MemorandumFrom: Mohamed Ebrahim, MBA (Manchester), CPA (K), C GMA, ACMA, FCT, FFATo: Mr. Joseph Kinyua, CBS- Permanent Secretary/TreasuryDate: 30th September 2011RE: NATIONAL BUDGET FOR FINANCIAL YEAR 2012/2013Further to your request for submission of proposals for consideration in the budget for the year2012/13, which would further measures to achieve the objectives of Vision 2030,simplify the taxsystem, enhance fairness in the tax burden and provide impetus to economic growth and developmentduring the year 2012/2013 and beyond in the Business Daily of 30 January 2012.TAXATIONIndividuals Taxation : Flat TaxMeasureA flat tax rate provides proportional taxation to all individuals i.e. it is non-discriminatory. I recommenda rate of between 20% to 25% being reasonable. It will be supported by a personal, non taxableallowance of KShs 15,000 p.m. for each tax filer. Only employment and rental income would be taxedunder individual taxation i.e. no taxation of interest income (taxed at source at flat rate), dividend (asalready 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 entrepreneurshipInternational experienceIn 1940 Jersey became the first country in the world to adopt a flat tax system at the rate of 20% and in1947 Hong Kong followed with a rate of 16% (currently 15%). More recently Eastern Europehttp://www.globalpolitician.com/22020-europe has led the flat tax revolution starting with Estonia in1994 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, Mongoliaand Montenegro. The common thing with these countries is that most of these countries haveexperienced 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
Business Taxation: Small business deduction for Kenyan Controlled Private EnterprisesMeasureThe basic business/enterprise tax rate be 35% with a SME abatement of 10% for KenyanControlled Private Enterprise (KCPE) and 5% rebate for enterprises engaged in Manufacturingand Processing.RationaleThis 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 biggestemployer and potentially the segment which will produce a vibrant middle class, which isessential if the goals in Vision 2030 are achieved with the major beneficiaries being Kenyan’s.International precedenceCanadian Controlled Private Corporation (CCPC) Small business deductionhttp://www.taxwiki.ca/IT-073+The+Small+Business+Deductionand its manufacturing & processingabatement http://www.taxwiki.ca/IT-145+Canadian+Manufacturing+and+Processing+Profits+-+Reduced+Rate+of+Corporate+Tax to encourage investment by enterprises in the manufacturingsectorBusiness Taxation: Elimination of the discriminatory distinction in business taxationMeasureBusiness should be taxed as businesses, hence should not discriminate on whether it is a soleproprietor, partnership or limited liability company.RationaleIt would remove the discrimination in the tax system for various business enterprises, which create anun-level business playing field.Practical applicationThe sole proprietor and partners in the business would apply the individual tax rate on anymonthly 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 businessincome. The residual as with a corporation would be taxed at the applicable business tax rateafter applying the appropriate abatement if applicable.
Business Taxation: Capital allowancesMeasureI 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%RationaleThe tax system should not be discriminatory based on the type of asset used. This system is easy tounderstand and has the potential to make Kenya an attractive destination for foreign investment inproductive enterprises. NB: allocating capital expenditure over its expected useful life is a financialaccounting concept and has little to do with the taxation system which deals with collecting revenue forthe government and assist in implementing the administration’s objectives.Value Added Tax to be replaced with General Sales TaxMeasureThe Value Added Tax (VAT) system would be replaced by a uniform tax rate of around 5% onthe consumption value of the goods or service. This tax would be the final tax at each level ofthe supply chain. There would also be no threshold for registration, and would be directlylinked to the PIN. The list of items exempt would be basic essentials like food and medicine.RationaleThis system would close the current leakage in the VAT system where unscrupulous tradersclaim fictitious input tax against output tax from fraudulent “brief case” companies whoregister for VAT, get an ETR machine and then sale ETR invoices for a fee. It would also be moretransparent and easier for traders to understand and revenue collector to implement, hence inthe process closing loopholes for corrupt practices and the need for a person who understandsthe 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 foodstuffMeasureEssential food stuff like maize, sugar and wheat, should have a Zero rate of duty.RationaleThis would make these products cheaper in effect reduce the level of inflation and enable the commonman to meet his basic need for food.
