Kenya lost about Sh156 billion between 2000 and 2008 to illicit outflows of capital perpetuated by wealthy businesspeople and multinationals. These resources can finance about 70 per cent of Kenya’s 2010/11 development budget of Sh222 billion.
Global Financial Integrity (GFI) director Raymond Baker said intra-company deals represent about 50 to 60 per cent of cross-border trade where most of the money is lost through clever accounting. “I have never known a multinational, multibillion-dollar, multiproduct corporation that doesn’t use fictitious transfer pricing in some part of its business to shift money in some of its entities,” Mr Baker says.
In a well-planned syndicate, and taking advantage of lack of expertise and weak laws Kenya, companies continue to shift profits to low tax jurisdictions and avoid taxes in countries where corporations have substantial trading operations — in what is called transfer pricing.
Transfer pricing – or transfer mispricing as this widespread practice might be more aptly called – distorts trade and taxation. Transfer prices are abusive if the cost of purchases in countries with a high tax rate is inflated (overbilling) or the profits from sales are artificially reduced (under-billing).
This increases profits in countries with low tax rate and raises costs in those with a high tax rate. This way the company reduces its tax burden in the high-tax-country and books its profits in the low-tax country. Overall, the total tax burden decreases.
For instance, a Swiss company buys flowers from its Kenyan subsidiary. How much does the parent pay the daughter for the products? The price determines how high the daughter’s profit and thus the taxes owed in Kenya will be. If the Swiss company were to buy the flowers from an independent dealer in Kenya it would have to pay a market price. If it pays less, the profit of its Kenyan subsidiary is smaller, resulting in a smaller tax payment to the Kenya government.
Kenya Revenue Authority (KRA) says it is investigating some multinationals for abusive transfer mispricing. Among them, according to Mr John Njiraini, the KRA commissioner of domestic taxes in charge of the large taxpayers, are the country’s three largest flower companies.
“We have seen cases of multinationals reporting losses in Kenyan subsidiaries while their parent firms are making huge profits. We are investigating whether they have abused their transfer pricing policies,” Mr Njiraini, said.
Mr Njiraini, who was giving a presentation to journalists attending Reporting on Public Spending course by International Institute for Journalism (IIJ) of Capacity Building International Germany (InWEnt), said KRA and other tax administrators in various countries have come up with Information Exchange Protocols to share intelligence.
It has joined the Global Forum on Transparency in the Exchange of Information for tax purposes. The forum brings together 95 countries (including all G20, OECD and Offshore jurisdictions) committed to combating international tax avoidance.
Mr Martin Kisuu, a tax partner at PKF Eastern Africa, says Kenya may have joined the forum to access information on its produce sold abroad. “In some cases, the Kenyan and foreign entities are related and it is always feared that the relationship would be exploited to minimise the incidence of tax in Kenya,” Mr Kisuu says.
Mr Njiraini says to be able to crack the abusive transfer pricing syndicate, Kenya requires experienced lawyers in the area as well as tax experts, who are not currently available. Some of the tax-avoidance methods are rampant because there is no legislation against them.
KRA has contacted Flora Holland, the world’s largest flower marketer based in the Netherlands to understand the operation of the fresh flower market. According to Mr Njiraini, Kenyan flower firms contribute $250 million a year in the flower market in Holland.
This, he says, that doesn’t include Kenya’s biggest three flower firms which control 70 per cent of the local flower market that are under investigation. Mr Kisuu says although Kenya crafted transfer pricing legislation modelled on OECD’s in 2006, there was no capacity in terms of technical skills and tools to enforce the rules. “Transfer pricing regulations present a complex field of international taxation and certainly the learning curve for both KRA and taxpayers is still stiff,” the tax expert says.
Prior the Income Tax (Transfer Pricing) Rules of June 16, 2006, there were no guidelines to assist multinational companies to comply with Section 18, particularly with determination of arm’s-length pricing.
Mr Alvin Mosioma, Coordinator of Tax Justice Network-Africa Secretariat, based in Nairobi says: “Our attempts to investigate companies practising transfer mispricing has in the past hit a dead end because many of them are not publicly quoted and hence are under no obligation to make their books of account public.”
Mr Mosioma says transfer mispricing is a difficult issue to investigate since it involves operations of related companies in several tax jurisdictions where companies use manipulative accounting to move their profits to a lower tax jurisdiction.
Most flower firms based in Naivasha are subsidiaries of Dutch-based companies. “Netherlands is recognized as a tax haven and there are studies that have shown that the country’s tax system has similarities with tax havens since it allows the creation of special vehicles (foundations, trusts etc) that are usually used for tax planning and avoidance,” Mr Mosioma adds.