Measures Aimed at Preventing DTAA Abuse

In Summary

• Kenya is making positive steps to ensure that DTAA granted benefits are utilised as envisaged, and not subject to abuse.

• This feeds into the ultimate purpose of DTAAs, that is, to increase investor interest, invigorate international trade through the prevention of double taxation, and consequently increase tax revenue collections in the long term.

Tax
Tax
Image: FILE

Flowing from our discussion last week on the status of the Kenya – Mauritius Double Tax Avoidance Agreement (“DTAA”), we discuss today specific measures that have been implemented to prevent the abuse of DTAA guaranteed tax benefits by corporate and individual investors alike. Herein, we discuss potential risks of DTAA abuse presented by the Tax Justice Network – Africa (“TJNA”) in its submissions against the validity of the Kenya – Mauritius DTAA and contrast this with measures contained in our tax legislation that specifically intend to prevent DTAA abuse.

TJNA, in its submissions before the High Court of Kenya in The Tax Justice Network – Africa v The Cabinet Secretary for National Treasury and Two Others, argued, inter alia, that Kenya stands to lose out in tax revenue collections should the Kenya – Mauritius DTAA be declared valid. In support of this position, the TJNA specifically highlighted that the Kenya – Mauritius DTAA gave preferential tax rates to Mauritian entities, that may be abused through treaty shopping mechanisms. In this context, treaty shopping refers to tax avoidance mechanisms that are purposed at taking advantage of beneficial tax rates offered by DTAA’s in multiple jurisdictions. As an example of this, TJNA noted in its submissions that investors can dodge Kenyan tax by round-tripping their investments illicitly through a Mauritius based shell company.

While concerns raised by TJNA are indeed valid with respect to the risks posed by the abuse of DTAA’s, we note that significant progress has been made to modernise our tax legislation so as to prevent said abuse. Through these efforts, safeguards have been incorporated in Kenya’s tax legislation to counter treaty abuse mechanisms such as treaty shopping and hybrid mismatch arrangements. These measures include limitation of benefits clauses and beneficial ownership requirements provisions as provided under Section 41 of the Income Tax Act.

Section 41 (5), the limitation of benefits clause of the Income Tax Act, stipulates criteria to be met in order for one to benefit from beneficial tax rates as guaranteed under a DTAA. Specifically, the same notes that DTAA benefits are only applicable in instances where: more than 50 per cent of the underlying ownership of that person is held by an individual or individuals who are residents of that other contracting state; or the resident of the other contracting state is a company listed in the stock exchange in that other contracting state. This clause serves to directly prevent treaty shopping by providing circumstances whereby DTAA reliance is prohibited.

In consideration of the above, it is noted that Kenya is making positive steps to ensure that DTAA granted benefits are utilised as envisaged, and not subject to abuse. This feeds into the ultimate purpose of DTAAs, that is, to increase investor interest, invigorate international trade through the prevention of double taxation, and consequently increase tax revenue collections in the long term.

Karen Kandie – MD, IDB Capital