Please click on each section to expand further:
- Section 18(3) of the Income Tax Act CAP 470 provides that, 'Where a non-resident person carries on business with a related resident person or through its permanent establishment and the course of that business is so arranged such that it produces to the resident person or through its permanent establishment either no profits or less than the ordinary profits which might be expected to accrue from that business if there had been no such relationship, then the gains or profits of that resident person or through its permanent establishment from that business shall be deemed to be the amount that might have been expected to accrue if the course of that business had been conducted by independent persons dealing at arm's length'.
- In addition to the above, a multi-national enterprise (MNE) is required to comply with The Income Tax (Transfer Pricing) Rules, 2006 which offer guidelines on how to apply the arm’s length principle.
- The rules prescribe a general overview on the application of transfer pricing rules and Kenya heavily relies on the OECD guidelines which offer a more formulaic expression on implementation.
- The TP rules empower the Commissioner of Domestic Taxes (KRA) to request for TP documentation to any Multinational enterprise operating in Kenya on transactions where transfer pricing is applicable.
- The Income Tax (Transfer Pricing) rules offer the actual framework for MNE to adopt in relation to the intercompany transactions.
- Additionally, an MNE is allowed to apply these rules hand in hand with OECD Transfer Pricing guidelines which offer a more procedural or formulaic expression on the application of the Arm’s length principle and the methods of transfer pricing.
- Paragraph 4 of the Transfer pricing regulations grants the taxpayer the liberty of choice of the method to apply in valuation of the arms- length price of intercompany transactions.
- The Income Tax Transfer Pricing Regulations 2006 recognizes five methods to apply in determination of the arm’s length price of transactions as outlined below:
- The comparable uncontrolled price (CUP) method
- The resale price method(RP)
- The Cost plus method
- The profit split method (PSM)
- The Transactional net margin
- such other method as may be prescribed by the Commissioner from time to time, where in his opinion and in view of the nature of the transactions, the arm’s length price cannot be determined using any of the methods contained in these guidelines.
- Kenya operates a self-assessment regime. The duty of developing a transfer pricing policy solely lies on the taxpayer. Currently, there is no penalty for not maintaining a policy, however, failure to have a document in place sets the stage for scrutiny from the Commissioner of Domestic Taxes.
- A company that fails to maintain TP documentation would be in a disadvantaged position when defending its intercompany pricing with related parties.
- For this reason, it is highly advisable to have a TP policy should a KRA audit take place, then there is minimal risk of wrongful estimation of the value of intercompany transactions.
- Kenya recognizes the OECD transfer pricing documentation model based on the Master File and Local File (BEPS Action 13) approach.
- Paragraph 11 of the Eighth Schedule of the proposed Income Tax Bill expected proposes to enact Country by Country (CBC) reporting as a mandatory requirement for entities.
- Currently, the KRA may request a taxpayer to submit the following documentations for purpose of transfer pricing.
- Books accounts
- The selection of the transfer pricing method and the reasons for selection
- The application of the method, including the calculations, made and price adjustment factors considered
- The global organization structure of the enterprise;
- The details of transactions under consideration
- The assumption, strategies, and policies applied in selecting the method
- Background information as may be necessary regarding the transaction.
All documentation is required to be prepared in or be translated into the English language.
- The presence of the documentation assists tax authorities in filling of TP questionnaires and proving that the application of the arm’s length principle.
- The master and local file offer useful information to tax authorities on evaluation of the functions carried out by MNE’s and their associated enterprises and provide comparability data of similar transactions worldwide.
- The Finance Act, 2022 introduced specific information requirements for each file prescribed in the section 18D of Income Tax Act, Cap 470. Additionally, the Commissioner is expected to issue guidance on the specify manner of filing for the master file and the local file.
Country by Country reporting
1. What is a CbC report?
A Country by Country (CbC) report is a three tier annual transfer pricing filing requirement, as a minimum standard reporting recommendation of the BEPS Action 13. The CbC reporting standard has been seen to increase information sharing on group operations worldwide and encourage transparency between tax authorities in different jurisdictions. This reporting standard requires ultimate parent entities to disclose financial information relating to their operations in each jurisdiction where the group has a taxable presence.
2. What is the statutory definition of an ultimate parent entity?
An ultimate parent entity (UPE) means an entity that is resident in Kenya for tax purposes, is not controlled by another entity and owns or controls a multinational enterprise group. MNE’s which meet the threshold for CbC reporting will be required to file a CbCR notification to the Commissioner within the financial year.
