Transfer Pricing and International Tax

Transfer Pricing and International Tax

Syllabus tag: KASNEB CPA | Advanced Level | CA35S1 Advanced Taxation

1. What is transfer pricing?

Transfer pricing refers to the prices charged in transactions between related parties (associated enterprises). When a Kenyan company sells goods or services to its foreign parent, subsidiary, or sister company, it must charge a price that reflects what independent parties would agree — the arm's length price.

If related parties set prices that deviate from arm's length, profits can be shifted from high-tax to low-tax jurisdictions, eroding the tax base.

2. The arm's length principle

Enshrined in Article 9 of the OECD Model Tax Convention and adopted in Section 18(3) of Kenya's ITA. The arm's length standard requires that prices in controlled transactions be the same as prices that would be charged between independent parties dealing at arm's length in comparable circumstances.

3. Transfer pricing methods (OECD)

Traditional transaction methods:

• Comparable Uncontrolled Price (CUP): compares the price in the controlled transaction with prices in comparable uncontrolled transactions. Most direct method — preferred where reliable comparables exist.
• Resale Price Method (RPM): starts from the resale price charged by the distributor to independent customers; deducts a gross margin to arrive at the arm's length price.
• Cost Plus Method: adds an appropriate mark-up to the supplier's costs.

Transactional profit methods:

• Transactional Net Margin Method (TNMM): compares the net profit margin of the controlled transaction with comparable uncontrolled transactions.
• Profit Split Method: splits the combined profit of associated enterprises in proportion to contributions.

4. Documentation requirements in Kenya

The Income Tax (Transfer Pricing) Rules 2006 require companies with related-party transactions to maintain contemporaneous documentation demonstrating that their transactions are arm's length. The KRA may request this documentation and make transfer pricing adjustments where it is satisfied that the prices are not arm's length.

5. Country-by-Country Reporting (CbCR)

Following BEPS Action 13, Kenya requires large multinational groups (consolidated revenue above KES 90 billion — equivalent to approximately EUR 750 million) to file a Country-by-Country Report with the KRA. The CbCR discloses: revenue, profit before tax, income tax paid and accrued, employees, and stated capital for each tax jurisdiction where the group operates.

6. Advance Pricing Agreements (APAs)

A taxpayer may enter into an APA with the KRA to agree in advance the appropriate transfer pricing methodology for future transactions, providing certainty and reducing the risk of disputes. APAs reduce compliance costs for large groups with complex intercompany transactions.