informal sector and taxation in kenya: issues and policy ... informal sector employment: overview...
TRANSCRIPT
Informal Sector and Taxation in Kenya: Issues and Policy Options
Presentation during a Public Forum
Held at
Nairobi Sarova Hotel - Nairobi
3rd May 2012
Martin M. Masinde
1
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
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
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
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, 17 – 19 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
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
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
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
Kenya’s Revenue Capacity and Tax Effort
9
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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
Estimates of the size of the underground
economy
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Estimates of the size of the underground economy
The Government lost Kshs. 63.5 billion, Kshs. 69.73 billion,
and Kshs. 79.273 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
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
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 micro-
enterprises by: simplifying tax procedures, simplifying tax
computation and by simplifying record keeping.
14
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
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
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Kshs Million
2007/08 2008/09 2009/10
Actual Target Per. Rate Actual Target Per. Rate Actual Target Per. Rate
July 25 93 27% 21 36 57%
August 2 6 33% 2.4 3 83%
September 4 6 65% 2 6 42%
October 27 93 29% 23 39 58%
November 2 6 27% 3 3 111%
December 4 6 60% 6 6 99%
January 35 102 34% 22 51 43%
February 2 9 26% 3 3 100%
March 3 6 51%
April 20 37 54% 23 96 24%
May 5 37 15% 7 9 77%
June 3 37 8% 3 9 29%
Total 28 111 25% 136 442 31% 57 92
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
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
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
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
Approaches the govt can use to ensure revenue collection from Informal Sector
A number of approaches have been tried to reduce risk of under-
declaration 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
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
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
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
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
THANK YOU &
GOD BLESS
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