Tax dispute threatens returns from unit trusts

A dispute over a tax regime on pooled investment vehicles between the taxman and unit trust providers is yet to be ironed out, throwing into uncertainty the level of returns investors are entitled to.

The association of unit trust managers says an agreement is yet to be reached over a difference in interpretation of Section 20 of the income tax act which touches on withholding tax levied on pooled investment vehicles.

Shifting landscape

The Kenya Revenue Authority’s (KRA) stand on the issue is expected to shift the unit trust landscape by shaving off a portion of the high returns that market leaders (now in KRA’s list of tax defaulters) have been using to recruit new clients offering the tax compliant players a chance to play the catch up game.

“The issues have not yet been resolved,” says Dominic Kiarie, British American Asset Managers and the chairman of the unit trust managers lobby group.

In October last year, the tax collection agency came knocking on the doors of five unit trust schemes demanding hundreds of millions of shillings in unremitted taxes dating back close to a decade.

Since then, attempts between the KRA and the unit trust industry players to try and find a middle ground on the issue have so far yielded little result with both parties remaining adamant over the interpretation of the law.

“If it means going the full hog and while it’s not what we (the unit trust managers lobby) want to do, we will do it,” says Mr Kiarie when queried over the industry’s position should the KRA remain unyielding. At the core of the issue is the divergent interpretation of the law.

One interpretation was that any returns issued to the unit trust or collective investment scheme investors were to be taxed.

The other was that the tax did not extend to the unit trust investor and as such, withholding tax on distributions did not apply.

Were the KRA to have its way, the affected unit trust providers would find themselves in a rut.

That would put the future of some unit trust schemes in jeopardy, more so because the withholding tax in question was paid out to members in returns over the years.

It would also provoke a role reversal in the segment, with market leaders reputed to pay better returns being upstaged by previous laggards.

At a time when asset classes in domestic and offshore markets are yielding minimal returns, a huge payout to the KRA could leave capital levels for some market players depleted, forcing them to shore up their capital positions.

Failure to remit tax proceeds to KRA attracts a fine of 20 per cent and a penalty interest of 2two per cent for each month that the amount remains outstanding.

While the tax collection agency contends that the law remains hazy in its current state, the KRA says little will change in the principle behind the law.

“We may need to re-examine that law further but just for administrative purposes and not in principle,” says Mr Duncan Onduro, senior assistant commissioner at KRA’s policy unit.

Some of the alleged tax defaulters have been paying bond and money market unit trust investors an annual average return of eight per cent meaning that KRA’s demand for its 15 per cent withholding tax may pull down the rate of return by up to two percentage points.

Capital positions

It might also be that some providers deducted the withholding tax but failed to remit the money to KRA instead choosing to account for it as revenue.

That means any fines and penalties incurred will hit the fund managers’ cash and capital positions and exert pressure for an increase in management fees that will hit the investors’ earnings.

Unit trusts account for nearly five per cent of the Nairobi Stock Exchange’s market capitalisation or about Sh45.7 billion, with the three top players controlling more half of the business.

The KRA is sticking to its guns, saying that the law remains that unit trust providers should charge the withholding tax as the law reads in its current form.

With the tax collection agency not known to back down on its demands, it remains to be seen how the matter will be resolved.

“The law is very clear on this matter, it is only the modality of this law that is yet to be finalised,” says Mr Onduro.