Manufacturing is a key economic driver due to its ability to generate jobs and create wealth. Beyond this two key factors, a vibrant manufacturing sector can reduce reliance on imported goods and drastically tilt the balance of payments, transforming a country from a net importer to an exporter.
In time, this can prop up a country’s economy by impacting on other factors such as the balance of payment and demand for foreign currency.
It is therefore no wonder that manufacturing is a key pillar in the Government’s “Big Four Agenda” with the intention of increasing its contribution to Gross Domestic Product (GDP) from the current 0.2 per cent to 15 per cent by 2022. The sector is however capital intensive and often relies on foreign investment.
Last year, Kenya recorded a 79.2 per cent increase of net foreign direct investment inflows from a surplus of Sh23.9 billion in 2016 to a surplus of Sh42.9 billion according to the Kenya National Bureau of Statistics’ Economic Survey 2018.
This is despite the economic slowdown occasioned by a prolonged electioneering period and the adverse effects of changing weather patterns.
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Traditionally, most of Kenya’s FDI is directed towards the finance and insurance sectors with manufacturing attracting about 20 percent of FDI.
Most foreign investors evaluate incentives awarded by various countries prior to making their investments as their main objective is to maximise returns.
Opportunity cost
Kenya is no exception and the Government should position the country as a manufacturing hub to achieve the Big Four Agenda. Part of this positioning will require extensive tax reform.
For instance, the Income Tax Bill 2018, which has been commended for its radical reforms, will negatively impact FDI inflows and may require redrafting to align it with the Big Four Agenda.
The Bill proposes to scrap 150 per cent investment deduction currently available to investors constructing buildings or installing machinery outside Nairobi, Mombasa or Kisumu counties. The deduction had resulted in an influx of foreign companies seeking to set up on the outskirts of Nairobi, Mombasa and Kisumu to enjoy this incentive.
If enacted in its current form, the Bill may reverse this trend, not to mention the opportunity cost and foregone job opportunities.
The Bill also proposes to introduce 10 per cent tax on income repatriated by branches of foreign companies.
The proposed methodology for computing this tax is rather unusual in the sense that it seeks to tax the net increase in value of the branch as opposed to actual amounts repatriated.
The situation is further complicated by the fact that a branch would still have to part with corporation tax at the rate of 30 per cent on its business income.
This is certainly a punitive approach to taxation as the effective tax rate will be higher than the current rate of 37.5 percent.
Practices devised
The Bill further delves into alterations on thin capitalisation provisions by altering the debt to equity ratio from the current 3:1 to 2:1.
Whereas the aim is to safeguard the country from harmful international tax practices devised by multinationals through Base Erosion and Profit Shifting; it is without doubt regressive in the sense that it hinders the very desire of attracting foreign direct investments.
In totality, the provisions outlined above coupled with the high cost of manufacturing products will negatively impact Kenya’s attractiveness as a manufacturing hub.
In effect the bill will claw back the gains that Kenya has made on the Ease of Doing Business as well as the Global Competitiveness Index.
A number of companies have already relocated their manufacturing activities to countries with better tax incentives and low cost of production.
To safeguard the gains made in boosting Kenya’s attractiveness and competitiveness, the government should review the Income Tax Bill 2018 while at the same time seeking to lower the cost of production. Incentivising Foreign Investment would not only kick start the Big Four Agenda but also spur job and wealth creation thus expanding the pool of taxable income.
While I advocate for each taxpayer to contribute fairly towards the country’s development by paying taxes and complying with the relevant tax laws, it is the Government’s duty to provide an enabling environment for taxpayers to nurture their businesses for sustainable economic development.
Mr Magu is a manager at PKF Kenya. Jmagu@ke.pkfea.com
