Tax Treaties and Double Tax Relief
International
Tax Treaties and Double Tax Relief
Syllabus tag: KASNEB CPA | Advanced Level | CA35S1 Advanced Taxation
1. Why double taxation arises
A person or company may be taxed twice on the same income — once in the country where the income arises (source country) and once in the country of residence. This discourages cross-border trade and investment.
Example: a Kenyan company earns dividend income from a South African subsidiary. South Africa may withhold tax on the dividend; Kenya may then tax the same dividend as part of the Kenyan company's income.
2. Tax treaties — bilateral agreements
Kenya has signed Double Tax Agreements (DTAs) with a number of countries including: Zambia, Germany, France, United Kingdom, India, Canada, Sweden, Norway, Denmark, Qatar, UAE, and Mauritius. DTAs allocate taxing rights between the two states and provide mechanisms for relief.
DTAs follow the OECD Model Tax Convention or the UN Model (more common in developing countries, preserves more source-state taxing rights).
3. Key provisions of a DTA
Residence and permanent establishment (PE): defines when a non-resident has a taxable presence in the source state. A PE includes: a fixed place of business (office, branch, factory), a construction project lasting more than a specified period, and a dependent agent.
Reduced withholding tax rates: treaties typically reduce the domestic WHT rates. For example, a DTA might reduce Kenya's domestic 15% dividend WHT to 5% for a qualifying recipient.
Elimination of double taxation methods:
- Exemption method: income taxed in the source state is exempt in the residence state
- Credit method: income is taxed in both states, but the residence state gives a credit for tax paid to the source state (most common in Kenya's treaties)
4. Kenya's unilateral relief
Where no DTA exists, Kenya grants unilateral double tax relief under Section 31 of the ITA. A credit is given for foreign tax paid on foreign-sourced income, limited to the Kenyan tax that would have been charged on that income. This prevents full double taxation even without a treaty.
5. Treaty shopping and anti-avoidance
Treaty shopping occurs when a person routes transactions through a treaty country to obtain reduced WHT rates they would not otherwise be entitled to. The OECD's BEPS Action 6 (prevention of treaty abuse) introduces the Principal Purpose Test (PPT) — a treaty benefit will not be granted if obtaining it was one of the principal purposes of the arrangement.
6. The OECD Multilateral Instrument (MLI)
Kenya has signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (MLI). The MLI modifies existing tax treaties simultaneously to incorporate BEPS measures without requiring bilateral renegotiation of each treaty.