The imposition of Value Added Tax (“VAT”) by the Kenyan Parliament on businesses whose primary source of income involves export of services from Kenya has had a dramatic impact on the country’s economy. In Kenya, VAT is a type of an indirect tax which is mostly paid by consumers of taxable goods and services which are either exported from and/or imported in Kenya.
Section 2 of the Value Added Tax (VAT) No. 35 of 2013 (“the Act”) describes the term “export” as to take or cause to be taken from Kenya to a foreign country. Simply put, export of services involves the business of selling services outside Kenya for the benefit of consumers located outside our jurisdiction. Currently, the Second Schedule of the Act deals with exportation of services. However, it is imperative to first understand the status quo prior to the amendments brought by the recent Finance Act 2023.
Historical Background
Before the introduction of the Finance Act 2022, taxable supplies on exported services were exempted from payment of VAT by the consumers. This in turn affected businesses which dealt in exportation of services negatively since they were barred from claiming any tax refunds on input VAT paid on the supply.
On July 2022, the government through the Parliament enacted the Finance Act 2022 which became operational until June 2023. During the said period, trade activities involving the export of services from Kenya were hugely impacted due to change of laws which required exported services to be charged 16% VAT. The only services which were zero rated under the Finance Act 2022 were Business Process Outsourcing (”B.P.O”) services.
BPO, as the term suggests refers to the process in which a company sources for services which form part of the standard business functions to be handled by an external person outside the company. The relations are mostly formal and are implemented through contractual agreements with the third party. Example of services which businesses may outsource include Research Process Outsourcing or Legal Process Outsourcing (LPO) as in the legal sector.
Later, the Finance Act 2022 was repealed when the current Finance Act 2023 was enacted by the Parliament and took effect on July 1, 2023. The new Finance Act amended various provisions under the VAT Act in a move which led to heated political debate across the country before passing the Finance Bill 2023 into law. The amendments under the Second Schedule of the Act mandates that exportation of taxable services shall be zero rated which is in compliance to Section 7 of the said Act.
“shop” means premises occupied wholly or mainly for the purposes of a retail or wholesale trade or business or for the purpose of rendering services for money or money’s worth;
Difference Between Zero-Rating And Tax Exemption
To understand these concepts, it is imperative to assess their economic impact in relation to both consumers and producers of such goods and services.
1. Zero rating
Section 7 of the VAT Act, No. 35 of 2013 provides that:
Where a registered person supplies goods or services and the supply is zero rated, no tax shall be charged on the supply….
By dint of the above, consumers do not pay any VAT, in this case, for exported services as they are zero rated. The rationale is grounded under section 5 (2) of the Act which provides that “…the rate of Tax shall be- (a) in the case of a zero-rated supply, zero per cent (0%) …” (Emphasis ours). In effect, the price of commodities tends to be cheaper for the consumers. For example, if the President assents the Finance Bill, 2024 into law, the price of bread in Kenya will increase since the bill proposes to impose VAT from zero-rating.
In the case of businesses, they are allowed to claim tax credit or refunds for the input VAT which is paid on the inputs used in manufacturing the end product. Currently, only registered taxpayers who sell zero-rated supplies are entitled to a refund of any input tax paid. Eventually, it boosts the economy of the country as it assists in furtherance of business activities.
2. Tax exemption
Although consumers will not pay any tax on the purchase of an exempted product, for businesses, they are not allowed to claim tax credit or refunds for the VAT paid on the inputs. In effect, such goods and services tend to be more costly as compared to zero-rated. The rationale is backed by the need for business to recover the tax paid on the inputs by increasing prices. Additionally, taxpayers who supply exempt supplies only are not required to register for VAT.
Procedure For Filing A Claim For Tax Refund Under Section 47 Of Tax Procedure Act
The procedure is laid down under Section 47 of the TPA for claiming tax refunds or tax credit where a taxpayer has overpaid a tax under a tax law.
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Firstly, the taxpayer lodges an application to the Commissioner in the approved form, for a refund of the overpaid tax. Applications for refund are required to be filed within 5 years of the date on which the tax was paid. However, the Finance Bill 2024, proposes to amend Section 47 of the TPA. It is intended to limit the said 5-year period for tax refunds to only income taxes and impose a 6-month limit for other tax heads.
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After filing the application, the Commissioner may conduct an audit for purposes of ascertaining the validity of the claim for a refund. It is not a mandate that the Commissioner conducts an audit since it is at their discretion in case of suspicion of illegality or fraud on the part of taxpayer.
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Upon receipt, the Commissioner shall notify in writing an applicant of the decision in relation to the application within 90 days of receiving the application for a refund.
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If satisfied that a taxpayer has overpaid a tax, the Commissioner shall apply the overpayment in the following order—
- in payment of any other tax owing by the taxpayer under the, same, tax law; (being the VAT Act)
- in payment of a tax owing by the taxpayer under any other tax law;(eg Income Tax, Excise Duty or other Tax Head) and
- any remainder shall be refunded to the taxpayer.
It is worth noting that, the Commissioner is mandated to repay the overpaid tax within a period of 2 years from the date of application, failure to which the amount due shall attract an interest of 1% per month or part thereof of such unpaid amount after the period of 2 years.
