Capital Markets

Taxman eyes billions earned by foreign traders on hedging


Times Tower in Nairobi, the headquarters of Kenya Revenue Authority. FILE PHOTO | DENNIS ONSONGO | NMG

The Kenya Revenue Authority (KRA) will from January go after the billions being made by foreign traders profiting from Kenyan-based derivatives, as the taxman casts its net beyond borders.

Gains accruing for foreigners from the financial derivative contracts will start attracting 15 percent withholding tax.

Currently, only local companies that have bought derivative contracts — which include options, swaps, futures, and forward contracts — to protect themselves against financial loss due to price fluctuations have been paying the 15 percent withholding tax on their gains.

According to an analysis by Bowman, a British-based law firm, the move is also a response by the government to earn revenue from the increased use of hedging by local entities caused by the need to navigate the volatile international markets due to the ongoing conflict in Eastern Europe.

Local companies that have bought derivative contracts to hedge against market fluctuations include banks, airlines, oil importers and cement manufacturers.

Also read: MWANYASI: Why derivatives are both good and bad weapons

Analysts say the move would widen the tax revenue base by bringing into the tax bracket gains from financial derivatives derived from the Kenyan market.

However, analysts have questioned the ability of the KRA to monitor such complex financial transactions, with the Treasury Cabinet Secretary Njuguna Ndung’u expected to publish regulations to usher in the new tax measure.

A hedge is a trade that targets reducing the risk of adverse price movements in another asset, for example a stock, interest rate, fuel or exchange rate.

“It is a little tricky to tell who is signing what with whom. And when they do, whether those losses or profits will be accurately measured so that these taxes can be imposed,” said Deepak Dave, a financial expert.

“Additionally, the charge to tax gains derived by non-resident persons from financial derivatives could be one way of promoting equity because such gains are taxed on resident persons,” said audit firm KPMG in an advisory on the Finance Act, 2022.

The Act defines financial derivative as a “a financial instrument the value of which is linked to the value of another instrument underlying the transaction which is to be settled at a future date.”

Normally, when you hedge, which is a type of derivative, you take the opposite position in a related security or in a derivative security based on the asset to be hedged.

In the case of banks, which hedge against the weakening of the shilling, they will take a bet that the currency will weaken in the future and will be paid should the depreciation happen.

Airlines, such as Kenya Airways, have also been known to hedge against a surge in the price of fuel, a major cost component in the airline business.

So, when the price of jet fuel increases in the international market, the airline is compensated.

However, hedges turned sour when prices of jet fuel started going south in mid-2014 as a result of increased supply from the US and decreased demand as the Chinese economy contracted.

Because Kenya Airways lost the bet, it was forced to pay out more to foreign traders who had taken a position that the price of jet fuel would drop.

Such companies, however, did not pay taxes on these gains, with the government now keen to benefit from such earnings.

Mr Dave, however, does not think the country has the capacity to track these complex transactions, given the different rules for disclosure in different countries.

“Frankly, I don’t know if our audit firms would know how to track these stuff (derivatives),” said Mr Dave.

“So, it would be very interesting to hear from KRA, how exactly they plan to enforce all these things. Who is going to provide the expertise? Where are the systems, the analysis and calculations?” he asked.

However, derivatives at the Nairobi Securities Exchange (NSE) are exempted from the new tax measure.

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