1. Executive Summary
The Kenya Revenue Authority (KRA) has proposed a significant reform to the Value Added Tax (VAT) regime through the anticipated Finance Bill 2026. The proposal seeks to remove the current KES 5 million annual turnover threshold for VAT registration, effectively making VAT registration mandatory for all businesses regardless of size.
If enacted, this would represent a fundamental shift in Kenya’s indirect tax framework, bringing micro, small, and informal businesses into the VAT net.
2. Current Legal Position
Under the existing VAT Act:
- VAT registration is mandatory only for businesses with annual taxable turnover exceeding KES 5 million
- Businesses below this threshold may register voluntarily.
This threshold has historically acted as a compliance relief mechanism for SMEs.
3. Proposed Amendment
The proposed changes include:
- Repeal of Section 34(1)(a) of the VAT Act
- Reduction of the VAT registration threshold from KES 5 million to zero
- Mandatory VAT registration for:
- Small traders
- Consultants and service providers
- Informal sector businesses
All affected entities would be required to:
- Charge VAT at 16% on taxable supplies
- File monthly VAT returns
- Issue eTIMS-compliant invoices
- Maintain detailed transaction records
4. Policy Rationale
KRA’s justification for the proposal includes:
- Broadening the tax base
- Addressing an estimated 38% VAT compliance gap
- Increasing VAT revenue collections from approximately KES 653 billion to over KES 1 trillion
The proposal is also aligned with efforts to enhance transaction traceability across the value chain.
5. Key Implications for Businesses
5.1 Increased Compliance Burden
Businesses previously outside VAT will now be required to:
- Register for VAT
- Implement compliant invoicing systems (eTIMS)
- Maintain robust accounting records
This represents a material administrative and cost burden, particularly for SMEs.
5.2 Pricing and Margin Pressure
Businesses must decide whether to:
- Absorb VAT (reducing margins), or
- Pass VAT to customers (increasing prices)
This is likely to result in price inflation across goods and services, especially in previously non-VAT segments.
5.3 Impact on Informal Sector
The proposal will significantly affect:
- Small-scale traders
- Freelancers and consultants
- Cash-based businesses
Many may face formalization pressures or risk non-compliance penalties.
5.4 Cash Flow Implications
VAT is a transactional tax:
- Businesses must remit VAT monthly (by the 20th) regardless of customer payment cycles
- This may create cash flow strain, especially for businesses with delayed receivables
5.5 Increased Audit Exposure
With mandatory VAT registration and eTIMS integration:
- KRA will have greater visibility over transactions
- Risk of audit and enforcement action will increase
6. Sector-Specific Impact
The proposal is expected to affect:
- Retail and wholesale traders
- Professional service providers (consultants, agencies)
- Digital and online businesses
- Informal and micro-enterprises
Even sectors previously operating below the VAT threshold will now need to restructure their tax position.
7. Key Risks
Businesses that fail to prepare may face:
- Penalties for late registration
- Incorrect VAT pricing
- Disallowed input VAT claims
- Non-compliance with eTIMS requirements
- Reputational and operational risk
8. Recommended Actions
Businesses should begin preparing immediately by:
- Assessing VAT exposure
- Determine whether supplies are taxable, exempt, or zero-rated
- Reviewing pricing models
- Recalculate margins under a VAT-inclusive framework
- Implementing compliant systems
- eTIMS onboarding
- Proper invoicing and record-keeping
- Training internal teams
- Finance and operations on VAT compliance
- Seeking professional advisory
- Structuring operations to optimise VAT efficiency
9. Conclusion
The proposed removal of the VAT threshold represents one of the most significant tax policy shifts affecting SMEs in Kenya.
While the measure is aimed at improving revenue collection and tax equity, it introduces substantial compliance, pricing, and operational challenges for businesses.
Early preparation will be critical to mitigate risks and preserve profitability.
