Insights From Mckinsey: Revamping Africa’s Tax Systems To Sustain Economic Growth

By Gatuyu T.J

Sleepy lions?

McKinsey & Company, in their recent (2016) report, “Lions on the move: The progress and potential of African economies” aptly interrogates Africa’s immediate economic challenges and prospects.

lion-sleepingIt observes, even though Africa economies are growing, they are performing below potential, and huge business building opportunities for companies remains unexploited. To accelerate growth and human development to renewed dynamism in Africa, governments are encouraged to effectively play their role.

One of the key priority governments must deliver is mobilizing more domestic resources. This will enable funding development and business growth, help to accelerate economic diversification, ramp up infrastructure investment, scale up the development of skills and supporting healthy urbanization.

Pooling domestic resources is only viable way of resource mobilisation given weakening currencies in emerging markets, rising interest rate spreads on sovereign debts, low commodity prices and higher volatility in capital inflows.

Further, data shows Africa’s financial depth, being total financial assets as a percentage of GDP, has declined from 108% in 2009 to 97% in 2015. The savings rates have dropped from 27% of GDP in 2005 to 16% in 2015.

Revamping revenue collection

To unlock funding for economic growth momentum, governments must adopt efficient and fairer tax collection methods by modernizing national tax systems, and this will lead to doubling of Africa’s tax revenue which today totals between $295 billion and $320 billion.

In Kenya, tax collection levels stands at a paltry 19% of the GDP.

Many factors lead to low tax collection. One, revenue authorities have limited data on the number of potential taxpayers. In Kenya, a citizen not registered for PIN will easily avoid paying direct taxes. Second, tax collection processes are often complex and burdensome.

Modernising tax system will significantly eliminate non-compliance resulting from fraud, neglect, error, and non-payment, and revenue collection will increase. Revenue authorities must therefore overcame structural challenges, the key one being high levels of informality in doing business.

The second challenge is revamping the tax system. Time taken to prepare and pay taxes and other tax related payments needs to be addressed. The third challenge is tax administration. This relates to the level of e-filing for corporations and qualitative assessment of tax administration modernization.

If revenue authorities were able to tackle the informality in doing business, revamp the tax system and make tax administration efficient, there would be an increase in the collection of both direct taxes, Indirect taxes, trade taxes, and lastly the resource taxes such as extraction royalties.

“Kick-starters and modernisers”

To measure tax modernisation efforts, McKinsey & Company formulates a modernisation Index classifying countries into three tiers: “kick-starters,” “transitioners,” and “modernizers”. Each tier measures efforts taken by countries to strengthen tax administration, build capabilities, and boost revenue.

‘Kick-starters’, being smaller countries, have a lax tax system collecting a relatively small proportion of GDP in tax revenue. These have a long way to go in modernisation efforts. They need to standardize and simplifying internal processes, closing tax loopholes, and improve collection procedures.

The second tier is the ‘Transitioners’. Kenya falls here. These are countries with more established tax systems and on path to modernization. They have potential to advance to higher-quality systems through tax reform. They need to diversify the tax system, upgrading IT infrastructure, increase the use of pre-filing and e-filing, and introduce sophisticated compliance programs.

The third tier is the ‘Modernizers’. Only Morocco and South Africa meet this cut. These are countries with well-functioning tax systems. These have an opportunity to build state-of-the-art tax administrations, rolling out targeted modernization initiatives to improve customer experience, and to use advanced risk analytical engines to improve compliance.

Transitioning Kenya

Kenya needs to move from a ‘transitioner’ to a ‘moderniser’. To achieve this, the country must improve the tax system. This could be done by expanding the tax base, balancing tax incentives and exemptions to attract Foreign Direct Investment without overly eroding tax revenue.

The administration of tax systems could be made more efficient by improving on data collection, using data to drive risk-based compliance, and ensuring better enforcement.

The informality in doing businesses in the country should be imperatively addressed. When businesses do not pay tax, they create unfair competition for the formal sector. Informality could be curtailed by digitisation of the economy efforts.

Lastly, tax regulations needs to be revamped. This will strengthen financial integration and encourage deeper regional market integration, resulting to increased cross-border capital flows and investment. Robust law reform effort in tax statutes and entering into tax treaties to deter double taxations should be prioritised

Introducing the Finance Act 2016: A Brief Commentary

By Gatuyu Justice

The Finance Act 2016 (the Act) is now in force. The Act makes introduces key changes in business and taxation laws in Kenya, changing the terrain, significantly. I have gone through the Act and extracted ten key changes that you need to know. Stay tuned.

