Compensating Tax: Change law for firms working with State

Times Tower, the headquarters of the KRA, in Nairobi. FILE PHOTO | NMG
Times Tower, the headquarters of the KRA, in Nairobi. FILE PHOTO | NMG 

Kenya’s many infrastructure projects cut across all sectors of the economy, including energy, health to information technology. Some are financed through public private partnerships.

As a result the government is under pressure to fund them in addition to running the core functions. With the debt to GDP ratio expected to hit 60 per cent by June 2018, there is more pressure on the taxman to collect more to feed the huge projects from local taxes as the borrowing window inevitably closes.

Moody’s downgrading of Kenya’s issuer rating to B2 from B1 has also affected the international reputation of the country, hence making foreign lenders and investors become jittery. This is despite the successful issue of Eurobond II that was oversubscribed.

Indeed the taxman’s corridors are busy as they hand out agency notices at a generous rate never seen before.

Further, the Kenya Revenue Authority (KRA) has turned to sections of the tax laws that were not in focus so as to bring as many tax payers as possible into the fold. This has been done through streamlining the existing laws and introduction of new ones to cast the net wider.

One of the taxes that have been ignored by many taxpayers but have a profound effect is the Compensating Tax.

Compensating tax is levied under Section 7A of the Income Tax Act (ITA) on resident companies by maintaining a memorandum account known as Dividend Tax Account which tracks the movement of dividends and taxes.

This tax was introduced to ensure that the incomes that are untaxed due to various tax incentives are ploughed back into the business to spur economic activity. In a nut-shell, it’s a deterrent from distributing a tax incentive.

Tax incentives are always designed to have multiplier effects in the long run hence the governments may forego tax for a moment but hope the resultant economic growth will lead to greater tax income in the future.

Some of the tax incentives include capital allowances and special concessions given to companies under the special economic zones, the various VAT exemptions....

Through this tax the government effectively sealed any loophole of re-directing the tax advantaged income. While this looks good from the government lenses, it makes no sense to give an incentive on one hand and take with the other.

Some of the hardest hit companies are those incorporated as subsidiaries to take part in the Public Private Partnerships (PPPs).

The Public Private Partnerships Act that came into force in 2013 requires the special purpose vehicles for delivery of the projects to be registered as subsidiaries and hence taxed at the corporation tax rate of 30 per cent. As a result, they fall under the ambit of compensation tax should they distribute dividends to the parent companies.

This is a disincentive to foreign companies that intend to take part in PPPs that the government desperately needs as its access to credit narrows.

It’s high time foreign companies involved in PPPs lobbied the government to amend the the law to allow them to register as branches that are not subject to compensation tax instead of registering subsidiaries.

For local companies, postponing payment of dividends until there are sufficient profits to cover the punitive compensating tax is desirable.

Nathan Omayio is a Tax Consultant.