The manufacturing sector is critical in driving a country’s structural transformation. The industry is widely recognised as labour-intensive and supports inclusive economic growth – countries with robust manufacturing sectors highlight the importance of implementing policies that promote this industry’s development. 

According to the Economic Survey 2025 report, released this week, the sector’s GDP contribution rose to 7.3%, signalling an incremental structural transformation. While still below the government’s ambitious targets set in the Big Four agenda, it suggests manufacturing is slowly regaining importance in the economy. Output also increased by 4.4% (up from 2.8%), showing improved productivity and production capacity. 

Manufacturing Output indicates increased activity in factories, possibly due to better demand, investment, or improved access to inputs. Employment rose by 1.9% to 369,200 workers, indicating that manufacturing is creating formal jobs, although moderately. These statistics suggest that the sector is on a path to recovery, with output and employment improving. However, the growth is not yet transformative, indicating the need for more aggressive support through policy, infrastructure, and investment to unlock its full potential.

Kenya’s Finance Bill, 2025, proposes sweeping changes to the country’s tax landscape with significant implications for the manufacturing sector. From repealing long-standing investment incentives to altering VAT on key inputs, manufacturers will be among the most affected if these proposals are enacted. 

One of the most impactful proposals in the Bill is the repeal of 100% and 150% Investment allowances.  Previously, manufacturers investing Ksh 1 billion outside of Nairobi or Mombasa, as well as those operating in Special Economic Zones (SEZs), benefited from tax breaks. The removal of these incentives will discourage capital-intensive investments, especially in underdeveloped regions, undermining industrial decentralisation and regional equity.

There is also a proposal to change the VAT status from zero-rated to exempt for key inputs, including solar and lithium batteries, electric buses, locally assembled phones, and pharmaceutical and animal feed ingredients. While zero-rating allows businesses to reclaim input VAT, exemption blocks VAT recovery, thereby increasing production costs and consumer prices. This change disproportionately affects manufacturers in energy, agri-processing, healthcare, and green technology sectors.

The introduction of VAT on locally manufactured passenger vehicles and inputs reverses earlier exemptions, increasing the cost of producing vehicles locally and undermining the gains in local automotive assembly. The Bill also reverses previous gains in the automotive sector by proposing a 16% VAT on locally manufactured passenger vehicles and their raw materials. This comes just three years after VAT exemptions were introduced to spur local car assembly. The proposal is likely to increase vehicle costs and erode Kenya’s competitiveness in regional auto manufacturing. Geothermal, solar, and wind equipment also lose VAT exemptions, which raises renewable energy costs for manufacturers, many of whom rely on these sources for production stability, especially during the ever-recurring blackouts. 

Under the Bill, there is also a new limitation to carry forward tax losses for five years, which is particularly damaging for manufacturers with long gestation periods. Industrial projects in energy, steel, chemicals, and infrastructure typically require more than five years to achieve profitability. This policy could discourage long-term investment and foreign direct investment in large-scale manufacturing.

New and increased excise duties on plastic-based materials, including films, sheets, tapes, and packaging materials, will impact packaging, fast-moving consumer goods (FMCG), and pharmaceutical manufacturers. These duties will increase input costs, particularly for businesses that rely heavily on high-volume plastic use in production and logistics.

This is a double blow to the manufacturing sector, given the Extended Producer Responsibility regulations (which hold producers accountable for the entire lifecycle of their products) that came into effect this year, slapping a Ksh 150 levy on most packaging. The industry calculated an increase of 16% in consumer goods due to the introduction of this levy. Withholding tax will now apply to scrap sales, a key revenue stream for manufacturers in the recycling and disposal sectors, as well as the public procurement sector, to expand the tax net.

 The Bill has also proposed changes to the VAT Refund Periods. It shortens the VAT refund application period from 24 months to 12 months and reduces the claim period for bad debts from three years to two. While aimed at enhancing revenue efficiency, this puts pressure on manufacturers’ administrative processes and risks loss of legitimate refunds. The irony is that while reducing these timelines, the government owes the sector an estimated Ksh 15 billion in VAT refunds and is notorious for not implementing a serious plan to clear the backlog despite many stakeholder meetings on this thorny issue over the years. 

The repeal of the capital loss deduction will affect capital-intensive manufacturers. Manufacturers sometimes sell old or poorly performing machines, buildings, or equipment at a loss. In the past, they were allowed to use that loss to reduce the tax they would pay later if they made a profit selling other assets. The new law removes this option. Now, if a manufacturer loses money selling an asset, they still have to pay the full tax later when they make a profit on another sale. This makes it more costly to upgrade or replace equipment, which is something manufacturers often do in industries where business fluctuates. In short, it discourages them from modernising because they get no tax break for their losses. Manufacturers disposing of loss-making capital assets can’t offset these against future gains, reducing post-sale tax efficiency.

The Finance Bill, 2025, signals a decisive shift toward broadening the tax base, but at the cost of reducing fiscal incentives for manufacturers. If passed without amendment, these proposals will increase the cost of doing business, reduce Kenya’s industrial competitiveness, and derail efforts to boost local value addition. The government must engage stakeholders in striking a balance between revenue needs and the broader goal of stimulating industrial growth.