July Issue 4 2011

COMESA-EAC-SADC Moves towards a common Free Trade Area

A declaration for the launch of a Free Trade Agreement (FTA) was signed between COMESA, EAC and SADC on 12th June 2011, effectively starting negotiations for the establishment of a Tripartite FTA stretching from Cape Town, South Africa to Cairo, Egypt.

FTA is a trading zone whose member countries have signed a free trade accord that eliminates tariffs, import quotas, and preferences on goods and services traded between them.

Expanding trade amongst the Common Market for Eastern and Southern Africa (COMESA), East African Community (EAC) and Southern Africa Development Community (SADC) has been a challenge mainly due to overlapping memberships by the Member States.

It is in the context of the foregoing challenges that the three Regional Economic Communities (REC) saw the need to initiate a process of coordination and harmonization of their regional integration programmes.

In recognition of the importance of promoting effective ownership of the Tripartite process, the Tripartite Task Force in 2007 agreed and recommended that a Tripartite Summit of Heads of State and Government of COMESA, EAC and SADC be convened to give political endorsement and direction to the process of cooperation and harmonization.

Status of the Tripartite FTA

The Heads of State and Government of the COMESA, EAC and SADC Tripartite met on 12 June 2011 and:

  1. Launched negotiations for the establishment of an integrated market of 26 Countries with a combined population of nearly 600 million people and a total Gross Domestic Product (GDP) approximately US$1.0 trillion;
  2. Noted that the region makes up half of the African Union (AU) in terms of membership and just over 58% in terms of contribution to GDP and 57% of the total population of the African Union. The establishment of a Tripartite Free Trade Area will bolster intra-regional trade by creating a wider market, increase investment flows, enhance
    competitiveness and develop cross-regional infrastructure;
  3. Adopted a developmental approach to the Tripartite Integration process that will be anchored on three (3) pillars namely: Market integration based on the Tripartite Free Trade Area (FTA); Infrastructure Development to enhance connectivity and reduce costs of doing business as well as Industrial development to address the productive capacity constraints; and
  4. Agreed that the Tripartite initiative is a decisive step to achieve the African vision of establishing the African Economic Community envisioned in the Lagos Plan of Action and the Final Act of Lagos of 1980, Abuja Treaty of 1991 as well as the resolution of the African Union Summit held in Banjul the Gambia in 2006 that directed the African Union Commission and RECs to harmonize and coordinate policies and programmes of RECs as important strategies for rationalization; and to put in place mechanisms to facilitate the process of harmonization and coordination within and among the RECs.

The Tripartite Summit:

  1. Signed the Declaration Launching the negotiations for the establishment of the COMESA-EAC-SADC Tripartite FTA;
  2. Adopted the Roadmap for Establishing the Tripartite FTA;
  3. Adopted the Tripartite FTA Negotiating Principles, Processes and Institutional Framework; and
  4. Directed that a programme of work and roadmap be developed on the industrialization pillar.

Scope of the negotiations

The negotiations shall be in two phases as follows:

i) The first phase will cover negotiations on the following areas: tariff liberalization, rules of origin, dispute resolution, customs procedures and simplification of customs documentation, transit procedures, non-tariff barriers, trade remedies, technical barriers to trade and sanitary and phyto-sanitary measures.

ii) Movement of business persons will be dealt with during the first phase of negotiations as a parallel and separate track.

iii) The second phase will cover negotiations on the following areas: trade in services, intellectual property rights, competition policy, and trade development and competitiveness.

EAC/EU- EPA negotiations progress

A meeting on the same was held in Arusha Tanzania in June where they drew a roadmap covering one year negotiation period (July 2011 to June 2011). The road map has not been approved and this may cause a delay in the 9th joint technical officials negotiation scheduled for July 2011. Funding of $1.2 million is now available.

The Kenya’s position has largely been integrated  into the EAC position.

ERD and AERC hold a workshop on Natural Resource Management

The European Report on Development (ERD) in conjunction with African Economic Research Consortium (AERC) held a workshop on Effective natural resource management for inclusive and sustainable growth in the context of increased natural resource scarcity and climate change at Intercontinental Hotel Nairobi on 11th and 12th July 2011.   The natural resources include especially water, energy, and land. The Kenya Flower Council participated in the even.

The Overseas Development Institute (ODI) in consortium with the German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) and the European Centre for Development Policy Management (ECDPM) has been contracted by the European Commission (DG Development on behalf of the Commission) and 7 Member States (Finland, France, Germany, Luxembourg, Spain, Sweden and the United Kingdom) to produce the European Report on Development (ERD) 2011/2012. The Report will focus on natural resource management (NRM) in developing countries in the context of increasing resource scarcity and climate change, and will attempt to provide policy recommendations toward NRM policies that can best promote inclusive and sustainable growth.

