The quote, “Tax complexity itself is a kind of tax” by Max Baucus highlights how the indirect costs of navigating a complex tax system can be as burdensome as the taxes themselves.
This insight is particularly relevant to transfer pricing (TP), where cross-border transactions expose businesses to regulations across multiple jurisdictions—each with its own complexities and competing interests.
These complexities amplify tax uncertainty, often resulting in TP adjustments that lead to additional taxes, penalties, and interest.
To address the challenges of tax complexity and uncertainty, the Organisation for Economic Co-operation and Development (OECD) developed the model legislation for Advance Pricing Agreements (APAs) in 1995.
The primary goal was to encourage countries to create frameworks for resolving TP issues through prospective negotiation, thereby providing certainty and fostering compliance for multinational companies.
So what are APAs? APAs are agreements between a taxpayer and tax authorities that establish, in advance of cross-border transactions, the criteria for determining the pricing of these transactions over a specified period.
For instance, a taxpayer can pre-agree with the revenue authority on the criteria to determine the price of for purchasing products purchased from related parties.
Adherence to these criteria by the taxpayer protects them from scenarios where the revenue authority conducts a transfer pricing audit and making tax adjustments.
APAs can be unilateral, bilateral, or multilateral, depending on the number of tax authorities involved. They may also apply prospectively (for future transactions) or retrospectively (addressing past years).
Kenya is a strategic investment hub, attracting multinational groups that view it as a gateway to operations across Africa. Key factors include a highly skilled workforce, robust financial services, and a central location with excellent international connectivity.
Multinational entities often engage in related-party transactions, which expose them to tax audits that can result in tax disputes requiring resolution by the Tax Appeals Tribunal or courts.
The introduction of APAs in Kenya could enhance tax certainty and bolster the country’s appeal as an investment hub. By providing a framework for taxpayers and the Kenya Revenue Authority (KRA) to agree on pricing methodologies for related-party transactions, APAs could significantly reduce the risk of transfer pricing disputes and hence promote tax certainty, provided the agreed criteria are followed.
Several African countries have introduced APA provisions in recent years—Tanzania (2018), Rwanda, Zambia (2020), and Uganda (2021).
However, none have successfully concluded APAs between taxpayers and revenue authorities. Challenges include: Limited experience among revenue authorities in negotiating APAs.
There is also perceived complexity of the APA process and the significant time investment required by both taxpayers and the revenue authority.
There is also the aspect of information asymmetry - where taxpayers are viewed as having more access to transactional details compared to revenue authorities and hence dissuading revenue authorities from entering into agreements with taxpayers.
In addition, revenue-focused tax policies, as governments generally prioritise tax policy actions that lead to immediate tax collection over creating a stable tax environment that minimises tax disputes.
While APAs could guarantee that the correct amount of pre-agreed tax is paid, they eliminate the possibility of revenue authorities of raising additional taxes through assessments from audits, making revenue authorities hesitant to adopt them.
KRA could begin by piloting APA programmes for simpler transactions, such as management services. This approach would allow KRA the authority to focus its resources on auditing more complex transactions while fostering compliance and certainty for straightforward arrangements.
For Kenya to establish a successful APA programme, collaboration between the revenue authority and taxpayers is essential. KRA would be required to shift its mindset toward stabilising the tax environment and promoting Kenya as an investment hub while and ensuring correct taxes are paid.
On the other hand, taxpayers must commit to transparency and providing the necessary information for APAs to succeed.
On June 14, 2024, the Finance Bill proposed the introduction of APAs as part of broader tax reforms. Although the Bill did not receive Presidential Assent, the expected benefits of APAs in fostering tax certainty and positioning Kenya as an investment hub underlines the need for their reintroduction in future legislative amendments.
By embracing APAs, Kenya can align itself with global best practices, providing a predictable and business-friendly tax environment that attracts investments by multinational enterprises.
Agape Ishengoma, is Senior Associate, Transfer Pricingax and Legal Services, PwC Kenya.
Alice Muriithi, is Partner, Transfer Pricing, PwC Kenya.
