The introduction of the income tax (transfer pricing) rules in 2006, brought an increased focus on transfer pricing by the Kenya Revenue Authority.
For many taxpayers, the question of the transfer pricing rules on their business, what the revenue authorities look out for in a TP audit and the impact of TP on other tax areas such as customs valuation remain a matter of great complexity.
As per the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, updated July 2010 (“the OECD guidelines”), transfer prices are the prices at which an enterprise transfers physical goods and intangible property or provides services to associated enterprises.
Transfer pricing is the process of finding an appropriate price for transactions between associated enterprises.
The price should reflect the arms-length principle.
The arm’s-length principle of transfer pricing states that the amount charged by one related party to another for a given product must be the same as if the parties were not related.
Where KRA is not satisfied with the transfer price applied in a transaction between a resident person and an associated enterprise, the transfer price may be adjusted.
An adjustment of a transfer price will have an impact on the income and expenses, and therefore taxable profits, of not only the resident person in Kenya but also the associated enterprises in the other tax jurisdictions.
A resident person is required by the Income Tax Transfer Pricing Rules, 2006 (TP rules) to maintain documentation of its transfer pricing policies for transactions with not-resident associated enterprises.
In the event of a tax audit by KRA, this document will usually be the starting point for the KRA.
The TP rules apply to transactions between associated enterprises within a group, where one enterprise is located in, and is subject to tax in Kenya, and the other is located outside Kenya.
An associated enterprise is one or more enterprises whereby one of the enterprises participates directly or indirectly in the management, control or capital of the other; or a third person participates directly or indirectly in the management, control or capital or both.
An entity would be said to have control over the other where it holds 25 per cent or more of the shares or voting power of the other entity. The rules also apply to transactions between a branch and its head office or related branches.
Since the introduction of the TP rules in 2006, the KRA is now more sophisticated in its audits of transfer pricing for multinational enterprises.
Key areas of consideration during audits include management services, capital expenditure equipment sold to or bought from related parties, head office or holding companies located in low tax jurisdictions and customs valuation of goods.
Kenya is fast becoming a hub for the management of company operations in the East African region.
As a result, entities that operate in multiple countries in the region provide goods and services to each other including shared services centres, central management offices, products and intellectual property.
As KRA seeks to improve tax efficiency and thereby increase its tax collections, multinational enterprises, in particular, need to be concerned with the transfer price applied on the supply of goods and services between associated enterprises and take steps to mitigate unfavourable audit conclusions by being prepared and aware of areas of concern to the KRA and how TP adjustments may affect business operations.
Emi-Beth Amable is a Tax Consultant with PwC Kenya.