Tax amendments could lead to collapse of our capital markets

 

The Tax Amendments Bill that is currently in Parliament could sound the death knell for Kenya’s capital markets if allowed to pass in its current form. The Bill, which was introduced in response to the presidential directive to cushion and stabilise the economy in the wake of the coronavirus pandemic, could end up fueling greater economic turmoil, if passed.

The Bill has problematic sections and omissions that need to be urgently amended. Without these critical amendments, the new tax regime could decimate trading activity on the bourse, undermine Nairobi’s place as the regional financial hub, drive away foreign and local investors, lead to massive job losses in the financial industry and cost the country billions if not trillions in future economic opportunities.

Parliament should not let this happen. Besides harming the financial industry, the Bill also carries significant risks for the government of the day and future administrations. The central government is one of the largest market participants in our capital markets.

It dominates the bond market and has significant equity stakes in blue chips such as Safaricom, where its 35 per cent stake yielded a dividend payout of Sh26.2 billion in 2019. The government, like the financial industry, stands to lose in a major way from a dysfunctional capital market, underlining the need to urgently revise the contentious sections of the Bill.

The Bill’s proposal to repeal the tax-exempt status of green bonds and infrastructure bonds needs to be rejected flat-out. Now is not the time to flip flop and introduce taxes on interest income barely a year after promising tax exemptions to local and international investors who bought the inaugural green bond in 2019.

Green bonds

We can’t afford to lose credibility in such a flagrant way as we will need the full trust of investors when we return to local and international markets to look for funds in the imminent future. Importantly, environmental sustainability, which is essentially what green bonds are designed to fund by matching green projects with affordable capital, is one of the defining issues of our time. We can’t cut off funding to it – which is what could happen if the Bill is passed – without pulling the plug on our future. 

In the same vein, the proposal to introduce taxes on infrastructure bonds is out of touch with the underlying state of our economy. Infrastructure bonds are longer tenured, meaning their repayment schedules are more manageable and don’t put a strain on government taxes and expenditures in the same way short-term debt does.

It is therefore self-sabotaging to take away the incentives that attract investors to long-term infrastructure bonds at a time when our public balance sheet is laden with short-term debt. Data from Capital Economics and the World Bank released in April shows the amount of money needed to service short-term external debt as a percentage of forex reserves stands above 70 per cent, highlighting the need for longer-term debt such as infrastructure bonds.

Other proposals in the Bill that pose a clear danger to the future of our capital markets include the introduction of 14 per cent VAT on brokerage services, which were previously exempted from VAT; the increase of the withholding tax rate for dividends for non-residents from 10 per cent to 15 per cent; a reduction in tax exemption for pooled funds such as retirement schemes; and the removal of corporate tax incentives for newly listed firms.

The inevitable outcome of these proposed tax changes is that trading activity on the Nairobi Securities Exchange (NSE) will drastically fall to economically unviable levels. This will not only put dozens of firms in the financial industry out of business, but also negate the progress Kenya has made to position itself as the financial gateway to Africa. Today the NSE is one of the best performing bourses in Africa, despite the current bear run.

Recent innovations such as the launch of M-Akiba, exchange traded funds and derivatives will be brought to naught. The Ibuka Programme, whose aim is to encourage new listings by incubating promising unlisted business, is also set to encounter challenges as companies may be discouraged from listing and look for alternative sources of capital. This will extend the IPO drought and the current bear run, eroding wealth from our economy.

Capital markets are the greatest wealth creation machines in economic history. This is because before capital is turned into profit, it first creates jobs and transforms the economy by funding production, supply chains, trade, infrastructure and real estate. You cannot restrict capital flows in an economy through disproportionate tax hikes without undermining long-term economic prospects. You cannot slay the goose that lays the golden egg in pursuit of quick gold.

While we acknowledge that someone has to pay the bill for the shocks brought about by the coronavirus, it is not prudent to solve one problem today by creating a bigger one tomorrow. The capital markets must be shielded from a hostile tax regime, lest we come to the painful discovery that Pulitzer Prize winning author Thomas Friedman was right when he said: “capital is a coward.”

- Mr Kittony, Vice Chair World Chambers Federation, is a member of the Board of Directors, Nairobi Securities Exchange