Compensating Tax: Change law for firms working with State
By Nathan Omayio
Kenya has been experiencing an influx of infrastructure projects in the country cutting across all sectors of the economy from energy to health sector and to the information technology sector. Some of these projects are financed through public private partnerships.
As a result the government is under pressure to fund such projects in addition to running the core functions. With the debt to GDP ratio expected to hit 60% by June 2018, there is more pressure on the taxman to collect so as to meet the insatiable demand for projects from local taxes as the borrowing window inevitably closes.
Moody’s downgrading of Kenya’s issuer rating to B2 from B1 has also affected the international reputation of the country hence making foreign lenders and investors become jittery. This is despite the successful issue of Eurobond II that was oversubscribed.
This has placed an enormous burden on KRA to collect. Indeed the taxman’s corridors are busy as they hand out agency notices at a generous rate never seen before. Further, KRA has turned to sections of the tax laws that were not in focus so as to bring as many tax payers as possible into the fold. This has been done through streamlining the existing laws and introduction of new ones to cast the net wider.
One of the taxes that have been ignored by many taxpayers but have a profound effect is the Compensating Tax.
Compensating tax is levied under Section 7A of the Income Tax Act (ITA) on resident companies by maintaining a memorandum account known as Dividend Tax Account which tracks the movement of dividends and taxes.
This tax was introduced to ensure that the incomes that are untaxed due to various tax incentives are ploughed back into the business to spur economic activity. In a nut shell, it’s a deterrent from distributing a tax incentive.
Government tax incentives are always designed to have multiplier effects in the long run hence the governments may forego tax for a moment but hope the resultant economic growth will lead to greater tax income in the future.
Some of the tax incentives include capital allowances, special concessions given to companies under the special economic zones and, the various VAT exemptions.
By introduction of this tax the government effectively sealed any loophole of re-directing the tax advantaged income. While this looks good from the government lenses, it makes no sense to give an incentive on one hand and take with the other.
Some of the hardest hit companies are those incorporated as subsidiaries to take part in the Public Private Partnerships. The Public Private Partnerships (PPP) Act which came into force in 2013 requires the special purpose vehicles for delivery of the projects to be registered as subsidiaries and hence taxed at the corporation tax rate of 30%. As a result, they fall under the ambit of compensation tax should they distribute dividends to the parent companies.
This is a disincentive to foreign companies that intent to take part in PPPs that the government desperately needs as its access to credit narrows.
Its high time foreign companies involved in the public private partnerships seeking to run projects in the country lobby the government to amend the PPP Act to allow them to register as branches which are not subject to compensation tax instead of registering subsidiaries.
For local companies, postponement of payment of dividends to such a time when they have sufficient profits to cover the punitive compensating tax would be smart move to make. Further, they can make strategic reinvestments of the surplus profits with their sights on growth of the company. In this regard, compensating tax would not arise as there will be no distribution.
We watch and wait to see whether this will be reformed in the new Income Tax Act expected any time.
Andersen Tax, Kenya is a member firm of Andersen Global. Andersen Global is an international association of legally separate, independent member firms comprised of tax and legal professionals around the world. Established in 2013 by U.S. member firm Andersen Tax LLC, Andersen Global now has nearly 4,000 professionals worldwide and a presence in over 126 locations through its member firms and collaborating firms.