1. Local shareholders, go away

The Companies Act 2015 has been amended removing the 30% Local Shareholding Requirement for foreign companies. This was effected by deleting Section 975 (2) (b) of the Companies Act which stated that for a foreign company to be registered in Kenya, it needed to have at least 30% of its shareholding being held by Kenyan citizens by birth. The provision was ‘toxic’ and almost impractical to implement. The national assembly seemed not to appreciate the differences between a branch and a subsidiary. But this is now water under the bridge.


2. Let the commodities trade flourish

The Capital Markets Act has been amended by adding provisions introducing the commodities market. The market will be regulated by the CMA. The process of starting the commodities markets have been moving on at snail pace. Rwanda has already established a very robust commodities exchange which is the premier in East Africa.

It is hoped this amendment will fast-track the process of establishing commodities exchange, which will provide efficient avenue for trading in agricultural commodities such as coffee, tea and sugar and also the minerals. It will probably be linked up with the upcoming Futures Exchange of the Nairobi Securities Exchange for purposes of trading in agricultural futures contracts.

3. Online Forex Brokers, you are tamed!

The Act has brought the carnival of online Forex brokers to unfortunate end. These were generally unregulated and operated on freelance basis. The Finance Act introduced provisions in the Capital Markets Act, bringing online trade in Forex under the radar of the Capital Markets Authority (the CMA). This will ensure the sector is regulated.

The CMA had already drafted regulations for regulating these Forex traders, which provided that they would be regulated by the Central Bank of Kenya. It is not clear what brought the change of heart. Forex trading is generally in the realm of money markets which is under the ambit of the CBK. It would have thus been appropriate to have the CBK regulate the Forex traders, and CMA concentrate in its role mandate of ensuring efficient and stable capital markets.

4. Let me transfer to my spouse

The Act has introduced changes in the capital gains tax regime. Some of the transactions now exempt from the capital gains tax include the following:

a) transfer of assets between spouses, between former spouses as part of a divorce settlement or a separation agreement;

b) transfer of assets to immediate family; and

c) the transfer of assets to a company where the spouses or spouse and immediate family hold 100% shareholding, from capital gains taxation.

These amendments have a retroactive application, with effective date being 9th June 2016.

5. Removing specialties on special zones

The Special Economic Zones Act 2015 created Special Economic Zones (SEZ), were established as distinct tax territories, with goods or services supplied to SEZs being exempt from all taxes. The word “import” and “export” includes not only international trade, but also goods exported out of and goods imported in to the Special Economic Zones. However, the blanket exemption of all taxes on SEZ has been tempered with, providing that exemption would be as outlined in the respective tax statutes.

6. More teeth to Njoroge: The Governor can now bite!

The Central Bank Governor has been complaining penalties provided in the banking laws to streamline errant banks are too mild. The Act has introduced new penalties. Now, any person or institutions and persons who fail to comply with directions of the Central Bank under the Banking Act or the Prudential Guidelines will now be liable for 20 million shillings penalty for institutions and credit reference bureaus. For natural persons, the penalty is 1 million shillings and further 100,000 shillings in each case for each day in default.

7. Supporting the builders of the nation

The Act has reduced the corporation tax payable for companies constructing at least four hundred residential units annually to 15% subject to the approval of the Lands, Housing & Urban Development CS. This benefit is effective as from the 1st of January 2017.

8. Milking the gamer

Legislator Jakoyo Midiwo has been on the case of gamers for some time, demanding they be taxed. The Act has reacted positively to Midiwo’s pursuit. It introduces a 7.5% betting tax on gaming revenue, which has been defined as the gross turnover less the amount paid out to customers as winnings. Also introduced are the lottery tax at 5% of the lottery turnover and a gaming tax at 12% of the gaming revenue.

9. Where is my refund?

A tax payer who has overpaid tax, the tax payer is entitled to refund within 2 years. If this is not done, the refund will attract an interest, chargeable to KRA. This has corrected an anomaly where KRA takes years to refund overpaid taxes. The time period for application for a refund on overpaid tax has been added from 1 year to 5 years from the date on which the tax was paid. Further, the Commissioner has 90 days to notify the taxpayer of a decision in relation to the refund of overpaid tax application.

10. Nits and bits

Other minor changes include:

a) With approval from the Cabinet Secretary for Sports, Corporate entities sponsoring sports activities will be allowed to deduct all the expenses. This will be effective 1st January, 2017.

b) You can now file return in different currencies other than the Kenyan shilling

c) Pay As You Earn rates have been increased. More taxes.

d) There is a new formula for calculating inflation adjustment. The formula is A (1+B) where A is the rate of excise duty before adjustment for inflation and B the average rate of monthly inflation of the preceding year.

