SPEECH BY THE COMMISSIONER GENERAL MR. JOHN K. NJIRAINI, MBS, DURING THE ANNUAL BUDGET REVIEW WORKSHOP OF ICPAK ON WEDNESDAY 20 JUNE 2012

Let me first start by restating the very great significance KRA places in the work performed by members of ICPAK. During my term as CEO of ICPAK, we strove to deepen the relationship between the two institutions, with remarkable success. It is then that provisions were entrenched within the tax laws to ringfence certain roles that only ICPAK members play today. These include the performance of functions stipulated under Section 54 of the Income Tax Act and those relating to the verification of VAT refund claims. During the same period, ICPAK was invited as the only external party to serve on the KRA Reform and Modernization Programme Committee.

I would like to urge ICPAK to keep striving to enhance and strengthen the working relationship with KRA through exploration of further avenues of partnership building. I deliberately use the term “partnership” here because I have always believed that statutory bodies such as ICPAK need to complement rather than impede the activities of government agencies. ICPAK’s objectives are therefore best achieved when you work cooperatively with regulatory or law enforcement agencies to ensure adherence to high standards of practice by your members rather than in the protection of their individual self interests depicted by attempts to shield those who besmirch the profession’s name through malpractice.

Mr. Chairman, Ladies & Gentlemen, the Finance Bill, 2012 introduced a requirement for the regulation of tax practitioners with the finer details contained in Legal Notice No. 60. The regulations contained therein which have been under development since 2008, are geared towards ensuring that only persons of integrity engage KRA on behalf of taxpayers. This approach is in line with the spirit of the Constitution of Kenya, 2010 which emphasizes amongst other issues integrity and compliance with tax requirements. We do not anticipate therefore that in the future, persons who fall foul of professional discipline requirements will be accorded opportunity to act as tax practitioners. Neither do we expect the same for those who fail to fulfill tax compliance obligations. I wish to seek ICPAK’S support in ensuring adherence to the principles above through speedy investigation of discipline related cases that KRA refers to the Disciplinary Committee (and I am aware of at least two such cases for which we still await verdicts).  In addition, we would like to conclude a framework for facilitating the vetting of practitioners for compliance with tax requirements.  This last request has been made to at least 10 other professional bodies with whom we expect to agree a framework for the vetting of those seeking practicing licences.

Mr. Chairman, Ladies and Gentlemen,

Let me now address a few issues relating to the Budget as presented by the Minister for Finance last week. The issue that continues to hog the headlines is that relating to the taxation of rental income.  It is intriguing to note the high profile this issue has taken while infact no new legislation was introduced relating to the taxation of real property income. For the benefit of the audience, the Budget statement by the Minister only stated and I quote…”Kenya Revenue Authority will …..embark on mapping out all residential and commercial areas and implement a …. strategy to ensure that all landlords are effectively brought into the tax net and all  …..income taxes due are paid”

I wish to take this opportunity to correct some misconceptions that have taken root about this matter. First, rental income has like any other business income been subject of taxation for as long as I can remember. There are no special rules or legislative provisions governing the taxation of rental income which has always been subject of tax at the prevailing rates.   Those who have not been paying therefore have been evading tax, which has both criminal and civil liability implications.   I therefore strongly urge those who have not been making rental income declarations to do so voluntarily at the earliest opportunity and to pay the taxes due thereof.  Failure to do so will result in unpleasant consequences when we finally catch up.  Details to facilitate those who wish to take advantage by making voluntary disclosures will be publicized soon. In the same breath, I wish to advise lobby groups that have threatened to take Court action over the taxation of rental income that theirs could be a futile exercise unless they are keen on having the Income Tax Act suspended.

I also wish to disabuse the notion that in this matter, the KRA will be acting in response to a Treasury directive.  The KRA’s work in the real estate sector commenced over two years ago when a pilot study was undertaken in the Kilimani area of Nairobi with the primary intention of establishing the extent of compliance among landlords.  The study revealed significant non-compliance which resulted in tax enforcement action amongst the survey population.  In 2011, we undertook a more extensive study within the Langata area involving more than 100 properties and similar results were noted.   Recovery actions are in progress in respect of this last initiative.  The results of these two pilot initiatives are what informed our decision to focus more aggressively on real property sector compliance.

In April this year while releasing our 3^rd quarter results, I spoke in a bit of detail about our plans in this respect highlighting some of the technological solutions we were considering. Some of these solutions have already been applied with a fair amount of success in the two pilot studies. Our focus at present is on implementing our short, medium and long term strategies as defined in our compliance workplan for the sector. From the observations above, it is clear that work to address compliance among real property owners has been ongoing and will be enhanced in the coming days.   KRA therefore knows what it has to do and how to do it and will stay focused on the goal despite some of the challenges we face.

One area that has escaped attention in the raging debate is that of the taxation of gains resulting from real property development and sale. This infact is an area which has attracted significant investment resources in the recent past.  Real property developers have in the past sought to shield the hefty profits they make by using as an excuse the suspension of Capital Gains Tax seventeen years ago in 1985.  In response to this KRA published rules in 2010 to provide guidance in this area, the import of which is that gains made by those involved in the development and sale of real property as a business are taxable.  Our present focus is therefore not just on landlords but also on developers.

