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Taxman’s bold strategy needs innovative approach to implement

In   light   of   increased   pressure   to collect more revenue, the Kenya Revenue authority has set its sights on   the   informal   sector,   which   is

colloquially known as the  Jua  Kali  sector. It  is  also  seeking  powers  to gain unfettered access into taxpayer mobile and banking records to smoke out cheats. However, implementing this bold strategy will require more  than  just a firm will: it demands out-of-the box  thinking. The   KRa   has   come   under sharper focus in recent years for several reasons. First, its revenue collections have improved con- sistently in the past five years, having come from sh534.6 bil- lion in 2010 to almost double that at sh1.06 trillion in 2015. this has understandably been  an uphill task as taxpayers have never been known to be enthusi- astic about giving the taxman his fair share.

second, the taxman has also lev- eraged on technology to improve effi- ciency and lower the cost of collections. this has primarily been done through the itax system, which saw the taxman gain global acclaim in June this year after winning the “Highly Commended Winner, Best in Class treasury solution in africa”award, in the treasury today’s adam  smith  awards 2016.

the third reason (and most per- tinent to this analysis) why KRa has come under increased scrutiny in recent times is that demands by the govern- ment on the taxman have significantly increased. although collections are up and efficiency has improved substan- tially, the government is still not con- tented. It wants more. Revenue targets keep shooting higher and higher each year.

Kenya has a lot of capital intensive projects currently underway, including infrastructure projects whose price tags run into the hundreds of billions of shillings. the country needs  to  raise  as much revenue as it can internally for these projects. this is because the alternative —that is, borrowing—is not feasible now.

Debt levels are high  in  Kenya  and both the local and international debt markets are not particularly favorable due to the risk premium associated with both the rising bud- get deficit and the current political environment. In this regard, Kenya may have its sovereign rating cut by one level to B due to a budget deficit ahead of elections next year, accord- ing s&P global Ratings financial services director Neil gosrani, who emphatically added that: “excessive spending on elections scheduled for august 2017 will raise more red flags.”

this means that borrowing over the next year will be expensive.  this bears a lot of  consequences  for Kenya, especially after consider- ing that the country has imminent plans to issue a second Eurobond to

ly after favorable pronouncements from influential commentators. For instance, professional services firm, PwC, affirmed in a media statement related to the 2016/17 budget that “there is a need to include this sector (informal sector) in the tax   base.”

 

Informal sector

the reason why the taxman is targeting the informal sector is a no-brainer. the size of  the infor- mal sector, otherwise known as the Jua Kali sector, has significantly increased over the past two decades. It now accounts for nearly 35 per cent of the country’s gDP and  80 per cent of its total work force.

traditionally, low education  lev- els among the population to warrant any other form of sensible employ- ment, and  the  inability  to  raise suf-

 

n   light   of   increased   pressure   to

collect more revenue, the Kenya Revenue authority has set its sights on   the   informal   sector,   which   is

colloquially known as the  Jua  Kali  sector. It  is  also  seeking  powers  to gain unfettered access into taxpayer mobile and banking records to smoke out cheats. However, implementing this bold strategy will require more  than  just a firm will: it demands out-of-the box  thinking.

 

the   KRa   has   come   under

sharper focus in recent years for several reasons. First, its revenue collections have improved con- sistently in the past five years, having come from sh534.6 bil- lion in 2010 to almost double that at sh1.06 trillion in 2015. this has understandably been  an uphill task as taxpayers have never been known to be enthusi- astic about giving the taxman his fair share.

second, the taxman has also lev- eraged on technology to improve effi- ciency and lower the cost of collections. this has primarily been done through the itax system, which saw the taxman gain global acclaim in June this year after winning the “Highly Commended Winner, Best in Class treasury solution in africa”award, in the treasury today’s adam  smith  awards 2016.

the third reason (and most per- tinent to this analysis) why KRa has come under increased scrutiny in recent times is that demands by the govern- ment on the taxman have significantly increased. although collections are up and efficiency has improved substan- tially, the government is still not con- tented. It wants more. Revenue targets keep shooting higher and higher each year.

