Informal Sector and Taxation in Kenya: Issues and Policy Options

Transcription

1 Informal Sector and Taxation in Kenya: Issues and Policy Options Presentation during a Public Forum Held at Nairobi Sarova Hotel - Nairobi 3 rd May 2012 Martin M. Masinde 1

2 Presentation Outline 1.0 Introduction 2.0. The Informal Sector: An Overview 3.0. Approaches for Revenue Collection Within the Informal Sector 4.0. Existing Opportunities for Revenue Collection in the Informal Sector 5.0. Policy Considerations and Options 2

3 The Informal Sector : An overview Comprises of activities primarily of small traders involved in such activities as the selling of second-hand clothes, shoe shinning, food selling and repair and construction; operating mainly from the streets of the main urban centers. It can also be described as any activity generating income and profits, though on a small scale, uses simple skills, is dynamic and not tied to regulation of the activities. Informal Sector is referred to as jua kali in Kenya Operates on small-scale, locally and at a subsistence level, have fewer employees (especially home-based enterprises), operate for a shorter period, and have poor access to water and electricity and few sell outside the establishments where the entrepreneurs live. 3

4 Informal Sector employment: Overview contribution to GDP in Kenya The taxation of the Informal Sector is an important topic for policy makers, as the sector makes up majority of businesses (Small &Medium Enterprises) and typically account for the bulk of employment. The First 1993 MSE baseline survey revealed that there were approximately 910, 000 MSEs employing up to 2 million people. The second MSE baseline survey (1995) estimated the size of the MSE sector at 708, 000 enterprises employing up to 1. 2 million people. Compared to the other sectors of the economy, the contribution of the MSE sector to the country s Gross Domestic Product (GDP) increased from 13.8% in 1993 to over 18% in 1999 (Sessional Paper No. 2 of 2005). According to the Kenya Economic Report, 2009, MSEs sector accounts for 87 per cent of all new jobs created and absorbs about 77 percent of total number of employees in Kenya. 4

5 Informal Sector employment: Overview contribution to GDP in Kenya (Cont d) The sector generates 18.4 percent of GDP and it is estimated that 74.8 per cent of all businesses in the country fall within SME The International Tax Dialogue (ITD) Global Conference on taxation of small and medium enterprises held in Buenos Aires, Argentina, October 2007 recognised that SMEs play a prominent role in all economies. They are important to the economy and they are important to tax policymakers and administrators. The large numbers of SMEs, their high turnover rates and their sheer diversity present challenges to all administrations. For SMEs, key considerations are to minimise administrative burden while ensuring compliance, including considering the drivers and impacts of operating in the informal economy. 5

6 Informal Sector tax evasion Informal Sector tax evasion is driven generally by a perception that the tax burden is too high, poses a number of problems to tax systems, raising difficult questions over how tax policies and tax administration may influence tax compliance incentives and behaviour. The compliance tax burden on the Informal Sector may be high relative to that for large companies (higher unit cost in relation to turnover) Further, the cost of complying with a given set of tax rules/regulations is generally higher for the Informal Sector as a percentage of turnover or profit. In theory, a taxpayer s incentive to comply with a tax system depends on an assessment of the relative benefits and costs of complying versus not complying 6

7 Common obstacles to taxing Informal Sector include It is easy for small businesses to remain outside the tax net, i.e. they are inconspicuous to the tax administration. They are largely cash businesses inadequate accounting records and audit trail. Complicated tax systems and numerous processes (licensing etc.) make it difficult and expensive for start-up firms to act in good faith. In developing economies, small businesses are rarely excluded from the tax base but are rarely properly attended to by the tax administration. Presumptive taxes proliferate and are rarely fixed or regularly adjusted these regimes become stagnant pools often beneficial to small business for all the wrong reasons. 7

8 Reasons for non compliance in the informal Sector Poor management and internal control practices many are merely trying to make ends meet, thus are essentially survivalists. Informal approach to establishment, operation and dissolution creates an ease of mobility making it difficult for the tax administration to keep up-to-date. Cash-based economies inadequate accounting records and audit trails. Compliance costs are much higher relative to larger business operations. Small businesses have limited resources and technical capacity. Often the priority of a tax administration is to focus on large taxpayers because of the high delinquency rate and low revenue yields associated with small businesses with very little enforcement action. This only encourages non-compliance. 8

