Inside Treasury’s plan to net tax-dodging multinational companies

National Treasury and Planning Cabinet Secretary Ukur Yatani during the launch of the Survey on Social Economic Impact of COVID -19 on Households report at Treasury building, Nairobi. July 9, 2020 [Elvis Ogina, Standard]

Sitting in their casual-themed offices at Purshottam Place in Nairobi, their colourful walls adorned with powerful African frescos, the top brass at Google Kenya must have been tempted to pop the champagne after the Tax Appeal Tribunal last week ruled in their favour.

It was a five-year legal battle pitting Google Kenya, a local branch of internet giant Google, against the Kenya Revenue Authority (KRA).

And it was not the Sh53 million that they would get from KRA in value-added tax (VAT) refunds that elated them; it was the sheer precedence of the decision.

KRA had denied them VAT refunds for the marketing and Research and Development (R&D) services that they had offered Google Ireland and Research and the US-based Google Incorporated respectively.

Exported services consumed outside of the country do not attract the 16 per cent VAT as they are zero-rated.

Thus suppliers are allowed to claim any VAT they might have paid on inputs used for the final product.

But KRA had insisted that the marketing services that Google Kenya offered its two affiliates were not exports as Kenyans consumed the adverts and read translations.

But just like in an earlier case pitting KRA against Coca-Cola’s marketing company in Africa where the taxman was told to pay Sh725 million in VAT refunds, the tribunal ruled that the services were exports as they were paid for by Google Kenya’s affiliates outside the country.

But Google Kenya management might as well put the champagne on ice.

Stung by a string of losses, the government has through the Finance Bill, 2021 proposed to make exportable services exempt rather than zero-rated.

This means that suppliers of exportable services will not be able to claim VAT refunds. It is a blow to many multinational enterprises (MNEs) that supply exportable services estimated at Sh380.7 billion as of twelve months ending March 2021 . 

And it does not end there for the multinationals. The National Treasury is aggressively looking for its pound of flesh from internet giants, including Google, Facebook and Apple, oil explorers such as Tullow and telcos such as Airtel Kenya.

The Finance Bill, 2021 also restricts payment of Digital Service Tax (DST) to non-residents only in an attempt to go after e-commerce giants such as Amazon where an increasing number of Kenyans have been flocking to buy various items from laptops to drones. 

Also to be affected are companies such as Google and Facebook, which only have representative offices in Kenya, yet their parent companies in Silicon Valley rake in billions of dollars from individuals and businesses who advertise on their platforms. 

Kenyans also pay for certain games and apps downloaded from Google’s and Apple’s stores.

A source from KRA who spoke on the condition of anonymity as they are not authorised to speak to the press noted that digital service tax will apply only to online service providers and not those dealing in tangible goods. 

Already, said the source, over 50 major online service providers, including Facebook, Google, YouTube and Amazon, have already registered as taxpayers.

“They have already registered and they are paying,” said the source. 

Just a few of these non-resident digital service providers want a tax agent appointed for them. The rest, said the source, can access iTax “from anywhere.” 

The introduction of digital services tax, which became effective in January, was expected to rake in Sh2 billion for the government in the current financial year ending June. But one of the most pronounced themes of the Bill is to make it difficult for MNEs to avoid paying taxes by employing Base Erosion and Profit Shifting (BEPS) schemes.

The Organisation for Economic Co-operation and Development (OECD), a club of mostly rich countries but which also includes developing ones like Kenya, BEPS are “tax avoidance strategies that exploit gaps and mismatches in tax rules, artificially shifting profits to low or no-tax locations.”

“This is part of the global thing that is happening. Globally we are moving towards making sure that everyone pays their fair share of tax in the jurisdiction in which they do business,” said Nikhil Hira, a director at Bowman’s Coulson Harney LLP, a law firm.

MNEs with deeper pockets than their local competitors are able to employ the best accountants and lawyers to help them substantially reduce their corporate income tax (CIT) liability in what is technically known as financial planning.

They achieve this by moving profits from a jurisdiction with higher corporate income tax (CIT) to one with lower CIT, such as Mauritius, Cayman Island, Ireland and other tax havens.

The money being shifted could be royalty payment for intellectual property or interest payments on debt.  

CS Ukur Yatani during a briefing with Council of Governors on County revenue allocation formula. [Wilberforce Okwiri, Standard]

One of the strategies that MNEs use to reduce tax liability is by paying more interest on a loan, particularly to a parent company domiciled in a jurisdiction with a low-income tax rate. The Bill proposes a new rule where interest on debt to a related company or third party that exceeds 30 per cent of earnings before interest, taxes, depreciation and amortisation (EBITDA) shall be subjected to corporate income tax.

Interest before the EBITDA rule is just one of the rail guards the government is putting in place against Base Erosion and Profit Shifting BEPS schemes.

