June 30, 2022
Kenya enacts Finance Act, 2022
On 21 June 2022, Kenya's President assented into law the Finance Act, 2022 (the Act). The Act has amended various tax laws including: the Income Tax Act (ITA), The Value Added Tax Act, 2013 (VAT Act), Excise Duty Act, Tax Procedures Act, 2015 (TPA), and the Miscellaneous Fees and Levies Act. The Act also provides for other miscellaneous amendments to the Insurance Act, Retirement Benefits Act, Capital Markets Authority Act, Public Roads Toll Act among others.
This Alert summarizes the key proposals contained in the Act. Unless specifically noted, the changes contained in this analysis take effect on 1 July 2022.
Corporate income tax
Definition of fair market value
The Act introduces a definition for the term "fair market value" to mean the comparable market price available in an open and unrestricted market between independent parties acting at arm's length and under no compulsion to transact, which is expressed in terms of money or money's worth.
Despite being referred to in different tax provisions, the term fair market value was previously not defined and has been subject to varying interpretations. This should therefore provide a synchronized interpretation.
Capital gains tax
The Act has increased the capital gains tax (CGT) rate from 5% to 15%. This is a culmination of previous attempts to increase the CGT rate, which stalled in the past due to intense lobbying by affected parties.
In our view, the increase in the CGT rate should have been accompanied by an indexation allowance to address inflationary impacts on the assets being disposed. Although the rate is still the lowest in the region, this will increase the cost of capital investments.
The Act however affords some reprieve to firms that are certified by the Nairobi Financial Center Authority. It provides that:
Effective date: 1 January 2023
The Act introduces a provision to subject gains from financial derivatives earned by nonresident persons to withholding tax at a rate of 15%. Under the Act, a financial derivative has been defined as a financial instrument the value of which is linked to the value of another instrument underlying the transaction which is to be settled at a future date.
Gains arising from financial derivatives that are traded at the Nairobi Securities Exchange will however be exempted. The Cabinet Secretary is expected to issue regulations to guide the taxation of such income.
Effective Date: 1 January 2023
Expansion of interest restriction exemptions
The Act has excluded the following organizations from the interest expense deductibility restriction, which is currently capped at 30% of earnings before interest, taxes, depreciation and amortization (EBITDA). This is in addition to banks and financial institutions licensed under the Banking Act and Micro and Small enterprises registered under the Micro and Small enterprises Act, 2012 that were already exempt.
This is a welcome move considering that the Finance Bill had only proposed to exclude microfinance institutions from the interest restriction provisions. It is laudable that the Act has broadened the exemptions to include other key players in the economy whose ratio of EBITDA to interest expense would naturally violate the threshold set out for thin capitalization purposes.
In our view, the Act should have also excluded interest payments to local persons and provided a de minis amount to ensure that businesses that have negative EBITDA and those with low EBITDA can deduct some reasonable amount of their respective interest expense.
Deductibility of foreign exchange loss
The Act has amended the current provisions around deductibility of foreign exchange losses on related party loans where a company is thinly capitalized. This follows the amendment of thin capitalization provisions by the Finance Act, 2021. In its place, the Act has restricted deduction of foreign exchange losses on all loans realized by a company whose gross interest paid or payable to related persons and third parties exceeds 30% of the company's EBITDA. The realized foreign exchange loss will only be deductible in the year when the interest payable or paid by the company is 30% or less than its EBITDA.
Otherwise, the Act has retained the deferral of foreign exchange losses until the thin capitalization ratio is met.
In addition, the list of entities exempted from foreign exchange loss restriction has been expanded to cover:
Deductibility of donations
The Act has expanded the scope of deductibility of donations against taxable income as follows:
This is a welcome move that will encourage more taxpayers to make donations for charitable causes. Previously a donation was only deductible if it was given in cash and to an income tax-exempt charitable organization registered under the Societies Act or the Non- Governmental Organizations Co-ordination Act, 1990.
Transactions within a preferential tax regime
The Act has repealed the scope of what is considered preferential tax regime for arms-length pricing (that mainly focused on domestic transactions) with one that seeks to include transactions with foreign jurisdictions that meet at least one of the following criteria:
It is noteworthy that the new provision includes transactions with both related parties and third parties operating in preferential tax regimes. This move aligns with Kenya's commitment to implement the four minimum standards as an associate member of the Inclusive Framework on Base Erosion and Profit Shifting (BEPS). Action 5 of the BEPS report proposes measures for dealing with the tax avoidance schemes channeled through preferential tax regimes.
