VAT exemptions will increase food and medicine prices

The government recently published the Tax Laws (Amendment) Bill, 2018 which proposes to reclassify some supplies from zero rated to exempt status. Its ultimate aim is to limit zero-rated status to exports.

Upon the successful enactment of the law, only exporters will be eligible for value added tax (VAT) refunds from the Kenya Revenue Authority (KRA).

The explanation the government has given for seeking to reclassify taxable supplies from the zero-rated to exempt category is to reduce the amount of VAT refunds. 

While it is important to prevent a return to the past, where the government owed businesses billions of shillings in unpaid VAT refunds, the goods the government has targeted will negatively impact ordinary citizens through increase in the cost of healthcare and basic foodstuffs.

Considering that the goods in question include medicine, cooking gas, milk, flour, bread and pesticides, it is important to ask whether the reclassification is the best solution. This question is critical given the widespread but erroneous belief that exempting goods from VAT makes them cheaper.

Under the exempt category, suppliers are unable to claim input VAT incurred to manufacture or distribute their products. By its nature, VAT is designed to be borne by the final consumer with the businesses in the production and distribution chain remaining neutral through input VAT deductions and refunds.

Compromising neutrality through exemptions transfers the input VAT cost to producers who eventually factor the additional cost in the price of their products.

To demonstrate this, a trader who incurs Sh1,000 on electricity, rent and transportation to bring a product to the market will be charged VAT of 16 per cent on the cost, equivalent to Sh160.

If the final product is exempt, the trader will not recover the VAT and will include this amount as part of the product price, effectively increasing the price by Sh160.

This is different for zero-rated goods where the traders are refunded the input VAT of Sh160 by the KRA, effectively reducing the cost and price of the product by this amount. If the National Assembly passes the proposed amendment, prices for critical goods such as medicaments, basic food supplies and cooking gas will skyrocket, thereby increasing the burden on the ordinary Wananchi.

The price increase will also make it harder for the government to achieve the Big Four agenda of food security and universal healthcare in the next five years.

The proposed amendments present the government which is facing a cash crunch with a near impossible choice. Either, increase tax collections through elimination of VAT refunds for local supplies or retain the zero-rating to keep the cost of basic commodities low as a cushion against vagrancies of inflation, unemployment, and falling income levels. 

Rotuk is a Tax advisor at KPMG Advisory Services Limited and can be reached at [email protected]