Parliament’s recent decision to impose value added tax (VAT) on large aircraft has left national carrier Kenya Airways (KQ) with one of the largest tax bills ever for its planned purchase of Dreamliner jets.
Tax experts say the airline could pay up to Sh14 billion in VAT for the six Boeing 787 Dreamliners and a Boeing 777-300 ER expected to arrive before the end of the year besides the one Dreamliner that was delivered last month.
Each Dreamliner is priced at about Sh11 billion and paying 16 per cent VAT on the eight aircraft poses a new challenge to the airline’s operations at a time it is struggling with high fuel costs, a dip in passenger numbers on some routes due to Kenya’s security concerns and stiff competition in the market.
The new law particularly hurts Kenya Airways’ ability to effectively compete with key rivals such as Ethiopian Airlines and Middle East carriers, who are not carrying the extra cost that is likely to be passed on to passengers in the form of pricier airline tickets.
“There will be a huge negative impact since all KQ aircraft, if purchased, are now taxable. Spares and engines are also taxable under this new legal regime,” KQ said in a statement, adding that the amendment “isn’t good news for the business”.
Parliament last month introduced VAT on aeroplanes weighing more than 2,000 kilogrammes, removing the burden on operators of small aircraft as it shook up the operations of the large aircraft owners.
The exempt aircraft account for about 46 per cent of the total Kenyan registered fleet. Helicopters are not affected by the law and do not attract VAT.
Tax experts say the change in law should ordinarily have no impact on Kenya Airways’ finances because all VAT payments are recoverable through the claims mechanism but the Kenya Revenue Authority’s (KRA) huge refunds backlog means a huge amount of the airline’s capital could be tied down with the taxman for years even as it struggles to keep its operations afloat in a difficult business environment.
“VAT is recoverable from the KRA, but the problem is the delay in refunds. It sometimes takes years before one gets back the money and this affects cash flow,” said Rajesh Shah, a tax partner at PricewaterhouseCoopers (PwC).
Kenya Airways chief executive Titus Naikuni said the full impact of the tax measure lies in the fact that the long delays may force the airline to take on expensive debt to fill the financing gap.
“The refunds take so long that we’re forced to borrow money to fill that hole,” he said. Parliament rejected nearly a third of the items that Suba MP John Mbadi wanted to be exempted from Vat to ease the high cost of living burden on ordinary Kenyans.
The decision left prices of many goods and services that increased after the government introduced a 16 per cent charge on hundreds of consumer goods last September unchanged.
The Kenya Air Operators Association (KAAO), an industry lobby, said Parliament’s choosing to cushion light aircraft owners that are mostly used by the rich for private travel while taxing big operators like KQ who employ thousands of people was discriminatory.
“We lobbied for all aircraft not to be taxed because any additional cost burden would have negative impact on the industry’s growth,” said Karumba Waithaka, the KAAO chief executive.
Originally, the Act had exempted aeroplanes weighing above 2,000 kilogrammes but owners of small aircraft appear to have convinced the law-makers to get them off the hook as they nailed the big operators.
Besides, industry players argued that all aircraft and their spare parts should be exempted from VAT in line with the East Africa Community Customs Management Act (EACCMA).
Mr Waithaka said exempting aircraft and their parts from VAT is a global practice that is in line with the Organisation for Economic Cooperation and Development (OECD) guidelines as well as the International Civil Aviation Organisation (ICAO) policies.
“Imposing a tax on large aircraft is a clear sign that the parliamentarians do not understand the sector,” he said. FLY 540’s chief executive and part owner Don Smith said the move would hurt the aviation business that is already heavily taxed.
“Spares are 10 per cent of our operational costs and with the recent increase in landing and parking fees, we are slowly being taxed to death,” he said on the phone.
Kenyan airlines are expected to pass on the increased tax cost to their passengers, making them less competitive on regional and international routes.
The high cost of spare parts also raises safety concerns as it may force operators to stretch their lifespan beyond the specified limits.
“Safety is of concern when operators are unable to import new parts and are forced to continue using the old ones,” said Mr Waithaka.
Kenya Airways had by end of March paid more than Sh700 million in taxes on spare parts following the imposition VAT in September 2013.
The airline was expected to pay an additional Sh400 million for the spare engine that arrived with the Dreamliner on April 4. The tax burden is expected to increase even further when the airline receives its second Dreamliner in June. This is because the aeroplane will now attract VAT alongside the spare engine.
“From September 2013 when the Value Added Tax Act came into force we have paid over Sh700 million in taxes,” Kenya Airways tax manager Beatrice Njagi told members of the National Assembly Finance Planning and Trade Committee during a hearing last month.
“We are paying more than Sh200 million monthly in taxes, but the law only allows KRA to refund Sh50 million per month per customer,” she said.
KQ’s bank and cash balances for the half year ended December 2013 stood at Sh13.14 billion, compared to Sh14.39 billion the same period on 2012 while its borrowings stood at Sh34.3 billion in December 2013, up from Sh30.5 billion in December 2012.
The airline is in the middle of an expansion drive that should see it increase its fleet to 107 planes by 2022. KRA owes the national carrier up to Sh1 billion in tax refunds.
The additional tax burden comes as KQ struggles to recover from the massive Sh7.8 billion loss it suffered in the financial year ending March 2013.
The airline has been on the recovery path, reporting a Sh384 million profit for the six months ending September. It closed its financial year in March with results expected to be announced on June 12.
The taxman has ruled out expediting tax refunds for the airline, stating it would have to wait in the queue or lobby Parliament over the 16 per cent consumer tax charged on aircraft spare parts.
KRA’s deputy commissioner in charge of marketing and communication Ezekiel Meru said the taxman had disbursed money it received from the Treasury to different parties on a first-come-first-served basis.
Most countries do not charge VAT on aircraft and spare parts. In February 2013, Nigeria removed import duty on all commercial aircraft and their spare parts in a bid to boost the aviation sector growth.
Previously, airlines paid about 10 per cent of the cost of imported aircraft in custom duties in addition to VAT.