The author is an Advocate of the High Court of Kenya.

Murky Oceans? Deeper Analysis on Somalia versus Kenya Maritime Dispute

By Gatuyu Justice

There at the International Court of Justice (ICJ), Somalia and Kenya are embroiled in a maritime legal spat. Somalia, the applicant, is raising hue with Kenya’s method of maritime delimitation in the Indian Ocean.

Disputed waters

The umpire, the ICJ, this being the principal judicial organ of the United Nations, as mandated by the UN Charter, is expected to settle the dispute “in conformity with the principles of justice and international law to avoid breaches of the peace.” The two neighbours have submitted to the jurisdiction of the court; good start.  For then, any court ruling that is made, it binds.

“The coastline of my maritime boundary runs due east. We measure from where the land border meets the coast.” Kenya argues. “No” Somalia screams. “Your boundary extends perpendicular to the coastline.” What if Somalia has her way? Then, Kenya stands to lose a reportedly mineral rich triangle of ocean waters stretching over 100,000 square kilometers.

Preliminary objection

The matter will not be considered on merit, yet. For Kenya raises a preliminary objection. Kenya disputes the jurisdiction of the court in hearing the matter. She argues the case ought to be resolved by way of mechanisms outlined in the 2009 bilateral agreement between the two countries. Somalia is rebuffing the submission. She cries that bilateral agreements should not torpedo her right to seek redress before the court.

The ICJ will balance these contentions to dispose the preliminary objection. Many scenarios may play; the most likely scenario being for the court to look at the bigger picture, and admit the case. If the court was to hold the case as inadmissible, a bad precedent would be set.  The court will be shying away from its core mandate; to settle disputes that may dismantle peace. Coercing a country in bilateral mechanisms she has no faith in would be unfortunate. Poor Kenya, she may lose the first round, and pave way for the real battle thereafter.

The subject of maritime boundary delimitations is technical and complicated. It is a pathway to realisation of the resources in oceans and seas. It is vital for strategic reasons. Often states may have overlapping claims, and this forestalls exploitation of ocean resources. To date there is no certainty as to modalities of maritime delimitations.

Historic perspective

The date was September 28, 1945; President Truman declared United States had ‘original, natural and exclusive right to the continental shelf of its shores.’ This declaration will trigger flurry of other claims and counterclaims. Sovereignty disputes between states were erupting, international peace was in danger.

Arvid Pardo, Malta’s Ambassador was alarmed. In his 1967 address to the United Nations, he called for sobriety. This started off global efforts to regulate the ocean, culminating into the enactment of the United Nations Convention on the Law of the Seas (UNCLOS), undisputed constitution for the oceans setting modalities of claiming maritime zones. But UNCLOS has chunks of grey areas.

Through the Maritime Zones Act and the Merchant Shipping Act, Kenya domesticated UNCLOS. Through the Gazette Notice No 55 of 2005 deposited with the United Nations, Kenya claimed her entitled maritime zones: territorial sea of 12 nautical miles (22 KMs) from the baseline; contagious zone of 12 nautical miles from the end of territorial sea; and exclusive economic zone (EEZ) of 200 nautical miles from the baseline.

Assume the case has gone to full hearing. Somalia will ask the court to delimit the maritime boundary on “equidistance line”. Kenya will root for the ‘parallel of latitude’ mode. UNCLOS does not provide for any specific modality, In fact, it allows the states to agree and in absence of agreement, resort to dispute settlement mechanism.

Kenya will further erect tent on predict she controlled the triangle Somalia claims since 1924, and thus entitlements due to ‘historical rights’. In response, Somalia may retrieve the recent International Court of Arbitration decision that invalidated China’s ‘nine-dash line’ claims in South China Sea, which indicated historical claims will not automatically bequeath territory.

Kenya may it back. She will cite the Organisation of Africa Unity declarations which instructed on immutability of boundaries of states left by colonial masters. This was to avert disputes among states. The disputed triangle; can Kenya prove it was part of her territory then?

Ripple effects

Maritime borders of the other countries along the Eastern Coast of Africa go due east. A ruling in favour of Somalia will trigger further maritime disputes between Kenya and Tanzania, which will turn to Mozambique, then to Madagascar then to South Africa. There will be undesirable ripple effects. The ICJ in the Delimitation of Maritime Boundary in the Gulf of Maine Area held the criteria for delimiting marine boundaries should be that suitable for multi-purpose delimitation.

