TAXATION OF CROSS BORDER ACTIVITIES

These are the various transactions or activities that are exercised by a Kenyan resident in another country and vice verse.
The issue here is: how the income earned or derived from such transactions is brought to charge?
The taxation of income of a person is based on the concept of residence.

Double Taxation Treaty in Kenya Sec. 41 42 (D.T.A)

Resident Kenyans are taxed on world wide employment income. For non-resident tax is charged on income which is deemed to
have occurred in Kenya. Non-residents with investments or incomes accruing from Kenya may be taxed twice, i.e. in Kenya and
in their country of origin.
To avoid this double taxation sec 41 of I.T.A deals with double taxation treaty or agreement D.T.A which is a bilateral
agreement between the Kenya country and other countries seeking to set out the implications and avoidance of double taxation.
Where a taxpayer is supposed to pay tax in Kenya and his country, he will be granted a tax relief or credit on t ax payable in
Kenya if his country of origin has a D.T.A with Kenya.

Currently, D.T.A exist between Kenya and a number of countries, which include UK, Denmark, Germany, Malawi, Zambia,
Switzerland, Canada, Italy, India, Sweden, and Norway. D.T.A with Tanzania and Uganda existed up to 1977 and was withdrawn
in 1978 by repealing sec. 41 of the I.T.A that deals with special arrangement for relief of double taxation treaty between
Kenya and other countries. D.T.A is intended to reduce tax liability and if D.T.A exists between Kenya and other countries
the tax payable in that other country can be offset against tax payable in Kenya. D.T.A in granted for the following reasons.
 Facilitate exchange of technology in commerce and industry without making investors feel that they’re overburdened with
double taxation.
 Facilitate exchange of qualified technical personnel without over burdening the persons with heavy taxation due to double
taxation.
 To make domestic legislation comparable with other countries with which Kenya has D.T.A. this is done provided that the
tax rate and tax relief in other countries do not exceed that of Kenya.

The double taxation relief is calculated as follows:

Foreign tax on foreign income xxx
Kenyan tax on foreign income xxx
(whichever is lower shall be the double tax relief)

Example-Individual Income:
Joan Smith who is a Kenyan, served in an employment in the UK for 4 months for which she was
paid a total of £ 4,000. She later moved to Kenya where she joined Unilever Kenya that paid her a
salary of ksh. 2,400,000 for the year 2020.

The UK authorities charged Joan a tax on her pay amounting to £600.

(Assume that the forex rate applicable to the above case is ksh 140 per pound sterling)

Required:
Calculate the amount of double tax relief due to Joan for the year 2020
Conditions under which Tax Credit/Relief is granted
 Approve that tax was actually paid in that other country with which Kenya has D.T.A
 The tax deducted in that country is not more than the tax that would have been paid in Kenya.
 The time limit for making the claim must be within 6 years since that tax liability was marked.

Implications of Double Taxation Agreement

 Exchange of qualified technical expertise
 Increased labour mobility between the two countries
 Transfer of technology from one country to Kenya
 Increased trade between the two countries
 Removal of any trade barriers e.g. tariffs and quotas
 Promotion of investments since D.T.A reduces the tax liability and increases the disposal income available for investment
 There will be savings in foreign exchange currency.

Most favoured Nation “Status Concept”

This is where once country in a particular region in given a preferal tax treatment by another country. The county that is
favoured is considered as a strategic trading partner. Usually new rules regarding the flow of trade between the two countries
are introduced e.g China is given the most favoured status by the U.S.A. The items of this status are:
 To facilitate trade between the two countries
 Ensure faster exchange of goods and services
 Foster economic co-operation
 Facilitate exchange of technical expertise and invest most in the two countries.

