VAT Refund Structure in Kenya and its Challenges
Value Added Tax (VAT) is a tax on consumer expenditure introduced in Kenya in January 1990 to replace Sales Tax, which had been in operation since 1973. VAT was introduced as a measure to increase government revenue by expanding the tax base, which hitherto was confined to sale of goods at the manufacturing and importation level under the sales tax system. The basic law establishing it is contained in the Value Added Tax Act, Cap. 476, 2012 of the Laws of Kenya and Regulations stemming from it.
VAT is levied on consumption of taxable goods and services supplied or imported into Kenya. It is collected by registered persons at designated points who then remit it to the Commissioner. Registered persons only act as VAT agents in collecting and paying the tax since the tax is borne by the final consumer of goods and services.
There are two tax rates applicable for VAT in Kenya: 16 per cent, which is the general tax rate applicable to all taxable goods and services, and zero per cent (zero rate) applicable to a certain category of goods and services including exports, agricultural inputs, pharmaceutical products, among others. Zero rating is imposing VAT at zero rate on specified supplies and goods. A person who supplies vatable goods and services and whose annual turnover is Ksh 5 million and above should be registered for VAT purposes. A taxable person is expected to deduct input tax incurred while making taxable supplies from the output tax charged on sales when submitting returns.
VAT contribution to total tax revenue in Kenya has averaged 25 per cent in the last five years. VAT collected from domestic production accounts for 12 per cent on average while VAT collected from vatable imports accounts for 13 per cent. Tanzania, Uganda and Rwanda, both with VAT rate of 18 per cent and zero per cent, had VAT contribution to total revenue averaging 15, 29 and 21 per cent, respectively. This reflects Kenya’s resilience in VAT tax collection compared to other East African states.
Meeting the revenue target for VAT has been a tall order for the Kenya Revenue Authority (KRA). However, the revenue agency has had a performance of an average 93 per cent on VAT revenue collection against Treasury target, missing the targets by seven (7) per cent in the last five years.
VAT refund occurs when a person or a business entity pays more VAT when they purchase vatable goods than they can collect whenever they sell the same goods. The difference is, therefore, reclaimed from the tax authority. Whenever such a refund arises, it is required that the individual or the business entity lodge a VAT refund with KRA within a period of 12 months, unlike previously where the refund could be lodged even after three years, leading to huge pile up of refund back logs. Generally, VAT refunds arise from the following five scenarios: (i) excess input tax, resulting from zero rated supplies and physical capital investments where input tax is Ksh 1 million and above; (ii) overpayments or credits resulting from withholding VAT system; (iii) VAT paid on bad debts; (iv) Tax paid in error; (v) VAT held on stocks, assets, civil works and buildings purchased or constructed twelve (12) months prior to registration of newly registered taxpayers.
The most common of the five is the refund arising from excess input tax from zero rated suppliers, which is quite common to exporters whose export sales are zero rated. It is estimated that 63 per cent of refund claims arise from this category.
The total value of VAT refunds can be quite substantial. According to the International Monetary Fund (IMF), VAT refund is high in emerging economies compared to developing countries. Countries such as Slovakia and Canada register a refund level of about 50 per cent of gross VAT while countries such as Sweden, Netherlands, Russia, United Kingdom, Hungary, and South Africa record a refund level of at least 40 per cent. On average, VAT refund in African countries excluding South Africa is 6 per cent.
Kenya’s VAT refund to gross VAT averaged 7 per cent between 2010/11 and 2016/17 while refunds to total revenue averaged 1.8 per cent, implying that at least 2 per cent of collected revenue goes to VAT refunds annually. In 2015/16, a total of Ksh 40.8 billion was used in VAT refunds against a total VAT collection of Ksh 293.8 billion.
Table 1: VAT refund Analysis
Data Source: Kenya Revenue Authority (2018)
In practice, VAT refunds are expected to be paid promptly by KRA following receipt of VAT returns that give rise to VAT excess credit. The situation in most developed countries is that refunds are usually made within four (4) weeks. However, in most developing countries, the processing of refund claims takes several months and sometimes more than a year. In Kenya, there is no statutory deadline for payment of VAT refunds, and tax payers are not entitled to interest for refunds made late (as is the case in South Africa, Singapore and Tanzania). However, it is expected that VAT refunds are made at the earliest time possible from the time the claim is lodged to the time the payment is made. KRA is committed to paying refunds within a period of 60-90 days based on the tax payer service charter, but this period is surpassed most of the times.
Some of the reasons for delay include the requirement that money must be remitted to the exchequer before it is released by the national Treasury to be paid back to the claimant through KRA. Due to numerous fraudulent claims, intense verification of the claims before approving is necessary. KRA estimates that at least 25 per cent of the claims are rejected due to fraud.
Delays in payment of refunds have impact on business operations. For example, the business community accuses KRA of amassing millions of shillings they need as working capital and constraining their cash flows when the refunds are delayed. As such, delayed VAT refunds increases the cost of doing businesses as businesses must find alternative sources of capital to take care of their day to day operations. The business community through Kenya Private Sector Alliance (KEPSA) and Kenya Association of Manufacturers (KAM) have been pushing to be paid interest on refunds that remain unpaid within a year, but this has not been the case.
Equally delayed payments are likely to impact public perception towards paying their fair share of taxes, while the backlog provides opportunities for corruption, as business are likely to bribe the authority to have their claims fast-tracked. This will further delay processing of genuine claims and therefore affecting business.
The KRA strategy to reduce the number of refund claims is to allow VAT refunds to be offset against other tax debts. This allows KRA to automatically deduct the refund from the existing tax liabilities. In other countries, the refunds are equally used to offset other liabilities that are due to the State.
Among the key issues that need closer attention in addressing the issue of refunds include a proper model for forecasting VAT refunds, as this will ensure accurate budgeting for VAT and eliminate unnecessary delays. Also, there may be need to amend the current VAT Act to allow KRA pay refunds through withheld gross VAT before submitting to the exchequer. Equally, in reducing the number of refunds, there is need for KRA to adopt a system that allows tax payers to carry forward excess VAT credit for a given period as is the case in most developed countries (Ireland, United Kingdom, Sweden, Netherlands). This will ensure that excess credits are paid at the end of the carry forward period for non-exporters. Excess VAT credit in one period can be absorbed by VAT liabilities arising in the subsequent periods. This will mainly apply to non-exporters since for exporter the VAT credit may not be offset by VAT liabilities in subsequent time periods.
By Vincent Okara, KIPPRA Young Professional (2017/2018)