Kenyan corporate tax increase

Kenyan President Uhuru Kenyatta on 26 May announced that an anti-corruption investigation was under way to prevent the misuse of budget revenue, while 'the Treasury on 31 May proposed increases in corporate taxation. The measures indicate the government's renewed commitment to fiscal consolidation in line with the "Big Four" economic strategy.

• Proposals to increase the corporate tax burden (from 30% to 35%) and an anti-corruption initiative to prevent the misuse of Kenyan government expenditure indicate a strong commitment to fiscal consolidation.
• The opposition National Super Alliance coalition rejects the new tax legislation but a consensus supporting the legislation is emerging within the ruling Jubilee party, which dominates parliament, indicating final approval will be granted shortly after the 2018/19 budget is tabled on 30 June.
• Likely implementation of a proposed 5% reduction to development expenditure and the corporate tax increases would improve Kenya's prospects of meeting International Monetary Fund conditions before 1 August and maintaining access to a USD1.5-billion standby credit facility. However, these reforms would threaten to delay or cancel several metropolitan transportation projects, and reduced corruption risks would be limited to government procurement.

President Uhuru Kenyatta on 26 May told media that several government agencies were conducting anti-corruption investigations into the alleged theft of public resources by senior government officials. The investigations will be concluded before the end of June and prosecutions are expected to follow. The president did not identify any affected officials, but undisclosed government sources reported to Kenyan media the same day that those under investigation included at least two current cabinet secretaries.

Kenyatta emphasised that the investigations were not being motivated by ethnic politics, but were instead necessary to prevent the misuse of budget revenue and achieve the policy aims he has outlined under the "Big Four" economic strategy. This strategy, which was launched during Kenyatta's inauguration to a second term in office on 12 December 2017, aims to provide access to affordable health insurance and housing, as well as stimulate domestic manufacturing.

Separately, Kenya's Treasury on 31 May proposed a new Income Tax Bill, after consultations with the private sector were concluded on 24 May. Key points of the draft legislation are:

• An increase in the rate of corporate tax from 30% to 35% for companies with annual incomes that exceed USD4.9 million, which amounts to the highest corporate tax rate within the East Africa Community (EAC) trading bloc.
• An increase in capital gains tax for all companies from 5% to 20% and adjust it for inflation as measured by Kenya's consumer price index.
• Tax incentives would not apply to any manufacturers that locate in special economic zones (SEZs) and export processing zones (EPZs) after the bill is finalised. Instead, the tax regime governing new investors in SEZs and EPZs would be unified to a graduated corporate tax rate of 10% in the first 10 years of operation, 15% in the next 10 years, and 30% thereafter.
• The current 150% investment deduction allowance for manufacturers would be repealed and a standardised 100% rate applied.
• Transactions between resident and non-resident companies that reside in a jurisdiction with a tax rate lower than 16% would be conducted at arm's length.
• The Tax Revenue Authority would enforce stricter penalties (fines and prison terms) for non-compliance with the tax law.

Deficit reduction strategy
The new initiatives are intended to reduce a growing budget deficit by preventing revenue leakage and enhancing revenue mobilisation. A draft Budget Policy Statement issued on 19 January by the Treasury revised budget deficit targets upwards from 7.2% of GDP to 7.9% of GDP, primarily because of an anticipated shortfall in revenue. However, these budgetary proposals were contrary to International Monetary Fund (IMF) guidance, which on 20 February clarified that Kenya's access to a USD1.5-billion standby credit facility would remain in place until the end of March 2018, but that progress in conducting a second and third review - due in June and December 2017 respectively - had stalled due to a lack of progress in implementing deficit reduction measures. Finance Minister Henry Rotich subsequently told international media on 22 February that Kenya would look to implement fiscal consolidation measures proposed by the IMF, which included boosting revenue collection and reducing expenditure. The IMF review period to determine whether access to this facility should be renewed ends in August, shortly after the 2018/19 budget is scheduled to be approved by the National Assembly on 30 June.

We assessed in January that the budget deficit reached 8.9% of GDP during the 2016/17 fiscal year ending on 30 June 2017. Only a small narrowing of the deficit to 8.5% of GDP is forecast to be likely in 2017/18, if efforts are not intensified to rationalise expenditures and improve revenue mobilisation in the context of GDP growth having slowed from 5.8% in 2016 to 4.5% in 2017.

Outlook and implications
The anti-corruption measures and corporate tax increases indicate President Kenyatta's government is committing more strongly to fiscal consolidation measures. The anti-corruption probe is, however, unlikely to significantly reduce revenue leakage or bribery and corruption risks outside of select government procurement programmes in education and health. Instead, the investigations will probably target a minority of officials, broadening ongoing investigations and court cases relating to the alleged misappropriation of funds dispersed to the National Youth Service between September 2016 and August 2017. This is especially the case as Kenyatta will need to retain the loyalty of his cabinet, which was newly formed on 26 January and draws support from several neutral constituencies that have traditionally not voted for the ruling Jubilee party.

Consequently, greater emphasis will probably be placed on finalising the Income Tax Bill, which is likely to be tabled in the National Assembly around 30 June to coincide with parliament approving the 2018/19 budget. Key members of the opposition National Super Alliance (NASA) coalition on 19 May publicly voiced their disagreement with the tax rises. Approval of the legislation is still likely, though, because the National Assembly is dominated by the Jubilee party, which controls a 49% share of seats, and there is broad agreement within the party that these measures are necessary to ensure the success of Kenyatta's Big Four strategy. If, however, the finalised 2018/19 budget retains a 5% reduction in development expenditure - as proposed in the 19 January Draft Budget Policy Statement - then there will probably be greater scope for Jubilee parliamentarians to argue for a smaller increase in the corporate tax burden. Another possibility is that amendments are made to exempt strategic sectors besides manufacturing in the SEZs and EPZs. This includes onshore oil production for which taxation terms would be formulated under a new version of the Petroleum (Exploration, Development, and Production) Bill. This was originally tabled on 25 September 2017 but withdrawn due to the disputed presidential election and subsequent re-run in October 2017. Subsequent delays ensued due to disagreements over revenue sharing arrangements. A reduction in development expenditure would threaten to delay or cancel several projects, including the Kisumu and Malaba railway extension projects; Eldoret, Kisumu, and Mombasa airport expansions; and the Nairobi Public Transport System.