COMESA Tax Treaty

COMESA in an economic integration standing for Common Market for East and Southern African Countries. Its members
include: Egypt, Kenya, Zambia, Botswana, Uganda, Malawi, Mozambique. The COMESA Tax treaty is an agreement among the
countries, which call for the reduction of tariffs between the member countries with the objective of achieving a uniform
custom tariffs or a Zero rate tariffs. However, this treaty has not been respected by several member countries thus creating
serious problems in trade. (Kenya and Egypt, Tanzania pulled out). The benefits that might accrue from this tax treaty include
 Increased trading between the member countries
 Increased labour mobility and investment among the countries.
 Prevention of tax evasion and fraud since custom tariff would be uniform
 Fostering economic corporation and growth
 Prevention of economic smuggling across the borders
 Foster exchange of goods and services including technical expertise

Disadvantages of Trade Treaties

 Loss of revenue to the government. This may lead to increased taxation on the citizens of the country to compensate for
lost revenue.
 Loss of economic sovereignty of the country e.g. a country may pursue fiscal, monetary and economic policies to fulfill
the conditions necessary for economic integration instead of its economic growth.
 Collapse of local industries due to increased importation of goods, especially where one country in trading partners.
(Egypt, South Africa, Kenya).
 It could lead to dumping of goods.

THE EAST AFRICAN COMMUNITY

The East African Community (EAC) is the regional intergovernmental organisation of the Republics of Kenya, Uganda, the
United Republic of Tanzania, Republic of Rwanda and Republic of Burundi with its headquarters in Arusha, Tanzania.

The Treaty for Establishment of the East African Community was signed on 30 November 1999 and entered into force on 7
July 2000 following its ratification by the original three Partner States – Kenya, Uganda and Tanzania. The Republic of
Rwanda and the Republic of Burundi acceded to the EAC Treaty on 18 June 2007 and became full Members of the Community
with effect from 1 July 2007.

Mission and Vision

The Vision of EAC is a prosperous, competitive, secure, stable and politically united East Africa; and the Mission is to widen
and deepen Economic, Political, Social and Culture integration in order to improve the quality of life of the people of East
Africa through increased competitiveness, value added production, trade and investments.

The EAC's core values are:

• Professionalism
• Accountability
• Transparency
• Teamwork
• Unity in Diversity
• Allegiance to EAC ideals
Aims and Objectives
The EAC aims at widening and deepening co-operation among the Partner States in, among others, political, economic and social
fields for their mutual benefit. To this extent the EAC countries established a Customs Union in 2005 and are working towards
the establishment of a Common Market in 2010, subsequently a Monetary Union by 2012 and ultimately a Political Federation
of the East African States.

Importance of the customs union

The key aspects of the customs union include:

1. a Common External Tariff (CET) on imports from third countries;

2. duty-free trade between the member states; and
3. Common customs procedures.

Withholding tax provisions

Income subject to withholding tax or tax at source for non-resident persons
Certain incomes derived from Kenya and paid to non-residents with no permanent establishment in Kenya are taxed at source
at special non-resident tax rates as follows:

WITHHOLDING TAX RATES

Tax Rates Non-Residents
Residents
Payments Notes % %

Dividends 5% 10%
Interest – Housing Bonds (a) 10% 15%
- other sources (b) 15% 15%
Insurance Commission (c )
- Brokers 5% 20%
- Others 10% 20%
Royalties 5% 20%
Pension and retirement annuities (d) 0%-25% 5%
Management and professional fees (e) 5% 20%
Sporting or entertainment income 20%
Real estate rent 30%
Lease of equipment 3% 15%
Contractual fee (e) 3% 20%
Telecommunication service fee (f) 5%

Note:
a) Qualifying interest in respect of Housing Bonds is limited to Kshs. 300,000 per year.
b) Withholding tax on interest income received by a resident individual from the following sources is final:
 Banks or financial institutions licensed under the Banking act.
 Building societies licensed under the Building Societies Act.
 Central Bank of Kenya.
c) Commissions payable to non-resident agents for purposes of auctioning horticultural produce outside Kenya are exempt
from withholding tax.
d) Tax deducted at source on withdrawals from provident and pension schemes attainment of the age of 50 years, or upon
earlier retirement on health grounds is final.
e) Withholding tax on payments to resident persons for management and professional fees applies to payments of Kshs,
24,000 or more in a month to both registered to citizens of the East African Community partner states is 15%.
f) The tax is subjected to payments made to non-resident telecommunication service providers and is based on gross
amounts
Note: various reduced rates of withholding tax apply to countries with double tax relief treaties with Kenya.