In this regard and as part of the writing process, the ERD team is organising a series of consultative events with senior experts on these questions.

The sustainable use and effective management of water, energy and land is crucial for inclusive and sustainable growth. Climate change, increased global resource scarcity, coupled with the continuing overexploitation of resources and inefficient use of associated rents provide a new context for an effective Natural Resource Management (NRM). The global economy will need to engage in a number of transitions to tackle these new challenges and this will have direct and indirect implications for developing countries.

With this context in the background, the consultation is bringing together senior experts to discuss their views on the natural resource management of the water-energy-land nexus (WEL nexus) in developing countries with a particular focus on the role played by private actors.

Thin capitalization in a transfer pricing regime

By: PKF

What is thin capitalization?

In a bid to curb tax avoidance through repatriation of untaxed profits, countries such as Kenya have implemented thin capitalization rules in their tax regime. Thin capitalization occurs when a company is funded almost entirely by debt with only a nominal amount of equity. In Kenya, a company is said to be thinly capitalized when it is foreign controlled, and its loans and debt exceed three times the sum of the revenue reserves (which includes accumulated losses) and the issued and paid up capital. Thus the ideal safety margin is a 25% equity financing or a 3:1 debt equity ratio.

Thin capitalization carries with itself specific consequences – any foreign exchange losses realized from foreign loans advanced by the controlling shareholder will be deferred until the state of thin capitalization diminishes. In addition to this, there will be a restriction of interest deductible as an allowable expense.

Meaning of foreign control

The Income Tax Act defines the meaning of control for purposes of thin capitalization rules. Control normally occurs when a nonresident person alone or together with 4 or fewer other persons, holds more than 50% of the issued and paid up capital of all classes of a company’s (except banks and financial institutions) shares. It also occurs when such a person or group of persons own more than 25% shares and the voting power.

Meaning of loans

There are various forms and modes of financing debt in companies. Thus for purposes of thin capitalization, loans have been defined to include all forms of indebtness for which a company is paying a financial charge, interest, discount or premium such as overdrafts, overdrawn current accounts and, ordinary trade debts.

Deemed Interest

With effect from 11 June 2010, interest free loans are also taken into account in determining whether a company is thinly capitalized, under the deemed interest principle. Under this principle, interest shall be imputed on any interest free loan that is advanced by a foreign company to its subsidiary domiciled in Kenya, at the 91 day Treasury Bill Rate. (Under the Finance Bill 2011, it is proposed that the Commissioner shall prescribe the form and manner in which the deemed interest shall be computed and the period for which it shall be applicable.) This is a move to combat tax avoidance schemes by some Multinational Enterprises (MNEs) which previously offered loans to their subsidiaries at no charge. With the introduction and enforcement of the deemed interest principle, thinly capitalized companies are now likely to face restriction of a higher proportion of their actual interest expense. Additionally, the deemed interest will be a disallowable expense on such companies and they will have to account for withholding tax on such expenses.

What is Transfer Pricing?

Transfer pricing is the determination of/setting of charges between related parties for sale or purchase of goods, services, tangible or intangible assets, provision of services, lending/borrowing of money or any transaction that may affect the profit or loss of the enterprise involved.

In Kenya, transfer pricing is regulated under Section 18(3) of the ITA and The Income Tax (Transfer Pricing) Rules, 2006. These require entities to transact at arm’s length with related nonresident parties. Thus entities engaged in related party transactions that come within the purview of Transfer Pricing Rules, are obliged to maintain a documented transfer pricing policy in support of the price charged for any of their intra group transactions. Therefore any interest charged on a loan advanced to a subsidiary by a foreign company should meet the arm’s length test for purposes of transfer pricing.

Relationship between thin capitalization and transfer pricing

Thin capitalization and transfer pricing have a common factor – the Arm’s Length Principle. The 3:1 debt equity ratio may be deemed to be the arm’s length debt test for purposes of thin capitalization. On the other hand, transfer pricing rules limit the consideration for transactions between related parties to the amount that would be charged between arm’s length parties.

Under thin capitalization rules, it is important to consider whether the debt has been raised on the same terms in an arm’s length transaction. More often than not, it will be highly unlikely for an unrelated party to lend money to another party at such high interest rates as to lead to the borrowing company being highly geared. This is where a middle ground between thin capitalization and transfer pricing is established. For instance, suppose a Kenyan subsidiary of a foreign parent company has Kshs 600M in assets and is funded by a share capital of Kshs 150M and loans worth Kshs 450M at an interest rate of 20%.

