Kenya introduced the withholding Value Added Tax (VAT) regime in October 2003 with the primary objective of addressing revenue leakages and enhancing VAT compliance.
Initially, the framework targeted government institutions in addition to other designated entities, mandating them to withhold 16 percent of VAT on taxable supplies and remit directly to the Kenya Revenue Authority (KRA).
However, the system faced significant operational challenges, including persistent VAT refund backlogs and negative cash flow implications for businesses which led to suspension of the regime in 2011. It was later reintroduced in September 2014 under the VAT Act, 2013 with a revised withholding rate of six percent.
Subsequently, the enactment of the Tax Procedures Act (CAP469B) (TPA) in January 2016 repealed Section 25A of the VAT Act, the enabling legal provision for Withholding VAT. This resulted in the temporary suspension until 2019. The Finance Act, 2019 later re-established the Withholding VAT regime - through amendments introduced under Section 42A of the TPA with a reduced rate of 2 percent to alleviate the cashflow burden on taxpayers.
Since its introduction, Withholding VAT has contributed to a steady growth in VAT collection from Sh61.7 billion in the Financial Year (FY) 2003/2004 to Sh314.157 billion in the FY 2023/2024, representing approximately 25 percent of total tax revenue as per the Kenya Revenue Authority (KRA)'s annual revenue report. This growth reflects broader economic expansion, improved tax compliance and key policy reforms. notably the implementation of the Electronic Tax Invoice Management System (eTIMS).
Notwithstanding its contribution to early tax collection, withholding VAT has introduced inefficiencies that could hinder further VAT revenue growth if not reassessed.
The recent deployment of the eTIMS, increased automation of tax administration processes, VAT special table and the emergence of digital tax compliance tools, have significantly diminished the initial rationale for withholding VAT. A comprehensive review is therefore not only timely but necessary.
Fundamentally, VAT is a pass-through tax or otherwise a consumption tax intended to be borne by the final consumer. VAT operates on a multi-stage payment system where registered businesses act as intermediaries where they charge output tax on their taxable sales and remit to KRA and offset it against input tax incurred on their purchases.
They are also entitled to credit for withholding VAT deducted and remitted in advance by the appointed agents. As a result, the offset of withholding VAT credits against output tax results in no incremental collection by the government.
Ultimately, while withholding VAT does not increase total VAT revenue, it leaves an undesirable impact on cash flow for suppliers as its advance collection model requires businesses to be out-of-pocket prior to self-assessing their VAT position.
As KRA gains from a cash flow perspective, businesses lose in delayed liquidity and constrained working capital due to delayed refunds. The impact is particularly pronounced for small and medium-sized enterprises (SMEs) and contractors which undermines the realisation of the government's Bottom-Up Economic Transformation Agenda.
As of March 2025, the Kenya Association of Manufacturers reported outstanding withholding VAT refund claims amounting to Sh15 billion owed to manufacturers. This imposes an increased cost of doing business as businesses have to grapple with costly borrowing to sustain their operations and meet vendor obligations.
Further, with the introduction of eTIMS in 2023 and the subsequent amendments to the Income Tax Act requiring eTIMS generated invoices to support deductible expenses, KRA now has enhanced capabilities to monitor real-time business transactions that are traceable and auditable.
This enables the Authority to detect and curtail fictitious claims and fraudulent transactions thus enhancing VAT compliance. The recent introduction of pre-filled VAT returns that allow taxpayers to claim input VAT only on invoices that were relayed to KRA’s iTax portal through eTIMS reinforces transparency.
Given these developments, the foundational purpose of withholding VAT was mainly to prevent fraudulent transactions and non-declaration which has been largely addressed through automation and eTIMS. KRA now has full visibility over purchases and sales for businesses.
Consequently, the withholding VAT regime becomes a duplicative and administrative burden to both taxpayers and KRA without necessarily improving compliance. Its initial gains are now realisable through the adoption of technology while its negative impact on cash flow for businesses persists.
In addition, the Finance Act, 2023 changed the previous framework of accounting for and payment of withholding VAT from the 20th day of the following month to within five working days of payment to the supplier.
While the new change supports the government's cash flow requirements, it imposes significant compliance obligations on withholding VAT agents.
The increased frequency of withholding VAT remittance has created administrative impediments which have necessitated additional human resources driven by the need to mitigate exposure to potential penalties and interest for failure to deduct and remit withholdingVAT on time.
In a digitally driven economy, enforcing withholding VAT without a seamless real-time, refund mechanism undermines tax efficiency. It represents a mismatch between policy intent and technological capability hence attempting to address legacy challenges with present-day tools ineffectively.
With the available data, technology and infrastructure, Kenya needs a reassessment of the effectiveness of the withholding VAT framework. Kenya must pursue implementation of a VAT system that reflects a modern economy and offers greater efficiency, equity, transparency and predictability in the tax landscape.
It is further worth noting that the provisions of the VAT Act allow registered persons to seek refunds for withholding VAT credits. The high volume of refund claims from withholding VAT places a burden on the refund processing system and impedes broader revenue operations.
It also contributes to tax expenditure, a fiscal area that the government is keen to streamline as evidenced by the gradual removal of items that are eligible for VAT refunds from the VAT law.
Kenya has entered a new digital era of tax management. With the integration of eTIMS and iTax, KRA possesses comprehensive oversight of taxpayer transactions enabling effective validation and early detection of irregularities.
Therefore, to align the country’s withholding VAT regime with modern tax administration practices, KRA should implement an automated mechanism of verifying withholding VAT refund claims and facilitating timely approvals for either direct refund settlement or offset against other tax liabilities.
The writer is a tax consultant at Deloitte East Africa. [email protected].
