One of the core objectives of businesses is to increase their shareholders’ value. It is the one overriding objective that gives chief finance officers and finance managers sleepless nights trying to figure out how.
The work of management is to make decisions that grow the business and the more successful a business becomes, the higher the tax it is expected to pay.
In some countries where the tax rate is computed on a graduated scale — increasing with increase in profits — it is often a case of punishing success.
Taxes reduce the profits available to shareholders and by minimising the tax payable, businesses increase the amounts available for payment to shareholders.
The tax legislation in many countries outlaws tax evasion, often prescribing stiff penalties for perpetrators.
With this reality in mind, taxpayers often structure their operations to take advantage of available tax incentives and to utilise loopholes in the tax legislation to minimise their tax liability.
Considering that corporation tax is often charged at about 30 per cent of the net profits, taxpayers derive great value from any reductions in the effective tax rate.
This is the reason most businesses invest in external tax advice or in-house tax advisers for expertise that can help them reap these benefits.
To a large extent, many companies have succeeded in minimising their tax liabilities by large margins or millions of dollars, causing concern to tax authorities and governments across the world.
It is principally for this reason that tax planning has more recently received a lot of attention among the G20 (the club of the world’s richest countries) as well as from the Organisation for Economic and Corporation Development (OECD).
The OECD has, for instance, developed robust guidelines for developing contemporaneous transfer pricing policies and action plans that are intended to curb base erosion and profit shifting.
In Kenya, the government early last year brought into force a new law, the Tax Procedures Act, 2016 (TPA), with anti-tax avoidance provisions. Prior to the enactment of the TPA, the tax avoidance provisions were only found in Section 23 of the Income Tax Act (ITA).
This section empowered the commissioner to make adjustments to tax liability where he was of the opinion that the main purpose for which a transaction was made was the avoidance or reduction of liability to tax.
The TPA defines tax avoidance as a transaction or a scheme designed to avoid liability, and provides for penalty equivalent to double the amount of the tax that would have been avoided were it not for the application of the tax avoidance provision.
Under the new law, tax agents who assist taxpayers to craft tax avoidance schemes are also liable to a fine equal to double the tax evaded or to a fine not exceeding Sh5 million, whichever is higher, or to imprisonment for a term not exceeding five years, or to both. Clearly, tax avoidance is extremely costly, according to the TPA.
Tax planning is the arrangement of one’s tax affairs in such a manner that enables the reduction of tax liability based on either loopholes or incentives in the relevant tax legislation.
This means that if a taxpayer is able to correctly apply the law and plan his tax affairs more efficiently, he or she is likely to avoid some taxes and ultimately pay less tax.
Such an approach to meeting ones tax obligations is not illegal. For instance, the ITA provides a 150 per cent investment deduction for an investor who sets up a manufacturing plant outside the major cities in Kenya, while the same investment qualifies for 100 per cent deduction if established in Nairobi, Mombasa or Kisumu.
An investor can tax-plan by opting to set up their operations outside the three cities to benefit from the 150 per cent deduction.
Under the new legislation, this may be deemed to be tax avoidance since the primary purpose of setting up outside the main cities can be deemed to be to enjoy the higher deduction.
If an investor opts for this clear incentive provided under the legislation, it may lead to tax avoidance, as stated under the TPA. Is that really illegal? Be the jury!