By Alex Mathini,Fredrick Ogutu Wednesday, September 13, 2023
  1. On 4th September 2023, the Commissioner General of the Kenya Revenue Authority (the Commissioner) published the Draft Income Tax (Transfer Pricing) Rules, 2023 (the Draft Rules). Upon gazettement, the Draft Transfer Pricing Rules 2023 will revoke the existing Income Tax (Transfer Pricing) Rules 2006 (the 2006 TP Rules), which are currently in force.
  2. In the recent past, there has been a global move towards enhancing tax transparency in relation to cross-border transactions through enhanced disclosure requirements, reporting and information sharing. While Kenya has enacted a number of statutory provisions under the Income Tax Act to give effect to some of these changes, the 2006 TP Rules have not been amended in tandem with the changes. In addition, the 2006 TP Rules lack relevant detail and as a result, taxpayers and the Kenya Revenue Authority (KRA) have relied on the detailed Organization for Economic Co-operation and Development Transfer Pricing Guidelines (OECD TP Guidelines)
  3. While the Draft Rules are far from being as detailed as the OECD TP Guidelines, the Rules seek to widen and define the scope of transactions subject to transfer pricing rules in Kenya to include among others, group re-organisations between associated persons as well as local transactions where one party operates under a preferential tax regime. Moreover, the Draft Rules seek to entrench the concept of cost contribution arrangements (CCAs) within Kenya’s transfer pricing regime, define and widen the type of information that the Commissioner may request for from taxpayers. The operationalization of CCAs in Kenya will give taxpayers more options of structuring their group operations while definition of transactions subject to transfer pricing and information that may be requested for by the Commissioner will make compliance easier and more predictable.
  4. On the other hand, the requirement of all taxpayers involved in any transaction subject to transfer pricing rules including one off simple transactions such as intra-group loans to comply with the full transfer pricing documentation requirements under the Draft Rules will place an unnecessary compliance burden on such taxpayers. For transactions such as intra-group loans, reliance on prevailing bank loan interest rates to justify the interest rate applied on such intra-group loans should suffice.
  5. While the Draft Rules have made reference to advance pricing agreements (APA) from other jurisdictions, the rules have not introduced the same in Kenya. APAs provide a degree of certainty to taxpayers in managing their tax matters and helps avert potential exposure to risks and liabilities in the future.

We comment on some of the notable provisions of the Draft Rules below:

A. Wider scope of transactions subject to transfer pricing rules

The Draft Rules have expanded the scope of transactions subject to transfer pricing rules to include the following:

  1. Cost contribution arrangements (CCAs) - CCAs are contractual arrangements entered into to allow the participants contribute and share the risks involved in the development, production or acquisition of assets or the execution of services in consideration for the equitable enjoyment of the benefits derived from the contributions. Depending on the circumstances of a group, CCAs could be a viable alternative to the arrangement where one of the group entities is designated to offer specific services to the rest of the group entities as a shared services centre for an arms’ consideration.
    Unlike a shared services centre, a CCA is a contractual arrangement and not necessarily a distinct legal entity or permanent establishment of the participants. The OECD TP Guidelines contain detailed guidelines on the operations of CCAs.
  2. Transactions involving derivatives – effective 1 January 2023, the Finance Act 2022 introduced a 15% withholding tax on gains accruing to a non-resident person from a financial derivative contract entered into with a resident person in Kenya[1]. The Income Tax Act defines a financial derivative as “a financial instrument the value of which is linked to the value of another instrument underlying the transaction which is to be settled at a future date.” Transactions involving derivatives between a resident and non-resident related person, or non-resident unrelated person operating in a jurisdiction with a preferential tax regime[2] will be subject to transfer pricing rules in Kenya.
  3. Transactions involving business restructuring or reorganization between associated persons – business reorganizations involving related parties (whether it has bearing on the profit, income, losses or assets of such persons at the time of the transaction or at any future date or not) will expressly be subject to transfer pricing rules. That said, it should be noted that currently, the Income Tax Act and the VAT Act require the transfer value of assets between related parties to be at arm’s length.

B. Choice of transfer pricing method

While rule 4 of the Draft Transfer Pricing Rules 2023 provide that it is the taxpayer who will choose the applicable transfer pricing method, rule 7(1)(f) provides that the Commissioner may prescribe any other transfer pricing method from time to time. Given that the transfer pricing method selected would ordinarily require to be justified as part of the transfer pricing documentation, the taxpayer is better placed to choose the transfer pricing method. However, it should be noted that the 2006 TP Rules contain such contradictory provisions.

C. Determination of the arm’s length price in relation to importation and exportation of commodities

The Draft Transfer Pricing Rules 2023 have extended the applicability of transfer pricing rules to commodities[3].While rule 7 provides for the “traditional” transfer pricing methods, the rule provides that in relation to the export or import of commodities, the arm’s length price would be the prevailing price on an international or domestic commodity exchange market, a recognized and transparent price reporting or statistical agencies, governmental price-setting agencies, or from any other index that is used as a reference by unrelated persons to determine prices of commodities in transactions between them (the Quoted Price).

However, where the price agreed upon between a person and a non-related person is higher in the case of exported commodities or lower in the case of imported commodities than the Quoted Price, the agreed price will be considered as the sale price or purchase price for the purposes of computing the seller’s taxable income in Kenya.

D. Nature of information that may be requested by the Commissioner specified

Rule 9 of the Draft Rules has expanded and defined the scope of information that the Commissioner may request from taxpayers. Some of the specific information that the Commissioner may request for include list and description of selected comparable uncontrolled transactions and the relevant information of those comparable, explanation of the selection of most appropriate transfer pricing method(s), details of any advance pricing agreements or similar arrangements in other countries that are applicable to the controlled transactions among others.

Definition of the information that may be requested by the Commissioner is welcome as it will make compliance more predictable for taxpayers.

E. Requirement to comply with documentation requirements on all transactions

Rule 10 requires a person who claims to have applied an arm’s length fee to (a) develop an appropriate transfer pricing policy (b) determine the arm’s length price as prescribed under the guidelines provided under these Rules and (c) avail documentation to evidence their analysis upon request by the Commissioner.

This rule does not provide for any exemption and the implication is that all taxpayers involved in any related party transactions including one off simple transactions such as intra-group loans, would have to comply with the full transfer pricing documentation requirements as opposed to, for instance, obtain prevailing bank loan interest rates to justify the interest applied on such intra-group loans.

[1] Implementation of the provisions on taxation of gains from derivatives was challenged in court by the Kenya Bankers’ Association on among other grounds possible double taxation and imposing a burden on Kenyan entities to account for tax on speculative gains accruing to non-resident persons. The case is still pending before the courts and no orders have been issued yet.

[2] A foreign jurisdiction that does not tax income, taxes income at a rate lower than 20%, does not have a framework for exchange of information, does not allow access to banking information or lacks transparency on corporate structure, ownership of legal entities, beneficial ownership, financial disclosure or regulatory supervision

[3] Rule 2 defines commodities to include agricultural produce, fisheries products, solid or liquid or gas minerals, hydrocarbons and derivatives thereof, other products or natural minerals or mineraloids obtained from the land or waters, and, in general, goods where publicly quoted price as described in rule 7, exists.