Introduction to Tax Incentives
Tax Incentives are measures that provide for a more favourable tax treatment of certain activities or sectors compared to what is granted to the general industry. These incentives offer a general cut in the tax rate or a generous depreciation scheme for certain sectors of the economy or population. Majority of countries have tax incentives provided for in their tax laws. These incentives usually serve different purposes like to stimulate sectoral growth, encourage trade and investment as well as help make a country seem more attractive in the global market.\
Tax Incentives in Kenya
In Kenya, these incentives are provided in form of tax holidays, Capital Investment Allowances on Industrial Buildings, Investment Deductions, accelerated depreciation, special economic zones, investment subsidies, reductions in tax rates and indirect tax incentives like input VAT claims.
From the year 1991, Kenya has had some form of tax incentive in its tax laws to encourage local and foreign direct investment. For example, the Income Tax Act allows for companies that intend to invest 10 billion shillings or more to have a special operating framework arrangement where the company may be taxed at a rate lower to that of other companies. This is just among other incentives available to potential investors. The rationale behind offering such incentives is for these companies to have lower production costs, be able to employ more individuals, thus lowering the unemployment rate, and encourage significant investment into the country and spark economic growth.
The Costs of Tax Incentives for Lower Income Countries
Developing countries are increasingly relying on a strategy of offering tax incentives to attract foreign direct investment. However, this leads to increased unhealthy competition between developing countries and regional partners where policy makers look to match, or even surpass, their regional neighbours by offering more generous concessions.
In a joint report by the Organisation for Economic Co-operation and Development (OECD), World Bank, International Monetary fund (IMF) and the United Nations found that the costs of incentives are most burdensome for lower income countries, which may already be struggling with revenue mobilisation, and tend to be less influential in attracting investment. In 2015, 65% of countries in sub-Saharan Africa made incentives more generous in at least one sector which was the highest of any other region in the world. The study conducted found that for each 10-percentage point increase in corporate tax incentives, corporate tax revenue goes down by around 0.35 percent of GDP. A plausible explanation to this may be that incentives do not only go to new, foreign firms, but also commonly reduce the tax liability of existing firms in the country, thus eroding the overall corporate tax base. This leads to increased fiscal deficits and debt overhangs.
Reassessing the Effectiveness of Tax Incentives in Kenya
Kenya has focused on various tax incentives to spark growth and investment, especially in the manufacturing sector, but for a tax incentive to be effective, there are other factors that potential investors consider; costs of production, infrastructural development, labour; and favourable legal environment. Tax incentives alone may not be enough to attract new investments or keep existing investors in the country. This is illustrated in the number of companies that have exited the Kenyan market. With the long-term negative effects of tax incentives on the Gross Domestic Product (GDP) and tax revenues felt in many developing jurisdictions, it would be prudent to reconsider and somewhat rework our existing tax incentive framework. This can be done through;
a) Evaluation of existing tax Incentives: There is a need by the National Treasury and the Authority to conduct a cost-benefit analysis of the tax incentives that exist in our tax laws, their utilization and/or abuse to identify the whether they have been effective in serving the purpose with which had been envisioned. This may assist the National Treasury and the Authority to weed out those incentives that may have been irregularly used by taxpayers to gain an unfair advantage, to the detriment of tax revenues.
b) Tax Base Expansion: A broader, more inclusive tax base that encompasses most if not all facets of the population including the informal sector. With a broad tax base, the Government may afford to lower tax rates but maintain revenue collection and growth and at the same time alleviate the negative feeling among the population of being overtaxed.
c) Creating a favourable business environment: This can be done through reducing bureaucratic red tape, infrastructural development and having a simplified tax system. Here, KRA plays an integral role as it is mandated to facilitate trade by providing quality and timely support to taxpayers.
By Alan Kasibiwa
