The Government is tightening the noose around tax leakage. In the finance bill 2012, Finance minister, Njeru Githae gave Kenya Revenue Authority powers to issue further guidelines on transfer pricing — which happens whenever two related companies – parent company and a subsidiary, or two subsidiaries controlled by a common parent firm trade with each other.
Transfer pricing is not, in itself, illegal or abusive.
What is illegal or abusive is transfer mispricing, also known as transfer pricing manipulation or abusive transfer pricing. Previously, only the minister could prescribe rules under the Income Tax Act.
According to PricewaterhouseCoopers Kenya (PwC), the changes could have far-reaching implications on taxpayers. “But will the Commissioner’s changes make compliance easier for taxpayers or make the waters murkier?” poses PwC in its Budget 2012/13 analysis document.
The Income Tax (Transfer Pricing) Rules 2006 have been amended to enable the Income tax Commissioner to prescribe conditions and procedures to guide taxpayers on the application of the transfer pricing methods as set out in the current rules. This will affect taxpayers engaged in transactions with non-resident entities.
The transfer pricing rules currently allow taxpayers to choose which method to apply taking into account their particular circumstances in line with international best practices and allows taxpayers to choose the most appropriate method.
“The change may be aimed at directing taxpayers, albeit not so gently towards how the KRA would like particular methods to be applied,” says Deloitte East Africa.
An investigation carried out with the support of Africa Centre for Open Governance (AfriCOG) through its Investigative Journalism Programme (I.J) found out that more than a dozen firms are under probe for possible abuse in transfer pricing.
The taxman zeroed in on these firms after scrutinising about 300 of them in an attempt to combat abuse of the practice that involves drastically reducing payable tax so as to transfer profits to associated companies in tax havens outside Kenya.
According to a source at KRA, hundreds of firms with multinational links have received letters from the taxman since November 2009 asking them to formulate and defend their transfer pricing policies.
Those under investigation are three horticulture firms while others are in tobacco, telecoms and manufacturing business. Some have been found to have evaded tax through irregular transfer pricing practices.
In a past interview, KRA Commissioner-General John Njiraini, confirmed that he was indeed investigating some companies for possible abuse of transfer pricing. However, KRA has not given a figure of how much it could have lost or recovered through transfer pricing.
In 2009, KRA auditors found that some Sh1.76 billion had been irregularly evaded with just one company responsible for half the amount.
Fredrick Omondi, head of transfer pricing practice in East Africa at Deloitte & Touche, in a past interview said KRA has targeted most of the large multinationals in Kenya and says the audits are at various stages.
“The increasing focus on transfer pricing means that multinationals — taxpayers with related parties outside Kenya — face an increased risk of tax adjustments,” Omondi said, in an earlier interview.
He says it is likely that there will be many contested cases in the initial period before precedents are set and both parties adjust accordingly. KRA plans to triple staff at the transfer-pricing unit in the next few years to handle the rising abuse of transfer pricing. The unit was set up in place in 2009 and has 17 staff.
Global Financial Integrity estimates that the country loses close to Sh17 billion annually in tax revenue, with significant amounts benefiting European and North American countries. The amount can finance free primary education for two years, taking into account the Sh8.25 billion budgeted for 2011/12 fiscal year.
It is also about half the amount used to rebuild Nairobi-Thika highway into an eight-lane super highway. Other figures from Tax Justice Network show that the country lost about Sh156 billion ($1.7 billion) between 2000 and 2008. The UK-based charity, Christian Aid says in a report that Kenya loses up to Sh130 billion annually in untapped tax from corporates.