Ideas & Debate

Banks contribute major revenue, but tax policy lags

kra

Taxpayers at KRA offices in Mombasa. FILE PHOTO | NMG

Summary

  • From a tax administration perspective, higher PAYE per capita in banking could also indicate that there is a need to broaden the tax base across the economy’s different sectors and recruit more taxpayers into the PAYE bracket.
  • The study also noted that unlike other industries such as hospitality and tourism which witnessed mass layoffs of staff, there was only a 5% decline in the total number of employees amongst the study’s participants.
  • This is not surprising, considering that even prior to the Covid-19 pandemic, banks had started digitizing their operations and, to some extent, rationalising their workforces.

We are living in a time of greater focus on transparency by corporate organisations. Diverse stakeholders such as potential and current investors, regulators, employees, suppliers and customers now expect more information about how organisations are aligned to a greater societal purpose, including but not limited to their financial performance.

In general, this is expressed through an organisation’s Environmental, Social and Governance (ESG) commitments and reporting. An organisation’s greater societal purpose, expressed through its ESG and financial reporting, includes disclosing its tax contributions accountably and transparently.

Against this backdrop, the Kenya Bankers Association (KBA) has produced a new study on the banking sector’s total tax contribution in Kenya for the 2019 and 2020 financial years. This is the second such study by KBA; the first one was produced in 2019, covering the 2017 and 2018 periods.

The current study is publicly available and a clear and powerful message from the KBA that its members believe in the promotion of tax transparency and tax governance, both key pillars of ESG reporting.

As in the previous study, the methodology used for the 2019 and 2020 study discloses both the taxes that a company bears, such as corporate tax and VAT that it is not able to recover (irrecoverable VAT), and also the taxes that it collects as an agent of government such as PAYE, withholding tax and excise duty.

The study shows that 32 taxpayers (banks) which participated in the KBA study contributed 7.5percent of the government’s total tax receipts during the period. Considering a total population of 6 million registered taxpayers countrywide, this is indeed a very significant contribution.

From a sustainability perspective, tax policymakers must carefully review the tax policy pertaining to this sector to ensure that it facilitates equitable growth and innovation.

When the banking sector thrives, so do many other sectors and, consequently, tax receipts also grow. Furthermore, the importance of the banking sector to other sectors and businesses, the government and indeed the economy as a whole, has become particularly clear during the Covid-19 pandemic.

The pandemic is not only a public health challenge but also an economic one; in the banking sector, economic distress has caused some loans issued by banks to move from performing to non-performing during the pandemic period.

Banking profits declined by 32.1 percent in 2020 relative to 2019 and data released by the KBA in the 2021 State of the Banking Industry report shows that the decline in profitability of the industry was largely driven by a 47percent increase in loan loss provisions in 2020 relative to 2019.

International accounting standards and CBK require banks to recognise loan loss provisions as an expense in their financial reporting. In other words, banks must assess how likely loans are to become bad and uncollectible and account for them.

The taxman applies strict criteria in terms of which provisions can be tax deductible in determining taxable profits. In practice, there is misalignment between provisioning for accounting purposes and the deductibility of the same provisions for tax purposes, and this misalignment continues to drive up the effective tax rates for banks.

Considering the current strict deductibility criteria for loan provisions, it is not surprising that the total tax rate (the ratio of taxes borne to profitability) is quite high at 48.5percent (2019 and 2020).

This rate is a strong indicator that banks’ taxation is not entirely in line with actual profitability (given the decline in profits but still high total tax rate) and, instead, is largely and more likely driven by the strict criteria for tax-deductibility of loan provisions.

Given the significant contribution of the sector to tax revenue in Kenya, it is time for tax policymakers to carefully relook at these rules so that there is more equity in loan provisioning allowed for tax purposes.

In 2020, the government issued several well-received directives to cushion taxpayers from the adverse effects of the economy. One of these directives was the waiver of transaction charges on the bank-to-mobile and mobile-to-bank money transfers as well as a waiver of balance enquiry charges.

It is therefore not entirely unexpected that excise duty, which banks are required to levy on transaction charges, declined by 42percent in 2020 relative to 2019.

Meanwhile, the study shows that PAYE per capita in the banking industry is five times that of the entire economy. PAYE per capita is measured by dividing total PAYE collected for the sector by the number of sector employees for whom PAYE applies.

The fact that PAYE per capita in the banking industry is five times higher could be indicative of the relatively higher wages in the sector compared to other sectors.

From a tax administration perspective, higher PAYE per capita in banking could also indicate that there is a need to broaden the tax base across the economy’s different sectors and recruit more taxpayers into the PAYE bracket.

The study also noted that unlike other industries such as hospitality and tourism which witnessed mass layoffs of staff, there was only a 5% decline in the total number of employees amongst the study’s participants.

This is not surprising, considering that even prior to the Covid-19 pandemic, banks had started digitizing their operations and, to some extent, rationalising their workforces.

Ms Muriithi is an Associate Director in PwC Kenya's tax practice.