The shortcuts and procurement mess that cost Treasury billions in excise tax

When John Njiraini took over the corner office at Times Tower as Kenya's top tax collector, he found that his predecessor had started procuring a system to monitor the production of alcohol real time from his office.

From a computer at the Kenya Revenue Authority (KRA) offices, the Commissioner General would see every bottle of beer as it drops out of the manufacturing line at the East African Breweries plant on Thika Road or Keroche Breweries in Naivasha.

Such a system would excite any taxman. The system, the Electronic Goods Management System (EGMS), was just what KRA needed.

It would eliminate the need to rely on the manufacturer to declare how much alcohol was produced, and for once, KRA was confident of being sure that each firm was paying a fair share of their taxes.

An excise stamp was to be automatically fixed on every bottle before packaging. This way, Njiraini could easily tell how much tax every manufacturer needed to remit even before checking their books.

At this time, the taxman was increasingly coming under pressure to collect more taxes. Besides plugging the budget deficit, fund the elections and infrastructure projects, the country was preparing for a devolved system of government, a new cost centre.

Given the runaway success of the system in the first few months of operations in the alcohol industry, KRA wanted more.

Njiraini's men rushed to replicate this success by extending the system to cover other products among them bottled water, soda and other non-alcoholic beverages.

But in this rush, KRA ended up breaking the procurement laws, glossed over the need for public participation and gave a deaf ear to industry concerns, mistakes that have come to haunt it several years later.

Procurement mess

The procurement of the system began in August 2010, two years before Njiraini took office. Njiraini found that SICPA Security Solutions SA had emerged as the only qualifying bidder in June 2011, after the tender was issued.

What followed were a series of procurement flaws driven by the temptation to want to collect more taxes, decisions that will now deny the country billions of shillings after the High Court this week repealed it.

The first signs of trouble emerged a few weeks after the first award was made when a special audit established that a Deputy Commissioner at KRA had interfered with the independence of the evaluation committee by issuing a memo to its chairman requesting a review of the evaluation report.

"This raised doubt on the objectivity of the evaluation report,” the ruling reads in part. The ruling quotes findings of Auditor General Edward Ouko, who says that the action by the KRA Deputy Commissioner amounted to changing the substance of the tender.

It says this was contrary to the procurement law that prohibits procuring entities from attempting to have the substance of a tender changed after the deadline of submitting forms. The tender was however terminated in September 2011, three months later, due to budgetary limitations.

The ruling finds that this was an indication that KRA started the procurement process without confirming that sufficient funds were available contrary to the procurement law.

The second procurement (EGMS II) commenced through an international bidding process in March 2012. The tender process was concluded in December 2012, and the same firm – SICPA – was awarded the tender one more time.

Shortly after KRA entered into a contract with the Swiss firm to supply security printed revenue stamps, track and trace software and an accounting system for the next five years. This meant that the contract would expire in 2017. At this time, the contract was valued at Sh4.8 billion.

Where trouble started

But trouble started when Treasury Secretary Henry Rotich moved to expand the scope of the contract via a legal notice he issued in June 2013, that brought other goods, among them bottled water, juices, soda and other non-alcoholic beverages and cosmetics into its purview.

The only excisable product spared from being affixed with the excise stamp was motor vehicles manufactured or imported into the country. This saw the contract price more than triple to a minimum of Sh15.9 billion and a maximum of Sh17.1 billion depending on the number of orders made by the taxman.

KRA realised that such a variation in the contract price would be in breach of the law, causing a third tender to be issued. The law does not allow a variation of more than 25 per cent without going through a fresh tendering process.

That is when KRA opted to cut another corner. The taxman used the direct procurement route, a short cut, which would also come to haunt it at a later date.

Public participation

But the biggest blunder committed by the taxman was to ignore public participation as enshrined in the Constitution, a ground that was exploited by activist Okiya Omtatah in his petition. "Courts have several times held that public participation is not a mere cosmetic venture or a public relations exercise,” the ruling reads.

