Understanding Kenya’s Latest Transfer Pricing Requirements in the Financial Act

Like many other nations, Kenya has recognized the significance of transfer pricing regulations in ensuring fair taxation and preventing profit shifting. The recently enacted Financial Act has introduced several changes to the country’s transfer pricing requirements. This article will delve into the key aspects of Kenya’s latest transfer pricing regulations, examining the implications for businesses and the broader economic landscape.

Background of Transfer Pricing in Kenya

To comprehend the recent changes, it’s essential to understand the background of transfer pricing in Kenya. Transfer pricing involves transactions between related entities, typically within a multinational corporation. It aims to ensure that such transactions are conducted at arm’s length – as if they were between unrelated parties. This helps prevent profit manipulation and tax evasion.

On September 4, 2023, the Cabinet Secretary of the National Treasury and Economic Planning released the Draft Income Tax (Transfer Pricing) Rules, 2023 (Draft TP Rules 2023) for public input and comments, intending to replace the existing Income Tax (Transfer Pricing) Rules, 2006. 

The proposed rules aim to address the growth of international trade, align with global efforts against base erosion and profit shifting (BEPS), and complement changes introduced in the Finance Act 2022 regarding country-by-country (CbC) reporting and transfer pricing documentation for multinational entities (MNEs) in Kenya.

Key Changes:

Scope of Covered Transactions:

• The Draft TP Rules 2023 align with Section 18 of the Income Tax Act, extending the scope to cover transactions involving:
  • Non-resident persons doing business in Kenya with related resident persons or permanent establishments.
  • Resident persons doing business with related persons in preferential tax regimes.
  • Resident persons doing business with non-resident persons in preferential tax regimes.
  • Resident persons doing business with associated enterprises of non-resident persons in preferential tax regimes.
  • Resident persons doing business with permanent establishments of non-resident persons in Kenya, located in preferential tax regimes.

• This broadens the range of transactions and imposes increased scrutiny on MNEs and associated parties regarding transparency and exchange of information.

Transactions Subject to Adjustment:

• The Draft TP Rules 2023 expand the scope of transactions subject to price adjustments. In addition to goods or services transfers, the rules now apply to:
  • Financing transactions (borrowing, lending, guarantees, securities trading, etc.).
  • Insurance and reinsurance transactions.
  • Business restructuring or reorganization transactions with associated persons.
  • Cost contribution arrangements.
  • Transactions involving derivatives.

• This extension has significant implications for MNEs engaging in loans, insurance, restructuring, shared costs, and derivatives, requiring compliance with the arm’s length principle and anticipating increased scrutiny from tax authorities.

These changes reflect a concerted effort by the Kenyan government to strengthen regulations, align with international standards, and enhance oversight of cross-border transactions to prevent tax avoidance and promote fair taxation. To ensure compliance and minimize potential risks, MNEs operating in Kenya should carefully assess their activities in light of the proposed rules.

Overview of the Financial Act

As a legislative instrument, the Financial Act is crucial in shaping Kenya’s fiscal landscape. The latest amendments related to transfer pricing underscore the government’s commitment to fostering transparency and equity in taxation.

Key Changes in Transfer Pricing Requirements

The Financial Act introduces several noteworthy changes to Kenya’s transfer pricing regulations. Among them, the following aspects merit closer examination:

Documentation Requirements

The preparation of transfer pricing documentation in Kenya adheres to the OECD model, incorporating the Master File and Local File approach outlined in BEPS Action 13. Proposed changes in the Eighth Schedule of the Income Tax Bill, specifically Paragraph 11, aim to introduce mandatory Country-by-Country (CBC) reporting for entities.

Under the existing framework, the Kenya Revenue Authority (KRA) has the authority to request the following documentation from taxpayers for transfer pricing purposes:

• Financial books and accounts.
• Explanation of the chosen transfer pricing method and the rationale behind its selection.
• Application of the selected method, including detailed calculations and considerations of price adjustment factors.
• Overview of the global organizational structure of the enterprise.
• Comprehensive details of the transactions under review.
• Assumptions, strategies, and policies employed in the method selection.

Relevant background information about the transactions as deemed necessary. Taxpayers must be prepared to provide this documentation upon request from the KRA to ensure compliance with transfer pricing regulations.

Country-by-Country Reporting

One of the significant changes is the introduction of country-by-country reporting for multinational corporations operating in Kenya. This mandates the disclosure of financial and operational information for each company’s jurisdiction. This move enhances transparency and enables tax authorities to assess the potential risks of profit shifting.

Advance Pricing Agreements (APAs)

The Financial Act also emphasizes the importance of Advance Pricing Agreements (APAs) as a mechanism to provide certainty to taxpayers regarding their transfer pricing positions. APAs allow businesses to seek approval from tax authorities for their transfer pricing methodologies in advance, reducing the risk of disputes.

Implications for Businesses

The new transfer pricing requirements have profound implications for businesses operating in Kenya. Companies must adapt their internal processes to comply with the enhanced documentation requirements. This may involve investing in sophisticated transfer pricing systems and engaging experts to ensure accurate compliance.

Furthermore, the country-by-country reporting obligation adds a layer of complexity for multinational corporations. They must now navigate the challenges of compiling and disclosing comprehensive financial and operational data for each jurisdiction, requiring robust systems and processes for data collection and analysis.

On the positive side, the emphasis on APAs allows businesses to proactively engage with tax authorities and establish clarity on their transfer pricing arrangements. This can lead to a more predictable tax environment and reduce the likelihood of disputes.

Challenges and Criticisms

While the changes aim to strengthen the regulatory framework and curb tax avoidance, some challenges and criticisms have emerged. Challenges and Criticisms of Kenya’s Transfer Pricing Changes:

• Compliance Burden:
  • Increased documentation requirements.
  • Country-by-country reporting.
  • Potential administrative challenges.
  • Higher compliance costs, particularly for smaller enterprises.

• Foreign Investment Concerns:
  • Stringent regulations may deter foreign investment.
  • Perception of increased compliance as a barrier to entry.
  • Striking a balance between preventing tax evasion and maintaining a business-friendly environment is crucial for economic growth.

Conclusion

In conclusion, as outlined in the Financial Act, Kenya’s latest transfer pricing requirements represent a significant step toward aligning the country with international best practices. The emphasis on documentation, country-by-country reporting, and APAs reflects a commitment to ensuring fairness in taxation and preventing profit shifting. While businesses may face challenges in adapting to these changes, the overall objective is to create a transparent and predictable tax environment that benefits both the government and the business community. Moving forward, stakeholders must collaborate to address any concerns and fine-tune the regulations to balance compliance and economic growth.

About the Author

Thank you for reading this article. The author, James Ndambiri, is an avid Business Advisor and Consultant: A Tax Surgeon, Proficient Accountant, Skilled Auditor, Guru in Financial and Investment Management, Expert in Business Strategy Formulation, Business Transformation Wizard, Family Business Advisor, Lecturer, Business Coach and a Family Man.

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