister David Mwiraria reduced the rate of VAT from 18 per cent to 16 per cent. Mr Mwiraria is the reason Kenya now has 16 per cent as the standard rate of VAT unlike the 18 per cent which prevails in other East African Community member states.

• 2005: Electronic tax registers revolutionize tax collection

It was also under Mwiraria in 2005 that the KRA would introduce the use Electronic Tax Registers (ETRs).

ETRs became effective on January 1, 2005 and were designed to ensure that Kenya entered the era of digitised tax collections to seal leakages through evasion.

“With increased use of computerised transactions, the requirement that business operators keep very specific tax records is no longer practical. Traders cannot issue tax invoices or keep full details on individual transactions in a computerised system. To deal with this problem KRA has consulted on the matter, both regionally and internationally, in search of best practises. Based on successful best cases, many countries opt for an electronic tax register,” Mr Mwiraria said in his June 2005 budget speech.

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These progressive reforms led to the clamour for an overhaul of the country’s VAT regime so as to streamline collections and address the growing number of products that were classified as exempt.

• VAT Act No.35 of 2013

That clamour led to the Draft VAT Bill published in August 2011.  Among its proposals was the bold effort aimed at trimming tax exemptions from a record 395 to just 39, with the goal being to reduce the amount of tax revenue foregone due to exemptions.

Stakeholder input into the VAT Bill of 2011 eventually yielded the VAT Act No.35 of 2013, which provided that VAT on petroleum products would, for the first time in Kenya’s history, be standard rated at 16.0 per cent.

The effective date would have been September 1, 2013 but the Act, realising the public angst that VAT on petroleum products would elicit, provided a 3 yearlong transition period to September 1, 2016.

The Finance Act of 2016 would then extend this transition period by a further two years pushing the effective date of VAT at 16 per cent on petroleum products to September 1, 2018.

As it would happen, the Finance Act of 2018 provided no further extension and there was public outcry over what VAT on petroleum products at 16.0 per cent would mean for ordinary Kenyans.

The bargain that was arrived at in the National Assembly was setting the rate at eight per cent and this has been the case ever since.

• Finance Bill 2023 and the quest for Sh50 billion

The Finance Bill of 2023, however, through a proposal to amend Section 5 of the VAT Act of 2013 would bring this to an end and now set VAT on petroleum products at 16 per cent.

It is important to note that the Finance Bill of 2023 comes against the backdrop of Kenya being on an International Monetary Fund (IMF) programme, part of whose performance benchmarks entails tax revenue-raising measures.

President Ruto is on record stating that the change in VAT on petroleum products from eight per cent to 16 per cent should see KRA raise an additional Sh50.0 billion in 2023/24.