Kenya Revenue Authority smokes out audit firms and multinationals in Sh4b tax evasion scheme

By JACKSON OKOTH and EMMANUEL WERE

Kenya’s chief taxman John Njiraini has put local audit firms on the spot for their role in helping multinational firms evade paying billions of shillings in taxes.

 It marks a bold step by the Kenya Revenue Authority, which is keen to seal any loopholes in the tax system as Treasury looks for ways to finance a growing Budget deficit.

 This also brings into question the cosy relationship audit firms have with their clients, helping them evade taxes at the expense of low and middle-income Kenyans whose tax burden is getting heavier by the day.

 Already, Kenyans are bearing the burden of a 16 per cent levy on previously exempt goods like books, processed foods and fuel. Treasury re-introduced the Value Added Tax Act to raise Sh10 billion in the current financial year ending June 2014.

When Kenya hosted an international tax seminar last week, Njiraini, the KRA commissioner-general, said the authority has recovered Sh4 billion since 2007 in unpaid taxes following an audit of 40 multinationals.

Donor-funded projects

KRA looked at the local subsidiaries of the multinationals - companies with operations in several countries across the globe - in the oil retail business, firms engaged in flower exports, fruit processing and consultants for donor-funded projects.

 KRA’s audit led to the recovery of taxes despite some of the multinationals employing top local audit firms.

 “We are beginning to question the role of those audit firms that are looking at the books of these tax cheats,” said Njiraini.

 “We have, for instance, been suspicious of large and highly successful multinational firms that keep on posting modest profits or even losses.”

 It was a damning admission of how several large multinational firms, helped by local audit firms, are outsmarting KRA by overstating their expenses, posting losses and consequently not paying any corporate tax.

 However, the big four audit firms – PricewaterhouseCoopers, Deloitte, KPMG, and Ernst and Young – have differed with KRA’s view that they are abetting multinationals in tax evasion.

“I think that his [Njiraini’s] comments are uncalled for. I don’t know where he is coming from with those comments,” said Sammy Onyango, the CEO of Deloitte East Africa.

 “Any group of companies will have their own pricing policy and it is charged differently. What KRA look at and what audit firms look at is different.”

 The issue has touched a raw nerve among some auditors.

 “I’m not in a position to give you an informed comment at this time. This is a very sensitive issue and I do not want to comment on it. I have asked my team to look at it and brief me,” Josphat Mwaura, the CEO of KPMG East Africa, told Business Beat last week.

 The multinationals are accused of misusing an accounting avenue called transfer pricing, which dictates what price subsidiaries of multinationals should buy and sell goods or services from each other.

 Transfer pricing happens whenever two related companies – that is, a parent company and a subsidiary, or two subsidiaries controlled by a common parent – trade with each other.

Consultancy services

 Take the example of an agri-business firm that grows flowers with headquarters in Europe and a subsidiary in Kenya.

 When the parent company is establishing a price for its consultancy services for the Kenyan subsidiary, it is engaging in transfer pricing. The price at which the European company sells its consultancy services to the Kenyan subsidiary should be done within the price range it would sell to any other customer.

 But the parent company can opt to price its consultancy services to the Kenyan subsidiary at a high rate so that it increases its expenses in Kenya and effectively reduces the amount it will pay in corporate tax.

It means the Kenyan subsidiary will either post modest profit or a loss because its expenses have been exaggerated. For a multinational, it is smart business because it allows them to pay less tax, or no tax at all if it registers losses, in countries where the corporate tax rate is high. In Kenya, the rate is 30 per cent of profits.

 Many multinationals are setting up offices in Kenya as their regional business hub.

The oil and gas boom as well as the “Africa rising” story will attract even more firms.

While the multinationals will bring their bags of goodies, including jobs and a market for office and residential real estate, most will get the better of KRA, finding ways to avoid taxes. 

Tax havens

A majority of the transactions that KRA flagged have the parent company or another subsidiary located in tax havens like Mauritius and Bermuda, where tax ranges between zero and 15 per cent.

Kenya’s corporate tax rate is double the maximum these tax havens charge.

 Kenya is losing billions that it would have collected in taxes at a time when Treasury is faced with a Sh330 billion deficit in this year’s Sh1.6 trillion Budget.

