The Kenya Income Tax Act requires that transactions carried out between non-resident and resident-related parties be conducted at arm’s length. The act further empowers the commissioner to adjust the returns earned by the resident company from such transactions to reflect returns conducted between independent parties. Until the enactment of the Kenya Income Tax (Transfer Pricing) Rules of 2006, there had been protracted disputes between the Kenya Revenue Authority (KRA) and taxpayers, most notably the momentous case involving Unilever Kenya and the Commissioner of Income Tax, which was determined by the High Court.
The 2006 transfer pricing rules provide guidance on how to determine arm’s length prices between non-residents and resident-related parties. The rules are modelled on the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations and stipulate that Kenyan taxpayers shoulder the burden of proof to demonstrate that any related-party transaction has been conducted at arm’s length. To this end, taxpayers are expected to complete supporting transfer pricing documentation justifying the arm’s length nature of the transactions involved, and to provide any additional information for auditing purposes upon request by the commissioner.
As the KRA seeks to maximise revenues in a bid to finance the ever-growing Kenyan budget, it has begun according more attention to the operations of multinational enterprises in the country. This shift is part of a growing worldwide trend to respond to perceived tax avoidance by multinationals.
Previously, the worldwide networks of multinationals allowed them to shift profits to tax havens, and for artificial losses to be reported in high-tax jurisdictions. Now, however, all transactions within multinationals are subject to transfer pricing rules. Such transactions include, but are not limited to, the sale and/or purchase of raw materials and finished products, the payment of royalties and payments for services, loan interest and technical assistance.
In July 2013 the OECD launched a global action plan on base erosion and profit shifting (BEPS). Specific strategies aimed at equipping governments and international instruments to challenge international tax avoidance by multinationals were identified. Kenya has since committed to involving itself directly in the BEPS process by joining the Africa Tax Administrators Forum, a working group on BEPS. Additionally, the KRA has taken a number of measures (both legislative and administrative) towards curbing perceived international tax avoidance by multinationals, including, amongst others, the following key initiatives:
• Empowerment of the commissioner to propose adjustments to transactions and to demand tax due if he is of the opinion that the sole reason a transaction was carried out was to evade taxes;
• Thin capitalisation rules, including stringent rules for companies in the extractive sector;
• Deemed interest provisions and introduction of the “limitation of benefit” rule in the Income Tax Act to curb abuse of tax treaty benefits; and
• Empowerment of the minister for finance to enter into tax information exchange agreements with other countries to increase the transparency of taxpayers’ information between the countries’ revenue authorities.
The growing involvement of multinationals in developing countries, including Kenya, coupled with the huge potential of transfer pricing rules to contribute to state revenues, has moved the KRA to adopt a rigorous approach to transfer pricing audits. Most multinational enterprises with investments in Kenya are potential nominees of audits, and therefore should maintain properly documented and defensible transfer pricing documentation. It is highly recommended that these documents be updated on a regular basis, especially when any changes in operations occur.
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