Executive summary

On 4 May 2020, the Kenyan Treasury Cabinet Secretary presented the Finance Bill, 2021 (the Bill) to Parliament. It is expected that Parliament will seek stakeholder and public comments before enactment. Once the public consultation period ends, the Bill will be resubmitted by Treasury to Parliament before it is signed into law by end of June.

The Bill is presented annually as a matter of ordinary Fiscal Budgetary course and amends the various tax laws: the Income Tax Act (ITA), the Value Added Tax Act, 2013 (VAT Act), Excise Duty Act, Tax Procedures Act, 2015 (TPA), and the Miscellaneous Fees and Levies Act. The Bill also provides for other miscellaneous amendments to other Acts.

This publication summarizes the key proposals contained in the Bill. All proposals are expected to come into effect upon assent by the President (or as specifically provided in the Finance Act, 2021).

Detailed discussion

Business tax

Definition of control

The definition of the term ”control” was deleted when the Second Schedule to the ITA was repealed. The Bill seeks to amend Section 2 of the ITA to provide for a new definition of control in relation to a person to mean:

• Direct and indirect shareholding of at least 20% of the voting rights in a company

• A loan advanced that constitutes at least 70% of the book value of the borrower’s total assets excluding loans from an independent financial institution

• A guarantee of at least 70% of a person’s indebtedness of any form excluding a guarantee provided by an independent financial institution

• The person appoints more than half of the board of directors of another person or at least one director or executive member of the governing board of that person

• The person is the owner of or has  exclusive rights over the know-how, patent , copyright, trademark , license, franchise or any other business or commercial right of a similar nature, on which another person is wholly dependent for the manufacture or processing of goods or articles or business carried on by the other person

• The person or their designate supplies at least 90% of the purchases of another person and for which the Commissioner opines that the person influences the prices or any condition of the sale

• Any other relationship, dealing or practice that the Commissioner may deem to constitute control

Similar to Uganda’s definition of control, the proposed definition is broad and deep; it will effectively impact a larger number of taxpayers. The Kenya Revenue Authority/Commissioner will also have discretion to impute control in business relationships, dealings and practices. The definition is also likely to have a bearing on licensing arrangements between independent parties and dependent/exclusive distribution models.

Definition of infrastructure bond

The Bill seeks to define the term “infrastructure bond” to mean, a bond issued by the Government for the financing of a strategic public infrastructure facility including a road, hospital, port, sporting facility, water and sewerage system, or a communication network.

Definition of permanent establishment

After many years of discussion, the Bill proposes to repeal the current definition of the term “permanent establishment” (PE) and introduce a new definition  which aligns with international best practice under the Organisation for Economic Co-operation and Development (OECD) and United Nations (UN) Model Tax Conventions, as well as the Base Erosion and Profit Shifting (BEPS) report. The following key changes have been proposed to the current definition of PE:

• Introduction of a service PE – The Bill introduces the service PE concept. Provision of services including consultancy services by employees or other personnel which exceeds an aggregate of 91 days in any twelve-month period commencing or ending in the year of income will constitute a PE.

• Threshold for split activities
  • The time period for construction, assembly or installation projects (and supervisory activities connected to the same project) undertaken at different periods to be aggregated in determining the 183 days threshold.
  • Connected activities done on the same project by related parties (over one or more periods of between 30 to 183 days) to be aggregated.

• Exploration activities – Installation or structures used in exploration for natural resources that continue for a period of not less than 91 days will constitute a PE.

• Dependent agent PE – A person who acts on behalf of a foreign enterprise in respect of the activities undertaken by the foreign enterprise in Kenya including playing a principal role leading to conclusion of contracts that are routinely concluded by the foreign enterprise without material modification will be considered a PE of the foreign enterprise.

• Exclusions from PE – Borrowing from the UN Model Tax Convention, preparatory or auxiliary activities have been defined to include:
  • Use of facilities for the sole purpose of storage or display of goods or merchandise belonging to the foreign enterprise.
  • Maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage or display or processing by another enterprise.
  • Maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or for collecting information for the enterprise.
  • Maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity.
  • Maintenance of a fixed place of business solely for any combination of activities mentioned in the above paragraphs.