GOVERNMENT BORROWING AND RELATED ISSUESInfrastructure borrowingMeasureThe governments capital expenditure borrowing (long terms 15-25years)needs for development ofinfrastructure be sourced from using Sukuks (Islamic bonds) possibly by listing the Sukuk’s in upcomingfinancial centres like Kuala Lampur (Malayasia), Manama (Bahrain) or Doha (Qatar).RationaleThis part of the world is cash rich and Islamic funds are looking for investments opportunities qualifyingas “halal” as there is a dearth of this asset class, hence would be receptive to invest in infrastructureprojects. Furthermore, it would remove the pressure to borrow from the local financial markets, whichcan then have to make available funds to local businesses (including SME’s). A side effect of thegovernment moving away from borrowing in the local market, is a drop in demand for funds leading tolower interest rates. Banks would then start playing their rightful role in the productive economy.Recurrent expenditure borrowingMeasureThe financing for bridging short and medium term borrowing 1to 5 years, should be sourced from theEurobond market, rather than from local banks and syndicated loans. If the borrowing is for a specificsector like tourism development, tea, horticulture, coffee etc., then securitisation of tourism earnings(in foreign currency)could be done to secure the Eurobond.RationaleThe rate obtained would likely be cheaper than borrowing in local market and make the internationalfinancial market familiar with Kenyan bonds. Hence pave the way for our Counties to borrow some ofthe capital expenditure projects in international financial markets. These benefits are in addition toreducing pressure on local market and reduce interest rates locally.International ExperienceA 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 thelender has added assurance to receiving the money lent (by pegging it to the returns from the projectfinanced) and for the Country it is a natural hedge.Added BenefitAn added benefit of the government borrowing in international market at least initially would be toinflow of foreign currency, which would strengthen the Kenya Shilling and on a long term basis if thebenefits of the infrastructure projects undertaken are realised.
Currency PegMeasureThe Kenya shilling should be pegged to a basket of currency rather than to a single currency. Theproposed currency basket would be US dollar, Euro, Sterling pound, Chinese Yuan, Indian Rupee andJapanese Yen. This peg could be a floating in a range of plus or minus 2%.RationaleThe peg would give the Kenya shilling increased stability and (a basket peg) would not be drasticallyaffected by the fortunes of any one currency in the international market. Furthermore, it would takeinto account the increasing economic power of Asia, who are increasing their trade and investment inKenya. A fairly determined peg would allow the interests of both importers and exporters to be lookedafter. It would also have a positive impact on controlling cost push inflation. Our agricultural exportsector earnings in Kenya shilling terms would be better managed.Hedging for Major ExportsMeasureCentral bank should consider using derivative preferably options to hedge for price risk for majorexports 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.RationaleThe commodity hedging (price risk) and crop insurance (production volume risk) would ensure thatshould the commodity in question be affected adversely (volume or price), the foreign exchange inflowswould not adversely affect the rate of exchange. This would also signal to our international lenders, thatwe are taking measures to secure our foreign currency inflows, hence their funds would be paid back.East African Community Common currencyThis is subject to plans materialising to have a common currency for the countries of the East Africancommunity(assumed called East AFRO).MeasureIn order to have a stable viable currency the East Afro, should be pegged to a basket of currencies andall the countries which are participate in this currency should have a common treasury.RationaleA key shortcoming exposed in the Euro zone debt crises was that the EU nation which have the Euro aslegal tender do not have a common treasury. In my view a significant amount of the Euro Zone criseswould have been avoided if they had a common treasury. As it is known that interest rates, inflationrates and foreign currency exchange rates are interconnected and interdependent due to theinternational fishers effect, hence the necessity to have a common regime of inflation and interest ratesacross the all the countries sharing the common currency. It will avoid future currency crises.
OTHER BUDGET ISSUESRelaxing of audit requirement for SME’s incorporated as limited liability companiesMeasureThe statutory audit requirement for Kenyan Controlled Private Enterprises qualifying as SME’s should berelaxed, to enable them take advantage of limited liability for investors in these enterprises. I wouldrecommend instead of a statutory audit , an Accountants report by a designated accountant besubstituted, which would potentially reduce costs. This would allow the designated accountant to placereliance on the management control of the enterprise, hence reduce testing levels.RationaleIt would improve risk taking and entrepreneurship in the SME sector by reducing annual compliancecosts. A similar provision exists in the United Kingdom and in Canada (3 tiered assurance system,Compilation, Review and Audit engagements).Small Business Board (SBB)MeasureAn 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 roleplayed would be similar to the Small Business Administration (SBA) plays in the United States.RationaleThis would promote entrepreneurship in the SME sector and help in achieving objectives of Vision 2030.Food Sector Support (local food producers)MeasureImportation of essential foodstuff (imported duty free) like rice, wheat, and Maize when necessary bedone by the Board responsible for the item and sold at the locally produced price at a discount of say10% to cover their selling and distribution costs. The profit between the sale price and the actual cost ofthe imported commodity would be used to improve the agricultural sector concerned by investing inimproved (including higher yielding) crop varieties.RationaleIt would assist in ensuring Kenya becomes self sufficient in food production.CONCLUSIONThis memorandum has been prepared to give my thoughts for consideration, in the coming Budget forthe 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.