In today’s global economy, where multinational companies do business in different geographical and tax jurisdictions, the need for arm’s length pricing of related party transactions is a growing concern for revenue authorities.

Tax bodies are increasingly requiring multinationals to document their related party transactions. Where these transactions are not well documented and the pricing justified, the revenue authorities make adjustments to the company’s income, giving rise to additional tax liability.

These documentation requirements, coupled with the additional tax burden arising from revenue adjustments, have led to the growth of advance pricing agreements (APAs).

Recently, the Kenya Revenue Authority Large Taxpayers Office commissioner Pancrasius Nyaga told a Kenya Association of Manufacturers meeting that the authority will start entering into APAs with taxpayers.

This is part of the KRA’s proposed changes to the current transfer pricing legislation to align it with the Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) initiative.

An APA is an agreement made in advance between a taxpayer and a tax authority on the prices charged on transactions between the taxpayer and related entities. Generally, the agreement describes the nature of transaction, pricing model adopted, records that must be maintained and the reporting responsibilities.

APAs deliver certainty both to the taxpayer and tax authority on the tax outcome of the taxpayer’s related party transactions. This is achieved by agreeing in advance the arm’s length pricing that will apply to the taxpayer’s international transactions.

Generally, there are three broad ways in which an APA can be structured: Unilateral APAs, bilateral APAs and multilateral APAs.

A unilateral APA is agreed upon by a tax authority and a taxpayer within its tax jurisdiction. But it may affect the tax liability of associated enterprises in the other jurisdictions.

This agreement is best suited to situations where it is unnecessary to involve another tax authority in the APA process, or where the transfer pricing method to be adopted poses little tax risk for the parties involved.

Unilateral APAs take a relatively shorter time to complete due to the involvement of only one tax authority.

Bilateral APAs are entered into through a mutual agreement between two tax authorities in the different countries. In most cases, this type of agreement will be entered into where there exist other tax treaties such as double taxation agreements between the countries involved in the controlled transaction.

The bilateral agreement ensures that there is no double taxation in respect of the transactions covered by the APA.

Multilateral APAs, on the other hand, are entered into by a taxpayer and more than two tax authorities. Such agreements take a long time to finalise due to the involvement of several tax authorities with conflicting views and interests.

Although KRA has not indicated the kind of APAs that it intends to enter into, its willingness to negotiate with taxpayers is a step in the right direction.

APA processes are well established in developed countries that have been playing the transfer pricing game for a long time. The US has the most advanced APA system, and more countries are adopting its process in formulating their APAs.

The concept of APAs is spreading in the emerging markets and countries such as India, China and Mexico. These countries have amended their legislation to incorporate APAs. India and Mexico have adopted the OECD guidelines in the formulation of their APA programmes, but have also borrowed heavily from the developed countries such as the US, Germany and the United Kingdom.

Taxpayers who have an APA in force are required to submit an annual report to the tax authority confirming the facts under which the APA was issued, a copy of the financial statements for the period under review and the annual tax return to ensure compliance with the terms of the APA.

In Africa, there are currently no countries that have APAs or provide for such in their legislation. Most of the tax authorities have rejected the requests by taxpayers to negotiate APAs.

Given the general reluctance by other countries in the region, KRA’s decision to pioneer the APA process in Africa is a bold step in bolstering the country’s appeal as a foreign investment destination.

Multinational companies that have a presence in Kenya stand to benefit from the adoption of the APA programme due to the certainty that APAs provide on the taxation of related party transactions.

The APAs will also reduce the risk of additional assessments and penalties arising from transfer pricing adjustments, as the transaction prices are agreed in advance with KRA.

KRA also stands to benefit from the APA programme, as it guarantees certainty on tax collection and will reduce the time the authority takes to carry out transfer pricing audits, which can take several years to conclude.

Although most tax authorities in Africa are reluctant to jump onto the APA bandwagon, increasing pressure from taxpayers and the uptake of APAs by other developing countries may force them to rethink their current stance.

Titus Nguhiu is senior tax advisor at KPMG Kenya. The views expressed here are his own.