Expansion of Digital Services Tax (DST)

The Bill expands the scope of DST to include any income generated by businesses over the internet or electronic networks. This is a deliberate effort to expand the tax base of the digital economy.

The Bill also proposes to exclude the following from the ambit of DST:

• Transactions by resident persons. Business carried out over the internet is taxed as business income.
• Payments made to nonresidents which are subject to withholding tax.
• Income received from transmission of messages by an apparatus established in or outside Kenya.

Persons subject to the DST will be required to submit returns and pay tax due on or before the 20th day of the month following the month in which the digital services were offered.

Indefinite carryforward of tax loss

The Bill proposes to remove the 10-year time limitation. If the Bill is passed, taxpayers will utilize a tax loss arising in a year of income to reduce taxable business income in subsequent years indefinitely.

While this appears to be a positive development, especially for the protection of tax losses resulting from a claim of investment allowances, its usefulness will be tested once the constitutionality of the minimum tax provision is determined.

Deductibility of interest expense on loans

The Bill seeks to tighten the thin capitalization provision from the simple 3:1 ratio, to 30% of EBITDA thereby limiting all debt-raising expenses. Interest paid or payable to related persons and third parties will be restricted to 30% of earnings before interest, taxes, depreciation and amortization (EBITDA). Exempt income will be excluded from earnings. However, payments that are economically equivalent to interest and expenses incurred in connection to raising finance will be considered as interest. Previously, the restriction of interest deduction was applicable to thinly capitalized entities, that is, those that exceeded the debt to equity ratio of 3:1.

The proposed formula introduces a paradigm shift in the computation of deductible interest expense by ignoring the gearing ratio of a company and seeking to protect the erosion of taxable income by claim of interest expenses.

Country-by-Country Reporting (CbCR)

The Bill seeks to legislate CbCR in line with the requirements of members of the OECD/G20 Inclusive Framework on BEPS. The BEPS Associate countries, Kenya included, committed to implement four minimum standards namely countering harmful tax practices (Action 5), countering tax treaty abuse (Action 6), transfer pricing documentation and CbCR(Action 13), and improving dispute resolution mechanisms (Action 14).

The ultimate parent entity of a multinational enterprise (MNE) group based in Kenya will be required to file an annual return within 12 months after the last day of the Group’s financial reporting year where the entity’s gross turnover exceeds a prescribed threshold. The Bill is silent on the threshold.

The information to be included in the return includes:

• The financial activities of the Group in Kenya and other jurisdictions where the Group has taxable presence (that is, gross revenue, earnings before income tax, income tax paid and accrued, stated capital and accumulated earnings)

• Number of employees

• Tangible assets excluding cash and cash equivalents

An MNE Group has been defined to mean a group that includes two or more enterprises that are resident in different jurisdictions including PEs while ultimate parent entity means, “an entity that is resident in Kenya for tax purposes; is not controlled by another entity; and owns or controls a multinational enterprise group.’’

The objective of the proposal is to enhance information sharing across different jurisdictions so that MNEs pay their fair share of tax.

Amendment on Limitation of Benefits (LoB) rule

Currently, in order to enjoy treaty benefits, 50% of the underlying ownership of a company must be held by individuals. The Bill widens this restriction to persons.

”Person” includes both natural and corporate person; the change effectively extends treaty benefits limitations to companies, partnerships, trusts, Governments or such other bodies.

Amendments to investment allowance

To address the gaps in the investment allowance regime introduced in 2020, the Bill proposes amending the basis for claiming an investment allowance on the 50% balance from the first year of investment from reducing balance to straight line.

The Bill also proposes to:

• Remove the narrow requirement for a producer to supply electricity through the national grid in order to qualify as manufacturing.

• Defines civil works in relation to manufacturing activities to include roads and parking areas, railway lines and related structures, water, industrial effluent and sewerage works, communications and electrical posts and pylons and other electrical supply works and security and fencing.

While these proposals are positive, the Bill did not define farm works as expected.