A Kenyan taxpayer who engages in transactions with entities in a preferential tax regime will need to prove that the prices charged for goods and/or services comply with the arm's-length principle. It remains to be seen whether this will pose additional administrative requirements on Kenyan taxpayers especially where the transactions are with third parties.
Effective Date: 1 January 2023
The Finance Act, 2021 introduced country-by-country (CbC) reporting (CbCR) requirements for certain qualifying multinational entities (MNEs) with operations in Kenya. Subsequently, the Cabinet Secretary for the National Treasury and Planning issued draft regulations to provide additional guidance on CbCR. The regulations, which were modelled on the Organisation for Economic Co-operation and Development guidelines and recommendations under the BEPS reports, have not been finalized to date.
The Act has incorporated the draft regulations into the primary legislation, the Income Tax Act, but has made the following key amendments:
The Act also contains exclusions from the CbCR requirement. For example, a resident constituent entity is exempted from filing the CbC report where the UPE is obligated to file a CbC report in its country of residence or the competent authority in the jurisdiction has an agreement for exchange of information with Kenya.
The requirement to comply with CbCR requirements will apply from 2022 and subsequent years of income. Failure to comply with the CbCR requirements will be an offense subject to a fine not exceeding KES1m, a prison term not exceeding three years or both upon conviction. The objective of the amendment is to enhance information sharing across different jurisdictions so that MNEs pay their fair share of tax in the different jurisdictions. As mentioned above, this amendment aligns with Kenya's commitment to implement the four minimum standards under the BEPS project.
Amendments to investment allowance
The Act has extended by 12 months to 31 December 2023, the accelerated investment deduction of 150% on capital expenditure of at least KES5b incurred on the construction of Bulk Storage and handling facilities for supporting the Standard Gauge Railway operations with a capacity of one hundred thousand metric tons of supplies.
The Act has amended the definition of manufacture in relation to power producers to remove the requirement of supplying to the national grid. The Finance Act, 2021 removed the requirement to supply electricity through the national grid for a producer to qualify as a manufacturer. This is a positive development that will encourage power producers who supply power directly to the consumers. The Act has introduced an investment deduction at 150% where the cumulative investment value for the preceding four years from 1 July 2022 or the cumulative investment for the succeeding three years outside Nairobi City County or Mombasa County is at least two billion shillings.
Increased ambit of exempt income
The Act has exempted the following from income tax (largely in respect of human vaccine manufacture and reinstatement of Special Economic Zone (SEZ) reliefs):
Special Operating Framework arrangement
Unprecedented, the Act has introduced a Special Operating Framework arrangement where certain companies will be subject to the rate of tax specified in the special operating arrangement with the Government. These include:
Green energy and shipping industry incentives
The Act introduces a reduced corporate income tax rate of 15%, for the first 10 years upon commencement of operations, for a company operating:
Reduction in tax rates for certain bonds
The withholding tax rate in respect of interest and deemed interest arising from bearer bonds issued outside Kenya of at least two years duration has been reduced from 15% to 7.5%.
Personal income tax
Definition of a permanent home
The Act has introduced the definition of a "permanent home" to mean a place where an individual resides or which is available to that individual for residential purposes in Kenya, or where in the opinion of the Commissioner the individual's personal or economic interests are closest. This is a welcome move because determination of tax residency for Kenyans who had left Kenya to go to work in foreign countries has been ambiguous given that a definition for permanent home was lacking.
Taxation of gains from employee share ownership plans
The Act changes the valuation of the benefit accrued from employee share ownership plans (ESOPs) to the difference between the offer price per share at the date the option is granted by the employer, and the market value, per share on the date when the employee exercises the option. The Act has amended the taxing point of the benefit from ESOPs to the exercise date of the employee share options.
The implication is that:
The Act however failed to amend the provision defining "market value" which still refers to the value at grant date which contradicts this amendment.
The Act amends the section on persons eligible for insurance relief to remove gender bias. The Act changes the wording to have eligibility of insurance relief granted to any gender depending on who has taken the insurance.
The implication is that wives will now also be eligible for insurance relief in cases where they have taken life coverage for the benefit of their husbands hence eliminating gender bias which is a welcome move.
Remission of late penalty on PAYE
The Act has deleted a provision that empowered the Commissioner to remit in whole or in part a penalty imposed on employers who fail to deduct tax or account for tax deducted on their employees' emoluments. This aligns with the powers as stipulated in the TPA.