Omtatah, who has made a name for himself as a litigant for public interest cases, argues that public participation is not a mere venture or a public relations exercise but a constitutional and legal imperative.

KRA says members of the public were invited for consultations on October 19 and 27 in 2017. Those who showed up included the Kenya Association of Manufacturers (KAM), who made presentations.

"Relevant to the issue under consideration is the observations by the Auditor General that there was no consultation between KRA and National Treasury on the one hand, and the manufacturers and importers on the other prior to the implementation and before issuing the statutory instrument contrary to section 5 of statutory instruments Act,” the court papers read.

KAM made it worse when they presented a memorandum to Parliament saying that the association was not involved during the introduction of the system and that the challenges identified were never addressed.

High Court Judge John Mativo observed that both local and foreign jurisprudence are awash with decisions holding that public participation ought to be real and not illusory and ought not to be treated as a mere formality for the purposes of fulfillment of the constitutional dictates.

"The Government agency or public official cannot merely be going through the motions or engaging in democratic theatre so as to tick the constitutional box,” the ruling notes.

The original contract was for making excise stamps for tobacco products, wines and spirits but the Treasury, through Legal Notice 110 of June 2013 increased the scope to cover beer, bottled water and soft drinks.

The judge notes that the goal of the legal notice issued by the National Treasury extending the usage of the system beyond alcoholic beverages was to impose a tax burden upon certain products.

"There is a financial cost element created by this burden. The burden will be borne by manufacturers who state that it will be inevitably passed to consumers. There is no mention that the general public, who are the consumers, were consulted at any stage,” the ruling reads.

The system imposed an additional Sh1.50 for the excise stamp, which was to be the commission passed to SICPA, over and above what was to be collected by the taxman. Juice and other non-alcoholic beverages attracts excise taxes of Sh5 per litre.

After the furore, KRA agreed to reduce the stamp fees to Sh0.5 per litre but this was still going to earn the firm billions given the millions of bottles produced on water and soft drinks.

The other failing by the Treasury was that it just held two meetings for the public, which it could not support with minutes, both of which were held in Nairobi yet the legislation was going to affect all citizens across Kenya.

The other matter that came to haunt the system was the move to opt for a direct method of procurement which had been flagged by the Auditor General.

Justice Mativo finds that from the Auditor General’s report, it cannot be said with some degree of certainty that the direct procurement was an extension of the previous contract that was terminated.

"The position is complicated by the fact that neither of the respondents deemed it fit to make available the contract documents at least to justify their allegation that indeed the contract was an extension of the previous contract,” he says.

"Absence of such crucial documents gives weight to assertions by the petitioner that indeed the direct procurement was undertaken in violation of the law," he rules.

It is on the basis of these blunders that Justice Mativo repealed the legal notice, and with it, denying KRA a system that would have helped it collect billions of shillings being lost through tax cheats.

East African Breweries said the ruling will not have any immediate impact on its operations because it was mainly targeting the non-alcoholic drinks. But it must be good news to water and soda manufacturers who have now been spared the extra charges.

On its part, the Alcoholic Beverages Association of Kenya (ABAK) says it does not wish to comment on the issues around the contract given that it was not party to the suit.

However, ABAK Chairman Gordon Mutugi told Weekend Business: "Whereas the absence of a fool-proof system of identifying illicit brands is catastrophic for the industry, the public good far outweighs any legal battles."

"The system was the only credible way to prove that products were genuine or fake. We are taken aback by the ruling."

"If there would be no EGMS, the impact would be massive. Over the last year, we have relied on the system as a means to fight counterfeits,” said Mutugi.

He, however, said that the stamp does not make sense for beer and wine manufactures because beer does not suffer counterfeiting as much as spirits and premium alcohol. "The cost of the stamp was a raw nerve. Why are we paying to collect taxes?” he says.

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