Kenya: International Tax Aspects
02 January 2012
Posted by: TaxFind™
Kenya: International Tax Aspects
Kenya, situated on the eastern seaboard of Africa, is well situated to be a gateway into Central Africa. With a free enterprise economy and a non-interventionist government, it seems the ideal location for multinationals expanding into Africa.This article focuses on the most significant provisions in the Kenyan Revenue Act that affect international transactions.
Brief overview of tax system
Kenya has a source-based tax system with a corporate tax rate of 30% for resident companies and 37.5% for non-resident companies. There are no group tax rules and no participation relief. Withholding taxes are levied on dividends (10%), interest (15%), royalties (15%) and technical and management fees (20%).
Kenya does not have a comprehensive set of double tax treaties and this aspect is one that needs significant attention by the Kenyan authorities if they are to become a truly attractive investment destination. Kenya has tax treaties with Canada, Denmark, Finland, France, Germany, India, Norway, Sweden, United Kingdom and Zambia. Treaties that have been signed and ratified are with South Africa, UAE and Seychelles. Notable omissions are with neighbouring countries of Tanzania and Uganda. The East Africa Treaty has been under discussion since 1999, but little progress has been made in getting this operational.
There are various tax incentives available such as export processing zones, manufacturing in bond programme for exporters, investment allowances on manufacturing equipment, and farming deductions.Kenya introduced transfer pricing rules in June 2006 after the judgment in the Unilever Kenya Ltd v Commissioner of Income Tax. Like South Africa, it also has a general anti-avoidance rule.
Specific provisions relating to international transactions
Residency and deemed source provisions
Resident is defined as any company incorporated under a law in Kenya, or any company managed and controlled in Kenya. The Minister of Finance can declare in the Government Gazette that a corporation is resident. Kenya has a deemed source provision which provides that where a business is carried on partly inside and partly outside Kenya by a resident person, then the entire profits are deemed to have accrued in or derived from Kenya. With the lack of treaties, the possible implications of this provision should be carefully considered.
The provision in section 4 is supplemented by additional rules relating to management, professional or training fees, royalties, interest, use of property fees and fees paid to entertainers and sportsmen. Income falling within these classifications is deemed to have been received or accrued in Kenya if they are paid by any resident of Kenya or any person with a permanent establishment in Kenya. As these payments are generally subject to withholding tax, no further tax implications arise.
Thin capitalisation rules
The thin capitalisation rules in Kenya are not well defined and are open to interpretation.The limitation it imposes may be more onerous than a first reading of the Act indicates.
Interest is only deductible if it is incurred wholly and exclusively in the production of income.Thin capitalisation rules apply only where the Kenyan company is controlled by a non-resident alone or by a nonresident and four or fewer other persons.
Interest is disallowed in proportion to the extent that the highest amount of all loans held by the company at any time during the year exceeds the greater of three times the sum of revenue reserves and paid-up capital of all classes of shares or the sum of all loans acquired prior to 16 June 1988.
Loans will include all loans, bank overdrafts, ordinary trade debts or any form of indebtedness for which any financial charge is paid. This is best illustrated by an example:
Assume the share capital and all reserves of the company amount to 500 000. During two months of the year the total of loans amounts to 2 000 000. For the other 10 months, the loans never exceed 1 500. Total interest paid during the year amounts to 400 000.
As the loans exceed three times the reserves during the year, a portion of the interest is disallowed. The disallowed portion is 500 000/2 000 000 x 400 000 = 100 000.
From the Act it is unclear whether the disallowance should be calculated only for the two months where the loans exceed the reserves or whether it should be done on an annual basis as per the example.
Foreign exchange gains and losses
Only realised foreign exchange gains and losses are taxed or deducted. In the case of realised losses, there is however an additional restriction. This restriction, like the thin capitalisation rules, applies where the Kenyan company is controlled by a non-resident alone or by a nonresident and four or fewer other persons. If the highest total of all loans at any time during the year exceeds three times the sum of revenue reserves and paid up share capital, and there is a loan from a nonresident giving rise to a foreign exchange loss, then that loss is deferred as a deduction.
There is a further limitation that can defer the realised foreign exchange loss. This stipulates that the loss will be deferred to the extent that there would be a foreign exchange gain if all the foreign currency assets and liabilities were disposed of on the last day of the year of assessment. A realised foreign exchange loss limited by this stipulation will qualify as a deduction in the next year of assessment.
Transfer pricing regulations
Section 18(3) requires that profits on transactions between nonresidents and related resident persons should be at arm’s length. This section has been in the Act for some time, but there were never any guidelines, an aspect which was important in the decision given in the Unilever case.On 16 June 2006, the Kenyan Revenue issued guidelines dealing with transfer pricing.
These guidelines define an arm’s length price, comparable transactions, controlled transactions and related enterprises.The purpose of the guidelines is to provide administrative regulations and records and documentation to be maintained.
The guidelines cover the sale or purchase of goods and tangible assets; the transfer, purchase or use of intangible assets; provision of services; the lending or borrowing of money; and the catch all provision that they apply to any other transaction which may affect the profit or loss of the enterprise involved.
The methods permitted are the standard OECD methods used to substantiate related party transactions and specify that taxpayers must select the most appropriate method for their enterprise. All taxpayers must develop an appropriate transfer pricing policy, determine an arm’s length price according to these rules and prepare and have ready documentation to evidence their analysis. This documentation must be submitted with their annual tax return.
The following documentation is required:
•Selection of TP method and reason why selected
•Application of method, including calculations and price adjustment factors considered.
•Global organisation structure.
•Details of transactions considered.
•Assumptions, strategies and policies applied in selecting method.
•Any other background information.
Failure to have the appropriate transfer pricing documentation is an offence under section 72A of the Act. While there are no specific penalties provided for under transfer pricing, the Commissioner has the power to make adjustments to the profits. Such adjustment is deemed to be an additional tax and will attract a 20% unpaid tax penalty under section 72D, interest of 2% per month under section 94, and possible penalties and interest for underpayment of provisional tax.
There are other regulations that will affect multinationals such as the dividend rules, limitation of deductions for non-resident persons, and rules relating to deductions for permanent establishments. This article does not deal with those, but should nevertheless be taken into account in any decision to invest in Kenya.
Source: By Karl Muller (TaxTalk)