Intricate tax laws a major hindrance to doing business in Kenya
By Rachel Muiru
In 1992, Kenya adopted the self assessment system of paying taxes. The responsibility of declaring and paying the correct taxes is vested on the tax payer. A tax payer is required by law to file a self assessment return by the end of the six month after year end. After filing the returns, Kenya Revenue Authority (KRA) reviews them and if it has reason to believe that a tax payer did not disclose the correct taxes, it is empowered under the law to carry out an in-depth tax audit to verify the information disclosed by the tax payer. This is where problems start! The tax payer then goes through the rigorous process that is both time consuming and costly for errors or omissions that would have been avoided had advance tax rulings been in place.
Further, businesses contemplating significant transactions are often faced with the problem of not knowing, with some degree of certainty, what the tax outcome of those transactions would be. This uncertainty could sometimes mean a deal is aborted because an adverse tax treatment could make it commercially non-viable. The situation is further complicated by the complexity of our tax laws and the fact that they are subject to change from time to time.
The way business is conducted has also become more sophisticated due to the geographical spread of enterprises. We have recently witnessed many multinational companies set up operations in Kenya in keeping pace with the wave of globalization. The world has become a global village but it is unfortunate that our tax laws have not kept pace with this trend. For instance, it is not a wonder to find a company producing goods in one country and selling in another country to benefit from tax advantages in low tax jurisdictions. The complexity of business transactions makes the application of intricate tax laws that have generally not kept pace particularly problematic. Tax payers often find themselves in difficult situations while making important business decisions as tax laws may not be clear as to the treatment of complex business transactions. Our tax legislation does not provide for advance tax rulings though in practice, tax payers seek the Commissioner’s interpretation of various tax laws or tax implications of certain business transactions. Sometimes this is done on a no-name basis in order to retain confidentiality.
What is an advance ruling?
An advance ruling is a written statement by the tax authority setting out its interpretation of a provision in the tax law as it applies to a transaction contemplated by a taxpayer who has applied for the ruling. The tax authority is bound to adhere to the ruling if the taxpayer proceeds with the transaction but only when the facts have not altered from those presented earlier. This provides the certainty sought by the taxpayer. Unfortunately, a taxpayer faced with an unfavorable ruling may not appeal against the ruling. He has the choice of not going through with the proposed transaction but if he does, he has to reflect the ruling's position in his tax return and pay tax accordingly.
When should a ruling be sought?
An advance ruling should only be sought where an issue requires interpretation of the law, or an interpretation on the manner in which a relevant provision would apply to an entity in respect of a specific transaction or arrangement.
No ruling will be given on schemes involving tax avoidance. This exclusion means that taxpayers are unable to benefit from the advance ruling system in an area where there is perhaps the greatest need for clarity, by virtue of the wide scope of the anti-avoidance provision in the tax law.
A ruling should be sought before a transaction is entered into. Taxpayers should not use the ruling system as a means to obtain advice from the tax authorities. They should be aware that seeking a ruling has its downside since they are precluded from contesting a ruling with the consequence of paying the applicable taxes. They should, before seeking a ruling, ask themselves questions such as whether the transaction involved is fairly certain, whether the particular provision in the law is really open to interpretation and if professional advice should be sought; whether there are assumptions to be made relating to the contemplated transaction and if these had been carefully considered; and the risks involved and if these have been adequately evaluated, taking into consideration the possibility of the issue being brought to litigation.
The draft VAT Bill has made an attempt to introduce advance tax rulings from a VAT perspective. It is therefore expected that the Minister for Finance will introduce advance tax rulings from an income tax perspective in the 2011/2012 budget. This will clearly complement the existing self-assessment system, which places on the taxpayer the onerous duty of making a correct tax assessment on oneself. Once that happens, Kenya will join the ranks of Singapore, Hong Kong, Canada, Australia and India, all of which have advance ruling systems.
Implementation of the advance ruling system will enhance capacity building in KRA’s existing technical resources. Over time, these resources will assist the authority to extend its ambit to areas currently excluded from the tax net. This will make the tax system more transparent, which will in turn add to taxpayers’ confidence in the system.
Rachel Muiru is a Tax Manager with Ernst & Young. Views expressed in the article are personal and may not represent the firm’s view.email:Rachel.firstname.lastname@example.org