Digital services tax
The Finance Bill, 2022 had proposed to increase the tax rate of the digital services tax from 1.5%. to 3% of the gross turnover. This proposal has now been dropped and the tax rate for digital services will remain at 1.5%. The Act has excluded from the ambit of the digital services tax, income earned by a nonresident person with a permanent establishment in Kenya.
VAT on Digital Marketplace Supplies
The Act has amended the definition of a "digital marketplace" under Section 5(9) of the Value Added Tax (VAT) Act by replacing the words "sell or provide services, goods or other property" with "sell goods or provide services." The new definition is now precise, and it avoids ambiguity in interpretation.
The Act has exempted digital marketplace supplies or supplies made over the internet or an electronic network from the ambit of reverse VAT (VAT on imported services). This serves as a big relief to importers of digital marketplace supplies as they will not be required anymore to account for the resultant VAT on imported digital services.
The Act has clarified that the annual turnover threshold of KES5m for VAT registration will not apply to suppliers of imported digital services/supplies. This means that all digital suppliers will be required to register for and account for VAT regardless of their annual turnover.
Clarification on claim of Input VAT
The Act has amended Section 17(1) of the VAT Act to include the filing of a VAT return as a requirement to deduct input tax. Currently, there is no express requirement to declare input VAT in the respective month's return as a precondition for the input VAT to be deductible. This amendment will however contradict the provision for declaring and deducting input tax/credit within six months.
The Act has introduced a requirement for additional documentation on deductibility of input tax for participants in the Open Tender System (OTC) for importation of petroleum products that have been cleared through a non-bonded facility. Such participants will be required to provide the custom entry showing the name and Personal Identification Number (PIN) of the winner of the tender, as well as the name of the other oil marketing company participating in the tender. The Act further clarifies that input tax that may have been incurred before 1 July 2022 by these participants will be claimable within 12 months with effect from (w.e.f) 1 July 2022.
The Act has extended the scope of VAT refunds to include input tax with respect to taxable supplies made to an approved official aid funded project by manufacturers. Currently, manufacturers can only offset such input tax against output tax in the VAT returns. The Act has also clarified that taxpayers (manufacturers) who may have accumulated input tax credits (between 24 December 2020 and 1 July 2022) with respect to taxable supplies made to an official aid funded project may apply for a VAT refund within 12 months w.e.f 1.July 2022. This is a welcome amendment as it offers manufacturers with the much needed cashflows in the form of VAT refunds.
Harmonization with the Tax Procedures Act
The Act has amended Section 22 (4) of the VAT Act by adding a provision that the Tax Procedures Act, 2015 shall apply regarding imposition of interest and penalties on tax payable on imported goods. In the past, it has not been clear whether penalties and interest charged on import VAT should be charged based on the provisions of the Customs law (EACCMA) or VAT Act. The proposal also confirms that interest charged on tax will be subject to the in duplum rule. This implies that interest and penalties charged should not exceed the principal tax payable.
The Act has also repealed Section 30 of the VAT Act on refund of taxes paid in error. A similar provision has also been introduced under the Tax Procedures Act.
Change in the VAT status of various supplies
Exempt to Taxable (16% or 0%)
The Act amends the VAT status of taxable goods/services for the direct and exclusive use in the construction and equipping of specialized hospitals (with a minimum bed capacity of 50) from exempt to taxable at 16%. The specialized hospital has to be approved by the Treasury Cabinet Secretary upon recommendation by the Cabinet Secretary responsible for Health. It is noteworthy that any exemption approval granted by the Cabinet Secretary before 1 July 2022 in respect of the supply of taxable goods and which is still in force at such commencement shall continue to apply until the supply of the exempted taxable goods is made in full.
The Act has also amended the VAT status of the following items from exempt to taxable (0%):
Even though this is a welcome move as taxpayers dealing in these items will be eligible for refund of input VAT, the Act has replaced the words "exportation of taxable services" with "exportation of taxable services in respect of business process outsourcing" limiting the benefit from zero rating to only business process outsourcing. The VAT Act does not include a definition of what business process outsourcing services are. Guidance will need to be issued to provide clarity to taxpayers on qualifying services under this provision.
