The High Court in Nairobi has stopped the Kenya Revenue Authority (KRA) in its efforts to widen taxation of cross-border consultancy and management fees paid by multinational firms operating in Kenya.
The setback follows a court decision blocking the collection of Sh179.9 million in withholding tax from global advisory firm McKinsey over payments made to its South African affiliate.
In a ruling with potential implications for multinational companies operating in Kenya, the court upheld a 2021 Tax Appeals Tribunal decision that exempted the payments from withholding tax under the Kenya-South Africa Double Tax Agreement (DTA).
The court ruled that the consultancy fees paid by McKinsey’s Kenyan branch to a related South African entity constituted ‘business profits’ under the treaty.
It said the fees could only be taxed in Kenya if the South African company had a permanent establishment in the country.
The court found that the South African entity had no permanent establishment in Kenya, effectively shielding the payments from local taxation.
‘The Commissioner’s approach in the interpretation of the DTA is overly formalistic and ignores principles of international tax law,’ the court said, dismissing the KRA’s appeal.
According to the court, Kenya could not impose taxes that were not expressly provided for in the Kenya-South Africa Double Tax Agreement, stressing that the government was bound by the terms it negotiated and signed with South Africa.
The Kenya-South Africa Double Tax Agreement was signed in November 2010 and became effective from January 1, 2016. This was after years of negotiations aimed at eliminating double taxation and reducing tax barriers for companies and investors operating between the two countries.
The treaty allocates taxing rights between Kenya and South Africa on income earned through cross-border trade, investment and professional services, such as business profits, dividends, royalties and management fees, while also seeking to prevent fiscal evasion and provide certainty for cross-border trade and investment.
The dispute pitted the KRA’s Commissioner of Legal Services and Board Coordination against McKinsey and Company Inc Africa Proprietary Limited, the African arm of the global consulting giant.
KRA had demanded Sh179,956,998 in withholding tax arising from payments made in 2016 and 2017 for professional and management services rendered by McKinsey South Africa.
The tax authority argued that the fees did not qualify as business profits under Article 7 of the treaty and instead fell under the treaty’s ‘other income’ provisions, making them taxable in Kenya.
KRA also argued that the Tribunal had failed to distinguish between ‘income’ and ‘business profits’ and wrongly relied on the bilateral treaty to invalidate the tax demand.
But the court rejected those arguments and affirmed the Tribunal’s findings in full.
‘The Tribunal correctly applied the primary rule under Article 7 instead of the default residual rule of Article 22,’ the judge ruled.
The court said professional and management fees generated through business activity fall within the meaning of business profits under the treaty.
It further held that Kenya could not seek taxing rights that were not expressly negotiated into the treaty.
‘The court cannot rewrite the treaty to give Kenya a right it bargained away,’ the judge said, adding that Kenya deliberately omitted provisions allowing taxation of management and technical service fees when negotiating the Kenya-South Africa tax treaty.
The court noted that while Kenya has included clauses allowing taxation of management and technical service fees in some other tax treaties, it failed to secure similar provisions in this agreement.
Hence, it could not later ask the courts to expand its taxing powers beyond the treaty’s wording.
McKinsey and Company is among the world’s largest management consulting firms, advising governments, banks, telecoms firms, manufacturers and multinational corporations on strategy, digital transformation, operations and public-sector reforms.
In its defence, the company cited the treaty and said the payments constituted business profits under the Kenya-South Africa Double Tax Agreement and were therefore not taxable in Kenya because the South African service provider had no permanent establishment locally.
McKinsey also argued that Kenya deliberately excluded provisions allowing taxation of management and technical service fees when negotiating the treaty and could not later seek rights outside the agreement.
The firm established its Nairobi office more than a decade ago and has expanded its East African advisory business across sectors including financial services, energy, agriculture, healthcare and infrastructure.
Court records showed that the Kenyan branch involved in the dispute was part of a South African holding structure.
However, the consulting services were provided by a separate South African entity that the court found had no taxable presence in Kenya.
The court noted that McKinsey had previously paid withholding tax for the 2014 and 2015 financial years before the Kenya-South Africa treaty took effect.
The dispute only arose after the treaty became operational. The court said the absence of specific treaty clauses allowing Kenya to tax management fees reflected a deliberate policy choice during treaty negotiations.
It observed that Kenya had included such provisions in some other double taxation agreements but failed to do so in the South African treaty.
The court also faulted KRA for attempting to rely on broad interpretations that could undermine the purpose of bilateral tax agreements.
‘Before taxing such income, the Commissioner should not be asking whether there is a specific Article for professional or management fees but rather whether that income is from a business activity,’ the court said.