The incomes of the non-residents are taxed at gross, that is, no expenses are allowed against the income.
The withholding tax must be remitted to the Domestic Taxes Department within 20 days of its being deducted. There is no
further tax for the non-resident after the withholding tax is paid as far as our country is concerned.

Transfer pricing
Transfer pricing for goods or services is important in international taxation and will be subject to specific laws. Transfer
pricing is widely in use by multinational entities, which are involved, in international trade in several countries.
Laws guiding multinational corporations ensure that transfer pricing is not abused because several nations have a tax interest
in their operations. There is a pending bill in parliament regarding Transfer pricing and the tax implications for multinational
companies.

Transfer pricing is a problem of apportioning taxable income among various jurisdictions where an enterprise engages in more
than one country or its belongs to a group of companies that are as international trade and as old as the existence of tax
boundaries. It is an issue that may arise in relation to any type of income, such as the purchase or sales of goods, the provision
of services, the payment of royalty fees and of interest on loans for instance.

The real culprit is transfer pricing manipulation; a phenomenon discouraged by governments. The fixing of prices based on
non-market criteria results in saving company tax by shifting accounting profits from high tax to low tax jurisdictions. This
amounts to moving one nation’s tax revenue to another.

Transfer pricing also leads to balance of payments distortions between the host country and home country bordering on
undermining sovereignty of the hose nation.

Transfer pricing has become a critical consideration in location of production as well as employment because multinational
corporations tend to open subsidiaries in countries where production is most profitable and the tax burden is less. Therefore,
a country with no transfer pricing controls would be most attractive to foreign investors. It is for the reason that the Asiatic
locations of Hong Kong and Singapore have succeeded in attracting foreign direct investments.

Most countries enforce tax laws based on the arms length principle as defined in the Organizations are based on the (OECD)
model. The following methods or definitions are based on the OECD guidelines:

i. Uncontrolled price method (CUP)

This method compares the price at which a controlled transaction is conducted to the price at which a comparable uncontrolled
transaction is conducted.

ii. Cost plus method (CP)

Is a method generally used for the trade of finished goods and determined by adding an appropriate mark -up to the costs
incurred by the selling party in manufacturing/purchasing goods and services provided with the appropriate mark -up being
based on the profits of other companies comparable to the tested party.

The methods is generally accepted by the tax customs authorities, since it provides some indication that the transfer price
approximates the real cost of item.

iii. Resale price method (RP)

This method is similar to cost plus method except it is found by working backward from transactions taking place at the next
stage in the supply chain, and is determined by subtracting an appropriate gross mark -up from the sale price to an unrelated
third party with the appropriate gross margin being determined by examining the conditions under which the goods or services
are sold and comparing said transactions to other third party transactions.

iv. Profit split method (PS)

Is the method applied when the businesses involved in the examined transaction are too integrated to allow for separate
evaluation and so the ultimate profit derived from the endeavour is split based on the level of contribution of each of the
participants in the project.
If, for example, Company A sent three researchers to its subsidiary to aid in the development of a product designed for use
in country X while the subsidiary allocated six identically compensated researchers to aid in the development of the product,
then we would expect that the subsidiary pays 3/6 that is 50% of the ultimate profits as a royalty frr for the technical
knowledge provided by Company A’s researchers.

v. Transactional net margin method (TNMM)

Is a method that uses arm’s length operating profit – that is earnings after all operating expenses, including overhead, but
before interests and taxes earned by one of the entities in the transaction. Relative operating profit relative to sales, costs
or assets allows comparisons between different transactions and is a more robust measure of an arms length result.
Other available method include advance pricing agreement between the tax authorities and the tax payer and also mutual
agreement procedure for purpose of relief from international tax grievances.

SUMMARY
 A resident individual is taxed on worldwide employment income while a non-resident individual will be taxed on the
income accrued in or derived from Kenya.
 Countries are encouraged to negotiate double taxation agreements to be able to agree on preferential tax rate and
as such help to improve trading relations.
 Transfer pricing is a concept that regulates the prices between related entities or transactions. The transfer pricing
rules were introduced in Kenya in 2005.