by Julie Martin
A legal challenge to the Kenya-Mauritius Double Taxation Agreement, brought by Tax Justice Network Africa (TJN-A) in the High Court of Kenya at Nairobi, is getting closer to resolution, as a hearing date for the matter will be set on December 9.
The lawsuit, filed October 3, 2014, is the first of its kind in Africa and could become important precedent for challenging tax treaties, not only in Kenya, but across the African continent, TJN-A’s director, Alvin Mosioma said. “Many other African governments are signing on to similar loophole-ridden tax treaties with all manner of countries,” Mosioma said.
The treaty was signed May 7, 2012, and was purportedly ratified by Kenya through a legal notice published in the Kenya Gazette on May 23, 2014. The treaty is not yet in force, though, because Kenya has not notified Mauritius of the completion of the ratification procedures. The agreement specifies it will enter into force on January 1 following the date of such notification by both counties.
TJN-A is suing Kenya’s government, specifically, the Cabinet Secretary to the Treasury, the Attorney General, and the Kenya Revenue Authority (KRA), claiming that the treaty contravenes the principle of good governance, sustainability, and accountability, in violation of Articles 10 and 201 of the Kenyan Constitution.
Further, TJN-A argues that the KRA failed to perform its statutory duty to advise the government of the harmful nature of the treaty, breaching article 10(c) of the Constitution. TJN-A also argues that the agreement was never appropriately ratified.
Specifically, TJN-A disputes treaty provisions that reduce the withholding tax on services, management fees, and insurance commissions to zero percent from its current rate of 20 percent. This is done through Article 21 of the agreement, which reserves taxation of income not dealt with in the other articles to the residence state. Such provisions breach the principle of good governance, integrity, transparency, and accountability, TJN-A said.
Also, while Kenya reintroduced a 5 percent capital gains tax as of January 1, 2015, TJN-A said in its petition that, through Article 13.4 of the tax agreement, Kenya has given away the right to tax capital gains from stock sales of Kenyan companies to Mauritius, which does not charge any capital gains tax.
As is the case with the much-abused India-Mauritius tax treaty, foreign investors can use the Kenya-Mauritius tax agreement to buy Kenyan companies through Mauritius holding companies and Kenya cannot tax any of the gains when they sell these businesses again, TJN-A said.
Similarly, domestic Kenyan investors can avoid Kenyan taxes by round-tripping their investments illicitly through Mauritian shell companies. Further, Kenyan companies can easily avoid Kenyan taxes in dividends paid to foreign investors through devices like share buy-backs, thereby denying the government development revenue, the NGO asserts.
The TJN-A petition said this capital gains provision is neither OECD nor UN compliant, and that similar provisions in the India-Mauritius tax treaty cost India an estimated US $600 million each year in lost revenues.
TJN-A further argued that the treaty cuts off revenue needed for sustainable economic growth and development through provisions that reduce Kenya’s withholding tax on interest and royalties to 10 percent from current rates of 15 percent and 20 percent.
TJN-A also maintains that even though a legal notice was published in the Kenya Gazette purporting to ratify the Kenya-Mauritius tax agreement, the agreement was never ratified according to law, in contravention of Articles 10 (a), (c) and (d) and 201 of Kenya’s Constitution.
TJN-A claims that the Attorney General incorrectly and illegally advised the Cabinet Secretary to the Treasury that the double tax agreement was not a “bilateral treaty” for purposes of the Treaty Making and Ratification Act 2012 (“Ratification Act”). As a result, TJN-A said, government officials sidestepped the law’s requirement that the agreement be presented to the Cabinet with a memorandum discussing the policy, financial, and other financial implications of the treaty, along with the views of the public on the ramifications of ratifying the treaty.
The failure to follow the Ratification Act was a violation of Kenya’s constitution, TJN-A’s lawsuit asserts, and so the government must withdraw its May 23, 2014, legal notice purporting to ratify the double tax agreement and must commence a new process of ratification in conformity with the law.
As Kenya’s Attorney General and Cabinet Secretary to the Treasury have not yet filed their responses, it is unclear how they will address these charges.
TJN-A spokesperson Kwesi W. Obeng said the Court ordered the officials to respond several times, and that it was expected that responses would be filed November 9, but that did not happen. The Court nonetheless intends to set a hearing date for the dispute on December 9, Obeng reported.
The KRA, in its response filed January 26, said that agreement is not contrary to the Constitution or open to abuse.
The KRA defended the inclusion of Article 21 in the tax agreement, which results in a zero withholding tax rate on services, management fees, and insurance commissions, stating that the provision is similar to those in most tax agreements signed by Mauritius with other African nations. Similar provisions are in Mauritius’ tax agreements with Zambia, Lesotho, Madagascar, Namibia, South Africa, Seychelles, Swaziland, and Uganda, the KRA said. “Kenya would be disadvantaged if it had negotiated the article differently,” the KRA said.
The KRA also said that Kenya’s tax treaties do not need to follow the OECD or UN models and that it is up to Mauritius to decide how it will tax capital gains. “Once a tax advantage is passed to the taxpayer it is not in the interest of Kenya to ensure that the advantage has been taxed in the other jurisdiction,” the KRA said.
The tax agency also said that “it does not follow that holding companies domiciled in Mauritius are set solely for the purpose of selling shares whose value is driven by companies operating in Kenya.” The KRA also said that some of the tax advantages accruing to non-resident taxpayers are meant to attract foreign investment in the country.
The KRA said that although the withholding rates for interest and royalties for nonresidents appear low in the tax agreement, the tax paid by nonresidents under the agreement may be more than what would be paid by a resident, as a resident is allowed to take deductions against the income. It therefore does not follow that Kenya’s tax base will be eroded, the KRA said.
Moreover, the lowered withholding tax rates on interest and royalties will enable Kenya to compete for foreign investment with neighboring countries, such as Uganda and South Africa. Similar withholding tax rates were negotiated by Mauritius in tax treaties with other African nations, the tax authority said.
In a statement, TJN-A said that Kenya has recently signed an equally harmful double tax agreements with the United Arab Emirates and Qatar. Both countries are tax havens, TJN-A said.
– Julie Martin is a US tax attorney and a member of MNE Tax’s editorial staff.
(Note: this article was edited 11/16/2015 to reflect the correct hearing date, which is December 9.)