The Finance Bill 2024 portends a tightrope for the financial services sector. While the government is keen to bolster its coffers by implementing a raft of tax changes in the financial sector, it risks stifling the very growth engine it seeks to fuel.

This feature examines the proposed changes in the Value Added Tax (VAT) regime and hikes in Excise Duty, analysing their potential impact and what this means for the value chain.

The domino effect on costs and demand of the VAT proposals

One of the most striking changes lies in removing key financial services from the VAT exemption list. Currently, exempt services such as issuing credit cards, cheque processing, and foreign exchange transactions, in the proposed changes, would now bear a hefty 16% VAT levy. 

If this is passed as is, the resultant scenario is a domino effect. Financial institutions who are likely to be burdened with this proposed expense will definitely pass it on to consumers through higher fees. The drift, consequently, is that consumers are already grappling with a costlier financial service landscape and may become less inclined to utilise them, potentially hindering financial sector activity.

Having a nuanced approach in this regard is fundamental. Such changes need to be informed by prevailing economic circumstances with increased input from relevant stakeholders. This will help address the complexities involved.

The OECD (Organization for Economic Cooperation and Development), a club of developed economies, highlights the complexities involved.  While some OECD countries do apply VAT to financial services, others exempt them entirely. This exemption is often used to promote financial inclusion and market efficiency.  For example, the UK exempts most financial services from VAT, recognising their importance in a healthy economy.

The excise duty hike is a double whammy for consumers

The proposed excise duty increments on financial services paint a concerning picture.  The hike from 15% to 20% on fees for money transfers and related services, exacerbated further by the potential VAT increase, results in a “double whammy” for consumers.

They face not only higher upfront costs for essential services but also a potential trickle-down effect on the broader economy.  This could stifle financial inclusion, making vital services less accessible to a considerable chunk of the Kenyan population.

Existential challenges

Kenya’s financial sector is already grappling with enough. The country’s Financial Stability Report 2022 outlined that, despite its resilience, it was faced with numerous challenges.

Globally, rising inflation in developed countries prompted central banks to raise interest rates. This shift followed a long period of low rates, low market fluctuations, and easy access to cash due to loose monetary policies.

The interest rate hikes aimed to tame inflation, but they had unforeseen consequences for some financial institutions, particularly banks. Banks heavily invested in bonds and relied on debt and short-term funding for liquidity. This strategy exposed them to several risks, including challenges managing cash flow (liquidity risk), interest rate fluctuations (duration risk), and potential borrower defaults (credit risk).

In the face of these existential challenges, the proposals on VAT and excise duty pose a further cost-absorption dilemma.  With higher excise duties and potential VAT charges, profitability may take a hit.  This could hinder innovation and investment in new technologies, ultimately impacting the sector’s ability to serve the evolving needs of the Kenyan economy.

Conclusion: A collaborative path forward

The Finance Bill 2024 presents a complex scenario for the financial services sector. While the government’s intention of boosting revenue is understandable, the potential pitfalls require careful consideration. A well-rounded Finance Act can be achieved through a collaborative effort between policymakers, the financial sector, and the public.

The final Act needs to embody fiscal sustainability while fostering financial inclusion and economic growth in Kenya. The path forward demands a nuanced approach, learning from international examples and prioritising dialogue to achieve a win-win for all stakeholders.