Like many other countries, Kenya has transfer pricing rules designed to stem substantial tax revenue loss that may result from multinationals inaccurately accounting for profits related to cross-border transactions.
As such, one would expect the transfer pricing rules to adequately address the complexities of transfer pricing.
However, a critical review of the current Kenyan transfer pricing rules reveals that these rules inadequately address the real complexities of transfer pricing.
This is probably because the rules were hurriedly drafted after KRA lost the Unilever case in late 2005. At that time, the KRA had little knowledge of transfer pricing.
However, in the three years since the rules were published, while KRA has obviously built up its transfer pricing knowledge there has not been any high profile case to test these rules nor has KRA publicly issued any guidance on transfer pricing.
So what are the shortfalls and ambiguities of the current rules?
A Unilever tea estate. Transfer pricing rules were hurriedly drafted after KRA lost the Unilever case on the issue in 2005. [PHOTO: FILE] |
The current transfer pricing rules should be commended for clarity in certain areas. Paragraph 2 clearly identifies related enterprises – persons who must comply with the transfer pricing rules.
Paragraph 10 clearly states that these persons shall "develop an appropriate transfer pricing policy……. and ……. determine the arm’s length price as prescribed under the guidelines provided".
Paragraph 9(1) of the rules empowers the Commissioner to request (demand) for "information, including books of accounts and other documents relating to transactions where the transfer pricing is applied."
Paragraphs 9(2)(a)-(g) clearly list the "other documents" a taxpayer must maintain or have readily available. Paragraph 6(f) ensures that all controlled transactions are subject to the transfer pricing rules. These are all good starting points for a sound legislation.
material change
However, there are shortfalls even in these definitions: The rules are silent as to how current this documentation should be or how often it should be prepared.
Given that the cost of preparing transfer pricing documentation can be quite high, other revenue authorities have provided guidance as to how often these documents should be prepared.
This omission on KRA’s part is actually a double-edged sword because a taxpayer can, by reading the law, update their transfer pricing documentation as often as they wish.
On the other hand, the KRA could argue that documentation must be current and relevant.
What then is current and relevant? The rules are silent on that too!
However, most practitioners would agree that transfer pricing documentation is current if there has not been any material change to the facts and circumstances surrounding the controlled transaction(s).
The practice in most countries is to prepare comprehensive transfer pricing documentation every three years, while reviewing the adequacy of the documentation each year. The rules fall short in a few other areas. They are silent on the penalties for failure to prepare and/or furnish the transfer pricing documentation and penalties for errors in valuation of the transfer price.
The transfer pricing laws in many countries specify penalties for failure to prepare documentation.
In such regimes, it is generally accepted that documentation provides penalty protection even if it’s wrong, provided there was no intent on the taxpayer’s part to defraud the government.
It is more than likely that KRA would argue that the penalty provisions under sections 72 and 72(a) of the Income Tax Act apply to transfer pricing.
cut and paste
The rules could definitely be clearer. Some practitioners have called the current transfer pricing rules a "cut and paste" job. This is easy to see when one looks at the rules and especially s. 7 which stipulates the methods a taxpayer can use to price transactions with related parties.
The rules mirrors the five methods stipulated by the OECD Guidelines for tangible goods, intangibles and services. Paragraph 7(f) makes interesting reading for transfer pricing practitioners.
This sub-section cheekily reserves the right to apply other methods (commonly referred to as "unspecified methods") by the Commissioner. Surely, this must be a typo! Must a taxpayer seek the Commissioner’s permission to use an unspecified (yet reasonable) method? If so, then the Commissioner is duty bound to publish his list of "other methods" at the beginning of each year. Again – more clarity would be beneficial.
