PUBLIC NOTICES 04/09/2023 DRAFT INCOME TAX (TRANSFER PRICING) RULES, 2023

The Kenya Revenue Authority (KRA) published the Draft Income Tax (Transfer Pricing) Rules, 2023, on September 4, 2023, for public comment. These proposed rules aim to replace the existing Income Tax (Transfer Pricing) Rules, 2006, and align Kenya's transfer pricing framework with recent amendments in the Finance Act, 2022, and international best practices, particularly the OECD Transfer Pricing Guidelines. The draft rules significantly expand the scope of transactions subject to transfer pricing review, enhance documentation requirements, and introduce greater clarity, thereby increasing compliance obligations for multinational enterprises (MNEs) operating in Kenya.

On September 4, 2023, the Kenya Revenue Authority (KRA) issued a public notice inviting stakeholders to submit comments on the Draft Income Tax (Transfer Pricing) Rules, 2023. This development signals a significant step in Kenya's ongoing efforts to modernize its tax legislation and strengthen its transfer pricing regime. The proposed rules are intended to supersede the Income Tax (Transfer Pricing) Rules, 2006, which have been in force for over a decade.

The issuance of these draft rules is a direct response to the evolving global tax landscape, characterized by increased scrutiny on base erosion and profit shifting (BEPS) practices. By aligning with international standards, particularly the Organisation for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines, Kenya aims to ensure that multinational enterprises operating within its jurisdiction pay their fair share of taxes. This move is crucial for safeguarding national revenue and fostering a transparent and equitable tax environment.

This article will delve into the statutory and doctrinal context of transfer pricing in Kenya, analyze the key changes introduced by the Draft Income Tax (Transfer Pricing) Rules, 2023, and discuss their practical implications for legal professionals and businesses. The overarching thesis is that these draft rules represent a comprehensive overhaul designed to enhance the robustness and enforceability of Kenya's transfer pricing framework, demanding proactive compliance from taxpayers.

Kenya's transfer pricing framework is primarily anchored in the Income Tax Act, Cap 470, Laws of Kenya. Specifically, Section 18(3) of the Act establishes the arm's length principle, requiring transactions between related parties to be conducted as if they were between independent entities. This principle was further elaborated by the Income Tax (Transfer Pricing) Rules, 2006 (Legal Notice No. 67 of 2006), which provided guidelines on transfer pricing methods and documentation requirements.

Over the years, Kenya has increasingly aligned its transfer pricing regulations with the OECD Transfer Pricing Guidelines, which, while not legally binding, serve as authoritative guidance for the KRA and the courts. Kenyan case law, such as *Unilever Kenya Limited v Commissioner Of Domestic Taxes (Income Tax Appeal Case No:753 Of 2003)*, has reinforced the practical application of these guidelines in comparability and transfer pricing assessments. Recent legislative developments, particularly the Finance Act, 2022, introduced significant amendments to the Income Tax Act, Cap 470, by incorporating specific provisions for Country-by-Country Reporting (CbCR), Master File, and Local File documentation, effective from July 1, 2022, and July 1, 2023, respectively.

These statutory changes also expanded the arm's length principle to domestic transactions involving related parties operating in preferential tax regimes, as stipulated in Section 18A of the Income Tax Act, Cap 470. The existing 2006 rules, however, lacked the necessary detail to fully operationalize these recent amendments and address the complexities of modern international transactions, necessitating the comprehensive review and drafting of the 2023 rules.

The Draft Income Tax (Transfer Pricing) Rules, 2023, are designed to replace the 2006 rules, providing a more robust and detailed framework that reflects the changes introduced by the Finance Act, 2022, and aligns with the OECD Transfer Pricing Guidelines. A key aspect of the new rules is the significant expansion of the scope of transactions subject to transfer pricing review. Beyond the traditional sale, purchase, or lease of tangible assets, transfer or use of intangible assets, provision of services, and lending or borrowing of money, the draft rules now explicitly cover insurance and reinsurance transactions, derivatives, cost-contribution arrangements, business restructuring or reorganization, and various financial transactions including guarantees, marketable securities, advances, and deferred payments. This broader scope aims to capture a wider array of intra-group dealings that could potentially be used for profit shifting.

Furthermore, the draft rules reinforce and elaborate on the three-tiered transfer pricing documentation approach (Master File, Local File, and Country-by-Country Report) mandated by the Finance Act, 2022, in line with OECD BEPS Action 13. While the 2006 rules required taxpayers to prepare a transfer pricing policy, the new draft rules are expected to provide more specific guidance on the content and format of these documents, increasing the compliance burden but also offering greater clarity. The Commissioner is explicitly empowered to request any other information deemed necessary for reviewing controlled transactions, emphasizing the KRA's enhanced investigative powers.

Regarding transfer pricing methods, the draft rules maintain the internationally recognized methods such as the Comparable Uncontrolled Price (CUP), Resale Price Method (RPM), Cost Plus Method (CPM), Profit Split Method (PSM), and Transactional Net Margin Method (TNMM). Notably, for transactions involving commodities, the rules propose that the arm's length price should be determined by reference to prevailing prices on international or domestic commodity exchange markets, recognized price reporting agencies, or governmental price-setting agencies. This provides a specific benchmark for commodity transactions, reducing ambiguity. While the rules state that taxpayers may choose the applicable method, they also retain the Commissioner's power to prescribe other methods, a potential area for interpretation challenges, though this provision existed in the 2006 rules as well.

In terms of penalties, the Draft Rules refer to general penalties under the Tax Procedures Act, 2015, for non-compliance, such as fraud, tax underpayment, and failure to file returns, replacing the older Income Tax penalties from the 2006 Rules. This aligns the penalty regime with the broader tax administration framework. A notable observation is that while the Commissioner may request information on Advance Pricing Agreements (APAs) from other jurisdictions, Kenya does not yet have a formal APA framework in place under these 2023 draft rules, though the Finance Act 2025 later introduced provisions for APAs effective January 1, 2026. This highlights a continuous evolution in Kenya's approach to transfer pricing dispute prevention.

The Draft Income Tax (Transfer Pricing) Rules, 2023, represent a pivotal moment for tax compliance in Kenya, signaling the KRA's commitment to a robust and internationally aligned transfer pricing regime. For multinational enterprises and their legal advisors, these rules will necessitate a thorough review and potential overhaul of existing transfer pricing policies and documentation. The expanded scope of covered transactions, coupled with enhanced documentation requirements, means a significantly increased compliance burden and the need for greater transparency in intra-group dealings.

Practitioners should proactively advise clients to assess their current transfer pricing arrangements against the proposed rules, paying particular attention to newly included transaction types and the detailed documentation requirements. Preparing robust Master Files, Local Files, and Country-by-Country Reports will be crucial to mitigate tax risks and avoid potential disputes with the KRA. As these rules move towards finalization, businesses should closely monitor their enactment and any subsequent interpretative guidance from the KRA, preparing for a stricter enforcement environment aimed at combating profit shifting and ensuring equitable taxation.