 Global Financial Integrity (GFI), a US-based financial watchdog, has put Kenya’s transfer pricing-related losses since 2003 at Sh115 billion. This is enough to fund the education and technology sector for nearly a year, or construct four Thika superhighways.

 Njiraini, though, admits that KRA does not have enough personnel to look through multinationals’ financial statements and pick out the discrepancies.

 Also, there is not enough data to make comparisons on the management fees and prices some of the multinationals charge their Kenyan subsidiaries to ensure transactions are done at “arm’s length”, Njiraini added.

 “When a multinational in Kenya is selling fruit to the UK market, we need comparative data that will enable us look at the prices it is charging. But we don’t have good and reliable databases that can help us challenge the prices charged by the multinational in the overseas markets. We are yet to improve and have a better framework for auditing suspected tax cheats, especially large multinationals,” he said.

 But professionals who focus on transfer pricing say the issue is not as straight forward as it might seem.

“I do not think it is as critical as we are reading about it in the media. The skepticism as to the extent of the problem has been overstated,” said Titus Mukora, the director of transfer pricing at PwC.

“It [transfer pricing] is an imprecise science since there is uncertainty as to whether the pricing that has been adopted is correct.”

Mukora added that pricing transactions between subsidiaries of different companies are subjective.  “This is an inevitable consequence of global dealing,” he said.

 On its part, KRA says it is taking several measures to curb the malpractice.

 One measure has been the setting up a dedicated team that will scrutinise transfer pricing among multinationals.

 Secondly, KRA joined the Global Forum on Transparency and Exchange of Information for Tax Purposes, which will help it share information with other tax authorities to curb the abuse of transfer pricing and other accounting practices.

 Third, Kenya is looking to access tax information held by 56 other countries by ratifying the Multilateral Convention on Mutual Administration Assistance in Tax Matters.

Finally, KRA is reviewing the exchange of information with the financial services sector, which includes banking, the stock exchange and the Registrar of Companies, to increase transparency and track down tax defaulters. This is known as the information exchange network and a global meeting is set for October in Paris to discuss this.

[email protected] October in Paris to discuss this.

GAccording to Deloitte, audit firms have one way of looking at it, while KRA looks at it another way, so of course there will be a divergence of opinion.

At the heart of the matter, however, is that Njiraini has shone a beaming spotlight on the audit profession. 

Ever since the Enron scandal in the US, the multi-million dollar question has been: Do audit firms help companies fudge their numbers to the detriment of the government, and shareholders of publicly listed companies?

 

Is the relationship between audit firms and clients too cosy to call?

 

In one of the most interesting revelations on tax avoidance, KRA last week said it had recovered Sh4 billion after going over the books of 40 multinationals since 2007.

The multinationals had been posting modest profits or losses, largely by making use of an accounting provision called transfer pricing.

Transfer pricing happens whenever two related companies – a parent company and a subsidiary, or two subsidiaries controlled by a common parent firm - trade with each other.

Transfer pricing is not, in itself, illegal.

What is illegal is transfer mispricing, also known as transfer pricing manipulation or abusive transfer pricing.

So what the multinationals had done was to either overstate the expenses incurred by local subsidiaries or provide goods and services at very high prices.

KRA took a bold step by stationing its officials in the offices of the suspected multinationals and going over their financial statements to the very last cent. This was after audit firms had given the multinationals a clean bill of health. There could be billions more in unclaimed taxes.

The questions now is, will Njiraini and his team closely scrutinise the work of the audit firms to catch more tax cheats?

The ‘Big Four’ – PricewaterhouseCoopers, KPMG, Deloitte and Ernst & Young – have grown their presence in the country, and business has been good for them. Kenyan companies have gone regional and Nairobi is attracting several multinationals.

Over the last three years, the Big Four have either built or bought their own buildings and have swanky offices. For university graduates and the middle-aged population, audit firms are some of the best employers.

But in recent years, the audit profession has been brought into disrepute. Deloitte and PwC have been caught up in the CMC motor saga, with Deloitte accused of misstating CMC’s accounts.

PwC’s forensic audit of CMC was questioned by Mr Peter Muthoka – the largest shareholder in the autodealer – who said it made findings based on unreliable information.

Questions have also been raised on how audit firms turned a blind eye as banks shifted their bond portfolios in 2011 to avoid showing billions of shillings in losses when interest rates shot up.