Taxation of extractive sector

The Bill seeks to reduce the claim of tax depreciation for machinery used to undertake prospecting/exploration operations from 100% to 50% in the first year of use, with the balance being claimed in the subsequent two years on straight line basis.

Further the Bill seeks to:

• Increase the tax rate on service fees paid to a nonresident subcontractor by a contractor or licensee from 5.625% to 10%

• Reduce the tax rate on management, training or professional fees from 12.5% to 10%

• Align the deductibility of interest expense to 30% of EBITDA

Personal tax

Amendment to insurance relief

The Bill seeks to extend the scope of insurance relief to contributions made to the National Hospital Insurance Fund.

The proposal is intended to encourage Kenyans to contribute towards health care in line with the Government’s agenda of universal health coverage.

Tax Procedures Act, 2015 (TPA)

Increased scope of TPA

The Miscellaneous Fees and Levies Act, 2016 has been brought under the ambit of the TPA. Administrative and procedural matters will thus be governed by the provisions of the TPA.

International tax agreements

Taking into consideration recent losses from tax disputes, the Bill seeks to incorporate the pacta sunt servanda principle by providing that international tax agreements that the Government has concluded relating to international tax compliance, prevention of tax evasion and exchange of tax information shall have effect in the manner prescribed in such agreements. Additionally, disclosure of any information obtained pursuant to the agreements will be governed by the provisions of the said agreements.

Common Reporting Standards

• In a bid to establish itself as a tax transparent jurisdiction, the Government has proposed to incorporate within its legislation the following provisions so as to implement the Common Reporting Standard (CRS) regime:
  • Common reporting standard means the reporting and due diligence standard for the automatic exchange of financial account information.
  • Financial institution (FI) means a custodial institution, a depository institution, an investment entity or a specified insurance company.
  • Kenyan FI means any FI that is resident in Kenya but excluding a branch of the FI that is located outside of Kenya. Additionally, a Kenyan FI includes any branch of a FI that is not resident in Kenya, if the branch is located in Kenya.

• The Cabinet Secretary is empowered to make regulations relating to CRS to be adhered to by a reporting FI.

• A reporting FI will be required to:
  • Comply with due diligence procedures and record keeping requirements set out in the CRS Regulations.
  • Identify reportable accounts and file with the Commissioner an information return on accounts held, managed or administered by that reporting FI.
  • File a nil return if no reportable account is held, managed or administered by that reporting FI.

• The due date for submitting the information or nil return will be prescribed in the CRS regulations.

Amendment to statute of limitations

The Bill proposes to extend the time period that a taxpayer is required to maintain their records from five to seven years. The time limit within which a taxpayer can amend a tax return is also to be increased from five to seven years.

Amendments on taxation of the digital economy

The Bill proposes to:

• Allow a nonresident person who is carrying on business through a digital marketplace to maintain their records in a convertible foreign currency upon approval by the Commissioner. This excludes a nonresident person who makes payments and files returns through a resident tax representative or those with a branch in Kenya.

• Enhance the collection of tax on income generated from services provided over the internet or through an electronic network including through a digital marketplace by empowering the Commissioner to seek intervention from any relevant authority to collect such taxes.

• To include selling of goods or services over a digital marketplace in the list of transactions for which a PIN (Personal Identification Number) will be required.

Exemption from withholding Value Added Tax (VAT)

The Bill seeks to take away the power of the Commissioner to exempt any supplier from withholding VAT obligations.

Currently, if a taxpayer can demonstrate to the Commissioner that due to the nature of his business and as a result of withholding VAT he will be in a continuous VAT credit for a period of not less than 24 months, the Commissioner can exempt such taxpayer from the withholding VAT regime.

This proposal will be punitive to taxpayers who are in perpetual VAT credit position as it will exacerbate the situation especially due to the delayed settlement of VAT refunds.

Other proposed amendments

The Bill seeks to:

• Expand the powers of the Commissioner to remit or abandon the collection of unpaid tax where there is any other reason other than the reasons currently stipulated in the TPA occasioning the inability to recover the unpaid tax. Further, the Commissioner will be required to submit bi-annual reports to the Cabinet Secretary on details of forfeited tax collections on or before 30 June and 31 December of each year.