Kenya has a lot of capital intensive projects currently underway, including infrastructure projects whose price tags run into the hundreds of billions of shillings. the country needs  to  raise  as much revenue as it can internally for these projects. this is because the alternative —that is, borrowing—is not feasible now. finance   its   ambitious  development

agenda. the country therefore needs the tax man to rev up revenue col- lection in order to limit the amount the government needs to borrow at such a time when finance costs are notably  high.

this state of affairs explains why the taxman has been increasingly aggressive in the past two years, plugging leaks and improving inter- nal structures to improve collection. It is now seeking to expand the tax base by bringing in the informal sec- tor into the tax net.

tapping   the   informal   sector to increase tax collection is some- thing that has  been  discussed  by  the  KRa  at  great  length  before, but that is only gaining the desired traction   in   recent   times,  especially after favorable pronouncements from influential commentators. For instance, professional services firm, PwC, affirmed in a media statement related to the 2016/17 budget that “there is a need to include this sector (informal sector) in the tax   base.”

 

Informal sector

the reason why the taxman is targeting the informal sector is a no-brainer. the size of  the infor- mal sector, otherwise known as the Jua Kali sector, has significantly increased over the past two decades. It now accounts for nearly 35 per cent of the country’s gDP and  80 per cent of its total work force.

traditionally, low education  lev- els among the population to warrant any other form of sensible employ- ment, and  the  inability  to  raise suf-

ficient  initial  capital  to  set  up    the

formal and more complex business ventures were the two key factors behind the growth of Jua    Kali.

In the recent past, however, the scarcity of formal employment even after concluding formal education has become a major push factor that has led to a majority of university and college graduates joining the informal sector. this means that the range of jobs in the informal sector has broadened beyond mechanic, capentry and metal work to now include professionals who offer ser- vices such as accountancy and other professional consultancy at cheaper rates than their counterparts in the formal sector.

Consequently, the value of trans- actions in the informal sector has picked up  tremendously,  presenting a golden  opportunity  for  the  KRa  to increase revenue collections. “By most indications, the growth in this sector (informal) far  outstrips  that  in the formal economy,” PwC notes, indicating that it is the informal sector that is increasingly driving the Kenyan  economy.

It     is     estimated    that,

owing to the  increased  value  of untaxed transactions in the infor- mal sector, the taxman loses up to sh60 to sh80 billion a year. this is according to  a  paper  presented  at  a recent pre-budget workshop by a KRa official titled, “Informal sector and taxation in Kenya: Issues and Policy  Options.”

In this regard, the KRa has put the informal sector in its crosshairs.  It intends to raise money from the informal sector through a presump- tive taxation method. unlike the typical taxation method that relies  on taxpayers’ accounts and records, presumptive taxation method relies on data such as bank deposits, net worth and loan application   forms.

 

Run into hurdles

It is clear that using the presumptive method on the informal sector will come with its fair share of challeng- es. the taxman will run into some hurdles collecting information about the informal sector. this is primarily because the informal sector is mark- edly poor at record keeping.

Informal businesses rarely keep consistent records. this is  because it is too costly for them—both in terms of financial capital and human capital—to meet the requirements of  a tax system such as record-keeping, book keeping and making filings with various authorities. this inabil- ity to furnish the taxman with timely and accurate information means that most of the information that will be used under the presumptive method to tax informal businesses will be speculative, introducing difficulties for both informal businesses and the  KRa.

the KRa needs more accurate information if it is to tax the infor-  mal sector. However, compelling the informal sector to provide neces- sary information or comply with tax requirements for that matter won’t be a walk in the park.  One  simply has   to   look   at   the   running   bat

tles that informal traders constantly engage with city council askaris in Nairobi’s CBD to fully appreciate the kind of resistance informal business- es can put  up.

the KRa also needs to appre- ciate that one of the reasons why informal businesses are not keen to comply is because the buearacracy and costs that usually come with compliance and formalization only serve to undermine the ease of doing business, which is not too great to begin with for informal  businesses.

