Residency raises tax burden

Kenya has a source based taxation system, which levies taxation on all income accrued irrespective of the residence of income earner.

The opposite of this is the income- based taxation system, which taxes residents irrespective of where the income is accrued or derived from.

It is important to determine the residency status of the taxpayer with a view to determining whether taxation is applicable or not, and in case of a source based taxation system to determine how the tax is applicable if sourced from the country.

There are a number of rules that determine residency.

Any person with a permanent home in Kenya is deemed to be a resident, particularly when he is present in the country during the year of income (January to December).

Unfortunately, the law does not quite explain what a “permanent home” is and it is generally accepted that all citizens are deemed to have permanent homes.

A person without a permanent home (read, non-citizen) will be deemed to be a resident either when he is in the country for 188 days in any year of income, or an aggregate of 122 days in the current year and in each of the preceding two years.

There are three residency provisions, i.e. incorporation in Kenya, management and control is exercised in Kenya, or when the Finance minister declares the person a resident.

There are subtle differences between the taxation of residents and non-residents.

To begin with, employees who are residents are taxed on their employment incomes while non-residents are not taxable in Kenya.

Goods providers

While resident service providers are taxed through the income tax system, non-resident service providers are taxed through the withholding tax system.

For goods providers, other than import taxes which affect both residents and non-residents depending on how carrier terms are negotiated, non-residents do not suffer Kenyan taxes.

There are situations when one does not wish to reside in a country but nevertheless wishes to declare his presence.

Such presence (permanent establishment) is recognised in Kenyan law and is often in the form of registration as a non-resident.

The tax rate of a company branch and a subsidiary of a non-resident is basically at 0.5 per cent, which for many purposes can be deemed to be insignificant.

The main disadvantage of branches in Kenya is probably the limitation of the expenses they can deduct for corporation tax purposes.

For branches of Kenyan entities elsewhere, there are tax advantages where they are in a loss position.

However, where they are profitable, the foreign tax is an expense and not an advance hence better from a tax point of view to incorporate.

Another major advantage of Kenyan branches is that due to the fact that they have no equity, the issue of thin capitalisation does not arise.

Effectively a branch of a foreign company can be fully financed by interest bearing loans without the risk of the interest being restricted.

Despite the flexibility and seeming tax advantages of branches, they carry a significant liability risk for the head office as they are transparent to the headquarters.

Moreover, when filing their tax returns they are required to file the financial statements of the head office.

The very fact that one takes legal and financial affairs across territories is often enough to discourage the formation of branches.

Nonetheless, one cannot discount establishing branches depending on the nature of their businesses.

kthuo@vivafricaltd.com