9 Kenya s Revenue Capacity and Tax Effort Type of tax Year (1) Average Growth Rate (2) Revenue Tax Potential Ksh Million (3) Actual Collection/Ksh Million (4) Compliance Percentage (est.) (2001/02) (5) Compliance Percentage (est.) (2009/010) (6) Personal income taxes 2009/ % 163, , % 79.90% 32,867 Excise tax 2009/ % 93,731 74, % 79.40% 19,308 Import Duty 2009/ % 109,855 57, % 51.90% 52,840 Corporate tax 2009/ % 196,817 89, % 45.50% 107,265 VAT 2009/ % 204, , % 69.00% 63,366 Grand Total 768, , ,648.7 Source: Parliamentary Budget Office Loss (7) 9

10 Kenya s Revenue Capacity and Tax Effort Assuming that tax effort is adjusted for various growth rates as a proxy for the improved tax effort, in the years running up to 2009/2010, Kenya lost revenue worth Kshs. 275 billion This corresponds to an average revenue effort of 35.9 per cent when revenue capacity is compared to revenue losses. This means that this sum of potential revenues remain uncollected. Correlation results indicate a strong correlation between tax collection and economic growth 10

11 Estimates of the size of the underground economy LRC (-1) Estimated nominal currency, underground economy Money Velocity Potential GDP Hidden economy Potential Tax Potential GDP hidden economy % of GDP % 2.52% % 3.09% % 4.22% % 5.07% % 6.14% % 6.74% Tax Potential hidden Economy as % of GDP % 7.66% 11

12 Estimates of the size of the underground economy The Government lost Kshs billion, Kshs billion, and Kshs billion in 2006, 2007, and 2008, respectively. In other words, in 2008, by bringing the underground economy fully into the tax net, the government could have increased the tax base by approximately 7.66 percentage points, translating to revenue worth Kshs.79.3 billion. If the underground economy remains untaxed, the government will continue losing billions of shillings in terms of revenue and as more people move into the informal sector to escape the burdensome taxation, it will become increasingly difficult for the government to hit its revenue targets. 12

13 Informal Sector: Introduction of Turnover Tax (TOT) in Kenya Pressure to generate sufficient revenue to meet expenditure needs amid dwindling customs revenues. A proposal was debated by the government in 2004/05 to increase VAT threshold from Kshs.3m to Kshs.5m. The total number of taxpayers envisaged to have been in that bracket was approximately 66,000. Out of this number 52,000 were falling below Kshs.5m. In the Finance Bill 2007 and Turnover tax was born. 13

14 Informal Sector: Rationale and performance of Turnover Tax (TOT) in Kenya Most of the micro and small traders either keep incomplete business records or do not keep any record at all. Attributed to low levels of education attained by majority of the traders. To enhance their tax compliance, there is need to isolate the micro and small traders from the current tax regime in accordance with international best practice. The objective of introducing Turnover tax (TOT) in Kenya was geared towards bringing the informal sector into the tax net and to simplify processes for the small and microenterprises by: simplifying tax procedures, simplifying tax computation and by simplifying record keeping. 14

15 Informal Sector: Rationale and performance of Turnover Tax (TOT) in Kenya (Cont d.) It was decided that the VAT threshold be raised from the previous threshold of Kshs.3 million to Kshs.5 million such that 85% of the non-designated businesses whose annual turnover fall below Kshs.5million of the new threshold. Turnover-based tax regime at 3% of the gross sales turnover per annum without considering any over head expenses. The performance of TOT revenue has been below average in most months since its inception. In year 2008/09, TOT performed at 31% with a total of Kshs. 136 Million against a set target of Kshs. 442 Million. From beginning of 2009/10, the performance of the TOT is above average but on a declining trend. 15

16 Informal Sector: Rationale and performance of Turnover Tax (TOT) in Kenya (Cont d.) On TOT recruitments, a total of 18,369 taxpayers have been recruited from April 2008 to Feb 2010, the number is likely to be larger now... The performance rate has on average been below 50%. 16

17 Turnover Tax Collection in Kshs Million Kshs Million 2007/ / /10 Actual Target Per. Rate Actual Target Per. Rate Actual Target Per. Rate July % % August % % September % % October % % November % % December % % January % % February % % March % April % % May % % June % % Total % %

18 Non compliant turnover taxpayers Taxpayers who fail to keep records. Taxpayers who fail to submit their Turnover Tax quarterly returns [TOT 3]. Taxpayers whose turnover is below Kshs 5 million and deliberately avoid registration. Taxpayers who falsify records. 18