We have noted however a tendency among some developers to use multiple corporate vehicles with the intention of defeating requirements for the taxation of the gains they make.  We have noted that in such schemes a separate company is used to develop each property after which the company is wound up and another one set up to handle subsequent developments.  This practice is intended to make it hard to follow a developer between projects because the corporate vehicle used is different. In order to address this malpractice, Finance Bill 2012, has amended the legal provisions to impose liability on directors in their personal capacity where they willfully use corporate structures to evade payment of taxes.  We intend to use this new ammunition to discourage tax evasion by pursing directors in their personal capacity.

Mr Chairman, Ladies and Gentlemen

Let me now make some observations on the VAT Bill, 2012 which was unveiled by the Minister on 14^th June.  This Bill which is the culmination of many months of intensive work seeks to provide sustainable solutions to some of the maladies that have afflicted our tax system.  What I have found disappointing though in the public commentaries emanating from among others some members of ICPAK, is the trivialization of the debate without an attempt to internalize the fundamental underpinnings of the proposed legislation.  I would like to highlight one or two of the key questions for us to reflect upon as we debate the Bill in the coming days.

There are several issues that those championing tax reform have previously raised.  The first is the need for simplicity in our tax laws in order to reduce complexity and the cost of compliance.  The second, as specifically relating to VAT, is the need to address the VAT refund quagmire.

In respect of the first issue; (i.e. simplicity) this implies that tax laws need to operate on the basis of a few general cross cutting rules with few exceptions.  What this means for VAT specifically is that there should be only minimal exceptions to the general rate of 16%. 

The introduction of many exceptions (such as zero or reduced rates and exemptions) complicates the law and creates fertile ground for disputes between taxpayers and the tax authority. A significant proportion of KRA auditor time is spent verifying whether taxpayers have correctly applied varied rules contained in our laws. Moreover due to the need to keep a check on potential abuse, KRA has to require taxpayers to provide detailed schedules of the various categories of goods (i.e. general rate, zero rate and exempt goods) as part of their monthly VAT declaration. How much easier would life be if we only had one tax rate?  When the VAT Act was enacted in 1989, only goods meant for export were zero rated while the current VAT Act has close to 400 items. It may therefore not come as a surprise that VAT compliance contributes over 75% towards the lengthy duration cited in successive reports on Doing Business & Paying Taxes as a major inhibitor to Kenya’s attractiveness as an investment destination.

The second question relates to the well acknowledged problem of VAT refunds whose portfolio currently stands at approximately sh 24 billion. This figure would have been much higher if KRA did not discontinue the withholding VAT system in July 2011, an action taken at great cost to government revenue.  I am sure that most of you know that the primary (and possibly the only) remaining cause of VAT refunds is the zero rating of products. In other words, if zero rating were abandoned, the VAT refund problem would disappear. While such an eventuality is not realistic, nevertheless, this utopian scenario poses for us the question of the extent to which as a society we are prepared to accommodate tax subsidies associated with VAT zero rating. At the end of the day, VAT refunds reflect the cost to the public kitty of the decision to subsidize consumption. While such subsidy may be justifiable in limited cases, a review of many of the items currently included in the zero rating schedule does not provide a strong “public interest” objective for their continued retention. Moreover in deciding whether or not we should subsidize consumption through zero rating, we have to weigh the cost of such subsidy against other sacrifices the public needs to make. These include considerations such as the number of extra children from marginalized areas we could provide with school bursaries or the additional health clinics we could build in disadvantaged regions as part of the growing need to meet new social aspirations in our Constitution and the Millennium Development Goals. These are the type of public choices we should be debating as we evaluate the cost of tax subsidies towards what is primarily urban based consumption. The simple argument that removal of zero rating makes basic foods expensive may therefore sound popular at a public level but it lacks the serious policy depth needed to address some of our entrenched national challenges.

Moreover I pose the question whether zero rating is the most efficient way to address such issues as the cost of basic necessities. The problem with consumption related tax breaks generally is that they extend benefits even to the rich who do not require them.  In the case of basic necessities, the rich who do not require tax subsidies have access to the same items at reduced prices. This dimension touches on the debate between the use of expenditure side as opposed to revenue side interventions to address socially desirable goals.

I can illustrate this way by use of the zero rating of educational materials which has been raised as one of the key concerns in the new Bill. When educational materials are zero rated the benefit extends even to rich parents who take their kids to expensive private schools. An expenditure side intervention in this case may require the imposition of tax on educational materials across the board such that everyone including the rich pay. To alleviate the burden on the poor, the government may introduce a subsidy scheme for public schools (selectively or otherwise) where grants are provided to public schools for the purchase of educational materials. What the second option achieves is equity where the rich pay the tax (since private schools do not enjoy the subsidy) while the poor have their burden alleviated through the provision of funding to schools to finance (wholly or partly) the purchase of educational materials. Again what we have here is a policy choice between different types of fiscal interventions – one better targeted for results than the other. My plea once again to professionals especially ICPAK is for you to lead public discourse in financial matters at a serious level in order for the value of our profession to be appreciated. In this way we shall play our rightful role as opinion leaders in our chosen area helping to shape our Nation’s destiny and to anchor it on strong and sustainable foundations.

I wish to conclude my remarks by expressing KRA’s desire to forge a strong working relationship with ICPAK and its members with a view to achieving both our collective and individual interests. KRA looks forward to your support as we strive to entrench the tax compliance culture among Kenyans as encapsulated in our motto “Tulipe Ushuru, Tujitegemee”.

J. K. Njiraini, MBS

COMMISSIONER GENERAL