Moreover, through cooperations with other jurisdictions, holding companies of MNEs, known as Ultimate Parent Entity (UPE) in the Bill, will also be required to reveal to KRA where their profits, sales, employees, assets are located and taxes paid to enable the taxman to carry out audits and transfer pricing assessments on transactions between linked companies.

Kenya has also adopted the common reporting standards, which allow KRA to seek information on a taxpayer from tax authorities in other jurisdictions.

“Once the necessary frameworks are in place, it is expected that the information will be used by KRA to collaborate with other countries on the exchange of information as well as carrying out transfer pricing risk assessments,” said audit firm Deloitte in an analysis of the proposed law.

Should these tax measures pass through the National Assembly, the Exchequer hopes it will help hit its income tax target projected at Sh834.5 billion in the financial year starting July.

This is nearly half of the tax revenues that KRA is expected to collect in the financial year ending June 2022.  This would be a boost at a time when the Covid-19 pandemic has thrown the local economy into a tailspin. 

Data collected by the Tax Justice Network, Public Services International and the Global Alliance for Tax Justice Africa, estimated that Kenya loses $565 million (Sh60 billion) annually to tax avoidance schemes. This is almost enough to fund the country’s development budget for health in the upcoming financial year.

At the continent level, Africa loses close to $25 billion (Sh2.6 trillion) to tax avoidance by MNEs.

Globally, the Organisation for Economic Co-operation and Development (OECD) estimates that every year, between $100 billion (Sh10.7 trillion) and $240 billion (25.6 trillion) is lost to BEPS in corporate tax revenue.

Another way through which foreign investors have been cheating the taxman is by manipulating their permanent establishment (PE) status.

Key among its recommendation is that provision of services, including consultancy, for an aggregate period of 91 days by a foreign entity crystalises a PE status. Thus, such a non-resident entity will be deducted income tax on its trading profit. One of the ways foreign entities have avoided PE status and thus not paying income taxes is by splitting the contract so that it does not add up to 91 days.

To remedy the artificial avoidance of PE status through the splitting of contracts, the Bill seeks to aggregate the time spent on the various connected activities on construction and installation projects in determining the duration of a project.

In a letter of intent to the Managing Director of the International Monetary Fund (IMF) Kristalina Georgieva, the National Cabinet Secretary Ukur Yatani and the Central Bank of Kenya (CBK)  Governor Patrick Njoroge listed the extractive sector as of the three non-compliant sectors that they would be going after to shore up tax revenues.

Consultants providing services on behalf of non-residents and players in the extractive industry will now result in a PE within 91 days, about half the time provided in the current Act, said KPMG, another consultancy firm, in its analysis.

And as the push and pull between the government and oil explorer Tullow continues on the latter’s expenses in oil exploration and production in the Turkana basin, Kenyan authorities told the IMF boss that they will ensure KRA’s participation in cost audits in the upstream petroleum sector.

The Bill also proposes to increase the withholding tax rate for the fees paid to a foreign entity for the provision of services to a licensee or contractor in respect of mining or petroleum operations from a rate of 5.625 per cent to 10 per cent.

Double taxation

Analysts fear this will increase the cost of operation in the nascent mining sector, a turnoff for potential foreign investors at a time when the country is looking for a new principal investor and operator for the Turkana oil project, said KPMG.

Another area through which MNEs escape the taxman’s net is through the 16 double taxation agreements (DTAs) that Kenya has signed up for. DTAs are aimed at preventing the same income from being taxed twice.

For example, after profits entities have been subjected to corporate income tax, a dividend that is paid to shareholders after the CIT deduction might also be taxed, resulting in double taxation.

But MNEs can subvert DTA by engaging in what is known as treaty shopping. For instance, if withholding tax on dividends in Mauritius, which has a DTA with Kenya, is lower than Kenya’s, an investor who is not a resident of the two countries can form a company (or buy a stake in the company) in Mauritius and benefit from a lower withholding tax in the latter country.

However, in the new proposal, a non-resident company and individual owns more than 50 per cent of the company in Mauritius, the relief will not be allowed. In the present Act, the rule applies to only individuals in the jurisdiction that was not part of the treaty.

Indeed, the bill also requires MNES to reveal their beneficial owners and carry out rigorous transfer pricing assessments.

But not all the provisions of the Finance Bill frown at MNEs.For example, one does not require a mining right to claim capital allowances on machinery used to undertake mining operations, a move that is expected to attract explorers into this budding sector. Moreover, the bill proposes to reduce the withholding tax rate for payments for the provision of management, training or professional fees from 12.5 per cent to 10 per cent.

This, according to KPMG, is a major reprieve to the extractive industry in Kenya since the reduced rates will allow for greater cashflows for players within the industry.

Foreign investors will also be allowed to file taxes in convertible currency should the Bill become law. Jason Rosario Braganza, an executive director at African Forum and Network on Debt and Development, an NGO, said the measures while good, they could also impede the recovery of the economy.