The noose is tightening around tax evaders with authorities investigating 20 multinational companies for transfer pricing, a form of tax evasion.
The Kenya Revenue Authority (KRA) has intensified audits to combat the malpractice, which involves drastically reducing payable tax so as to transfer profits to associated companies in tax havens overseas.
The revenue collector intends to triple the size of its audit staff in the next few years to handle the rising abuse of transfer pricing.
“We will increase the staffing for purposes of transfer pricing audits in the next few years. We know it is a growing problem but we will go further and ask auditors to raise queries whenever they come across this,” said Mr John Njiraini, the commissioner for domestic taxes in charge of the large taxpayers’ office.
The transfer pricing unit was only put in place in 2009 and has 17 staff. Due to the small number of the employees, the KRA concentrates on firms, numbering 20 currently, that are perceived as most risky in terms of abusing transfer pricing policies.
The increasing focus on transfer pricing is prompted by studies such as that by the Global Financial Integrity suggesting Kenya loses Sh17 billion annually in tax revenue, with significant amounts benefiting European and north American countries.
This amount can be used to finance free primary education for two years taking into account the Sh8.25 billion budgeted for 2011/12 fiscal year. It is also about half the amount being used to rebuild the 40-kilometre Nairobi-Thika road into an eight-lane super highway.
Charity group Christian Aid says in a report that the country loses up to Sh130 billion annually in untapped tax from corporate entities, even though it concedes that Kenya is among the most aggressive in Africa in collecting taxes.
As more foreign companies set shop in Kenya, the losses are likely to increase, explaining why Kenya and Uganda included in their 2011/12 budgets the plan to exchange information on taxes with other foreign countries.
Mr Njiraini said that KRA would seek the help of the Institute of Certified Public Accountants of Kenya (ICPAK) to take disciplinary action against auditors who ignored the abusive transfer pricing practices and passed the accounts and financial statements as reflecting the true picture of a company’s financial position.
The former head of ICPAK, said abusive practices “are close to fraud”.
“How can a company ran losses for more than a decade and still remain in operation? It does not make business sense. This happens when a company is engaging in transfer pricing to deny government revenue. An auditor should qualify accounts of companies that are always in losses,” said Mr Njiraini.
He said two firms – one in telecoms and another in tobacco business – have been conclusively found to have evaded tax through transfer pricing practices.
The firms have since been forced to pay the taxes due to the government, Mr Njiraini said without disclosing the identities of the companies involved.
“The 20 other firms we are investigating are in the horticultural, manufacturing and telecoms sectors. These are the firms we have found have the highest risk of abusing transfer pricing,” he said.
The authority zeroed in at the 20 companies after perusing through some 200 firms. Tax experts, however, gave an account that indicates a figure much higher than 200 companies have received letters to show cause why they should not be investigated for tax evasion through transfer pricing practices. The firms were asked by KRA to prepare their transfer pricing policies, on which the authority would raise queries. “We have found that even these policies have a lot of caveats designed to ensure they escape liability,” said Mr Njiraini.
Kenya is listed by Christian Aid among the top 10 low-income countries losing tax revenues to Europe — and this is only for cases that could be easily spotted.
However, it is not so easy for the authorities to catch up with the tax evaders in the name of big corporate entities because of their complicated global structures as well as the fact that many of the transfer pricing practices are perfectly within the law – thus amounting to only tax avoidance and not evasion.
Even Christian Aid, which details the case of a South African brewer under investigation in seven countries over transfer pricing, insists that it is only questioning the company’s ethics and does not imply it has committed any offence.
Mr Nikhil Hira, tax partner at Deloitte East Africa, said more than 300 Kenyan companies with multinational links have received letters from the taxman since November 2009 asking them to formulate and defend their transfer pricing policies. “We have seen a big increase in audit queries on transfer pricing in the past year from KRA. So many companies, perhaps at least 200 of them, have put in place transfer pricing policies. Some 50 to 70 of them have told the taxman they have no related party transactions,” said Mr Hira.
Such policies are supposed to include a group’s structure, transactions such as sales, borrowings and the like. “The issue is not straightforward as such. We believe KRA is now looking at these policies,” said Mr Hira. He said that in 2009, some Sh1.76 billion was found to have been irregularly evaded with half of the amount having been evaded by just one company.
“I understand a company owed half the amount queried but none of them is my client. I don’t know which firm it was that owned half the amount. But we have also seen some incorrect allegations made against companies,” said Mr Hira.
He said that KRA has strengthened its transfer pricing unit to 17 staff and now conducts regular audits. Uganda has also proposed amendments to its income law to facilitate information sharing similar to Kenya’s in the latest budget statement in what is being seen as a coordinated way to corner firms and ensure that they do not evade tax.
“We know revenue authorities in the region and even beyond are talking to each other. But most multinational firms ensure that they comply,” said Mr Hira.
He added that there are many cases when a firm makes a tax loss even though it has an accounting profit such as when it has been given an investment deduction allowance.