3. Who does CbC reporting apply to?
CbCR applies to ultimate parent entities resident in Kenya and part of a multinational enterprises (MNE’s) with a gross turnover of KES 95 Billion, including extraordinary or investment income. The CbC reporting requirement includes an additional compliance requirement to file a master and local file containing standardized information relevant for all multinational enterprise group members and the material transactions of the local taxpayer, respectively.
4. When is CbC filing due?
A CbC report should be filed in Kenya within 12 months of MNE’s financial year end, where the ultimate parent entity is resident in Kenya. The requirement to comply with CbC reporting will apply from 2022 and subsequent years of income. For those who are eligible for CbC reporting, it would be prudent to begin preparing and reviewing the Master file and Local file for purpose of filing within 6 months from the group financial year-end.
5. Why are CbC reports required in Kenya?
It is now a statutory requirement to provide the tax authority with information relating to the amount of revenue, profit or loss before income tax, income tax paid, income tax accrued, stated capital, accumulated earnings, number of employees and tangible assets other than cash or cash equivalents with regard to each jurisdiction where the group has taxable presence.
This information enables the tax authority to assess transfer pricing risks, understand resources are allocated and the ascertain extent of income is attributable to Kenya for tax purposes.
6. Exemption to filing CbC report
- An multinational enterprise group with total consolidated group income of less than KES 95 Billion (in a financial year)
- Where the ultimate parent entity (UPE) is obligated to file a country-by-country report in its jurisdiction of tax residence outside Kenya
- The resident UPE has an international agreement (bilateral or multilateral) and an exchange of information on CbC reports agreement in force
- The Commissioner has not notified the resident constituent entity in Kenya of a systemic failure
- A non-resident parent entity file a CbC report of the group with the tax authority in its jurisdiction of residence, as a requirement
- The tax authorities of jurisdictions where the group operates have an Exchange of Information agreement
- The tax authority in a jurisdiction of the where the non-resident parent is resident has not notified Kenya of a systemic failure
- The non-resident parent entity notifies the tax authority in the jurisdiction of its tax residence that it is the designated surrogate parent entity of the group.
7. Our comments on the recently introduced CbC reporting requirement in Kenya
This reporting obligation applies to returns for the year of income 2022 and subsequent years, therefore it would be prudent, for MNE’s resident in Kenya to assess their operations for their financial year to gauge their eligibility to meet the country-by-country report, master file and local file requirements.
Whereas in certain circumstances some eligible entities are excluded from the country-by-country reporting, the requirement for master and local file reporting will not be extinguished. Therefore, such entities will need to have their master and local files in place for reporting purposes.
The penalty for non-compliance with the CbC reporting requirement, will be an offense subject to a fine not exceeding KES 1 million, a prison term not exceeding three years or both, upon conviction. We observe that the most applicable provision would be Section 94 of the TPA, which provides that a person commits an offence if the person without reasonable cause fails to submit a tax return or other document required under a tax law by the due date.
- Online platforms and complex business models offering IT services and have a digital presence in Kenyan market.
- Limited legal remedies to cope with the rapid changing framework of international business models and treaty agreements which offers legal loopholes for MNC to avoid taxation.
- Limited risk distributor and contract services / contract R&D arrangements could also potentially be affected, especially where significant people functions are in Kenya.
- Post-restructuring arrangements may pose certain challenges with respect to the identification of potential comparable in cases where the restructuring implements a business model that is hardly found between independent enterprises.
- Lack of alignment of transfer pricing outcome with value creation undertaken in the country.
- Economic analysis involves searching and selecting comparable transactions or companies considering the quality of data, assumptions and comparability factors and selection of the appropriate economic and statistical data related to a transaction.
- Paragraph 10(c) of the Income Tax Act (Transfer Pricing Regulations) states that 'where a person avers the application of arm’s length pricing, such person shall avail documentation to evidence their analysis upon request by the Commissioner's.
- In absence of guidance from the local transfer pricing rules, the tax authorities, in our experience, heavily rely on the OECD TP Guidelines as supplementary guidance but not as a legally binding instrument.
- Mutual Agreement Procedure (MAP) is available in Kenya for a resident taxpayer if he establishes that an action of KRA or one of Kenya’s tax treaty partners, or both, will result in taxation not in accordance with a tax treaty in force between the two jurisdictions.
However, the MAP request must initiated with the Kenyan Competent Authority and filed within three years from the date of notification of the act.
- Advanced Pricing Agreement (APAs) - There is no APAs in Kenya, however, the Law allows for taxpayers to seek a private ruling with respect to transaction needing clarification.