COVID-19: IMPACT ON TAX RESIDENCY AND PERMANENT ESTABLISHMENT STATUS IN KENYA
Countries across the world tax income under two main principles, the source of the income and residency of the taxable person. Taxation based on the source of income can either be on a territorial or worldwide basis. Where a country adopts the territorial system, only income accrued in or derived from within the territory is subjected to income tax, whereas under a worldwide system, income accrued in or derived from both within and outside the territory by the residents of a country is taxable. On the other hand, residency is determined by the individual rules of each jurisdiction and may be varied by different or alternative rules under Double Taxation Agreements (the DTA). The same applies to the permanent establishment status of a legal person. The residency of an individual or legal person, and the permanent establishment status of a legal person, may have a number of tax implications.
In this briefing, we discuss the impact of the government directives for the containment of the COVID-19 outbreak, on the residency of individuals and legal persons, and the permanent establishment status of legal persons.
1. Residency - Individuals
The tax residency of an individual is important in determining whether and how their individual or employment income will be taxable in Kenya under the Income Tax Act (Cap. 470 of the Laws of Kenya) (ITA). In addition, taxation rates may differ depending on the residency of a taxable person. The Kenyan income tax framework is territorial, and only income accrued in or derived within Kenya is chargeable to income tax. However, there are two exceptions where income derived from outside the Kenyan territory is taxable in Kenya. Firstly, the individual/employment income of Kenyan residents earned from services rendered is taxed on a worldwide basis, that is, regardless of whether the income is derived from or accrued within or outside Kenya. Secondly, resident companies that conduct business partly within and partly outside Kenya, are taxed on their total income accrued in and derived from both within and outside Kenya.
The domicile or residency of a person varies depending on the legal regime in which it is invoked. However, for taxation purposes, residency in Kenya is defined by the ITA, which provides three tests for the determination of residency. Firstly, an individual is tax resident in Kenya if he/she has a permanent home in Kenya and was present in Kenya for any period in a year of income. A permanent home is not defined in the ITA but the proposed Income Tax Bill, 2018 (ITB) does include a definition. Secondly, an individual is tax resident if he/she has no permanent home in Kenya but was present in Kenya for a period or periods amounting in the aggregate to 183 days or more in that year of income. Lastly, an individual will be tax resident in Kenya if he/she was present in Kenya in a year of income and in each of the two preceding years of income for periods averaging more than 122 days in each year of income.
The travel restrictions put in place by the Kenyan Government and other national governments to contain the spread of the COVID-19 have rendered it impossible or difficult for individuals to travel to different jurisdictions. The effect of these restrictions is that individuals may either find themselves tax resident in Kenya, because of their period of stay here; and/or find themselves dual residents of two jurisdictions. For example, people employed in the United Kingdom but have since visited Kenya, and find themselves residing in Kenya for a period of 183 days or more, will be considered resident in Kenya and their employment income will become chargeable under the ITA. In addition, they may find themselves tax resident in the United Kingdom too. It is not uncommon for a residency conflict to arise, and in such cases, existing DTAs may provide tie breaker rules and any complexities may be resolved through mutual agreement between the contracting states.
2. Residency - Companies
The ITA establishes three tests for determining the residency of a company in Kenya. Firstly, if a company is incorporated in Kenya, it is resident for taxation purposes. Secondly, a company will be considered to be resident under the ITA where the Cabinet Secretary for the National Treasury by notice in the Gazette declares such company to be resident for any year of income. Thirdly, where the management and control of the affairs of the company is exercised in Kenya in a particular year of income, it will be considered tax resident for the year under consideration. It is this last test, that we anticipate is likely to be problematic in the period of COVID-19.
Neither the ITA nor the Kenyan Courts have defined or established the “management and control” test for purposes of residency determination. In the absence of a definition or test, we may be persuaded by the interpretation of the concept under different jurisdictions. In the United Kingdom, the concept is referred to as “central management and control” and the Courts have opined that its determination is wholly a question of fact, and that factors which together are decisive in one instance may individually carry little weight in another. According to a guidance by Her Majesty’s Revenue and Customs (HMRC), a series of court decisions have attached importance to the place where a company’s board of directors meet. However, the guidance stipulates that the place of directors’ meetings is significant only insofar as those meetings constitute the medium through which central management and control is exercised, which may not necessarily be where they meet. Consequently, where the control is vested in a single individual, the residency will be determined by the place where they undertake the decisions. According to paragraph 24 of the Commentary on Article 4 of the 2014 OECD Model Treaty, the place of effective management is the place where key management and commercial decisions that are necessary for the conduct of the entity’s business as a whole are in substance made.
