VAT is a broad-based tax on consumption, originally meant to be a tax on final consumption by households. In principle only private individuals as opposed to businesses, engage in the consumption and these are the persons that VAT targets. Despite this principle, financial services including insurance services have for a long time been exempt from VAT. This is because it has historically been difficult to assess the base for determining VAT on such services.
In Kenya, insurance-related services such as brokerage and agency services have always been exempt from VAT mainly because imposing VAT on such services would lead to insurance companies bearing the VAT burden contrary to the principle of VAT as a tax on final consumption.
Following the onset of Covid-19 in Kenya earlier this year and the subsequent social and economic effects, on 25 March 2020 the President introduced a number of fiscal and non-fiscal measures to cushion the country against the effects of Covid-19.
The fiscal measures were submitted to the National Assembly under the Tax Laws (Amendment) Bill, 2020 (the Bill) for consideration and approval. It only took about a month from the submission of the Bill to the National Assembly to the assent of the same by the President on 25 April 2020. This was unusually fast but at the time, it was testament to the government’s commitment to cushion Kenyans from the impact of Covid-19. However, as various players of the Kenyan economy would later realise, the tax measures introduced had far reaching implications rather than just offering relief from the economic effects of Covid-19.
One of these measures directly affected the insurance sector. Through the Tax Laws (Amendment) Act 2020, the government excluded insurance brokerage and agency services from the list of VAT exempt supplies. This move effectively made these services Vatable meaning that effective 25 April 2020, insurance brokers and agents were required to charge VAT on the services provided to insurance companies. With VAT being a new tax aspect to the brokers and agents, there was understandably a lot of confusion on how to implement the same. Nevertheless, most brokers and agents were already accounting for VAT by May 2020. As insurance services remain exempt from VAT, VAT charged to insurance companies by brokers and agents is now a cost to insurance companies as they cannot pass on the VAT to the policy holders without increasing the premium costs.
As a result, insurance companies through the Association of Kenya Insurers (AKI) moved to the High Court seeking conservatory orders staying or suspending implementation of the VAT amendment brought about by the Tax Laws (Amendment) Act until the determination of its petition. In its petition, AKI argued that industry players were not given ample time to deliberate the proposed provisions as part of the public participation process under the Constitution.
In addition, AKI argued that the additional VAT cost is likely to affect the permitted management expenses that insurance companies are allowed to claim by the Insurance Act. These are usually determined at the end of the previous financial year and as such, this additional VAT cost that came into effect in April 2020, will not have been factored in when setting the management expenses for the year 2020. Exceeding these limits would contravene the provisions of the Insurance Act for general insurance business.
Expenses exceeding the permitted expense levels for life insurance business will be disallowed for corporation tax purposes at 25 percent.
Upon considering AKI’s application and the submissions of the Kenya Revenue Authority (KRA), National Treasury and the National Assembly as the respondents to the case, the presiding Judge on 16 July 2020 ruled in favour of AKI. The Judge issued conservatory orders staying or suspending further implementation, administration, application and/or enforcement of the contested VAT provision.
On the face of it, this ruling looks like a positive move for the insurance industry as it seems to provide for suspension of the implementation of the VAT on brokerage and agency fees. However, in my view one of the reasons why the Judge issued the conservatory orders could cause more confusion than relief to the industry. While determining whether to issue the conservatory orders or not, the Judge under Paragraph 93 of the ruling observed that the issuance of the orders would not prejudice the KRA if the contested VAT law was found to be constitutional.
The Judge held that in such an event, the KRA would still be at liberty to collect any taxes due together with interest from members of AKI. On the other hand, the Judge observed that if conservatory orders are refused and the contested law is held to be unconstitutional, it would be difficult for AKI members to recover VAT already paid and as such they would be greatly prejudiced.
The confusion brought about by this ruling is that, while the insurance companies can rely on the conservatory orders to ignore any VAT charged by brokers and agents, the obligation to charge and account for VAT remains with the brokers and agents. Interestingly, none of the brokers or agents’ associations were enjoined in the case as interested parties. It is no wonder that the interest of the brokers and agents were not articulated in the case.
As a result, brokers and agents have been left in a very dicey situation. Should they continue to charge VAT to the insurance companies especially given the Judges’ comments under Paragraph 93 of the ruling? If the KRA is still entitled to recover tax due and interest where the contested law is held to be constitutional, will this tax and interest be recovered from the insurance companies (as alluded in the ruling) or from the agents and brokers as is required by law? Also, given that most brokers and agents collect money on behalf of insurance companies from policy holders, do the insurance companies really have an option to ignore the VAT if the brokers and agents decide to deduct the same before remitting the balance to the insurers?