Treasury needs to tread carefully on tax amnesty

The taxman recently issued the long-awaited guidelines on tax amnesty on foreign incomes and assets.

He followed that up with an invitation to tax professionals and industry players to a stakeholders’ briefing to make an input in fulfilment of the constitutional requirement for public participation.

When Treasury secretary Henry Rotich first introduced the subject of tax amnesty in his 2016 Budget Speech, the objective was clear: To spur re-investment in Kenya and encourage compliance by taxpayers with investments and assets held outside Kenya.

During the stakeholders’ briefing, the government made it clear that it aims to achieve two main objectives from this process: (1) subjecting to tax in Kenya, foreign earned income, and (2) compelling physical repatriation of foreign held assets.

The consensus between the Kenya Revenue Authority (KRA) and stakeholders at the briefing was that it would be in Kenya’s best interest for this amnesty to be successful.

The KRA referred to two recent successful tax amnesties administered by India and Indonesia as benchmarks. In Indonesia, for example, the 2016 tax amnesty saw Indonesians declare foreign assets worth about $368 billion held at home and abroad.

Two main contentious issues surrounding the Kenyan tax amnesty have, however, emerged. How the government tackles these issues will determine the success or failure of this amnesty.

The first contentious issue relates to which foreign income is covered under the amnesty and thus supposed to be disclosed, while the second issue is whether compelling repatriation of foreign-held assets is the best approach to ensure re-investment into Kenya.

With regards to the covered income, the amnesty guidelines have defined income to include all foreign-sourced income that would be taxable in Kenya had it been earned in Kenya.

Through this, the amnesty is essentially looking to net all foreign income unless that foreign income qualifies as exempt income in Kenya.

The first and indeed major challenge that arises is that this definition contradicts the provisions of Section 3(1) of the Kenyan Income Tax Act (ITA).

Section 3(1) provides that income tax is only applicable on income accrued in or derived from Kenya — making it a source-based taxation regime.

Thus, under the ITA, the only foreign incomes that are taxable in Kenya are foreign employment income earned by a person who is tax resident in Kenya and foreign income earned by a business that is carried on partly in Kenya and partly outside Kenya.

This means that income such as rental, investment or capital gains earned in foreign jurisdictions is by law not taxable in Kenya.

The pertinent question then is why the amnesty guidelines require declaration of all foreign income. To better understand the quagmire, it is important to consider the definition of the word amnesty.

This refers to an undertaking by the authorities to take no action against specified offences during a certain period. It has also been defined as a sovereign act of pardon and oblivion for past acts, granted by a government to all persons who have been guilty of a crime or a violation of the law.

It is clear from these definitions that an amnesty is mainly granted to pardon past offences, in the hope of securing future voluntary compliance.

With regard to taxation of foreign income in Kenya, an offence is committed under the ITA if a resident individual fails to declare foreign employment income or a resident business fails to declare foreign income from its business that is carried on partly in and outside Kenya.

Therefore a person who has, for example, earned foreign rental, investment or capital gains does not commit an offence by not declaring these incomes in Kenya.

Ideally, such a person does not need to rely on the amnesty as they have not committed any offence in the first place. Such a person is also not obliged to disclose that foreign income in Kenya, since at any rate, it is not income subject to tax in Kenya.

The amnesty guidelines, however, allude to the fact that all persons who earned foreign income, whether having committed a non-declaration offence or not, are required to declare this income under the amnesty. Granted, an honest and compliant taxpayer may still end up declaring all their foreign income under the amnesty, that is, whether taxable in Kenya or not. But the question is whether mere declaration of non-taxable foreign income does make it taxable in Kenya.

My view is that it does not. The only way that these foreign incomes can become taxable is if Kenya changes its taxation system and adopts a universal residence-based system such as that of the US.

Even if this change were to occur, the effect would not be applied retrospectively and hence the amnesty would not be necessary to persons who have foreign income that is not taxable in Kenya and therefore, who have not committed any offence.

Without this change, the declaration of non-taxable foreign income under the tax amnesty is a moot, and perhaps, academic point.

The second contentious issue is with regard to repatriation of foreign-held assets. Under the amnesty guidelines, the KRA is looking to make it mandatory for Kenyan residents to physically repatriate foreign held assets. While the government’s intention to spur re-investment into the country is noble, its approach of compulsory repatriation may not work in the long run.

One of the challenges that compulsory repatriation would face relates to physical property held abroad. Such assets would need to be liquidated in order to repatriate them.

While one may argue that offshore markets are better developed and hence efficient to facilitate quick liquidation, a sale of physical assets and repatriation within nine months would likely be a distress sale in order to take advantage of the amnesty deadline of December 31, 2017. Secondly, without foreign exchange controls in Kenya, compulsory repatriation is not foolproof. This is because an investor may easily repatriate cash one day as required and the next day, he re-invests the same cash abroad.

It is, however, important to note that hard currency inflows that would come into Kenya as a result of forced repatriation would, at the very least, result in a surge of the forex reserves and possibly a strengthening of the shilling.

This may also be the reason why the government is looking to make repatriation compulsory.

During the stakeholders briefing, the KRA repeatedly referred to the recent Indonesia and India tax amnesties as its benchmark. It is important to note that both India and Indonesia maintain a residence-based tax system.

This means that residents of these countries are required to account for tax on their worldwide income, irrespective of where such income is earned.

With such a tax system, an amnesty to declare foreign-held income and assets which are taxable in these countries makes sense.

In addition, the Indonesia and India tax amnesties made repatriation of foreign-held assets optional.

However, declaration of foreign-held assets was compulsory in order to qualify for the amnesty on income generated by the foreign-held assets. It is no doubt one of the reasons why these particular amnesties were successful.

This means that for Kenya’s tax amnesty on foreign incomes and assets to be successful, the government may need to change the tax system from a source-based system to a residence-based system. Perhaps with the current Income Tax Act review, this is the time to adopt such a change.