Gains from special export zones dip despite huge tax incentives

Kenya is foregoing huge tax income from companies operating in the Export Processing Zones (EPZs), whose returns are not commensurate with the economy’s expectations and targets.

This is as the firms’ key roles of creating employment and growing the economy dim. While the companies operating at various EPZs and their volume of export goods have been growing over time, their contribution to the economy has stagnated, according to the Tax Justice Network Africa (TJNA), a lobby against tax evasion.

After analysing data from various State agencies, including the EPZ Authority, TJNA noted that the contribution of firms operating in EPZs to the country’s gross domestic product (GDP) dropped over time, accounting for 0.96 per cent of the GDP in 2016.

This is in comparison to 1.04 per cent in 2012, which has since gone down to 0.87 per cent in 2018.

The decline in contribution to the economy is despite an increase in production, with the companies jointly accounting for 10.9 per cent of all exports out of Kenya in 2016, a rise from 7.72 per cent in 2012.

In 2018, the firms exported goods worth Sh72 billion, a bulk of them being clothing items, which accounted for Sh41 billion of the exports.

“Performance of EPZs from 2012-2016 raises concern on the significance and productivity of the incentives granted to the sector. They were expected to catalyse investments,” noted TJNA.

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“The export contribution of the EPZs to the total exports and over the period between 2012 and 2016 increased marginally, while the contribution of EPZ exports to GDP remained practically constant over the same period.

“The trend reinforces the notion that tax incentives do not necessarily play a huge role in facilitating investment. Many commentators contend that tax incentives may now play a larger role in influencing investment decisions than in past years.”

However, there is no clear evidence that can support this due to the lack of a review mechanism to assess their relevance and progress towards achieving the intended objectives.

The companies at the EPZ enjoy generous tax holidays over long periods to attract investors - both local and foreign - who can inject cash into the economy to create employment and grow wealth.

They also benefit from the availability of ready land and buildings within secured zones with requisite services and access to export markets under preferential trade arrangements.

TJNA said the trade-offs – where the government foregoes tax revenues to attract investors to EPZs – had failed to work owing to some defective tax policies as well as under investments in infrastructure over lengthy periods.

The report noted that tax holidays cannot compensate for deficiencies in the design of the tax system or inadequate physical, financial, legal or institutional infrastructure.

“Government can provide better alternatives to improve the investment climate as opposed to blanket tax holidays. Such options include reduced power costs, improved infrastructure, transparent governance of the tax incentives regime and improved security among others,” said TJNA.

The report also highlighted key loopholes in the legal regime that govern EPZs, including sections of the EPZ Act that give the Treasury Cabinet secretary discretionary powers to bestow companies EPZ status.

TJNA said this creates room for abuse in areas where the ministers can yield to lobbyists and rent-seekers.”

“Tax incentives must be used in pursuit of an industrial policy that is part of a strategic development plan. The policy and plan should be the basis for designing tax incentives that will only apply to the type of investments needed in a specific industry or location,” it noted

“When tax incentives are given for reasons of economic self-interest (‘rent-seeking’) and result from private lobbying and discretionary decision-making, they work for the financial gain of the company involved and those with whom they have colluded and have a limited social benefit.”

TJNA noted that the absence of credible technical justification for an incentive’s link to economic strategy or broader social benefit or without clear rules and lack of transparency lead to misuse of tax incentives.

“Under these circumstances, the policy-making process tends to be more vulnerable to corruption with potential consequences to the economy, democracy and development process.”

According to the EPZ Authority, there are 72 zones spread across 19 counties, with plans to increase them to cover 47 counties.

There are also 135 companies operating at the EPZ as of December 2018, according to data by the Kenya National Bureau of Statistics.

The authority notes that the EPZs’ contribution to the total manufacturing sector employment accounted for 18.56 per cent in 2018 from 18.07 per cent posted in the year 2017.

Despite the tax holidays and other incentives, the firms operating in EPZs have in the past decried high operating costs that have significantly eroded their earnings.

These include power and labour costs. In 2018, the firms paid Sh947 million for power, compared to Sh772 million in 2017, a 22 per cent increase.

Other costs that went up included water (17.3 per cent) while salaries paid to their Kenyan employees increased 16.5 per cent.

Local labour was one of the major spending areas where the firms paid Sh11.7 billion to 57,743 employees in 2018, up from Sh10 billion in 2017, according to the latest available data.

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Export Processing ZonesEPZTaxTax Justice Network Africa