BY MARTIN KISUU
Like with most developing countries, Kenya places a lot of reliance on excise duty to raise government revenues. Excise duty is an internal tax imposed on goods produced or sold in a country, as opposed to customs duty that is imposed on imported goods.
Over time, excise duties have been employed for raising government tax revenues as well as to discourage the consumption or production of goods and services that are considered harmful socially, environmentally and to public health.
Generally, most jurisdictions in the world target alcohol, tobacco and fuel as the main objects of excise taxation. In developing countries where the overriding consideration for excise taxes is the revenue take, the scope of the tax is extended to include services such as mobile telephony, gambling, and even prostitution. Goods and services that are considered luxuries may also be in scope. Within EAC member states, excise taxes contribute up to 30 percent of total tax revenue, with a good proportion thereof derived from tobacco products.
Back in Kenya, the revenue take form excise duty for the current fiscal year has suffered greatly, owing to ongoing price wars in the mobile telephony sector. Equally, changes brought in the 2010 Finance Act on the basis of levying excise duty on cigarettes have caused significant revenue erosion.
It is almost certain that the government would be looking to stem further revenue loss, and possibly compensate itself for what it has lost. Social pressure arising from the recent drought, rising inflation, increased fuel prices that forced the government to lower or waive certain taxes means there are few options left other than increase excise taxes. Tobacco and alcohol appear, for now, to be the soft targets.
Whilst there has been some relative stability in the alcohol excise regime, the tobacco excise regime has seen a number of significant changes over the last 10 years. There are three main ways in which the liability to excise tax duty is determined. Firstly, a fixed monetary amount is levied on a technical or quantity unit – such as weight, volume, quantity, etc. This is often referred to as a specific tax. Secondly, excise duty may be determined based on a fixed percentage of the value of goods or services. Such is referred to as ad valorem regime. Finally, excise duty may be determined on both the specific and ad valorem systems – a hybrid of the two.
Traditionally, taxation of cigarettes in Kenya has been based on a hybrid system where excise duty is charged as a minimum specific tax per 1000 cigarettes (mille) or an ad valorem rate – a percentage of value. In 2003, the government introduced an excise regime for cigarettes by classifying the product into four bands based on physical characteristics: plain cigarettes, soft cup 1, soft cup 2 and hinge lid. The government went ahead to give specific tax rates for the four tiers per mille in every category. Successive changes in the taxation of cigarettes have affected the specific rate per mille on the four tiers.
In 2007 the second and third tier were amended to include a new characteristic. The description of the second band became: soft cup of length not exceeding 72mm" while the description of the third band changed to "soft cup of length exceeding 72mm". In 2008, the description of the four tiers was amended to include retail selling price (RSP). The description for category 1, as an example, changed from "plain cigarettes" to "plain cigarettes or RSP of up to – Sh1,500. It is important to note that the descriptions gave the option of the basis for taxation as the physical characteristics or the RSP.
The 2010 Finance Act amended the then existing hybrid structure – which was based on physical characteristics and RSP- with the current structure which is solely based on RSP for soft cup cigarettes. Thus two specific rates of excise duty on soft cup cigarettes apply.
Products with a RSP exceeding Sh70 attract a higher rate of excise duty. The producers are now free to determine the tax band applicable on their products based on the RSP applied. Indeed, some manufacturers have effected price changes to take advantage of the flexible regime. Like with mobile telephony, the first victim of the price changes has been the exchequer. For this reason, it is unlikely that the minister of finance will not take action to protect the vital revenue base.
From the foregoing, it is evident that we will see some changes in the taxation of tobacco products in the 2011 budget. The main driver of the changes will be revenue erosion and possibly the issues that the industry has raised. Other key factors that may drive the changes may include the need to commence the harmonisation of taxes within EAC and the pressures imposed by the anti-tobacco movement. There are also industry and revenue challenges to consider, mainly counterfeiting and smuggling. Whichever direction the government takes, it is essential that a relatively stable and balanced regime is defined.
It can be argued that the current excise structure governing the taxation of cigarettes does not embrace the principles of neutrality, certainty and adequacy. The structure does not abide by the principle of neutrality as it has forced some of the players in the industry to reduce their RSPs to take advantage of lower taxation.
The RSP structure is not adequate as it has led to drastic fall in excise duty collection by the government. It is only logical that the government did not intend to reduce revenue on cigarettes considering the excise duty on these products is a "sin tax". It is also imperative to consider the fact that the structure is totally uncertain as manufacturers have the leeway to reduce the RSP of their products at a whim. This then means that the government cannot effectively estimate the amount of revenue expected from the industry.
Ideally, the structure for excise duty should not encourage price distortions in order to foster a level playing field while maintaining the profitability of producers and a steady revenue yield to the government. An analysis of different tax structures may shed light on the optimal excise structure that maximizes government\’s revenue collection goals and the traders\’ profitability motives. Certainly, dialogue between government and the industry would be for a mutually rewarding structure
(Mr Kisuu is the Regional Tax Leader for PKF in Eastern Africa. The views expressed herein are not necessarily those of the firm)