Under such a circumstance, the company will have satisfied the 3:1 debt to equity ratio for thin capitalization purposes and will be allowed to claim the whole Kshs 90M as an allowable expense. For transfer pricing purposes however, if the maximum amount that the company can borrow on an arm’s length transaction in open market is at an interest rate of 11%, this interest rate will be deemed to be the market (arm’s length) interest rate to be used in arriving at the deductible interest expense, based on the 450M loan satisfying the 3: 1 debt ratio.

Time to act is now!

In light of the increased scrutiny by the KRA on companies likely to face thin capitalization and transfer pricing issues, MNEs with subsidiaries in Kenya have to revise their working capital and transfer pricing strategies. At PKF Taxation Services they believe in being prepared regardless of the circumstances. They can assist in determining the thin capitalization limits of a company and the debts which should be considered in the determination of thin capital amounts. They can also warn before you walk into the thin capitalization and/or transfer pricing trap, thus ensuring that you have a well-balanced debt/equity ratio in your company. All this is in a bid to ensure that you achieve the best compliance status with thin cap and transfer pricing regulations.

Changeable but Reasonable Half Year

Year 2011 started with a ‘high’ market: January and February were much better than in 2010. As from March onwards results are less than last years. However, the bottom line at the end of the first 26 weeks is not negative. It looks like the market went through the ‘normal’ seasonal fluctuations, typical to weather changes. In flower business weather has an impact on both, production and demand. Therefore the actual impact is never predictable, especially since production is spread over several continents.

Total cut flower quantities in the Dutch flower auctions during the first half of 2011 increased by 217 million stems (+3.3%), compared to the same period in 2010. The major growth was realized by imported flowers: plus 205 million stems (+9.7%). Local Dutch supply increased by only 12 million stems (+0.3%).
The cut flowers turnover decreased by -0.9%, compared to the same 6 months of 2010, as mentioned – with +3.3% more stems.

Highest growth-rate was with: spray carnations (+75%), spray roses (+42%), gladiolus (+33%), limonium (+25%), helianthus (+21%), delphinium (+14%), small & medium roses (+12%), and big roses (+8 %).
Quantities of other products decreased; like: alstroemeria, anemones, anthurium, asters, standard carnations, carthamus, large gerberas, gypsophila, leucadendron, lilies (Asiatic, LA and longiflorum), ornithogalum, proteas, solidago and wax flowers.

The total average price for cut flowers ended up at 20 cents per stem, which is 1 cent (-4.1%) lower than in the same period in 2010.
Products that achieved higher prices in 2011 than in 2010 were: asters, carthamus, gerberas large, Asiatic and longiflorum lilies, proteas, and ornithogalum.
Considerably lower prices are for: helianthus, hypericum, oriental lilies, limoniuim, large roses, spray roses, rudbeckia, solidago, trachelium, veronica and wax flowers.

The houseplants’ sector showed a more ‘stable’ picture, with minor changes in quantities and prices. Remarkable was, for the first time since many years, the –20% decreased supply of the flowering houseplant phalaenopsis orchids, which had a very positive effect on the prices.

Source: ITC/MNS Bulletin & VBN Stat Weeks 1-26 2011

Standard BI at FloraHolland as of July 14, 2011

At the end of 2010 FloraHolland announced the planning and implementation of a standardized Reliability Index (BI) system at FloraHolland. By harmonizing the BI and bonus norm systems, FloraHolland’s inspection and quality policy can be carried out in a more equal and balanced manner. As of July 14, 2011 FloraHolland will implement the standardized BI system.

The most significant changes for suppliers to Aalsmeer are as below:

Bonus norm scheme –the correction fee will always be charged when an error is detected and immediately correct the fault before the next shipment. If the average BI is above the bonus norm, the supplier is refunded the fee at the end of the period. Suppliers can start afresh in each period.

Standard product clustering – a number of smaller product groups have been combined for the BI calculation. Suppliers with a broad and diverse product range, in particular, can get their BI for a 100 lots much more quickly by using product clustering than by product type. The product clustering table has been compiled using VBN’s crop level and market and grower’s data.

Bonus norm – in Aalsmeer, it has been agreed to increase the bonus norm from 90% to 95%. From now on the same bonus norm level will be used in all marketplaces of FloraHolland.

The same ‘day BI on the clock’ and the calculation over the same maximum period of 53 weeks means suppliers have, ultimately, a greater chance of increasing their BI at all locations.

Read on for more information on: BI and the bonus norm.

What’s it all about?
• New table on product clustering 2011
• Standardized BI system and bonus norm
• Questions and answers

for more information please contact the Aalsmeer Service punt at T +31 297 39 70 00 or your account manager or your quality advisor.

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