Benefits Of Exporting Services
- Increase in GDP due to an increase in Trade Balance or Balance of Payment (BoP). Simply put, Balance of Payment or Trade Balance is obtained from the difference between a country’s exports and imports of goods and services. The system is a crucial economic metric of the movement of goods and services between Kenya and its trade partners in the international market. If a country’s value of exports of services is more compared to its imports, then it has a trade surplus. On the other hand, a trade deficit is when the value of imported goods and services exceeds the value of exports. A trade surplus increases is a good indicator of the BoP which indicates an increase of the country’s Gross Domestic Product.
- Increased revenue generated by businesses which engage in export of services. This is attributed to the increased demand from consumers outside Kenya since they do not incur any taxable liability as the services are zero-rated.
- It also provides source of employment for the locals as it offers opportunity for the unemployed to seek job positions in order for the companies to meet the demands for experts and skilled persons. This in turn reduces unemployment rate among the job-seekers who are mostly highly skilled youths.
- Compliance with best international practices such as destination principle by OECD which then offers Kenya a competitive edge in the global market.
Difference between Origin Principle Versus the Destination Principle
1.The Origin Principle
This principle advocates for taxation of goods or services within the jurisdiction where the goods or services are produced.
2. The Destination Principle
It advocates that, goods and services are taxed only in the country where they are consumed. This is in tandem with the Cross Border Doctrine which mandates that no VAT shall be imposed to form part of the cost of goods destined for consumption outside the territorial border of the taxing authority.
Tax Disputes On Exported Services
The petition, among other things, challenged the imposition of VAT on exported services by the Finance Act 2022. The Finance Act, 2022 introduced amendments to various tax laws including the Value Added Tax Act, 2013 (“VAT Act”). The Petitioners challenged the constitutionality of Section 30(b) of the Finance Act which amended the First Schedule to the Act by deleting the export of services from the list of zero-rated services. This deletion effectively made the export of service subject to VAT at the standard rate of 16% effective 1 July 2022.
On the issue of whether the imposition of VAT on export of services would subject taxpayers to double taxation, the court associated itself with the Organization for Economic Co-operation and Development’s (OECD) paper: Addressing the Tax Challenges of the Digital Economic (2014). In this paper the OECD noted that
“the exercise of tax sovereignty may entail conflicting claims from two or more jurisdictions over the same taxable amount, which may lead to juridical double taxation.”
Bilateral tax treaties address instances of double taxation by allocating taxing rights between the contracting states. In dismissing the claim for double taxation, the Court opined that Kenya has various double taxation avoidance agreements in place to address the issue of double taxation in two jurisdictions.
However, tax professionals are of the opinion that Double Taxation Agreements (DTAs) only relate to payment of direct taxes rather than indirect taxes which include VAT.
CCCEWA argued that the marketing and promotional services rendered by it were services rendered to Coca Cola Export, a non-resident based in the USA, hence the exported services. CCCEWA argued that the services were exported outside Kenya and therefore should be zero-rated in line with the VAT Act. CCCEWA also stated that KRA failed to observe the ‘’destination principle’’ as per OECD guidelines. KRA through its Commissioner of Domestic taxes asserted that these supplies of services amounted to local sales, therefore chargeable to VAT. The High Court considered the services as exported services, hence, zero rated. In determining the question of whether the service is exported or not, the test is based on the location of use or consumption of that service.
Panalpina Airflo Limited (Panalpina) was contracted by Airflo BV Company that is incorporated in Netherlands for logistical processes to operate as a transport and freight for Airflo BV clients who export horticultural produce from Kenya.
Panalpina applied for VAT refunds on account of supplying exported services, which were zero rated for VAT purposes. The Commissioner rejected the Panalpina’s VAT refund claim on the basis that the services it provided were not exported services. Panalpina objected the rejection for a zero-rate tax refund on basis that the services it provided to its parent company in Netherlands were exported services as they were consumed outside Kenya.
The issue of determination was whether Panalpina’s services were exports. The Commissioner argued that, the services provided by the Panalpina were logistical and did not qualify as ‘exported services but the standard rate of 16% that it is the flowers that were rather exported. The High Court held that the services provided by Panalpina qualified as exported services. It stated that, the logistical services provided were to specifically facilitate exports whose consumption was outside Kenya and it benefitted buyers that were also outside Kenya. Thus, the parent company was the final consumer and the beneficiary of the service.
Conclusion
In conclusion, the move by the Kenyan Parliament seeking to zero-rate the business of exporting services outside Kenya seeks to give Kenya a competitive edge in the global market. Imposing VAT on export of services has a devastating impact on the consumers of exported services due to high pricing. Aside from consumers enjoying cheaper prices, businesses dealing in exported services also reap the benefit of tax refunds through their application to Commissioner at KRA.
However, the Kenya Revenue Authority (KRA) has waged numerous court battles against companies which deal in cross border supply of exported services. The main issue for contention upon which these disputes arise is on what constitutes ‘use’ or ‘consumption’ of services outside the local boundaries of Kenya. The VAT Act does not provide any clarification on the meaning of these terms which are integral in distinguishing services which are either local supplies or exported.
