Memorandum on proposal for consideration to Joseph Kinyua - PS Treasury. Kenya Budget for the year 2012/13

1. Memorandum
From: Mohamed Ebrahim, MBA (Manchester), CPA (K), C GMA, ACMA, FCT, FFA
To: Mr. Joseph Kinyua, CBS- Permanent Secretary/Treasury
Date: 30th September 2011
RE: NATIONAL BUDGET FOR FINANCIAL YEAR 2012/2013
Further to your request for submission of proposals for consideration in the budget for the year
2012/13, which would further measures to achieve the objectives of Vision 2030,simplify the tax
system, enhance fairness in the tax burden and provide impetus to economic growth and development
during the year 2012/2013 and beyond in the Business Daily of 30 January 2012.
TAXATION
Individuals Taxation : Flat Tax
Measure
A flat tax rate provides proportional taxation to all individuals i.e. it is non-discriminatory. I recommend
a rate of between 20% to 25% being reasonable. It will be supported by a personal, non taxable
allowance of KShs 15,000 p.m. for each tax filer. Only employment and rental income would be taxed
under individual taxation i.e. no taxation of interest income (taxed at source at flat rate), dividend (as
already taxed at business level).
Rationale
 Simplicity- reducing compliance costs as it is easy for the layman to understand
 Eliminates bias against capital formation, by ending the double taxation of income
 Reduces penalties on work, risk taking and entrepreneurship
International experience
In 1940 Jersey became the first country in the world to adopt a flat tax system at the rate of 20% and in
1947 Hong Kong followed with a rate of 16% (currently 15%). More recently Eastern Europe
http://www.globalpolitician.com/22020-europe has led the flat tax revolution starting with Estonia in
1994 with a rate of 22% followed by Latvia, Lithuania, Russia, Serbia, Ukraine, Georgia and Romania.
Other countries with a flat tax system include Iraq, Kyrgyzstan, Iceland, Macedonia, Mauritius, Mongolia
and Montenegro. The common thing with these countries is that most of these countries have
experienced exceptional economic growth and significant growth in tax revenue.
http://www.iris.org.il/blog/archives/422-IRIS-Exclusive-All-Flat-Tax-Countries-Experiencing-Explosive-
Growth-Rates.html

2. Business Taxation: Small business deduction for Kenyan Controlled Private Enterprises
Measure
The basic business/enterprise tax rate be 35% with a SME abatement of 10% for Kenyan
Controlled Private Enterprise (KCPE) and 5% rebate for enterprises engaged in Manufacturing
and Processing.
Rationale
This measure would promote the SME segment and the manufacturing and processing sector,
which is the engine of growth of the Kenyan economy, collectively as a group the biggest
employer and potentially the segment which will produce a vibrant middle class, which is
essential if the goals in Vision 2030 are achieved with the major beneficiaries being Kenyan’s.
International precedence
Canadian Controlled Private Corporation (CCPC) Small business deduction
http://www.taxwiki.ca/IT-073+The+Small+Business+Deductionand its manufacturing & processing
abatement http://www.taxwiki.ca/IT-145+Canadian+Manufacturing+and+Processing+Profits+-
+Reduced+Rate+of+Corporate+Tax to encourage investment by enterprises in the manufacturing
sector
Business Taxation: Elimination of the discriminatory distinction in business taxation
Measure
Business should be taxed as businesses, hence should not discriminate on whether it is a sole
proprietor, partnership or limited liability company.
Rationale
It would remove the discrimination in the tax system for various business enterprises, which create an
un-level business playing field.
Practical application
The sole proprietor and partners in the business would apply the individual tax rate on any
monthly drawings from the business and remit it together with the PAYE for its employees;
these drawings would be treated as salary for tax purposes and deductible against the business
income. The residual as with a corporation would be taxed at the applicable business tax rate
after applying the appropriate abatement if applicable.

3. Business Taxation: Capital allowances
Measure
I would have liked to suggest a complete tax write-off for capital expenditure in the year of purchase,
however due to its effect on revenue collection I suggest the following straight-line rates:-
Year of purchase 25%
Following year 50%
Final year 25%
Rationale
The tax system should not be discriminatory based on the type of asset used. This system is easy to
understand and has the potential to make Kenya an attractive destination for foreign investment in
productive enterprises. NB: allocating capital expenditure over its expected useful life is a financial
accounting concept and has little to do with the taxation system which deals with collecting revenue for
the government and assist in implementing the administration’s objectives.
Value Added Tax to be replaced with General Sales Tax
Measure
The Value Added Tax (VAT) system would be replaced by a uniform tax rate of around 5% on
the consumption value of the goods or service. This tax would be the final tax at each level of
the supply chain. There would also be no threshold for registration, and would be directly
linked to the PIN. The list of items exempt would be basic essentials like food and medicine.
Rationale
This system would close the current leakage in the VAT system where unscrupulous traders
claim fictitious input tax against output tax from fraudulent “brief case” companies who
register for VAT, get an ETR machine and then sale ETR invoices for a fee. It would also be more
transparent and easier for traders to understand and revenue collector to implement, hence in
the process closing loopholes for corrupt practices and the need for a person who understands
the output tax and input tax deductions system. It also eliminates innocent mistakes by traders,
who are then heavily penalised for wrong application of VAT law, a nuisance to small entities.
Duty on essential foodstuff
Measure
Essential food stuff like maize, sugar and wheat, should have a Zero rate of duty.
Rationale
This would make these products cheaper in effect reduce the level of inflation and enable the common
man to meet his basic need for food.

