To address economic pressures, the government is prioritising enhanced tax compliance, leading to a rise in the frequency and scope of tax audits.
Due to the complexity of Kenya’s VAT framework, which often leads to ambiguities and compliance errors for businesses, Kenya Revenue Authority's (KRA) VAT audits are increasingly prevalent.
Kenya’s VAT system operate on a three-tier structure - standard rate (16 percent), zero rate (0 percent), and exempt categories - with input and output sides.
Standard and zero-rated supplies are taxable, while exempt supplies are non-taxable. Due to diverse products and services, VAT status follows an exclusion criterion: items not listed as exempt or zero-rated in Schedule 1 or 2 of the VAT Act automatically fall under the standard rate.
Businesses offset input VAT (paid on purchases) against output VAT (charged on sales) and remit the difference to KRA, but complex VAT rules often lead to compliance challenges for taxpayers.
Firstly, not all input VAT is recoverable; businesses cannot claim input VAT on exempt supplies or restricted items like passenger vehicles and entertainment. This requires careful segregation of eligible and ineligible inputs.
Secondly, claiming input VAT demands proper documentation and adherence to strict timelines, with missing or incorrect invoices rendering claims ineligible and thirdly, input VAT can only be offset when it is properly recorded.
However, timing mismatches, such as delayed supplier invoices, may complicate reconciliations, especially for businesses with irregular transaction cycles.
Lastly, frequent amendments to the VAT legislation lead to reclassification of products and services, while industry-specific rules, like the exemption of most financial services, further hinder input VAT recovery and compliance tracking.
The complexity is amplified by the VAT Act’s broad and sometimes unclear definitions which create ambiguity. This makes it difficult for businesses to accurately classify certain goods or services, especially in emerging sectors like digital services or hybrid products. The above factors make VAT compliance onerous thus increasing the risk of non-compliance for taxpayers.
Considering the above, KRA has invested heavily in technology to enhance VAT compliance and address complexities and revenue leakages. Key tools include the VAT Automated Audit (VAA) system and the Electronic Tax Invoice Management System (eTIMS).
The VAA System detects inconsistencies in VAT returns by comparing buyer’s and seller’s declarations (PIN, invoice number, date, and amount), flagging under-declarations or non-declarations. It generates reports sent to taxpayers, who have two 15-day periods to amend returns, or risk disallowed input VAT claims.
The system also enforces the six-month rule under Section 17 of the VAT Act, rejecting claims for older invoices.
eTIMS, on the other hand has revolutionised KRA’s ability to monitor VAT compliance real-time and optimise performance. Complimenting the VAA system is the VAT special table – implemented by KRA on iTax to enhance fairness and integrity in the VAT system.
It targets non-compliant taxpayers - those failing to remit VAT for six months without a payment plan, not transitioning to eTIMS, missing six months of returns, filing nil returns while having input VAT linked to the taxpayer, or making fictitious VAT claims.
Listed taxpayers are blocked from filing returns, their input VAT is unclaimable by others and may face administrative penalties, which are handled administratively. Such taxpayers receive a KRA contact prompt and can appeal or regularise by submitting documents for removal.
Working synergistically, the two system strengthen VAT compliance. The Special Table isolates non-compliant taxpayers, while the VAA system flags discrepancies across all taxpayers, ensuring dual layer of scrutiny to uphold VAT system’s integrity. Beyond automation, the taxman has incorporated other checks under a multi-prong approach.
KRA primarily validates the accuracy of VAT returns by checking whether input and output VAT are correctly reported and reconciled.
Financial records (invoices, receipts, ledgers, and bank statements) are examined to align with declared returns.
Potential fraud such as the “missing trader” scheme, identify-theft tax evasion or claiming input VAT for non-qualifying expenses are probed. Using a risk-profiling matrix, high-risk taxpayers, such as those with consistent nil VAT returns, large VAT refund claims, or suspicious transactions are flagged.
A robust internal control system is vital for ensuring compliance through timely reporting, invoice validation, error prevention, and fraud detection. A strong VAT control system also ensures that input VAT claims are filed within the six-month limit to avoid rejections under the time-bar rule.
The writer is a Transfer Pricing Senior Manager at RSM (Eastern Africa) Consulting Ltd ([email protected]). The views and opinions are those of the author and do not necessarily reflect the view and opinion of RSM
It verifies that all invoices, both issued and received, comply with VAT regulations, including correct VAT rates and proper classification of supplies.
Businesses with strong controls report fewer audit queries, reduced penalties and better relations with the tax man.
Audits are tailored to specific industries with common VAT compliance issues creating a comprehensive approach that has strengthened KRA’s ability to enhance compliance.
How Can Taxpayers Enhance Compliance?
In one of his famous writings, Chinua Achebe states - 'Eneke the bird says that since men have learned to shoot without missing, he has learned to fly without perching.'
This quote about a bird adapting to the hunters’ precision underscores the need for taxpayers to proactively navigate Kenya’s complex VAT system to avoid compliance errors. Compliance is no longer merely an obligation but a strategy for business survival and success.
To achieve this, taxpayers must maintain organized records, including eTIMS invoices, receipts, sales ledgers, and bank statements, for at least five years, ideally in digital format for easy retrieval.
Regular reconciliations, conducted at least monthly, are recommended to resolve discrepancies in VAT returns before filing, while cross-checking sales and purchase invoices against eTIMS submissions ensures accuracy.
Additionally, the control system should verify the legitimacy of all transactions and suppliers’ credentials to mitigate fraud risks. Regular staff training on VAT rules is essential to minimize errors, while checks for timely filing of VAT returns helps to avoid penalties.
