By Ali Amersi
The Finance Bill 2022 was brought for its first reading on April 12, 2022, to provide for the scheduled break before the August 2022 elections. With the rising cost-push inflation, there is a need for the government to increase revenues, reduce bond yields, and increase interest rates. Therefore, through the Finance Bill, several changes have been introduced to increase taxes within the jurisdiction, such as increasing capital gains tax from 5 percent-15 percent. Vitally, large changes impact multinationals and Kenyan businesses conducting business within preferential tax regimes.
Transfer pricing, also called transfer cost, is where related parties interact with each other, usually to benefit from preferential tax regimes in foreign jurisdictions. The concept is made in transactions between a subsidiary and its ultimate mother company or between divisions of the same company in different countries. In most cases, the beneficial owners between the two entities are usually related and are using preferential tax regimes to reduce taxable income globally.
Therefore, to bring these companies within taxable income in Kenya, the Finance Bill has dramatically increased the scope and definition of the preferential tax regime by implementing an arm’s length interpretation of doing business with a foreign entity. Foremost, a preferential tax regime is defined as a foreign jurisdiction that does not tax income, has a lower tax rate than Kenya, or does not share banking or ownership information with Kenya.
Regarding sharing information, Kenya ratified the Mutual Administrative Assistance in Tax Matters (MCMAA) in 2015, which implements the Common Reporting Standards (CRS) requirements, which is an OECD condition on sharing information—in particular, sharing individual tax pins information simultaneously between all signatories. Currently, over 90 countries have signed the MCMAA.
The impact of MCMAA and CRS will allow Kenya Revenue Authority (KRA) to gain tax information about all Kenyan residents, individuals and corporations who have incomes within the signatory countries. Therefore, firmly recognizing that Kenya operates a source-based taxation system through Section 3(1) of the Income Tax Act, which was further exhibited by Motaku Shipping Agencies Limited vs Commissioner of Income Tax (Civil Suit No. 60 of 2013), where it was confirmed businesses that conduct transactions partially in Kenya and partially outside would be deemed to be residents companies with their entire income taxable in Kenya.
In explaining the impact of transfer pricing within preferential tax regimes, a Kenyan business importing goods, or yielding services from a country with a preferential tax regime, such as Dubai, Mauritius, or other similar preferential tax jurisdiction, will be deemed to have done the transaction by an independent person or if none of the parties were located in the preferential tax regime. This may lead to reclassifying certain accrued incomes and expenses to increase the taxable profit payable to KRA for both local companies and multinational cooperation(MNCs).
To gain access to information on the impact of using preferential tax regimes to benefit from transfer pricing, the amount of information that is provided to the commissioner of tax by MNCs has increased. Throughout section 18 of the Finance Bill, MNCs have to provide detailed financial activities within all jurisdictions. Moreover, the information must include capital, accumulated earnings, revenue and other vital balance sheets, cash flow, and income statement items. Further information that must be provided includes foreign tax disputes and transfers of intangible assets.
Therefore, MNCs that attempt to conduct a transfer of assets, or choose their jurisdiction to declare a taxable profit, and take advantage of other preferential tax regimes will be obligated to pay the relevant taxes in Kenya through the defined arms-length rule; where parties are presumed to be independent within an equal playing field.
International minimum tax
By implementing the arm’s length rule, Kenya will have a much higher tax jurisdiction than the proposed implementation of the 15 percent worldwide tax by the Biden administration. Likely, MNCs will now be forced to pay at least 30 percent tax on their activities within Kenya.
Therefore, there may be a reduction in foreign investment and have an overall negative impact on the economy.
Nevertheless, the implementation tax benefits on high capital investments offered to certain industries within the Finance Bill, such as hotels, manufacturers and other industries operating outside Nairobi and Mombasa, may increase investment within these localists. Moreover, the implementation of 0 duty and vat on locally manufactured cars might lead to great impacts overall; however, the cost of electricity is still a great area of concern for all manufacturers.
In summary, the implementation of the arm’s length may increase KRAs revenue in the short-term with MNCs being forced to pay higher amounts of taxable income; however, without the application of other key benefits, such as a reduced tax on the first years of business and dramatically reduced costs, such as electricity, the long term impact may be grim. (