The National Treasury has expanded the list of transactions to be checked for prices charged by multinational firms when trading with subsidiaries within the same company, signalling deeper scrutiny by the Kenya Revenue Authority (KRA).
New regulations published by National Treasury Cabinet Secretary John Mbadi showed that the KRA will now check at least 25 items on transfer pricing transactions between related divisions, subsidiaries, or affiliates of the same multinational company, marking a sharp increase from the past when about 10 areas were covered.
‘The object and purpose of these rules are to provide guidelines for determining arm’s length prices for transactions between related persons,’ Mr Mbadi said. Transfer pricing is an accounting practice used to determine the prices charged for transactions between related divisions, subsidiaries, or affiliates of the same company.
It’s commonly used by multinational corporations to allocate costs, revenues, and profits across different parts of the organisation while complying with tax regulations.
However, there are concerns that some multinationals misuse the provision to alter taxable income and cut their overall taxes.
The recently published rules on transfer pricing give KRA access to detailed information on related-party pricing, contracts, financial statements and the basis used by companies to determine whether their transactions are conducted at arm’s length.
The updated rules require companies to provide the taxman with information for each category of controlled transaction (which refers to transactions between related entities), including the parties involved, transaction value, settlement currency, contractual terms and the trading model.
‘The level of detail prescribed for transfer pricing information and supporting documentation signals the KRA’s continued, and intensifying, focus on transfer pricing as an audit and revenue mobilisation priority,’ experts at law firm Bowmans Kenya said in a commentary.
‘Collectively, the enhanced documentation requirements substantially increase the compliance burden for taxpayers and reflect a shift towards a more rigorous and evidence-based transfer pricing regime. Taxpayers should review their existing transfer pricing processes and documentation frameworks to ensure they can meet the increased disclosure and substantiation requirements.’
The new framework shifts transfer pricing compliance beyond simply declaring related-party transactions, requiring multinationals to maintain detailed evidence showing why the prices used in their cross-border dealings are commercially defensible.
The increased disclosures will give KRA a more detailed basis for testing whether prices used in transactions between related companies reflect what independent parties would have agreed.
The changes come on the back of KRA having already identified inter-company loans and royalty payments as sensitive areas in its transfer pricing reviews, amid concerns that inflated financing costs and royalty charges can reduce taxable profits in Kenya.
KRA said in March this year it was going to enhance focus on taxpayers whose declared profits do not match expected taxable income.
Under the updated rules, multinationals will also have to disclose intra-group payments and receipts broken down by the tax jurisdiction of the foreign payer or recipient, as well as the identities of connected persons and their relationships.
The rules state that the KRA commissioner may, where necessary, request a company for ‘books of accounts and other documents relating to transactions where transfer pricing is applied.’
The companies will also have to provide KRA with analysis showing the functions performed, risks assumed, and assets used by the Kenyan entity and its related parties.
Firms must also provide details of comparable transactions, the process used to identify them, the reasons for rejecting potential comparables, and an explanation of how the transfer pricing method was selected.
The rules expand the scope of transactions covered to include long- and short-term borrowing and lending, guarantees, marketable securities, advances, receivables and other debts. They also cover insurance and reinsurance, business restructurings, cost distribution arrangements and derivatives.
In addition, companies must provide audited financial statements, financial statements of transaction counterparties, segmented reports and schedules showing how financial information used in transfer pricing calculations relates to their annual accounts.
The rules also require companies applying arm’s-length pricing to develop an appropriate transfer pricing policy, determine the arm’s-length price in accordance with the rules, and provide documentation supporting their analysis when requested by KRA.
Any tax due and unpaid in a transfer pricing arrangement will be treated as additional tax under the Tax Procedures Act, exposing affected firms to penalties.
‘The provisions of the Tax Procedures Act relating to fraud, failure to furnish returns and underpayment of tax shall apply to transfer pricing,’ read the new rules.