Kenya's tax law adjustments the definition of everlasting institution and will increase the reporting necessities for switch pricing – MNU Tax

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Kenya's tax law changes the definition of permanent establishment and increases the reporting requirements for transfer pricing - MNU Tax

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

Kenya's Finance Act 2021, which was published on May 5th and introduced into Kenyan lawmakers on May 11th, contains a new definition of “permanent establishment”, a country-specific reporting requirement and new rules for determining “control” among affiliated companies.

The bill is due to be passed by the end of June, after parliament has taken into account the opinions of business and the public.

Establishment definition

An important suggestion is to revise the current definition of a permanent establishment. According to the proposed definition, the use of the specific exceptions to the existing definition would be discontinued, particularly in the area of ​​digitized companies. In addition, the proposed definition includes an explicit recognition of services that are preparatory or supportive in nature, which are not covered by the existing definition and which have given rise to disputes between the tax authority and taxpayers.

A major change to the proposed definition is the inclusion of a tax agent in the constituent parts of a permanent establishment and the provision of services, including advisory services, by a person through employees or other persons employed for this purpose. The proposed definition seems to aim to bring national legislation in line with international best practices as set out in Article 5 of the United Nations and OECD Tax Treaties. The proposal also appears to be aimed at preventing strategies that circumvent the existing definition.

Transfer Pricing Reports

Another proposal is that the top-level units based in Kenya must make a declaration no later than twelve months after the last day of the reporting year of the multinational group.

The statement is intended to collect aggregated information for each jurisdiction in which the multinational group of companies operates, relating to sales, profit or loss before income tax, income tax paid, income tax accrued, reported capital, accumulated profits, number of employees, and tangible assets other than cash or cash equivalents. This will result in the use of country-by-country reporting on all multinational companies headquartered in Kenya.

If these proposals are adopted, the tax authorities would have more transparency about the financial information that would be useful in assessing transfer pricing risk or any risks related to Profit Reduction and Profit Shifting (BEPS). This would definitely add additional transfer pricing requirements for Kenyan taxpayers who are part of a multinational corporation.

Extended definition of control

Another change that would affect multinational corporations and foreign companies operating in Kenya would result from the expanded definition of “control”. Control currently means that a person owns at least 25% of the shares or voting rights. The draft law provides for a reduction to 20%. Control would also arise when a person grants a company a loan that is at least 70% of the book value of the person's total assets, or when a person has guaranteed at least 70% of the company's total debt, and when a person has mandated more than that Appoint half of the board of directors or at least one executive director.

Other unique transactions that would create domination in the Proposals include having a person deliver and buy at least 90% of a company's supplies or purchases and have the ability to influence prices. The extension of the control parameters would broaden the scope of transactions with controlled entities, where transfer pricing rules would apply in relation to transactions with related parties.

The proposed changes would also affect companies such as licensed manufacturers and others with individual suppliers or buyers who do business with independent parties as part of their business. In such cases it will be interesting to observe the applicability of the arm's length principle, as transactions with independent suppliers and buyers are for arm's length purposes.

In addition, the bill proposes changes to the new Kenyan tax on digital services. Kenya started introducing the tax this year, targeting both resident and non-resident taxpayers. The bill provides for exempting residents from this tax and only making non-residents liable for compliance and assessment.

Exported services

Finally, the bill also contains proposed amendments that appear to be a response to tax disputes by the tax authorities in which taxpayers have contested through various mitigation channels, such as the taxation of the export of services, which has been contested in several cases. The bill now aims to amend the current rules to deny taxpayers the reimbursement of the appropriate input tax on purchases related 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 issues, such as applying the concept of control to companies with sole suppliers and independent buyers.

While the proposed rules will help align Kenyan tax law with the best practices of the UN Convention and OECD Guidelines, additional clarity and simplicity could help with taxpayer compliance.

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