The method Somalia proposes is only unique to her desires. Upholding it would be inapposite. This is the strength in the Kenya’s case. Past jurisprudence will not give much hope. In the North Sea Continental Shelf cases, the court said sea boundaries are determined on case by case basis.

Nevertheless, the underbelly of the dispute is ocean mineral resources. Perhaps, should settle the dispute amicably, or maybe share the disputed region. Nigeria and the archipelago of Sao Tome and Principe have done so in some contested waters.

In his spare time, the author thinks a lot about seas and oceans.

New law will not trigger doomsday in the financial sector

By Gatuyu Justice

Note: This article was first published in the Business Daily. It is available here

Pundits of the Banking (Amendment) Act 2015 have hinged their argument on three major issues. They say interest rates should not have been regulated because exorbitant rates are driven by the cost of lending.

Secondly, the government was wrong in intervening and should have left free economy dynamics ensure market correction.

Thirdly, low credit rating consumers will suffer most as banks will cut them from financial services. These narratives are not necessarily true.

When the Central Bank of Kenya (CBK) introduced the Kenya Banks Reference Rate (KBBR) the presumption was that if a bank was to lend only at the KBBR rate to a riskless borrower it would get returns.

However, due to variations in the risk of lending banks were to mark up the KBRR rate by a constant K, which was left upon them to determine and disclose. But Alas! Instead of banks treating K as a shrine and apply it diligently, they degenerated K to a bordello, an avenue of financial vice and iniquity to their customers. Banks cited a plethora of reasons on why they could not lower the cost of credit.

However, they did not mention that their high interest rates were not necessarily due to risks of lending, but a chase of returns from Treasury bills. Banks ensured that interest rates they charge did not fall below Treasury bill returns.

Such a scenario would trigger arbitrage in the credit markets, with borrowers taking loans to invest in Treasury securities for the purpose of benefiting from the differentials.

Banks were eager to hold on their dominance of trading Treasury securities. To deter arbitrageurs, they would hike interest rates arbitrarily and in this rat race, blameless borrowers were caught up in the mire.

The new law may not necessarily translate to low cost of credit. In the event of volatility in the economy, the Central Bank of Kenya (CBK) will always raise the base reference rate. The advantage, however, is the rate will not oscillate by the whims of banks.

Was the government justified to intervene? We live in an era which demands more utilitarian government, with a mandate of being concerned with affairs of the people, from the cradle to the grave. Economic theories which fail to reconcile with the role of the government fail. Even the UK has imposed various interest rate caps.

Free markets ideologies

Ben Bernanke, the former Chairman of the US Federal Reserve Bank, was a studious student of free markets ideologies. When he saw banks engaging in risky securitisation and trading of sub-prime mortgages he asked for restraint in intervening. The market will regulate, he argued. The Federal Reserve’s indifference eventually blew up to a financial crisis of 2008, whose wounds are yet to heal.

A government that does not intervene to moderate certain aspects of its economy is naive. Governments worldwide use a mix of various tools to boost their economies. It is not populism. It is all about mechanics of governance. It would have been reckless for President Uhuru Kenyatta not to assent to the Amendment Bill.

Are the banks the final frontiers of monetary economy? Commercial banks play a key role of financial intermediation in the economy. They connect depositors and borrowers.

The fear among some citizens is that bank might abandon the poor. In such a sorry eventuality it would be the banks, not customers, that would eventually lose.

In 1933 the world was recovering from the Great Depression in the US. Banks were blamed, and to deal with them the Glass-Steagall Act, which called for separating investment banks from commercial ones, was passed. The Act’s principles still apply in Kenya even though they have been done away with in the US.

The Act became untenable in the US partly due to the rise of shadow banking, being mechanisms of credit creation outside the purview of regulated institutions.

This reduced, significantly, earnings of commercial banks. Shadow banking is yet to gain root in Kenya but in a globalised economy it is never far off. If our banks make good their threat and cut off the poor, it may turn out to be a blessing.

It will be a chance for the poor to discover other sources of finance. They may discover that one can start a business not by borrowed finance but by equity crowd-funding.

Kickstarter, a crowdfunding platform, is already spreading its tentacles worldwide. They will discover that instead of running to the bank for loans a circle of peers can be a better shoulder to lean on, paving the way for peer-to-peer lending mechanisms, among other sources.

If banks refuse to finance the poor other options will emerge and the lenders will be the ultimate losers.

The author is an Advocate of the High Court of Kenya. Email