Kenya
Dr Mohamud Gedi
by Dr Mohamud Gedi
The Kenyan Income Tax Act (ITA) empowers the Commissioner of the Kenya Revenue Authority (KRA) to adjust the profits accruing to a resident company from any business conducted with non-resident related persons to reflect such profits as would otherwise have been made by independent persons dealing at arm’s length.
The ITA defines “related persons” as persons who participate either directly or indirectly in the management, control, or capital of the business of the other; a third person who participates directly or indirectly in the management, control, or capital of the business of both; or an individual who participates in the management, control, or capital of the business of an “other”, associated by marriage, consanguinity, or affinity to an individual who participates in the management, control, or capital of the business of the other.
The ITA also empowers the KRA to adjust profits accruing from resident persons conducting business with related resident persons operating in a Preferential Tax Regime (PTR), or a resident person conducting business with a non-resident person, an associated enterprise of a non-resident person, or a permanent establishment of a non-resident person located in a PTR.
A PTR has been defined as any Kenyan legislation, regulation, or administrative practice which provides a preferential rate of tax to such income/profit, including reductions in the tax rate and the tax base or a foreign jurisdiction, that lack transparency on corporate and financial information exchange protocols.
In 2006, the minister in charge of the national treasury issued the guidelines that determine the arm’s length value of related party transactions, also known as the Income Tax (Transfer Pricing Rules) in 2006. These rules borrow heavily from the OECD guidelines.
Transfer pricing in Kenya applies to the following transactions: i) the sale or purchase of goods and services; ii) the sale, use, purchase, or lease of tangible and intangible assets; and iii) the lending or borrowing of money and any other transactions which may affect the profit or loss of a company. The KRA may request necessary information and documents for review where a taxpayer claims the use of transfer pricing rules in Kenya.
TP regulations in Kenya require that the arm’s length standard be properly documented in a transfer pricing policy, and evidence of how the arm’s length standard has been applied must made available to the KRA upon request.
The comparable uncontrolled price (CUP) method compares the transfer price in a controlled transaction with prices in an uncontrolled transaction, and provides that an accurate adjustment should be made to eliminate material price differences.
The resale price method (RPM) compares the resale price of the product with the resale price at which the product would be sold to an independent enterprise, provided that, in the application of this method, the resale price would be reduced by the resale price margin (the profit margin indicated by the reseller).
The cost plus method (CPM) assesses the cost incurred by the supplier of a product in a controlled transaction, with a markup added to make an appropriate profit in light of the functions performed, the assets used, and risks assumed by the supplier.
The profit split method (PSM) juxtaposes how the profits earned in very closely interrelated controlled transactions are split among the related enterprises, depending on the functions performed by each enterprise in relation to the transaction, and compared with a profit split among independent enterprises in a joint venture.
The transactional net margin method (TNMM) analyses the net profit margin attained by a multinational enterprise in a controlled transaction compared to the net profit margin that would have been earned in comparable transactions by an independent enterprise.
The KRA also may prescribe the use of any other method where the above methods are ascertained to be unreliable in determining the arm’s length price.
Kenya has embraced the OECD Transfer Pricing Guidelines and the OECD Base Erosion and Profit Shifting (BEPS) project outcomes as internationally recognised best practices to provide supplementary transfer pricing documentation guidelines.
The ITA requires constituent entities of a multinational group (whether the ultimate parent entity is in Kenya or not) that has an overall group turnover of KES 95 billion or more to comply with the three-tiered approach to transfer pricing documentation.
Reports to be provided to the Kenyan revenue authority to include filing a country-by-country reporting (CbCR) notification, preparing and filing a local file and master file on or before the end of the sixth month following the entity’s financial year end, and a CbCR on or before the last day of the twelfth month following the group’s year end.
Transfer pricing documentation in Kenya largely adopts the documentation approach outlined in the OECD Transfer Pricing Guidelines. This includes the selection of the TP method and the reasons for the selection; the application of the method, and factors considered; the organisational structure of the group; and details of the controlled transaction and economic assumptions, strategies, and policies applied in selecting the method.
The master file contains a detailed overview of the group, a description of the supply chain, the group’s research and development policy, a description of each constituent entity’s contribution to value creation, financing activities, information about intangible assets, and the group’s intercompany agreements. The local file contains information on the resident constituent entity’s activities within the multinational enterprise group, the management structure of the resident constituent entity, business strategies including structuring, description of the material-controlled transactions, and the resident constituent entity’s business and competitive environment.
The CbCR contains information relating to the identity of each constituent entity, its jurisdiction of tax residence, the nature of the main business activity, group’s financial information including information relating to the amount of revenue, profit or loss before income tax, income tax paid, income tax accrued, stated capital and accumulated earnings.
There are no specific penalties prescribed for failing to file TP documentation in Kenya. However, non-compliance with CbCR attracts a fine not exceeding KES 1 million, a prison term not exceeding 3 years, or both, upon conviction.
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.
There are no APAs in Kenya, however, the law allows taxpayers to seek a private ruling with respect to transactions needing clarification. Mutual Agreement Procedure (MAP) is available in Kenya to resident taxpayers for dispute resolution. Additionally, a strong independent judiciary provides amicable dispute settlement for transfer pricing.
Dr Mohamud Gedi is managing partner of Geal and Associates LLP, a CPA firm based in Nairobi, Kenya. He has nineteen years of experience in audit, tax and advisory. He has been instrumental in expansion of the firm in East African Countries with corporate clients in Kenya, Somalia, South Sudan as well as Ethiopia.Contact Mohamud.
GGI member firm Geal and Associates LLPNairobi, KenyaT: +254 793006064/ +254 793006071
Audtiting & Accounting, Tax, Advisory, Corporate Finance, Fiduciary & Estate Planning
GEAL and Associates LLP is a registered accounting firm in Kenya, serving clients in government, commercial, manufacturing, and financial sectors. The firm specialises in accountancy, audit, and taxation services to small, medium, and large enterprises in Kenya and other east African countries.