this  means  that  the   KRa  will need to push other govern- ment authorities to do their part in improving the business environment for informal business. Only when the business environment is favorable will informal businesses warm up to the idea of paying taxes and formal- izing their operations. the current situation is still deplorable as many Jua  Kali  and  informal businesses still suffer from want of basic ame- nities such as proper sanitation and access to reliable water, despite these being indispensable features of a dignified  work place.

apurva sanghi, the lead econ- omist for Kenya, Rwanda, uganda  and Eritrea at the World Bank, observed that there should be no need to rush to formalize the infor- mal businesses, but instead govern- ment should strive to improve the business environment, and simplify tax procedures before roping them into the tax  base.

this means that the success of KRa’s bid to include the informal sector in the tax net is to a large extent predicated on what other gov- ernment authorities do to improve the ease of doing business for the informal sector. this calls for stra- tegic partnerships that may require the taxman to think outside the box. It also calls for a lot of patience as partnerships generally need time to be struck.

the KRa  must  take  care  not to come across as apprehensive in the eyes of the informal sector, but rather supportive. the informal sec- tor does support a lot of jobs and undermining activity in it through disproportionate aggression on the

part  of  the  taxman   would   serve to undermine the broader economy. there are a lot of forward and back- ward linkages between the informal sector and formal businesses.that is, a lot of formal industries depend on raw materials supplied by informal businesses.

For now, the best route for the KRa is to leverage on existing struc- tures such as the county govern- ments, which have their own chan- nels of tapping into the informal sector through licensing fees and other indirect taxes.

Likewise, the KRa must also enhance its data collection and ana- lytics capabilities. this will allow it to craft a suitable taxation policy for

the informal sector without  having to burden it with the cost of compli- ance. a good strategy is to encour- age electronic transactions.

Electronic transactions help populate data which can then later be analyzed to derive insights that inform a good taxation policy. the taxman is already aware of the merits of electronic transactions, explaining why it has digitized oper- ations by introduction of the itax platform. It also going a step further by seeking powers to access taxpay- ers’ mobile and bank records in order to have an inside view of mobile and bank transactions, especially for the informal sector, where a seemingly small business can be conceal huge turnovers through mobile and bank transactions. Mobile money users transacted a total of sh2.8  trillion  las year, sh504 billion more than the national budget.

 

Unfettered powers

the taxman is seeking unfettered powers to taxpayers’ mobile money and bank account records through a treasury-backed amendment to the tax Procedures  act. “In  order to make it easier for taxpayers to submit their returns in the itax system,  I  propose  to  amend  the

tax Procedures act to grant Kenya Revenue authority powers to col- lect information in advance from identified persons for purposes of pre-populating the information in the itax system,” said Henry Rotich, Cabinet secretary for the treasury, while reading the 2016/17 budget in parliament.

Expectedly, this move has not been welcomed cordially by stake- holders, especially safaricom, which cannot risk the global reputation of its iconic M-Pesa brand being com- promised. safaricom said it would  not give the taxman any information about its users unless laws touching on confidentiality are  changed.

Banks are also not keen to   com-

 

ply with the KRa’s bid to snoop into transactions unless the necessary legal framework to support such a move is instituted. this means that the KRa’s move to gain access to taxpayer data in order to gain vital insights with regard to their income might run into a lot of legal challeng- es. there is also the likely backlash from consumer rights groups, which may see the KRa’s move as an infringement on privacy.

Even if such a move to gain direct access to taxpayers’ electronic data is successful, it could encour- age taxpayers to move to parallel banking and payment systems that are unregulated and outside the con- trol  of  the  legal  system. this could

 

not only undermine the tremendous strides that Kenya has made in tran- sitioning into a cashless  economy,  but  encourage  the   mushrooming   of cartels in the financial markets, which is never  good.

In concluding,  the  KRa  may need more than just the backing of treasury to gain access to taxpayer data.  It  will  need  the  backing  of the entire government as well as media to sensitize the public on the benefits of compliance. this means that it must remain open to strategic partnerships with key stakeholders, partnerships that may challenge its model of doing business but still achieve desired results at the lowest cost and the fastest time.