The Kenya Revenue Authority (KRA) has poked holes in the tax agreement which Kenya signed with Beijing in September cushioning Chinese firms from paying tax on interest they earn.
The taxman says the country risks losing billions of shillings in tax exemptions if the deal, signed in Nairobi on September 21 but yet to be enforced, is not amended.
KRA's chief manager in international tax office with a key focus on transfer pricing, Mr George Obell, said the agreement should be amended to include a binding clause that compels China to collect tax dues on behalf of Kenya.
"China has capital. So they will bring capital into the country and when they are paid interest, it is not subject to tax. That's a big loss because they have got a lot of money. That must be addressed," Mr Obell said.
China is Kenya's largest bilateral lender, accounting for 20.9 per cent or $4.6 billion (Sh474.94) billion as at June 2017. This largely goes into infrastructure development.
The world's second largest economy after the US is also the largest source of Kenya's imports, having shipped in consignments valued at Sh273.03 billion between January and August this year. This is a growth of 24.71 per cent compared with Sh218.93 billion in the same period last year.
Mr Obell said KRA has recommended to the Treasury to include a clause that will see Chinese authorities collect taxes on behalf of Kenya. This, he said, will seal loopholes for firms which may try to evade tax on completion of short-term projects.
"The agreement should have the power for other jurisdiction to help you collect your taxes. The moment taxpayers know that when they come and do something and go back without paying tax, they can be followed because there is an agreement, they will comply," Mr Obell said.
The avoidance of Double Taxation Agreement (DTA) was negotiated and concluded during a meeting in Beijing in November 2016, paving the way for its signing in September.
Treasury Secretary Henry Rotich said during the signing ceremonies that the tax treaty with China was likely to increase capital flows from Beijing because it creates certainty on cross-border taxation.
Mr Rotich singled out the struggling manufacturing sector which, he said, was likely to benefit from China's technological advancements.
This is the second time the Treasury has come under sharp scrutiny for inking tax treaties aimed at attracting Foreign Direct Investments (FDI), which fell to an estimated $394 million (Sh40.62 billion) in 2016 from $620 million (Sh63.92 billion) the year before, according to the Geneva-based UN's Conference on Trade and Development (UNCTAD).
Tax Justice Network-Africa (TJN-A in October 2014 sued the Treasury for "illegal" DTA with low-tax country Mauritius, which was signed in 2012 and ratified in May 2014. The case is awaiting determination by the court.
The civil society lobby wants the agreement, which allows multinationals operating in both countries to pay tax only in one jurisdiction, withdrawn. Critics of the Mauritius DTA have cited unfair competition for firms in the same sector, given lower tax rates in the Indian Ocean island nation.
A model company in Mauritius pays an average 21.9 per cent in profit, labour and other levies in a year compared with 34.8 per cent in Kenya, the "Paying Taxes 2018" report by the World Bank Group and PricewaterhouseCoopers released on November 21 shows.
Kenya has signed 18 DTAs with other countries, but only 15 are in force, largely because of bureaucracies in ratifying them.
"DTAs are designed to make sure income is not taxed twice, which is fair. There's nothing wrong with having DTA. Why should one's source of income be taxed twice?" Deloitte's East Africa tax partner Nikhil Hira posed.
"What's more important is the tax information exchange agreements that we are signing because that's where we are going to get real information about investment flows, who has got money abroad and how to tackle it."
About four DTAs were ratified this year alone -- with India and South Korea, which came into force on August 30 and April 3, respectively; with the United Arab Emirates (UAE), enforced on February 22; and with Iran on July 13.