Taxable to Exempt
The Act has also amended the VAT status of the following products from taxable at a rate of 16% to exempt:
The exemption of the above supplies implies that the suppliers will not be entitled to a claim of input tax. Also, these suppliers will need to consider VAT de-registration as persons dealing wholly in exempt supplies are not required to register for VAT. The exemption of the locally manufactured motor vehicles is a welcome move as it seeks to increase investment in local production of passenger vehicles since 30% of the raw materials must be sourced from local equipment manufacturers as a requirement for exemption. This move may not achieve the intended objective of making these commodities cheaper since the manufacturers will not be able to claim input VAT on their purchases and expenses. This cost will be passed to the consumers. It may have been more effective if these supplies were made zero rated.
Reduced taxable rates
The Act reduces the VAT status of Liquefied Petroleum Gas (LPG) including propane from 16% to 8%. This is a welcome move by the Government as LPG will become affordable for most households. This is also a positive step towards realization of reduced carbon emissions and energy/environmental conservation.
The Act has also amended the VAT status of inputs or raw materials locally purchased or imported by manufacturers of fertilizer (as approved from time to time by the Cabinet Secretary responsible for Agriculture) from 16% to 0%.
Excise Duty Act
Section 10 of the Excise Duty Act allows the Commissioner to adjust the specific rate of excise duty annually to factor in inflation. The Act has introduced an amendment that empowers the Commissioner (subject to approval by the Cabinet Secretary) to exempt specified products from inflation adjustment after considering the prevailing economic circumstances in respect of such products.
Further, the Act clarifies that revisions to specific rates of export levy will be done no later than 1 October of every financial year instead of by 1 July of every financial year (likely to align the same with the excise duty inflationary adjustments).
Ex-factory selling price of excisable goods
Section 11 of the Excise Duty Act defines the excisable value for manufactured goods to be the ex-factory selling price if the excisable goods are sold by the manufacturer, or, in any other case, the open market value of the goods at the time of removal from the manufacturer's factory. The Act clarifies that where there is a sale, an arm's-length selling price is acceptable for purposes of determining the ex-factory selling price.
Harmonization with Tax Procedures Act
Section 36(4) of the TPA delegates administration of assessment, collection, accounting, and enforcement of excise duty payment relating to imported excisable goods to the East African Community Customs Management Act, 2005. The Act has clarified that the applicable tax statute should be the TPA.
Further, the Act has delegated the imposition of interest and penalties in instances involving imported excisable goods to the TPA and clarified that any interest charged tax will be subject to the in duplum rule.
Amendment to the list of excisable goods
The Act has amended the list of excisable goods and corresponding excise duty rates as set out in Part I of the First Schedule to the Excise Duty Act as follows (note: currency references are KES):
Suppliers of goods and services that were originally not excisable will need to apply for a license or register and start complying with the Excise Duty Act and Regulations before the effective date of the changes. There is no threshold for registration or licensing and compliance. This requirement will introduce filing obligations which will be an added compliance requirement for these entities that may previously have not had excise duty obligations.
Exemptions from Excise Duty
The Second Schedule to the Excise Duty Act provides for exemptions from excise duty of excisable goods. The Act has amended Part A of the Second Schedule to exempt the following excisable goods from excise duty;
Miscellaneous Fees and Levies Act
Export duty on iron ores
The Act has introduced an export levy at US$175 per ton on iron ores and concentrates, including roasted iron pyrites.
Exemption from Import Declaration Fee (IDF) and Railway Development Levy (RDL)
The Act exempts the following items from IDF:
The Act has exempted the following items from RDL:
Tax Procedures Act, 2015
Supply of information upon change in particulars
The Act has amended Section 9 of the TPA to require trusts, whether carrying out business or not, to notify the Commissioner of any change to the trust affecting the full identity and address of the trustees and beneficiaries of the trust within 30 days of such a change.
Amendment of assessments
The Act has amended Section 31 of the TPA to the effect that, in the case of VAT, input tax shall be allowed for deduction within six months after the end of the tax period in which the supply or importation occurred.
Security on property for unpaid tax
The Act has repealed Section 40 of the TPA and replaces it with a new section which provides the Commissioner with additional powers over a taxpayer's property registered with the registrars of land, ships, motor vehicles among others. This will allow the Commissioner to dispose any property it has directed the Registrar to place restraints on, within two months of such a notification, where there is an outstanding tax liability. However, if the property had a restraint before the said notification, the prior restraint would have the first priority of recovery after such a disposal.
The Act has limited the instances when an agency notice can be issued to where the Commissioner has confirmed an assessment through an Objection Decision and the taxpayer has defaulted to appeal to the Tax Appeals Tribunal within the prescribed timelines.
