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Vital questions to ask ahead of income tax law reforms

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It may be a mistake for Kenya to increase the effective tax rate for companies operating in the country. FILE PHOTO | NMG

In December, the US passed tax legislation that slashed the US corporate tax rate from 35 per cent to 21 per cent.

With this significant corporate tax rate cut, the US joined an ever growing number of developed and developing economies whose corporate tax rate is in the 20s. By way of example, the UK corporate tax rate is 21 per cent and falling.

Although this trend has raised concerns by some that countries (especially developing countries like Kenya) should not engage in harmful tax competition, such a conclusion risks being over simplistic.

In many cases, the significant reduction in corporate income tax rates was part of a package of reforms including a greater focus on indirect taxes (with VAT rates, for example, increasing at the same time in many countries).

As Kenya is about to undertake a reform of its Income Tax Act, it is pertinent to ask whether this should be an opportunity to engage in a similar rebalancing that has occurred in more developed jurisdictions.

Prior to the passing of the US tax reform legislation, Oxfam had released a report urging Kenya to increase its effective taxation of companies by increasing capital gains from the current five per cent rate, reintroducing capital gains tax for shares traded on the stock market, increasing taxation of Kenya’s high net worth individuals, eliminating enhanced capital allowances available for investments in manufacturing and eliminating the export processing zones and its stepchild the special economic zones.

In other words, Kenya should take the exact opposite approach to the US and instead increase the effective tax rate.

This view makes the assumption that such changes would not have any adverse impact on the level of economic activity, and so should result in an increased tax take that would cater for higher spending in social programmes relating to health and education.

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Many African countries – including Kenya – are planning for significantly increased government spending (to fund initiatives such as free secondary education, universal healthcare and infrastructure programmes) and this will continue to exert budgetary pressures.

On the other hand, the need to raise finances will not sit well with the government industrialisation model that would replicate the Asian model of attracting manufacturing companies by providing subsidised infrastructure and significant tax incentives to foreign enterprises.

This model has seen significant manufacturing enterprises establish themselves in countries such as Vietnam, Bangladesh and more recently Ethiopia.

While there is certainly some case for reform of some aspects of Kenya’s tax legislation, it may be a mistake for Kenya to increase the effective tax rate for companies operating in the country or to do away with the current set of tax incentives (in any case, relatively narrow) available to companies.

Instead, a better focus might be to take a leaf from Mauritius’ experience which has showed that rationalisation of the income tax regime, including reducing income tax rates, can result in increased compliance and resulting revenues.

Titus Mukora is Tax Partner with PwC Kenya and Head of Transfer Pricing.