19 Penalties, fines and interest A TOT Taxpayer who fails to file a return shall be liable to a default penalty of Kshs. 2,000/=. A TOT Taxpayer who fails to pay the tax on the due date shall be liable to pay a late payment compounded interest of 2% per month or any part thereof. A TOT Taxpayer, who knowingly submits an incorrect return, will be charged double the difference between the normal tax chargeable on the basis of his return and the actual tax due. A TOT Taxpayer who fails to keep records which in the opinion of the Commissioner is necessary for the determination of his turnover, shall be liable to a penalty not exceeding Kshs.20,000/. 19

20 Policy Considerations Under what conditions can the Informal Sector make their biggest potential contribution to a healthy economy? What policy, including tax policy, can make a considerable difference on how well the SME sector fulfils its potential role in contributing to a healthy economy. Informal Sector is often disadvantaged vis a vis large firms by market imperfections, especially in the capital and product goods markets. Since most market imperfections cannot be fully, often not even partially, removed, policy analysis must be carried out in the context of the ROLE OF STATE. 20

21 Policy Considerations (Cont d.) Areas to focus for policy: Labour Legislation. The capital market, which is almost by definition very imperfect. Incentive to pay tax??? Prudent Financial Management Tax policy: Negative incentive effects on each of SME creation, output, and labour intensity 21

22 Approaches the govt can use to ensure revenue collection from Informal Sector A number of approaches have been tried to reduce risk of underdeclaration of business turnover as follows:- Loans. In the Netherlands lenders limited to financial institutions and regional development grant institutions receive tax-free interest income. Equipment Purchase. In Austria, Micro (Small) businesses having in excess of 70% of the micro threshold amount that reinvests profits into the purchase of new equipment are allowed a 10% reduction to total turnover if the cost of the new equipment exceeds the 10% reduction to total income. Audits. It is cost ineffective to audit micro enterprises. However, to assure compliance, spot inspections have been implemented in Australia. 22

23 Approaches the govt can use to ensure revenue collection from Informal Sector (Cont d.) Providing incentives for improving recordkeeping. Turnover-based systems, if well designed, offer a good possibility of providing specific incentives for improving recordkeeping standards. Promotion of credit card use: Under-declaration of turnover is much facilitated in a cash-dominated economy. Tax invoice lotteries: Introduction of incentives for issuing receipts. This can be done, for example, in the form of organizing receipt lotteries. Some countries have established a legal requirement to use the banking system for making payments for purchases or services above a specified amount. 23

24 Cont d. Despite the high risk of turnover evasion, the system must be based on actual and not on presumed turnover. A badly designed turnover-based system, which does not sufficiently take into account actual business turnover as a base for calculation of the presumptive tax burden, in fact turns into a simple patent system. A presumptive tax system can create major obstacles to small business growth if the transition from the presumptive into the standard taxation regime is costly or complicated. There is need to:- Offer some incentives to improve recordkeeping of businesses in the presumptive system. Extensive assistance and information campaigns on the importance and details of recordkeeping. The possibility to claim and carry forward losses is an important element of the standard regime, which benefits MSEs during loss-making periods. 24

25 Way Forward / Lessons Instead of lumping the TOT tax regime amongst the general Domestic Revenue, informal sector requires special attention. Due to the complexity of the sector, there it is urgent to have a one stop shop whereby the entities pay the fair share of taxes at the point of licensing. A typical example will be to harmonize the registration system of the Nairobi city council and the KRA database. Ouma (2007), there is need to improve data capture and have a reliable database to allow for further analysis of the characteristics of the underground economy. Improve bookkeeping among micro and small enterprises by offering incentives such as application of a lower presumptive tax rate for small businesses meeting certain recordkeeping standards. 25

26 Way Forward / Lessons Enhance voluntary compliance by establishing a strong enforcement. Educate the small businesses on the importance and details of book keeping and offer them assistance to improve their record keeping standards. Encourage transition from the presumptive to the standard regime such as by offering the possibility to claim and carry forward losses which benefits MSEs during loss-making periods. Enhance the capacity of the formal sector by offering them with business counseling, training and reducing their cost of registration among other incentives aimed at assisting their businesses to flourish and in turn, drive economic growth and increase revenue collection 26

27 THANK YOU & GOD BLESS 27