BACHELOR OF LAWS (LL.

B)

TAX LAW: LECTURE NOTES

COURSE INSTRUCTOR: B.K.SANG

WEEK 13: INTERNATIONAL TAX PERSPECTIVES

14.1 International Tax?

 Do we have international tax?
 Taxation is jurisdictional i.e. each county has its own tax system defined by
its jurisdiction and rational tax laws – sovereignty.
 There is no treaty on international tax – double tax agreements are bilateral
agreements between countries aimed at tackling double taxation.
 International taxation is about how tax systems of sovereign states interact
with each other.

14.2 Double Taxation

 Double taxation arises when the same transaction, asset or income source
is subject to two or more taxing authorities.
 Double taxation arises when the taxing jurisdictions do not follow common
principles of taxation.
 One taxing authority may tax income at its source, while another may tax
income based on the residence or nationality of the recipient.
 Double taxation may arise where foreign investments are taxed in the host
county/county of origin and then again upon repatriation.
 For expatriates, income may be taxed at the county where they work (i.e.
where income is earned) and again at their home county.

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  In order to avert double taxation, countries enter into double taxation
agreements/treaties.
 Section 41 of the ITA allows the Cabinet Secretary for Finance to enter
into special arrangements with any country for purposes of affording relief
from double taxation.
 Relief from double taxation means a person may not be taxed on income
where the same income has been subjected to taxation in the country of
source i.e. the country where the income was earned.

14.2.1Double Taxation Treaties/Agreements

 Double taxation treaties are agreements entered between two countries
signed with the aim of eliminating the double taxation of income or gains
arising in one country and paid to residents of another country.
 Double taxation treaties provide a means where an individual whose
income that would normally be subjected to taxation in more than one
county, is granted relief from paying tax twice on the same income or
credit for tax paid in one country is given against a taxpayer’s liability to
tax in another county.
 Kenya has in place double taxation treaties with the following countries:
Zambia, Norway, Denmark, Sweden, UK, Germany, Canada, India,
Mauritius, France and Iran.
 Double taxation treaties are based on the OECD Model Tax convention,
which allocates taxing rights between the resident and source country to
eliminate double taxation where there are competing tax rights.
 The UN Model Tax convention is similar to the OECD Model Tax
convention and also serves as the model on which countries design tax
treaties.
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  Students are urged to have a look at the UN and OECD Model Tax
conventions – check their websites.
 The design of the UN or OECD Model Tax convention follows the plan of
chapters and each chapter has its own articles running in a sequential
manner.
 The convention has a standard design which may be amended by the
contracting states.
 Thus, the design of a double taxation treaty is summarized as follows:
 Title of the Agreement
 Preamble of the convention
 Chapter I: Scope of the convention
 Chapter II: Definitions
 Chapter III: Taxation of income
 Chapter IV: Taxation of capital
 Chapter V: Methods of elimination of Double Taxation
 Chapter VI: Special provisions
 Chapter VII: Final provisions

Title of the Agreement

 This would be, “Convention between (State A) and (Stat B) with respect to
Taxes on Income and Capital” (usually the double tax treaties are in
respect of income and capital).
 There is a widespread practice of including in the title a reference to either
the avoidance of double taxation or to both the avoidance of double
taxation and the prevention of fiscal evasion

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 Preamble of the Convention
 The preamble convention is drafted in accordance with the constitutional
procedure of both contracting states

Chapter I: Scope of the convention

 Article 1: persons covered.
 Usually, the persons covered are residents of one or both of the
contracting states.
 Article 2: Taxes covered.
 Usually, taxes on income and capital.

Chapter II: Definitions

 Article 3: General Definitions.
 Defines general terms like ‘person’, ‘company’, ‘enterprise’ etc.
 Specific definitions are contained in the following articles;
Article 4: definition of the term ‘resident’.
Article 5: Definition of the term ‘permanent establishment’.

Chapter III: Taxation of Income

 Article 6: deals with taxation of income from immovable property.
 Article 7: deals with taxation of Business Profits.
 Article 8: deals with taxation of profits from shipping, inland waterways
transport and air transport.
 Article 9: deals with taxation of profits of associated enterprises.
 Article 10: deals with taxation dividends
 Article 11: taxation of interest

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  Article 12: taxation of royalties
 Article 13: taxation of capital gains
 Article 14: which dealt with taxation of independent personal services
(usually professional services) was deleted in the OECD Model but is
retained in the UN Model.
 Article 15: taxation of income from employment
 Article 16: taxation of Director’s fees
 Article 17: taxation of incomes of entertainers and sportspersons
 Article 18: taxation of pensions
 Article 19: taxation of wages or salaries paid in respect of government
service
 Article 20: taxation of incomes paid to students for their education.
 Article 21: taxation of other incomes not captured in the foregoing articles.

Chapter IV: Taxation of Capital

 Article 22: deals with taxation of capital represented by immovable
property, movable property, ships and aircrafts operated in international
traffic and by boats engaged in inland waterways transport.

Chapter V: Methods of Elimination of Double Taxation

 Article 23A: Exemption method.
 Income or capital tax has been taxed elsewhere is exempted from
taxation.
 Article 23B: Allows a deduction of tax on income or capital, an amount
equal to the income tax or capital tax already paid in a contracting state.

