Changes to transfer pricing rules add to taxpayer burden

A number of new radical changes and amendments have been introduced in Kenya in the recent past that are related to transfer pricing (TP).

TP regulations are contained in the Income Tax Act (ITA) and were only augmented by the introduction of the Transfer Pricing Rules of 2006 which provided further guidance on the applicability of TP in Kenya.

Thereafter, the Kenya Revenue Authority (KRA) has been carrying out TP audits on taxpayers in an effort to implement the regulations.

Through the Finance Act of 2021, there was an expansion in the definition of the term ‘control’. The new definition provides a catch-all rule for all cases where the facts and circumstances of transaction evidence effective exercise of control over the business decisions of the other person, even where there is no actual shareholding or voting rights.

This will effectively bring under the ambit of TP scrutiny transactions that were hitherto deemed to be completely third-party.

TP benchmarking

Such scrutiny will create unnecessary burden to taxpayers in documenting that the transactions are being carried out at arm’s length terms. It will also greatly impact on the choice of comparables for TP benchmarking analysis.

For instance, there shall be deemed control if an entity provides loans or guarantees that constitute more than 70 per cent of the total indebtedness of another entity, except for loans and guarantees from unrelated financial institutions.

Further, the supply or purchase of more than 90 per cent of the supplies or purchases to or from one person and where the KRA commissioner determines there is influence in the prices or other conditions of the transaction shall result in control.

Additionally, the threshold of control was lowered from direct or indirect ownership of more than 25 percent of shares or voting rights to direct or indirect ownership of more than 20 percent of voting rights of another entity.

In an effort to ensure that the KRA has more visibility on any TP arrangements, the Finance Act 2021 introduced the country by country (CbC) reporting requirements for ultimate parent entities of multinational enterprises (MNEs) headquartered in Kenya.

The ultimate parent entity of the MNE shall be required to submit to the commissioner a return describing the MNE group’s financial activities in Kenya and all other jurisdictions where the group has taxable presence.

The return shall contain information on the MNE group’s aggregate revenue, profit and loss before tax, income tax paid or accrued, number of employees, tangible assets among other stipulated information with regard to each jurisdiction in which the group operates.

A subsidiary or branch office of a MNE group may also be required to file a CbC report in Kenya if the jurisdiction of the parent company has not implemented CbC reporting or there are difficulties in implementing the exchange of CbC reports with the KRA.

The purpose of the CbC return is to provide the KRA with high-level information for it to asses any inherent TP risks from the MNE group’s operations in Kenya. The KRA cannot, however, make any TP adjustments based on the CbC report and shall be required to carry out an audit before making such adjustments.

The CbC return shall be submitted not later than 12 months from the last day of the fiscal year of the MNE group. It is important to note that though this provision became effective from January 1, 2022, the final regulations to enable the implementation of the CbC reporting are yet to published.

Additionally, through the Finance Act, 2021, Kenya introduced the Common Reporting Standards (CRS) regime effective July 1, 2021, which brought about the automatic exchange of financial information for financial purposes.

The reporting will be done by financial institutions operating in Kenya through filing CRS returns with the KRA.

Risky transactions

Subsequently, there will be automatic exchange of information on reportable accounts between Kenya and all participating jurisdictions, which will also see tax authorities in the participating jurisdictions work together in identifying risky transactions from both sides. The KRA shall use such information for purposes of ascertaining taxes due and payable in Kenya.

From the above changes and developments, it is clear that there is increased focus on TP as a new frontier for tax collection by the KRA, in a period of a diminishing tax base. This, in tandem, increases the compliance burden on taxpayers.

There is likely to be an increase in the number of TP audits, queries and information requests by the KRA to taxpayers. Subsequently, the number of TP disputes will keep on increasing owing to the fact that TP audits are quite onerous and subjective nature.

Therefore, taxpayers will need to evaluate their operations and maintain robust TP documentation to support their related party transactions and alleviate any TP risks.

Chege is Assistant Manager - Tax Advisory, PKF