Kenya tax bill alters permanent establishment definition, increases transfer pricing reporting requirements

By Ian Mota, Tax Advisor, Rödl & Partner, Kenya

Kenya’s Finance Bill 2021, published 5 May and tabled in the Kenyan legislature on 11 May, includes a new “permanent establishment” definition, country-by-country reporting requirement, and new rules for determining “control” among related entities.

The bill is expected to be assented into law by the end of June after parliament takes into consideration views received from the business community and the public.

Permanent establishment definition

One major proposal is to overhaul the current definition of a permanent establishment. Under the proposed definition, exploitation of the specific exceptions in the existing definition would cease, especially in the area of digitalized businesses. Additionally, the proposed definition includes an express recognition of services that are of a preparatory or auxiliary character, which is not captured in the existing definition and had been a source of disputes between the revenue authority and taxpayers.

A major change in the proposed definition is the inclusion of a tax agent in the components of a permanent establishment, as well as the provision of services, including consultancy services by a person through employees or other personnel engaged for that purpose. The proposed definition appears to seek to align domestic legislation with international best practices, as captured in Article 5 of the UN and OECD tax conventions. The proposal also appears to aim to prevent strategies that have been used to circumvent the existing definition.

Transfer pricing reporting

Another proposal introduces a requirement for a return to be filed by the Kenyan-based ultimate entities not later than twelve months after the last day of the reporting financial year of the multinational enterprise group.

The return is anticipated to capture aggregated information for each jurisdiction that the multinational enterprise group operates in 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.  This will entail the application of country-by-country reporting on all Kenyan-headquartered multinational enterprises.

If these proposals are adopted, the revenue authority would have greater visibility with respect to the financial information that would aid in assessing transfer pricing risk or any risks related to base erosion and profit shifting (BEPS). This would definitely mean additional transfer pricing requirements for Kenyan taxpayers who are part of a multinational group.

Expanded definition of control

Another change that would affect multinationals and foreign entities operating in Kenya would arise from the expanded definition of “control.” Presently, control entails ownership by one person of at least 25% of the shares or voting rights. The bill proposes to reduce this to 20%. Further, control would arise if a person advances a loan to an entity that constitutes at least 70% of the book value of the total assets of the person or if a person has guaranteed at least 70% of an entity’s total debt, and if a person has a mandate to appoint more than half of the board of directors or at least one executive director.

The other unique transactions that would entail control in the proposals include if a person supplies and purchases at least 90% of supplies or purchases of an entity and has the capacity to influence prices. The expansion of control parameters would widen the scope of controlled company transactions in which transfer pricing rules would apply with respect to transactions involving related parties.

The proposed changes would also affect businesses such as licensed manufacturers and others with single suppliers or purchasers who deal with independent parties in the course of their business. In such cases, it will be interesting to observe the applicability of the arm’s length principle since transactions involving independent suppliers and purchasers are at arm’s length.

In addition, the bill proposes changes to Kenya’s new digital service tax. Kenya began implementing the tax this year targeting both tax residents and non-residents. The bill proposes to relieve the residents from this tax and only make non-residents liable for compliance and assessment.

Exported services

Finally, the bill also includes proposed amendments that appear to be reactions to revenue authority tax disputes in which taxpayers have challenged through various mitigation avenues, for instance, the taxation of export of services, which has been litigated in several cases. The bill now seeks to amend the applicable rules to deny taxpayers refunds of the corresponding input VAT arising from the purchases in relation to exported services.

The bill has been released to the public for review and comment. Tax and finance professionals will seek clarity on the ambiguous aspects, such as the application of the concept of control to businesses with sole suppliers and purchasers who are independent.

While the proposed rules are helpful in aligning Kenya tax law with the best practices under the UN convention and OECD guidelines, additional clarity and simplicity could help with taxpayer compliance.

Ian Mota is a tax advisor with Rödl & Partner, Kenya.

Be the first to comment

Leave a Reply

Your email address will not be published.