VAT exemption on exported services not a good proposition

International best practices state that VAT should be a tax borne by the end user of the goods or services. [Courtesy]

Winston Churchill once argued that “for a nation to try to impose itself in prosperity is like a man standing in a bucket and trying to lift himself by the handle.”

This statement rings true in the Kenyan context where, despite a myriad of legislative and policy measures aimed at further reducing Wanjiku’s taxes, the state of the economy is not proportionately representative of the revenue collected by the Treasury.

The 2021 finance bill, as might be expected, proposed a series of tax legislation aimed primarily at ensuring that the government closes its revenue gap for the coming fiscal year.

One of the notable proposals in the bill is to exempt exported taxable services from value added tax (VAT). These services currently benefit from a zero-rated VAT status.

Exported taxable services have long been zero-rated under VAT law and in accordance with generally accepted principles of international trade.

The exemption means that the service is not considered fully taxable, while zero-rating means that the service is taxable but at zero percent.

However, the underlying effect is different. The exemption prevents a person registered for VAT from claiming a deduction from the VAT incurred when acquiring taxable business purchases (commonly referred to as input tax).

The zero rate, on the other hand, allows a person registered for VAT to claim a deduction from input tax.

This is based on the fact that only persons making taxable supplies (which include zero-rated supplies) can claim a deduction (or compensation) for input tax paid on purchases.

The unrecoverable input tax resulting from the exemption becomes a business cost to the registrant and may affect profitability.

International best practices state that VAT should be a tax borne by the end user of the goods or services. In other words, it is a consumption tax. Ordinarily, therefore, businesses should not bear the burden of VAT.

In the case of goods traded cross-border, the country of origin does not apply VAT on these goods; rather, it is the country of destination where the goods are consumed that has tax rights on the goods.

This is to ensure that VAT does not become a tax borne by companies.

A good example is a Kenyan who buys a used car in Japan. At the port of exit in Japan, VAT is exempt. However, upon arrival in Kenya at the port of entry, VAT will be levied on the car along with other customs duties.

Similar treatment should apply to VAT on services traded across borders. However, this is complicated by the intangible nature of the services. Unlike goods, the export or import of services generally does not go through customs and the level of control by the government or the Kenya Revenue Authority is much lower.

However, the application of VAT on international transactions, whether goods or services, must not depart from the principles of neutrality and destination which dictate the application of VAT on such transactions. .

Kenya cannot impose its path to prosperity. Any tax change should aim to create an environment conducive to business prosperity.

An initiative to exempt the export of taxable services from VAT is likely to have a chilling effect on businesses and its gains may be disproportionate to the resulting losses.

The decision proposed by the government departs from international best practices. It is also, at best, a simple solution to a complex problem.

– The writer is tax director at Deloitte East Africa. Its opinions do not necessarily represent those of Deloitte. [email protected]


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