The harsh economic conditions in Kenya have pushed everyone, including the government and the private sector, to be uptight with their money. Everyone wants to make more money and spend less. That is true of taxes.
Individuals and businesses often use tax minimisation strategies to reduce their tax burden and maximise profits.
While tax avoidance is legal, some view it as unethical, calling for everyone to pay their fair share of taxes.
For Kenya Revenue Authority (KRA), tax avoidance and tax evasion are two sides of the same coin. The tax agency has become increasingly sophisticated in its attempt to detect and pursue tax avoidance cases.
So, should firms and individuals make use of legal tax minimisation strategies?
What is tax avoidance?
This is the use of legal methods to minimise the amount of income tax paid by an individual or business, either by claiming as many deductions or credits as it is allowed or prioritising investments with tax advantages such tax-free infrastructure bonds.
What is the difference between tax avoidance and tax evasion?
Tax evasion is using illegal methods to reduce tax obligations.
For example, individuals or businesses may report lower income or higher expenses leading to reduced or no profit, which attracts less income tax.
Tax evasion also includes the smuggling of goods, under declaration or non-declaration of income, tax fraud, dishonest tax reporting, and overstating deductions.
Andrew Warambo, a senior associate in the tax practice at Dentons Hamilton Harrison & Mathews, a law firm, says that with tax evasion, an individual or company refuses to pay taxes after the liability has crystalised.
For example, an employer deducts pay as you earn (PAYE) from employees but does not remit it to KRA. “There is no context where tax evasion can be legal,” said Mr Warambo.
In tax avoidance, an employer can decide that, rather than employ permanent employees for whom he has to pay PAYE at a rate as high as 30 percent, he “instead, can structure the business in such a way that he gets services only from independent contractors for whom he pays only withholding tax,” added Mr Warambo.
Are there some forms of tax avoidance that are illegal?
Generally, there is a thin line between tax avoidance and tax evasion. Depending on which side they find themselves on, tax experts disagree on whether all forms of tax avoidance or tax planning are legal.
What does the taxman say?
The Kenya Revenue Authority (KRA) says that the Tax Procedures Act defines tax avoidance as “a transaction or a scheme designed to avoid liability to pay tax under any tax law.”
“The Act further allows the Commissioner to impose a penalty equivalent to double the amount of tax that would have been avoided were a taxpayer found to have engaged in any tax avoidance scheme.”
But Nikhil Hira, a tax expert, says it is not easy to prove the illegality of tax avoidance.
“Tax avoidance is generally where a taxpayer enters into a scheme, say of restructuring or reorganisation, with the sole intention of avoiding tax,” said Mr Hira.
What are some forms of tax avoidance?
In tax avoidance, the individual or business uses tax planning, profit shifting, use of branches in jurisdictions with lower tax rates and utilisation of tax incentives to reduce their tax bill.
The most common way for multinational corporations (MNCs) to avoid paying taxes is by using Base Erosion and Profit Shifting (BEPS) schemes.
The Organisation for Economic Corporation and Development (OECD), a club for mostly rich countries but which also includes Kenya, says BEPS “are tax avoidance strategies that exploit gaps and mismatches in tax rules, artificially shifting profits to low or no-tax locations.”
These jurisdictions with low corporate income tax (CIT) are known as tax havens. They include countries like the Cayman Islands, Ireland, and Mauritius.
Money shifted could be royalty payment for intellectual property or interest payment on a debt. The money could also be a dividend payment, which attracts a lower withholding tax in the tax haven.
What's the most prominent case of tax avoidance in Kenya?
The 'Pandora Papers', an investigation based on the leak of some 11.9 million documents from 14 financial services companies worldwide, revealed how the global elite used offshore tax havens to hide assets worth hundreds of millions of dollars.
Retired President Uhuru Kenyatta and six family members were linked to a network of offshore companies.
According to the documents, Mr Kenyatta, his mother, sisters and brother used foundations and companies in tax havens, including Panama, to hold assets worth more than $30 million for decades.
The use of secretive trusts and foundations in low-tax jurisdictions is often seen as an effort to avoid paying taxes.
How has Kenya tried to address the problem of tax avoidance?
In the Finance Act, 2021, the government tried to seal loopholes exploited by companies to avoid taxes.
The Act introduced a new rule where interest on debt to a related company or third party that exceeds 30 percent of the earnings before interest, taxes, depreciation and amortisation (EBITDA) would be subjected to income tax.
Holding companies of multinationals must also reveal to KRA where their profits, sales and assets are located and taxes paid to enable the taxman to conduct audits and transfer pricing assessments on transactions between linked companies.