Treasury moves to plug revenue loss

Goods traded between branches of companies in Kenya and their parent firms abroad will be valued at market rates in the latest effort to fight transfer pricing through which the Treasury loses billions in revenues.

Transfer pricing refers to distortion of rates at which goods and services are sold between related parties, inflating costs and effectively understating the gross profit on which tax is charged.

“To further deter use of transfer pricing scheme, I have proposed an amendment on the definition of permanent establishment to restrict transactions between related parties and their local establishment at an arms’ length for tax purposes,” Treasury Secretary Henry Rotich said when he presented the 2014/15 budget last Thursday.

Previously only the entire subsidiary was considered when assessing transfer pricing. The restriction means that only market prices would be considered for taxation purposes rather than the friendly rates related companies often present in tax statements.

“Billions are being lost every year in transfer pricing. We clearly would not need to borrow any money either locally or abroad if companies did not shift profits to foreign entities,” said Ernst & Young CEO Gitahi Gachahi.

READ: Rules on transfer pricing to rein in rogue global firms

The Budget has a deficit of Sh342 billion which will be sealed through borrowing. Global Financial Integrity, an international NGO, estimated that Kenya had lost more than Sh115 billion in transfer pricing in trade during the 10 years to 2010.

Companies are now expected to come up with policies on how they will treat transactions among related parties.

“These transactions may therefore be subject to transfer pricing adjustments. There will be a need for the local establishments to have transfer pricing document to support the pricing of the related party transactions,” said PricewaterhouseCoopers in their report analysing the 2014-15 Budget.

PwC said the wider definition of transfer pricing would turn tax avoidance, a legal effort to minimise tax incidence, into tax evasion which is illegal.

Mr Gachahi said some firms were perpetually making losses because they were shifting the profits to their foreign entities in order to avoid paying income tax. Transfer pricing is believed to be rampant in horticulture, banking and oil marketing.

Last year, the maximum number of years that a firm can declare losses and pay no tax was fixed at four unlike in the past when it was open ended.