Upon issuance of the agency notice, the Commissioner will be required to serve both the taxpayer and the agent with the notice. If the agent cannot comply with the notice, the agent will have to notify the Commissioner in writing within 14 days, setting out reasons for inability to comply.
The Act seeks to exempt agents from withholding VAT on supplies by registered manufacturers whose value of investment is at least KES3b in the preceding three years from the commencement of the provisions of the TPA.
Refund of overpaid tax
The Act has amended the TPA to allow a taxpayer who has overpaid tax to make an application to the Commissioner in the prescribed form to offset the overpaid tax against the taxpayer's future tax liabilities or refund the overpaid tax within five years (for corporate income tax) or six months (for VAT). This is a welcome move that will allow taxpayers to utilize such credits and avoid delays associated with refund of tax. The applications will still be subject to an audit by the Kenya Revenue Authority within a period of 90 days from the application date.
Refund of tax paid in error
The Act introduces a provision on the refund of taxes paid in error under the TPA, upon application. Previously, this was only available for VAT. Tax paid in error is defined as tax paid which the Commissioner is satisfied ought not to have been paid.
Objection to tax decisions
Currently, the TPA provides that where the Commissioner has determined that a notice of objection has not been validly filed, the Commissioner is required to notify the taxpayer immediately in writing that the objection has not been validly filed. The Act has capped this period to 14 days. In addition, where a taxpayer applies for extension of time to file a notice of objection, the Commissioner will be required to notify the taxpayer of its decision within 14 days after receipt of the application.
Currently, the Commissioner is required to make an objection decision within 60 days from the receipt of the notice of objection or any further information the Commissioner may require from a taxpayer. The current provisions, as they are, have resulted in the delay of issuance of objection decisions. The amendments require the Commissioner to make an objection decision within 60 days from the date of receipt of valid objection. The Act also includes a provision allowing taxpayers dissatisfied with the Commissioner's objection decision to appeal to the TAT within 30 days after being notified of the objection decision.
Transactions for which a PIN is required
The Act has amended the TPA to include the registration of a trusts among the transactions for which a PIN is required.
Other Miscellaneous Amendments
The Statutory Instruments Act (No. 23 of 2013)
The Act has extended the automatic revocation period for statutory instruments issued under the Income Tax Act, the Stamp Duty Act, the Value Added Tax Act, Tax Appeal Tribunal Act, Excise Duty Act and the Tax Procedures Act for a period of 24 months with effect from 25 January 2023. This means that the proposal to remove the automatic revocation of statutory instruments issued under the various tax laws has been postponed.
The Act has been amended to limit the time taken by the National Assembly to consider and either approve or reject statutory instruments which contain provisions dealing with taxes, levies/fees or any statutory instruments which have the effect of imposition of a charge on a public fund or variation or repeal of such charge to 28 days from the date of receipt of the notice.
For statutory instruments other than the ones listed above, the National Assembly has the power to extend the time allocated for an additional 21 days. The introduction of a timeline will enhance timely resolution of disputes.
Unclaimed Financial Assets Act
The Act has amended the Unclaimed Financial Assets Act to cap the penalty that is recoverable as civil debt to the value of the assets found to be reportable and deliverable. The Act has also given the Cabinet Secretary power to waive penalties and fines in part or in full, under one of the following scenarios;
The Act also seeks to amend the Unclaimed Financial Assets Act to introduce a Voluntary Unclaimed Financial Assets Disclosure Program which will run for a period of 12 months starting from 1 July 2022. This will apply to assets held up to 30 June 2022.
This will provide any person who may not have delivered unclaimed assets in accordance with the law relief from penalties and interest.
Capital Markets Act
The Act seeks to amend the Capital Markets Act to expand the spectrum of persons who can act as investment advisors. This is in a bid to address the shortage of experienced investment advisors in the country.
Investment advisors will now not be limited to only incorporated entities that have met the minimum share capital but to any legal entity as may be prescribed in the Regulations. Additionally, where any person (not necessarily a director as was the case before) within the legal entity satisfies the minimum licensing requirements, the entity shall be approved as an investment advisor.
For additional information with respect to this Alert, please contact the following:
Ernst & Young (Kenya), Nairobi
Ernst & Young Société d'Avocats, Pan African Tax — Transfer Pricing Desk, Paris
Ernst & Young LLP (United Kingdom), Pan African Tax Desk, London
Ernst & Young LLP (United States), Pan African Tax Desk, New York