Businesses that are under a common ownership and control don’t always use the same prices for goods and services. A multinational company with subsidiaries and branches in different jurisdictions might have varying prices for similar goods and services.
For instance, Total Energies in Kenya might sell one litre of petroleum for $2 while the same amount is retailing at $2.50 in Uganda. How does Total Energies, the global multinational oil company, reach these prices? And how does this affect cross-border taxation? Let me introduce you to transfer pricing.
Transfer pricing is a term that describes how a business sets prices for internal transactions between related companies, like subsidiaries and foreign branches. In taxation, transfer pricing rules and policies prevent tax evasion through price manipulation and ensure fair pricing.
KRA outlines the transfer pricing rules in Kenya. For the longest time, businesses conducting trade activities in Kenya were governed by a transfer pricing policy enacted in 2006. In 2023, KRA updated the policy to match modern business needs and practices. This post explains the new transfer pricing rules 2023.
Transfer Pricing Rules 2023 Review: What Are the New Transfer Pricing Rules in Kenya
Kenya Revenue Authority updated the transfer pricing rules in 2023, and called the new rules the “Income Tax (Transfer Pricing) Rules, 2023.”
According to KRA, the purpose of these new rules is to “provide guidelines to be applied by related enterprises, in determining the arm’s length prices of goods and services in transactions involving them, and to provide administrative regulations, including the types of records and documentation to be submitted to the Commissioner by persons involved in controlled transactions.”
We will look into all these aspects later in this article to provide deeper insight into the new transfer pricing rules in Kenya.
Glossary of Significant Terms Used in the New Transfer Pricing Rules in Kenya
Here are the notable terms that KRA uses to outline the new transfer pricing rules:
- Related Enterprises: These are businesses that are connected through ownership. Examples are a parent company and a subsidiary, or two sister enterprises with a common owner or controller.
- Arm’s Length Prices: This is the price that an independent enterprise would pay in a transaction with an unrelated enterprise. It is used as a point of reference to create fairness when related companies are transacting with each other.
- Controlled Transactions: These are business deals between related enterprises.
- Transfer Pricing Method: This is the method or strategy used to compute a fair price for any transaction with a related enterprise.
- Comparable Transactions: These are similar business deals between unrelated enterprises that you can use to determine if your prices are fair.
Which Businesses Are Affected?
The transfer pricing rules don’t apply to every business. You should care about these rules if:
- Your Kenyan company sells goods or services to a branch or related company in another jurisdiction.
- Your Kenyan business buys goods or services from a related company outside Kenya.
- Your company borrows or lends money to a related company abroad.
- Your company shares costs and services with a related enterprise across borders.
- Your business deals with related companies in Export Processing Zones (EPZ).
Understanding The Arm’s Length Principle
The new transfer pricing rules can be summarized into one main message: the arm’s length principle. In a nutshell, the arm’s length principle dictates that when a business transacts with a related enterprise, the price must be fair and similar to what the company would charge an independent company. Other significant rules in the Income Tax (Transfer Pricing) Rules, 2023 include:
- Choose the most appropriate method to set fair prices.
- Maintain records and documents to show how you arrived at the prices.
- Present information to KRA when requested, such as agreements and financial data.
How to Set Fair Prices
KRA allows businesses to choose the best transfer pricing method for their particular situation. There are many ways to set fair prices, but we will focus on the two most popular methods. These are market comparison and cost plus margin. Let’s see how each method compares.
Market Comparison
The primary idea of setting fair prices in transfer pricing is to ensure prices match what unrelated businesses would agree on in similar circumstances. In market comparison, you charge an amount close to what you’d charge an independent company.
Cost Plus Margin
Normally, when a business produces and sells a product, it considers the production cost and desired profit margin to reach a fair price. For instance, if creating a product costs you Ksh. 1000 and you desire a 25% profit, you’d price it at Ksh. 1250. This is a good transfer pricing method even when dealing with a related enterprise.
Tip: If you are not sure of the method to use, consult a transfer pricing advisor or tax consultant.
Transfer Pricing Proof: Documents Required by KRA As Proof of Prices and Calculations
You are required to submit various documents to KRA upon request to validate your prices and calculations: These include:
- Contractual agreements with related companies.
- Invoices showing the paid or charged prices.
- Computations showing how you arrived at the set prices.
- Financial statements for your company and related enterprises.
- Quantity, price, and payment terms of bought or sold supplies.
- Comparison of your prices and market prices.
- Copies of other supporting documents, like transfer pricing policies and board approvals.
Consequences of Violating Transfer Pricing Rules
What happens when businesses don’t follow the new transfer pricing rules in Kenya? Below are the steps that KRA takes when a business violates the transfer pricing policies:
- Charge additional tax.
- Adjust your income to reflect what is considered a fair market value.
- Impose penalties and interests.
All these aspects can damage your business reputation, impact cash flow, and affect your profits.
Tips for Businesses to Remain Compliant with Transfer Pricing Rules
As a business affected by the new transfer pricing rules in Kenya, follow these tips to remain compliant:
- Regularly review all transactions with related enterprises.
- Ensure your prices are fair.
- Keep a record of all your transactions, documents, and calculations regarding transfer pricing.
- Ensure your finance department is continuously updated on changes in transfer pricing policies.
- Consult a tax advisor: Cross-border transactions are complex and intricate. Work with an international tax consultant to help abide by the transfer pricing requirements and rules.
Need Help Reviewing Transfer Pricing Policies in Kenya?
Transfer pricing policies are meant to ensure fairness in trade and proper taxation. It’s wise to stay on top of these rules to avoid surprises during KRA audits. If you need help reviewing transfer policies in Kenya, we are here for you. At Gichuri & Partners, we specialize in international tax services and transfer pricing advisory.
