Government should reconsider the proposed tax amendments relating to the energy sector

The Tax Laws (Amendment) Bill, 2020 (the Bill) was published on 30 March 2020 and is expected to be tabled in Parliament anytime soon for consideration before being passed into law. The Bill proposes to make a raft of amendments to various tax laws in Kenya including the Income Tax Act (Chapter 470), the Value Added Tax Act, 2013 and the Miscellaneous Fees and Levies Act, 2015 (the Tax Laws). There is already public uproar on the magnitude and impact of the changes that are proposed under the Bill which was expected to only address COVID-19 related measures.Noteworthy, a number of the proposed amendments relate to withdrawal of various incentives and tax exemptions that are currently available to players in the energy sector, particularly, the renewable energy segment. These incentives proposed to be deleted from the Tax Laws include: a)nbsp;nbsp;nbsp;nbsp;nbsp;VAT exemption on importation of taxable supplies for construction of a power generating plant to supply electricity to the national grid; b)nbsp;nbsp;nbsp;nbsp;nbsp;VAT exemption on specialized equipment for the development and generation of solar and wind energy, including deep cycle batteries which use or store solar power; c)nbsp;nbsp;nbsp;nbsp;nbsp;nbsp;VAT exemption on taxable supplies, imported or purchased for direct and exclusive use in geothermal, oil or mining prospecting or exploration, excluding motor vehicles;d)nbsp;nbsp;nbsp;nbsp;nbsp;VAT exemption on inputs or raw materials supplied to solar equipment manufacturers for manufacture of solar equipment or deep cycle-sealed batteries which exclusively use or store solar power; e)nbsp;nbsp;nbsp;nbsp;nbsp;inputs of raw materials for electric accumulators and separators supplied to manufacturers of automotive and solar batteries in Kenya which are currently zero rated, are proposed to be subject to VAT at the new standard rate of 14%;f)nbsp;nbsp;nbsp;nbsp;nbsp;nbsp;investment deduction (currently claimed at a rate of 100% or 150%)nbsp;on capital costs incurred in the construction of a power generating plant is proposed to be reduced to 50%; g)nbsp;nbsp;nbsp;nbsp;nbsp;withholding tax on dividends to non-resident shareholders which is currently 10% is proposed to be increased to 15% for all companies; andh)nbsp;nbsp;nbsp;nbsp;nbsp;the exemption from compensating tax for power producers which was introduced in July 2018 is proposed to be deleted.The above exemptions constitute the bulk of incentives that are currently available to independent power producers and other investors in the energy sector. Why are these incentives important?The energy sector, without any doubt, plays a critical role in Kenya’s socio-economic development. The Kenya Vision 2030 identified energy as one of the infrastructure enablers of its socio-economic pillar and is indeed the key pillar in the implementation of the President’s ‘Big Four’ agenda which focuses on manufacturing, universal healthcare, food security and affordable housing. On whether much progress will have been made by the end of his term in 2022 is a story for another day.With a fast growing population, increased focus on manufacturing and the Big Four agenda (not forgetting Vision 2030), cheaper electricity will be a key driver for economic growth. The cost of energy has a significant bearing on economic activities, particularly those that are energy intensive such as the manufacturing sector. This was in fact the rationale for the introduction of a 30% deduction of the electricity expenditure incurred by manufacturers, in addition to the normal electricity expense (an incentive which is also proposed to be withdrawn under the Bill). nbsp;In order to provide affordable and competitive electrical energy to transform Kenya‘s economy, public private partnerships are vital in the development, operation and maintenance of energy infrastructure and delivery systems. The Government of Kenya (GoK) has in the recent past made concerted efforts in the development of appropriate legal, regulatory and institutional framework (including the above tax related incentives) to attract private investors in renewable energy generation from wind, solar and geothermal sources.nbsp;The proposed changes under the Bill, if passed into law, will have the effect of reversing the huge efforts and progress that the GoK has made in the energy sector over the years. Equipment, machinery and services that are currently exempt from VAT to encourage investments in the energy sector will be subject to VAT and this will lead to an increase in the already high cost of undertaking power projects by at least 14%. With the compensating tax exemption withdrawn and the withholding tax rate on dividends increased to 15%, it will be very costly for shareholders to extract profits from the project companies and this will be a disincentive to invest in Kenya. The ripple effect would be that investor confidence in foreign direct investments, particularly in large-scale infrastructure projects, will be shattered. Predictable, stable and consistent implementation of the existing tax and legal policy in the energy sector is vital in transforming Kenya into a globally competitive and regional industrial hub with reliable and affordable power to all its citizens and investors. It is therefore important for GoK to continue supporting and attracting investors (both local and foreign) in this sector, not only for supply of power to the national grid, but also for off-grid connections in line with the Last Mile Connectivity Project in remote areas. For this reason, the proposed amendments relating to the energy sector should be shelved, at least for now!