The effect of the current and future government restrictions is that in the event that the person or persons who exercise the management and control of a company or companies based in other jurisdictions find themselves staying in Kenya, and making important decisions on behalf of the company from Kenya, that company may be considered a tax resident of Kenya. Consequently, the trading profits derived from or accrued in Kenya may be taxable at the resident corporation tax rate – income that would otherwise not have been subject to Kenyan income tax. However, we do not think that a temporary change in location of the chief executive officers and other senior executives is an extraordinary situation due to the COVID-19 crisis and such change of location should not trigger a change in residency.
3. Permanent Establishment Status
Where a non-resident company has a Permanent Establishment (PE) in Kenya, the company accrues tax liability that would otherwise not accrue save for the PE status. Under the ITA, "permanent establishment" is established where a non-resident person has a (i) fixed place of business which has existed for six months or more where a company wholly or partly carries on business or (ii) a dependent agent of the company who acts on its behalf and who has, and habitually exercises, authority to conclude contracts in its name.
The effect of the government restrictions is that if a non-resident person had a fixed place of business in Kenya whose operations may need to be extended, it is likely that they will be deemed to have a PE in Kenya. Secondly, t is likely that the dependent agents of a non-resident company who were/are carrying out activities in Kenya may/will be unable to leave Kenya, and if they continue to remain in Kenya for a period of six months or more, the company may be considered to have attained PE status in Kenya. In addition, if a non-resident had engaged an agent in Kenya and may need to expand the agent’s duties and powers for purposes of business continuity in Kenya to the extent that the agent will conclude contracts on its behalf, it may be deemed to have a PE in Kenya.
Consequently, any non-residents that offer individual or employment services to the PE will become taxable in Kenya and, the trading profits of the company accrued in or derived from Kenya will be chargeable to corporate tax at the non-resident rate, as provided for in the ITA.
Putting it into Perspective
- To ensure that you are not considered resident in Kenya (which you would not have been, save for Covid-19), we recommend that you engage counsel to request a waiver from the Kenya Revenue Authority (KRA) explaining the circumstances. However, in the event that travel restrictions are lifted, you should ensure that your travel out of Kenya is within the period required to establish residency.
- You should consult your legal advisers with respect to the possibility of dual residency and the tax implications that may accrue in the event that residency is established in Kenya.
- Where the person or persons responsible for the management and control of a non-resident company are in Kenya and thus unable to exercise his or her responsibilities in the usual location, the company should consider delegating/assigning the responsibilities or if appropriate, deferring the decisions until such time that the person or persons are in the company’s taxable jurisdiction.
- Where a non-resident has dependent agents carrying out activities in Kenya, they should consider terminating their engagements or varying or suspending obligations if the term of their engagement with the company is likely to exceed the six-month period of establishing PE status in Kenya.
- Where a non-resident had set up a place of business in Kenya, it should decouple itself with the place for the period of the pandemic and ensure that it does not maintain it for a period of six months or more.
Impact on Immigration
Notwithstanding the tax implications highlighted above, the government restrictions on travel may also have adverse effects on non-residents that had applied successfully for a work or residence permit before the implementation of the restrictions. The Kenya Citizenship and Immigration Act (KCIA) stipulates that where a permit has been issued and the person without approval of the Director of Immigration, fails to engage within 90 days of the date of issue of the permit or entry into Kenya, in the employment or occupation or activity in respect of which the permit was issued or take up residence, the permit shall cease to be valid. In addition, if the person ceases to engage in the said employment, occupation, trade, business or profession, the permit shall cease to be valid and presence in Kenya shall be unlawful.
In addition to assessing their tax liabilities arising from continued presence in Kenya, non-resident individuals should ensure that their permits are in compliance with the KCIA and should engage the Director of Immigration in the event that they contravene or are likely to contravene the KCIA on account of the COVID-19.
The uncertainty of the length and scale of government restrictions that may be implemented in Kenya and across the world, create problematic questions on the tax residency and PE status of companies and individuals who find themselves within the territory of Kenya. This has the effect of accruing tax liability on persons who may have otherwise not been taxable persons in Kenya, save for the COVID-19 outbreak. It is thus important to understand the tax implications of continued stay or operations in Kenya, take mitigation measures and factor the potential liabilities or costs in your personal or business planning. Lastly, non-resident individuals with work or residence permits should ensure that their continued stay is in compliance with the KCIA.