Ideas & Debate

Address grey areas in VAT regulations on global business

rotich

Treasury secretary Henry Rotich. FILE PHOTO | NMG

The Kenyan VAT Act under Section 67 allows the Treasury Cabinet secretary Henry Rotich to make regulations for better carrying of the provisions of the law.

The underlying purpose of the issuance of regulations is, therefore, to provide clarity in the implementation of the tax law. In compliance with the law, Mr Rotich in April published the much-awaited VAT regulations through Legal Notice 54 of 2017 — a welcome move and a step in the right direction.

However, certain aspects of the regulations on international trade seem to make it even more difficult to implement the VAT law itself and create an avenue for protracted tax disputes contrary to the original intention of the guidelines.

The issue of exportation of services has been a grey area in the VAT Act, which stipulates that a service exported means it is provided for use or consumption outside Kenya.

This is in keeping with the destination principle as set out by the Organisation for Economic Cooperation and Development, which is aimed at achieving neutrality in global trade.

However, the contentious issue has been what qualifies as use or consumption outside Kenya since the law does not expressly define “use or consumption”.

In the recent past, many companies have been receiving VAT assessments on services that, in their view, were exported and, therefore, zero-rated but which the Kenya Revenue Authority (KRA) contends were consumed locally and thus subject to value-added tax. There are tax cases both at the tax tribunal and others pending high court determination.

The expectation was for the VAT regulations to provide much-needed clarity on what use or consumption is and possibly provide a detailed analysis with examples of the same.

The regulations have however brought about even more uncertainty in this area, which will add to the troubles in international business transactions. Regulation 13, specifically states that the exportation of services shall not include: “Taxable services provided in Kenya but paid for by a person who is not a resident in Kenya.”

The above exclusion raises two key issues: what exactly would be deemed an export of service and does the exclusion actually directly conflict with the provision of the VAT Act.

From a layman’s perspective, an export out of Kenya means a service is provided by a person whose place of business is in Kenya, and the service is provided to someone outside the country. So, the service could actually be performed in Kenya or abroad but by a person whose place of business is in Kenya.

The basic interpretation of the above exclusion in the VAT regulations is that as long as one performs the service in Kenya and the same is paid for by a non-resident, then the service is not an exported service and should be subject to VAT.

This literally means you need to perform the service outside Kenya for it to be considered an export. This is despite the VAT Act clearly providing that there is an exported service where use and consumption of a service are outside Kenya regardless of where the service is performed.

Since the regulations are not the law in themselves but rather designed to clarify the existing Act, it is arguable that they do not override the provisions of the law.

The question to be answered is what is the relevance of the exclusion which can easily be misapplied leading to costly tax battles for companies while the real problem remains unresolved, that is, what qualifies as “use or consumption” outside Kenya.

As long the issue of use or consumption remains unclarified, many companies, especially those in the services sector such as law firms, audit firms, security firms, marketing firms, banks and shared service centres of multinational entities should prepare for more trouble ahead.

There is likely to be more legal battles with the KRA on this aspect that remains a grey area and a key target for the taxman in the recent past.

Exporters with zero-rated sales have an even bigger problem in view of VAT regulation 8 which, if implemented, would have a huge impact on their refund claims.

Under the VAT Act, a registered person is entitled to a refund of excess input tax arising from the generation of zero-rated supplies.

Currently, exporters make refund claims of the excess input VAT after netting off any output VAT. Regulation 8 has introduced a formula, which seeks to further restrict this excess amount using the ratio of zero-rated sales to total taxable sales.

Where this formula is applied, one could end up restricting a huge proportion of the excess input VAT claim that could be attributable to zero-rated supplies.

Exporters will also end up with many tax disputes or situations where most of the excess input VAT is not refundable by the KRA leading to huge cashflows being tied up with the taxman. This runs counter to express provisions of the law which entitle taxpayers to refund of overpaid tax.

As the two issues above unfold, companies involved in international trade should be prepared for continued tax disputes with the KRA, which is time-consuming and can be very costly.

The solution to these issues lies with the tax man and the Treasury who should engage the stakeholders to come up with clear guidelines.

International best practice should also be considered since this aspect directly touches on global trade.

Esther Wahome is Senior manager, Deloitte East Africa.