Tax agreements

The true price of management fees

Tax treaties are supposed to serve two purposes. They are meant to avoid double taxation and to prevent tax evasion. In practice, they all too often turn out to be double non-taxation agreements.
Flourishing no-tax industry: Kenyan flower farm. picture-alliance/Photoshot Flourishing no-tax industry: Kenyan flower farm.

Tax is like a cake. Everybody wants to have a slice, but you really only want to share it with people you like. If everybody who wishes to have a piece gets one, the cake is gone soon. For this reason, governments agree on tax treaties that spell out what country gets to tax what part of an internationally run business.

Tax agreements are complex legal arrangements, but it can generally be said that they distinguish active from passive incomes. Typically the host country has the right to tax activities that take place within its borders, while the country where the company resides is entitled to collecting taxes on dividends, royalties, interest payments and other kinds of passive income. The passive income, of course, reduces the profit made in the host country – and thus the host country’s scope for taxation.

One term that helps to boost passive income is “management fee”. It is so vague that it doesn’t really mean anything much at all. A foreign company can simply charge its African subsidiaries management fees for any kind of advice or service it provides, syphoning off profits from the host country. Corporate giants like Google, Amazon or Starbucks use management fees and royalties to shift profits to tax havens. They claim that their various subsidiaries are paying for intellectual property rights, management services and other things. In reality, of course, the multinationals are not running serious operations in the tax havens concerned.

Kenya is one of the largest flower exporters to Europe. Despite this, most flower companies in Kenya do not pay taxes in Kenya. Foreign owners, who mostly reside in the Netherlands, provide the capital and have found clever ways of shifting profits by charging the Kenyan flower companies all sorts of fees including marketing and management fees. In accounting terms, they are not making money in Kenya. We must not take for granted, moreover, that the flower companies pay taxes in Netherlands. Rich nations’ tax systems have all sorts of loopholes, and their governments are creating tax havens of their own. The Netherlands are known to be a low-tax country.

The truth is that Kenya needs government revenues to build infrastructure and provide public services, but a large number of companies that are active in an important sector of the economy are probably not being taxed at all. This is not fair, but it is perfectly legal.

It would be wrong to blame only the rich nations’ governments for this sad state of affairs. African governments are signatories of the treaties too. The truth, however, is that there is a lot of elite capture, which is why the African Union is unlikely to become a force for positive change in international tax matters. After all, the people who make decisions in the AU context are the people who have money in Swiss banks.

Tax treaties tend to contain very many loopholes. Combined with national loopholes, they often add up to double non-taxation agreements. The good news is that African countries have begun to close national loopholes. If tax authorities work hard on improving their transfer pricing units, moreover, they can claw back some money from multinationals. Kenya has recently been quite successful at doing so.

On the other hand, African leaders are tempted to create tax havens of their own. When the public was not paying attention before the elections in summer, Kenya passed a law to establish the Nairobi International Financial Centre. The official mission is to create an internationally competitive hub for the financial industry, but the hidden agenda is to have a tax haven. Strict secrecy rules will apply to firms registered there, and the central bank will not have oversight. Top policymakers, including the president, are on the Centre’s board, and they will be in control.

They are determined to have a tax haven of their own, but whether they will succeed, remains to be seen. Kenyans are known to be fond of litigation, and the new centre is likely to be challenged in court.

Catherine Ngina Mutava is the associate director of Strathmore University’s Tax Research Centre in Nairobi.

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