Taxman faults CBK bid to have banks increase bad debts class

The Central Bank of Kenya (CBK) and the Kenya Revenue Authority (KRA) have differed over the treatment of non-performing loans (NPLs) in commercial banks for purposes of income tax.

While the CBK has asked banks and their auditors to be realistic in providing for bad and doubtful debts, thereby leading to higher provisions for the 2015 financial year, the KRA is insisting that it cannot allow for excessive loss provisions that will artificially diminish the amount of tax paid.

The banks regulator has lately forced banks to become more prudent in providing for loans that will not possibly be recovered in order to protect depositors’ cash.

The gross NPLs in 2015 rose to Sh139.4 billion from Sh108.3 billion in 2014 — representing a Sh31.1 billion increase. At the end of March this year, the gross NPLs had risen to Sh176 billion — Sh36.6 billion in just three months.

READ: Bank sector loan defaults hit a ten-year high of Sh176 billion

“We have written to banks to remind them that providing for nonperforming loans for tax purposes is different from the accounting method. Before you provide for purposes of tax, you must ensure that all has been done to ensure repayment of the debt,” said the KRA Commissioner-General John Njiraini when commenting on the extent to which corporate profitability had affected tax revenues.

The KRA had just reported that its revenue had fallen short of the nine-month target by Sh69 billion as a result of, among other factors, low corporate profitability, most notable among commercial banks that had made huge provisions for bad and doubtful loans.

READ: KRA misses revenue target on tough corporate sector environment

'We’re worried'

Mr Njiraini further noted that even in the period between January and March, banks had experienced an even more difficult environment.

“We are worried about the profitability in the banking sector. Profitability only grew by five per cent in the first quarter and this means that one key sector is almost out of the equation in terms of raising tax money,” said the commissioner-general.

Joseph Thogo, a tax expert with Deloitte East Africa, said the key issue in the disagreement between the CBK expectation and the KRA had to do with the high thresholds set by the KRA for tax purposes relating to the NPLs.

“The KRA has higher thresholds as it does not allow a bank to provide for NPLs unless it shows that it has done everything to ensure they are collected. But the CBK wants you to provide for all loans of a customer as nonperforming even if just one is not performing for two or three months,” said Mr Thogo.

READ: Bad debts to hurt lenders’ profits on tight CBK scrutiny

Alpesh Vadher, a partner at PKF Kenya, said the tax guidelines relating to NPLs are strict in the sense that they require more and clear documentation showing that a loan is uncollectable, despite this being in conflict with the international financial reporting standards and the prudential requirements of the CBK.

“If you don’t have documentation to show that a loan has become nonperforming and that all has been done to make it perform, then you don’t provide for it for purposes of tax. That is what the KRA is saying,” said Mr Vadher.

For the CBK, non-performing loans are those classified as sub-standard, doubtful and loss.

Substandard loans are those that are not adequately protected by the current sound net worth and paying capacity of the borrower, and, are overdue for more than 90 days but less than 180 days.

Loans in the “doubtful” category have all the weaknesses of a substandard loan not well secured and is overdue for more than 360 days. A loan is classified as a loss when it is considered uncollectable.