20 April 2018

Kenya: Will New Legislation Turn Kenya Into a Tax Haven?

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The relationship between development aid and capital flows from Africa.
analysis

A recently passed law could make it easier for companies to dodge tax in Kenya. This could increase the rate of illicit financial flows and, contrary to government's goals, undermine economic growth and development.

In July last year, President Uhuru Kenyatta signed the Nairobi International Financial Centre Act, 2017. The law aims to 'facilitate and support the development of an efficient and globally competitive financial services sector in Kenya'. It sets up the Nairobi International Financial Centre Authority (NIFCA), which will 'establish and maintain an efficient operating framework in order to attract and retain firms'.

This came amid warnings from observers that despite the implementation of NIFCA, Kenya could become a tax haven. Earlier this year, the Tax Justice Network Africa (TJNA) ranked Kenya first in Africa and 27th in the world on its Financial Secrecy Index. There are concerns that the new law creating NIFCA, which had only just come into force when the TJNA report was released, could 'facilitate tax dodging by companies and individuals in Kenya and worldwide'.

Kenya relies heavily on corporate tax, which occupies more than 40% of the total revenue

Financial secrecy occurs when an entity refuses to share information with legitimate authorities. When financial centres protect secrecy, individual and corporate entities can escape or undermine laws, rules and regulations. International financial centres have been used elsewhere to facilitate money laundering, tax evasion, tax avoidance, and other harmful practices. The Seychelles, for instance, has been linked to international corruption and money laundering.

Critics of the new law argue that it could be used to evade tax and various regulations, and allow non-resident entities to operate in the country without having to show their contribution to the economy. This would significantly lower levels of taxation.

Multinationals, including accounting and banking firms, as well as major political powers, maintain tax-free financial interests in secrecy jurisdictions like Mauritius and Liberia. Mauritius serves as a gateway for capital flowing into and out of Africa and India. Liberia is notorious for its 'flags of convenience' shipping registry. Tax Justice Network describes such registries as 'maritime versions of tax havens, allowing shipping operators to do what they would not otherwise be allowed to do at home, whether it be paying taxes properly, or evading environmental regulations or other prohibition'.

Analysts warn that Kenya could become a tax haven

Analysts warn that Kenya, similarly, could become a tax haven, and that the new law could encourage base erosion and profit shifting - tax avoidance strategies that exploit gaps in tax rules to artificially shift profits. This would be to the detriment of Kenya's economy - contrary to the government's intentions.

Shortly after independence, Kenya adopted an ambitious plan to mobilise resources for rapid economic growth through 'African socialism'. This was soon overshadowed by a powerful and coercive bureaucracy, characterised by capitalism and self-interest. More than 50 years after independence, Kenya's development - or lack thereof - is an outcome of a vicious cycle of vested interests. Many of these were inherited from British colonial extractive institutions, which were not designed to keep profits within the colonised countries.

This led to an environment that allowed money laundering to thrive. Systemic corruption has become 'institutionalised', and political elites are frequently implicated in scandals involving bribery, drug-trafficking and poaching.

Since independence, Kenya has seen the embezzlement of billions of shillings intended to be invested in the country's governance, growth and development. This problem has become entrenched, as the proceeds of corruption are constantly transferred abroad or laundered back into the economy through various schemes, especially investment in real estate.

A recently passed law could make it easier for companies to dodge tax in Kenya

Against this backdrop, worries about the implications of Kenya's new NIFCA act are justified. Joy Ndubai argues in Business Daily that 'a strong secrecy regime combined with a corruption-ridden economy is certainly a recipe for disaster with a potential to facilitate illicit financial activity without the need of accessing offshore jurisdictions'.

Kenya relies heavily on corporate tax, which occupies a relatively large share of the total revenue at more than 40%. The government has been eager to favour the corporate sector by offering a low-tax environment to attract investment, but this is likely to have adverse effects. The latest Global Financial Development Report shows that between 1970 and 2017, illicit financial flows were higher than foreign direct investment. Another survey by the World Bank says that 93% of the investors would have invested regardless of whether tax incentives had been on offer.

Jeffrey Owens, former president of the Organisation for Economic Co-operation and Development, once warned that 'the last thing Africa needs is a tax haven in the centre of the African continent'. His warning was directed at Ghana's initiative to set up an international financial centre in 2010.

Kenya's development - or lack thereof - is an outcome of a vicious cycle of vested interests

The centre failed to attract foreign direct investment and stimulate economic growth. Instead, weak internal regulation opened it up for exploitation, which saw Ghana blacklisted. Even after shelving the financial centre, Ghana continues to suffer the aftershocks of its catastrophic venture.

Many of the conditions seen in Ghana are also present in Kenya. The risks that come with compromised financial integrity and a lax regulatory environment must be acknowledged and accounted for. Kenya should pursue reforms such as more transparency in the operations of firms, a public registry of listed firms, disclosure of beneficial ownership information, and enforcement of the law in the event of violation - strategies that have, arguably, worked for South Africa.

Moreover, the executive branch of government should not appoint and oversee NIFCA, because this would lead to an undue influence over its operations. To get any benefit from this venture, public participation and oversight is crucial.

Duncan E Omondi Gumba, Regional Coordinator East and Horn of Africa, ENACT project, ISS Nairobi; and Paul McOlaka, Researcher, Data Analyst, Writer and Programmer, Kenya

This article was first published by the ENACT project. ENACT is funded by the European Union (EU). The contents of this article are the sole responsibility of the authors and can under no circumstances be regarded as reflecting the position of the EU.

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