Finance Bill: Is turnover tax magic bullet to expanding the tax base?

Taxation plays a major role in a country's economic growth. The growth is largely dependent on the amount of revenue collected and how such revenue is deployed to provide social services and invest for future growth.

When designing an optimal tax system, the country needs to look at the key economic activities, the needs of its citizens and the future aspirations for the country.

In Kenya, micro, small and medium enterprises (MSMEs) contribute over 35 per cent of the national gross domestic product together with a significant portion of the national employment, especially in the informal sector.

With representation across all sectors of the economy, they are a critical cog in national development and any incentives that grow the MSMEs have a direct positive impact on the economy.

When designing a tax system, the importance of the MSMEs cannot be ignored. Unfortunately, Kenya has struggled to find an effective system to tax MSMEs while encouraging the sector to grow.

Record-keeping

In 2019, the government introduced a turnover tax (TOT) targeting small and medium enterprises, designed to be simple to implement with minimal record-keeping.

As the name suggests, TOT is charged on turnover. When TOT was first introduced, the rate was three per cent on the gross turnover and applied to businesses with an annual turnover of between Sh500,000 and Sh5 million.

However, following the onset of Covid-19, the government - in a bid to cushion taxpayers from the adverse effects of the pandemic - introduced a raft of measures which included the reduction of the TOT rate from three per cent to one per cent, and expansion of the turnover threshold to include businesses with turnover between Sh1 million and Sh50 million.

Notwithstanding the turnover threshold, a taxpayer who is eligible for TOT can opt out and continue paying income tax on their business profits rather than turnover.

This is especially beneficial for companies with low profit margins or those in a tax loss position.

The Finance Bill, 2023 has proposed radical changes to the tax regime which include reducing the threshold and turnover bands for TOT to between Sh500,000 and Sh15 million and increasing the TOT rate from one per cent to three per cent.

Profit earned

Consequently, businesses with a turnover exceeding Sh500,000 and up to Sh15 million would be liable for turnover tax, while persons with a turnover above Sh15 million who previously were taxed under TOT would now revert to the mainstream tax regime with tax rates of 30 per cent on the profit earned from the business.

A keen look at the changes to the TOT regime through the years shows the government's struggle to find a balance between ease of tax compliance, encouraging MSMEs to register and pay tax and ensuring that there is no tax leakage.

It remains to be seen whether the Finance Bill, 2023 proposals, if implemented will achieve the intended purpose of bridging the revenue gap without crippling the SME sector.

The writer is Senior Tax Advisor with KPMG Advisory Services. The views are those of the author and do not necessarily represent those of KPMG