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 Chapter VI: Special Provisions
 Article 24: Non - Discrimination.
 Nationals of one contracting state should not be subjected to more
burdensome tax treatment as compared to the nationals of other
contracting state.
 Article 25: Mutual Agreement Procedure.
 MAP is designed to furnish a means of settling questions relating to
the interpretation and application of the treaty.
 Through MAP, competent authorities should resolve by mutual
agreement any difficulties or doubts arising as to the interpretation or
application of the treaty.
 Article 26: Exchange of Information.
 Contracting states should exchange information relevant for carrying
out of the convention/treaty.
 Article 27: Assistance in collection of taxes.
 Contradicting states should lend assistance to each other in collection
of revenue claims.
 Article 28: safeguards the priviledges that members of diplomatic missions
and consular posts receive under international law or special agreements.
 Article 29: Territorial Extension.
 The treaty may be extended to any part of the territory of contracting
state which is specifically excluded from the application of the
convention, to any state or territory for whose international relations
the contracting state is responsible, which imposes taxes substantially
similar in character to those to which the convention applies.

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 Chapter VII: Final Provisions
 Article 30: entry into force.
 Stipulates the manner and time on which the convention comes into
force.
 Article 31: Termination.
 Stipulates the manner of terminating the treaty.

14.3 Transfer Pricing

 Transfer price is the price that one department or division of an entity
charges for the products or services supplied to another division of the same
entity.
 Transfer pricing is the general term for the pricing of cross – border, intra –
firm transactions between related parties.
 Transfer pricing as such refers to the setting of prices at which transactions
occur involving the transfer of property or services between associated
enterprises, forming part of a Multinational Enterprise Group (MNE
Group).
 Transactions between these associated entities are also referred to as
“controlled” transactions, opposed to “uncontrolled” transactions between
non – related entities which can be assumed to operate independently. (On
“an arm’s length basis”).
 Transfer pricing is a normal incident of how MNEs must operate, and as
such transfer pricing does not necessarily give rise to an avoidance or tax
evasion.
 However, where the pricing does not accord with applicable norms
internationally or as per domestic law, issues of “mispricing”, “incorrect
pricing”, “unjustified pricing” or tax avoidance or evasion, arise.
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  Transactions between two related parties must be based on the “arm’s
length principle” (ALP).
 Under ALP, transactions within a group are compared to transactions
between unrelated entities to determine acceptable transfer prices.

14.3.1Transfer Pricing Methods

 How is the arm’s length principle applied in practice in order to determine
the arm’s length price of a transaction?
 Various transfer pricing methods include the following five:
i. Comparable Uncontrolled Price (CUP).
 This method compares the price charged for a property or service
transferred in a controlled transaction to the price charged for a
comparable property or service transferred in a comparable
uncontrolled transaction in comparable circumstances.
ii. Resale Price Method (RPM).
 This method is used to determine the price to be paid by a reseller for
a product purchased from an associated enterprise and resold to an
independent enterprise.

iii. Cost Plus

 This method is used to determine the appropriate price to be charged
by a supplier of property or services to a related purchaser.
 The price is determined by adding to the cost the supplier incurred, an
appropriate gross margin so that the supplier makes an appropriate
profit in light of the market conditions.
iv. Profit – based methods

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  These are the profit comparison and profit split methods
a) Profit Comparison Method
 This method compares the level of profit that would have resulted
from controlled transactions with the profits that would have been
realized by comparable uncontrolled transactions.
b) Profit Split Method
 This method takes the combined profits earned by two related parties
from one or a series of transactions and then divides the profits so as
to replicate the division of profits that would have been anticipated in
an agreement made at arm’s length.

14.3.2 Transfer Pricing in Treaties

 As seen, the UN and OECD Model Conventions at Article 9 provides for
taxation of incomes of associated enterprises.
 Article 9 is a statement of the arm’s length principle and allows for
profit adjustments if the actual price on transactions between
associated enterprises differs from the price that would be charged by
independent enterprises under normal market terms.

14.3.3 Transfer Pricing in Domestic Law

 Article 9 of the Model conventions regulates the basic conditions for
adjustment of transfer pricing and advises the application of arms length
principle, but does not go into the particulars of transfer.
 Article 9 is not ‘self – executing’ as it does not create transfer pricing regime
in a country.
 Transfer pricing regimes are creatures of domestic law.

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  Each country is required to formulate detailed legislation to implement
transfer pricing rules.
 In Kenya, Section 18(3) of the ITA empowers the commissioner to adjust
the profits accruing to a resident person from a course of business
conducted with related non – resident persons to reflect such profit as would
have accrued if the course of the business had been conducted by
independent persons dealing at arm’s length.
 The Transfer Pricing Rules 2006 (TP Rules) were introduced in Kenya in
2006, to supplement the provisions of Section 18 (3) of the ITA.
 The TP Rules provide guidelines to be applied by related entities in
determining the arm’s length prices of goods and services in transactions
involving them and to provide administrative regulations, including the
types of records and documentation to be submitted to the commissioner by
a person involved in transfer pricing arrangements.
 Students are urged to have a look at Article 9 of OECD/UN Model
Convention as well as the Transfer Pricing Rules under the ITA – Kenya.

14.4 . Other International Tax Perspectives

14.4.1 Tax Havens

 There is no precise definition of a tax haven.
 However, it can be said that a tax haven is a jurisdiction with relatively
favourable tax conditions.
 It could be a country with no or low taxes.
 Examples of tax havens are; Bahamas, British Virgin Islands, Cayman
Islands. Costa Rica, Mauritius, Seychelles, Bahrain, Bermuda and Samoa –
there are many more.
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 14.4.2 Most – Favoured – Nation (MFN) Doctrine (MFN)

 MFN doctrine is a principle of non – discrimination contained in Article 1of

the General Agreement on Tariffs and Trade (GATT).
 GATT is the agreement that preceded the establishment of the WTO.
 MFN treatment is commitment that a country will extend to another country
the lowest tariff rates it applies to any third country.
 Students are urged to at the WTO regime for more information (look at its
website).

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