The election of Donald Trump as US president was expected to bring radical changes to international trade due to his “America first” mantra.
And he has lived true to his pre-election promise of carrying out overdue tax reforms. This has caused disruption in international trade. On December 22, 2017, Trump signed the US tax reform legislation, which brought to an end more than 20 years worth of work.
The tax reforms’ major highlights include the drastic reduction of the corporation tax rate from a high of 35 per cent (which was one of the highest among developed economies) to 21 per cent.
This rate is lower than organisation for Economic Co-operation and Development (OECD) countries average of 25 per cent, BRICS 28 per cent and Africa 29 per cent. Kenya’s corporation tax rate is 30 per cent for resident companies and 37.5 per cent for branches.
The drastic reduction has sent shock waves across the world as America is now poised to be the new tax haven. This has made several countries to rethink their corporation tax rates so as not to lose their attractiveness. UK, France and Netherlands are some of the countries that are considering lowering their tax rates to remain competitive.
Further, the reduction of rates by major economies may lead to a ripple effect for developing economies like Kenya that may want to reduce their tax rates in conformity with their trade partners.
Kenya like most of the developing countries entirely relies on taxes to fund its deficit budget. A plunge in rates will increase the budget to unsustainable levels leading to bankruptcy.
The 2017 budget deficit was estimated at Sh880 billion by the Institute of Economic Affairs (IEA) despite the government capturing a deficit of Sh524 billion in its summary.
Plugging this deficit was difficult in the year 2017 being an election year hence the unpopular decision of going for a second Eurobond. With the elections over, it is highly likely that the government will go for increase of taxes as a strategy to raise funds to plug the 2018/2019 budget deficits.
Already, the Treasury has fired the warning shots by yielding to IMF’s pressure to introduce VAT on petroleum product from September this year.
The VAT on petroleum products has been suspended severally in order to manage the cost of living, but it seems now the horses cannot be held any longer.
Consequently, maintaining the current rate at 30 per cent may see the businesses shifting elsewhere where there are favourable rates as a result of the US tax reforms disruption.
This is a catch-22 situation for the Treasury and it will be interesting to see Kenya’s reaction since we are also working on the reformation of our Income Tax legislation.
Treasury’s budget policy statement has already projected an increase of income tax from Sh625 billion in last year fiscal year to a high of Sh 1.26 trillion by the 2021-2022 fiscal year. The other landmark change in the US tax reform is the shifting of US’ tax policy from a worldwide tax system to a territorial based tax system.
In the worldwide tax system, American companies were taxed on all the income they receive from all jurisdictions in the world and would take a credit of the taxes paid in those jurisdictions if they repatriated the profits to the US.
However, if they retained the earnings abroad and reinvested them, this was not subject to tax. Consequently, most US corporations with foreign subsidiaries stashed their retained earnings abroad. US Treasury estimates that the retained earnings stashed abroad are in the excess of $2.6 trillion.
In the new territorial based tax system, American corporations will pay tax in the jurisdictions that they operate and should they choose to repatriate their retained earnings through dividends, they will not be further subjected to tax upon certain conditions.
This will incentivise US corporations to repatriate profits from countries like Kenya. This is disadvantageous to Kenya’s economy especially at this time when the Foreign Direct Investment (FDI) is plummeting. UNCTAD’s world investment report for last year reported that Kenya’s FDI flows dropped 36 per cent in 2016 to Sh 40.7 billion.
The new US law will make things worse for Kenya. Treasury’s work is cut out to innovate ways to make Kenya attractive so as to tap into the international mobile capital.
Further, the new law has provided leniency to any US corporation that repatriates the foreign retained earnings that they have accumulated over the years. They have an eight year period to repatriate the accumulated earnings.
A rate of 15.5 per cent will be charged on cash repatriations and eight per cent on dollar based financial assets. This may see American corporations domiciled in Kenya repatriating their accumulated earnings in Kenya to US where the tax rate is now favorable at 21 per cent instead of Kenya’s 30 per cent.
This mirrors Kenya’s amnesty programme whose deadline is June 2018. The Kenyan amnesty targets residents with foreign incomes that have not been taxed by giving relief for any taxes, penalties and interest for incomes declared up to 31 December 2016.
Nathan Omayio is tax consultant.
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