How multinationals exploit gaps in treaties to avoid tax

Kenya has been losing millions of money in taxes avoided by multinationals, due to engaging in ambiguous tax treaties that have seen otherwise taxable services offered freely and companies re-route funds to tax havens.

This is according to a new report by the Tax Justice Network Africa (TJNA), which shows how developed countries have been manipulating tax treaties, to ensure that corporates registered in their countries do not pay taxes for services they offer in developing countries.

The study, Trick or Treat(y)? Kenya’s Tax Treaty giveaways to Tax Havens, analysed a select of articles in Double Tax Agreements (DTAs) Kenya has signed with Mauritius, the United Arab Emirates (UAE) and Netherlands, evaluating among others,  with key tax concerns emanating from the articles in the DTAs.

It reveals that Sub-Saharan African countries, Kenya included, have fallen prey to DTAs entered with the tax havens, losing the much needed tax revenues.

“From the review, Kenya risks losing the much needed public resources through instances of round tripping and treaty shopping in cases where multinational will take advantage of the ambiguities in the articles contained in the said tax treaties. Further, the treaties are likely to propagate incidents of aggressive tax planning meaning Kenya losing a lot of tax revenue instead of the intended outcome of promoting investment and international trade,” the report notes.

Tax revenues

With the high pressure developing countries are under to increase tax revenues, the report argues that DTAs have ended up being a bottleneck and are diluting the existing tax base by redistributing their taxing rights.

TJNA notes that there is need to enhance transparency, public participation, and accountability in the treaty formulation and implementation of tax treaties, which is currently lacking.

“Whereas DTAs have been hailed as enablers of international trade and investment by equitably and efficiently sharing the taxing rights between the participating countries, studies have indicated that DTAs have been used by developed countries to the benefit of their multinational corporations in exploiting developing countries,”  the report notes.

Among the ways in which the multinationals operating in Kenya use to dodge paying tax, TJNA reports, is through Treaty Shopping, where a firm that does not operate in either of the contracting states enjoys treaty benefits by directing investment through one of the countries, and Round Tripping, where a resident of one country routes investments through another country back to his own country as foreign direct investment, among others.

In February, Treasury Cabinet Secretary Ukur Yatani published a legal notice, directing the exemption of tax from Japanese companies, consultants and employees involved in 16 projects under Financing Agreements, signed between November 2007 and September 2020.

Double taxation

A TJNA 2015 study showed that Sub Saharan Africa has at least 300 DTAs in force, majority of which have been signed with European countries. In 2014, the International Monetary Fund warned developing countries to exercise caution while signing DTAs.

“It is worthy to note that besides the objective to minimise instances of double taxation, DTAs should be negotiated to ensure that the provisions contained therein do not propagate instances of double non-taxation, tax avoidance and evasion,” the report notes.

The TJNA says that all treaties it reviewed have not included an article on taxation of technical, management services, despite those being the services developing countries are mostly in need of and from which they could reap considerable tax revenues.

“Exclusion of this from the DTA has been used as an avenue in limiting the extent of taxation of incomes realised from the provision of technical services. This is critical in the understanding that developing countries especially in Africa are net importers of services and as such any loophole will be detrimental in raising of the needed revenue to finance development,” it states.

To save itself from the trap, Kenya needs to include an article on taxation of technical, management services to form bear minimum that should be included in any treaty to initiate the treaty negotiation process.

“This practice has been adopted in countries like Ghana to provide basis of a meaningful negotiations. Inclusion of this article will minimise the ambiguities that have been experienced on how to tax imported services in cases where there is a treaty in existence and that the service provider has not created a permanent establishment,” the report says.