4. GOVERNMENT BORROWING AND RELATED ISSUES
Infrastructure borrowing
Measure
The governments capital expenditure borrowing (long terms 15-25years)needs for development of
infrastructure be sourced from using Sukuks (Islamic bonds) possibly by listing the Sukuk’s in upcoming
financial centres like Kuala Lampur (Malayasia), Manama (Bahrain) or Doha (Qatar).
Rationale
This part of the world is cash rich and Islamic funds are looking for investments opportunities qualifying
as “halal” as there is a dearth of this asset class, hence would be receptive to invest in infrastructure
projects. Furthermore, it would remove the pressure to borrow from the local financial markets, which
can then have to make available funds to local businesses (including SME’s). A side effect of the
government moving away from borrowing in the local market, is a drop in demand for funds leading to
lower interest rates. Banks would then start playing their rightful role in the productive economy.
Recurrent expenditure borrowing
Measure
The financing for bridging short and medium term borrowing 1to 5 years, should be sourced from the
Eurobond market, rather than from local banks and syndicated loans. If the borrowing is for a specific
sector like tourism development, tea, horticulture, coffee etc., then securitisation of tourism earnings
(in foreign currency)could be done to secure the Eurobond.
Rationale
The rate obtained would likely be cheaper than borrowing in local market and make the international
financial market familiar with Kenyan bonds. Hence pave the way for our Counties to borrow some of
the capital expenditure projects in international financial markets. These benefits are in addition to
reducing pressure on local market and reduce interest rates locally.
International Experience
A few years back Turkey borrowed for its communications sector by securitising the cash flow (earnings)
from international calls which are receivable in foreign currency, to secure the loan. In this way the
lender has added assurance to receiving the money lent (by pegging it to the returns from the project
financed) and for the Country it is a natural hedge.
Added Benefit
An added benefit of the government borrowing in international market at least initially would be to
inflow of foreign currency, which would strengthen the Kenya Shilling and on a long term basis if the
benefits of the infrastructure projects undertaken are realised.

5. Currency Peg
Measure
The Kenya shilling should be pegged to a basket of currency rather than to a single currency. The
proposed currency basket would be US dollar, Euro, Sterling pound, Chinese Yuan, Indian Rupee and
Japanese Yen. This peg could be a floating in a range of plus or minus 2%.
Rationale
The peg would give the Kenya shilling increased stability and (a basket peg) would not be drastically
affected by the fortunes of any one currency in the international market. Furthermore, it would take
into account the increasing economic power of Asia, who are increasing their trade and investment in
Kenya. A fairly determined peg would allow the interests of both importers and exporters to be looked
after. It would also have a positive impact on controlling cost push inflation. Our agricultural export
sector earnings in Kenya shilling terms would be better managed.
Hedging for Major Exports
Measure
Central bank should consider using derivative preferably options to hedge for price risk for major
exports like Tea, Coffee and Horticulture based on expected output of the commodity in question.
Furthermore, the industry board like Tea Board and Coffee board should have crop insurance.
Rationale
The commodity hedging (price risk) and crop insurance (production volume risk) would ensure that
should the commodity in question be affected adversely (volume or price), the foreign exchange inflows
would not adversely affect the rate of exchange. This would also signal to our international lenders, that
we are taking measures to secure our foreign currency inflows, hence their funds would be paid back.
East African Community Common currency
This is subject to plans materialising to have a common currency for the countries of the East African
community(assumed called East AFRO).
Measure
In order to have a stable viable currency the East Afro, should be pegged to a basket of currencies and
all the countries which are participate in this currency should have a common treasury.
Rationale
A key shortcoming exposed in the Euro zone debt crises was that the EU nation which have the Euro as
legal tender do not have a common treasury. In my view a significant amount of the Euro Zone crises
would have been avoided if they had a common treasury. As it is known that interest rates, inflation
rates and foreign currency exchange rates are interconnected and interdependent due to the
international fishers effect, hence the necessity to have a common regime of inflation and interest rates
across the all the countries sharing the common currency. It will avoid future currency crises.

6. OTHER BUDGET ISSUES
Relaxing of audit requirement for SME’s incorporated as limited liability companies
Measure
The statutory audit requirement for Kenyan Controlled Private Enterprises qualifying as SME’s should be
relaxed, to enable them take advantage of limited liability for investors in these enterprises. I would
recommend instead of a statutory audit , an Accountants report by a designated accountant be
substituted, which would potentially reduce costs. This would allow the designated accountant to place
reliance on the management control of the enterprise, hence reduce testing levels.
Rationale
It would improve risk taking and entrepreneurship in the SME sector by reducing annual compliance
costs. A similar provision exists in the United Kingdom and in Canada (3 tiered assurance system,
Compilation, Review and Audit engagements).
Small Business Board (SBB)
Measure
An SBB be set up as a one-stop information and support organisation for Small & Medium Enterprises
(SME). Its mandate would include giving guarantees to commercial banks to lend to SME’s. The role
played would be similar to the Small Business Administration (SBA) plays in the United States.
Rationale
This would promote entrepreneurship in the SME sector and help in achieving objectives of Vision 2030.
Food Sector Support (local food producers)
Measure
Importation of essential foodstuff (imported duty free) like rice, wheat, and Maize when necessary be
done by the Board responsible for the item and sold at the locally produced price at a discount of say
10% to cover their selling and distribution costs. The profit between the sale price and the actual cost of
the imported commodity would be used to improve the agricultural sector concerned by investing in
improved (including higher yielding) crop varieties.
Rationale
It would assist in ensuring Kenya becomes self sufficient in food production.
CONCLUSION
This memorandum has been prepared to give my thoughts for consideration, in the coming Budget for
the year 2012/2013, which are based on good faith to improve the Kenyan economy.
Mohamed Ebrahim, MBA (Manchester), Certified Public Accountant (K),Chartered Treasurer (Fellow)
and Chartered Global Management Accountant.