Global Tax Alert | 29 August 2013

Kenya Revenue Authority invokes force of attraction rule with respect to permanent establishments

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Kenya Revenue Authority invokes force of attraction rule. A trend has emerged within the Kenya Revenue Authority, to target the permanent establishments (PEs) of various Multinational Enterprises (MNEs) located in Kenya.

Normally, and in line with international tax practice, the arm’s length principle (ALP) embodied in the OECD Model Guidelines on Transfer Pricing, should dictate the extent to which business profits of MNEs should be liable to taxation in either the resident State or the State where the PE is located. The ALP requires that the profits attributable to a PE to be those which would be earned by the establishment if it were a wholly independent entity dealing with its head office as if it were a distinct and separate enterprise operating under conditions prevailing in the regular market.

Kenya has nine Double Taxation Agreements (treaties) in place whose provisions heavily draw from the OECD Model Convention. These treaties are with the following countries: Germany, United Kingdom, Sweden, Norway, Denmark, Canada, India, Zambia and more recently, France. In spite of the expectation under the OECD model convention that only profits derived or accrued from Kenya and attributable to the permanent establishment should be taxed, there has emerged a trend to bring into the ambit of Kenyan taxation rights more than would normally be attributable to the PE.

According to the Kenya Revenue Authority (KRA), where the head office of the PE or other related enterprises within a group accrues income from Kenya in relation to the PE, such income would be subject to tax in Kenya. The KRA has argued that the PE, were it an independent entity, would have had the opportunity to make profit from the transactions that its foreign related parties had undertaken in Kenya. However, by virtue of its relation with the head office and its other affiliates it has passed off the opportunity to those related entities while playing a key role in generating income. As a result, KRA is pursuing taxation of that income which is derived or accrues from Kenya.

In essence, the KRA has introduced the “force of attraction” rule in Kenya. Under the rule, where a multinational enterprise carries out business in Kenya through a PE, such MNE will be taxed not only on its business profits attributable to the PE but also on profits that relate to the PE but arise from activities conducted outside Kenya. This income will therefore be “attracted” to the PE. A substantial number of tax assessments have been issued on this basis with no resolution as yet.

This approach creates great uncertainty for taxpayers. This is particularly so, in light of the fact that the tax authority does not have to ascertain whether or not the transactions in question relate to the PE and whether income was attributable to the PE. In the case of treaty countries it might be possible to address the problem through the Mutual Agreement Procedures (MAP), however this is clearly not possible with non-treaty countries.

MNEs with PEs in Kenya should therefore evaluate the activities of the PE as well as transactions undertaken by the head office and other group companies for purpose of either quantifying their exposure or re-arranging their mode of operations.

For additional information with respect to this Alert, please contact the following:

Ernst & Young (Kenya), Nairobi
  • Jemimah Mugo
    +254 20 271 5300
    jemimah.mugo@ke.ey.com
  • Geoffrey G. Karuu
    +254 20 271 5300
    geoffrey.g.karuu@ke.ey.com
Ernst & Young Advisory Services Ltd, Johannesburg
  • Justin Liebenberg
    +27 11 772 3907
    justin.liebenberg@za.ey.com

EYG no. CM3770