• Stand over¹ accumulation of penalty and interest on outstanding tax upon notification by the Commissioner that a tax refund has been ascertained and will be utilized to offset against the taxpayer’s outstanding tax liabilities. However, any other outstanding tax after the offset will continue to accumulate penalty and interest.

• Introduce a provision to the effect that where a person submits a notice of objection in electronic form, the due date shall remain the date specified in the relevant tax law. This will take care of due dates falling on a weekend or a public holiday.

• Introduce a penalty in relation to offenses under the CRS as follows:
  • KES100k or imprisonment for a term not exceeding three years or both for each false statement or omission.
  • KES1m for a financial institution that fails to file an information or "Nil" return.
  • General penalty of KES20k and subsequent KES20k per day for non-compliance for a period not exceeding 60 days.

Value Added Tax

Expansion of scope of taxation of digital marketplace supplies

The Bill proposes to amend Section 5(7) of the VAT Act to expand the tax base for taxation of the digital marketplace to include supplies made over the internet or an electronic network.

Clarification on imported services

The Bill proposes to delete the word ”registered person” from section 10 to align the changes enacted by the Finance Act 2019 which brought to tax imported services provided to non-registered persons in addition to registered persons.

Expansion of restriction on deductibility of input tax

The Bill proposes to expand the restriction on deductibility of input tax to include leased and hired passenger cars or minibuses and their repairs and maintenance thereof unless they are acquired, exclusively for the purposes of making taxable supply of that automobile in the ordinary course of the business of selling or hiring/leasing of passenger cars or mini buses.

Deferment of payment of tax

The Bill proposes to amend Section 19(2) of the VAT Act to also allow unregistered persons to be eligible for deferment of payment of tax due.

Registration for VAT by Group companies

The Bill proposes to delete the current provision allowing single VAT registration by a group of companies. The regulations required to operationalize this provision have never been issued hence the lack of implementation.

Group VAT registration (if implemented) would have been administratively efficient for companies within a group as all would have been treated as one person and would have filed a single VAT return. Group VAT registration has worked in other jurisdictions (e.g., the United Kingdom). Group registrations would also have been efficient for group companies providing digital services and earning related revenues from Kenya.

Enactment of VAT regulations

The Bill proposes to remove the requirement to table VAT Regulations made by the Cabinet Secretary (CS) before the National Assembly for approval before they take effect.

This appears to be contrary to the principle of separation of powers with the CS seemingly having legislative powers.

Harmonization with the Common External Tariff (CET)

The Bill has proposed several deletions from and inclusions in the First schedule which are meant to align the Harmonized System Codes in the Value Added Tax Act, 2013 to the East African Community Common External Tariff, 2017. However, the VAT status of these products remains exempt.

Excise Duty

Amendments to key definitions

The Bill seeks to amend Section 2 of Excise Duty Act, 2015 to introduce the following new definitions:

• Compound to mean communicate any flavor to, or to mix any ingredient or material with, spirits, but not so as to denature the spirits.

• Possession to mean having, owning or controlling any excisable goods including:
  • Having in one’s possession any excisable goods
  • Knowingly having any excisable goods in the actual possession or custody of any other person
  • Having any excisable goods in any place, whether belonging to or occupied by oneself or not, for the use or benefit of oneself
  • Having any excisable goods for the use or benefit of another person

Provided that if there are two or more persons and any of them with the knowledge or consent of the others has any excisable goods in his custody or possession, such goods shall be deemed to be in the custody and possession of all of them.

• Other fees by deleting the words ‘’..fees or commissions earned in respect of a loan...’’ from the definition. Other fees will be defined to include any fees, charges or commissions charged by financial institutions relating to their licensed activities, but does not include interest on loan or return on loan or any share of profit or an insurance premium or premium based or related commissions specified in the Insurance Act or regulations made thereunder. The proposal to exclude these fees and commissions from the definition of ”other fees” means that fees or commissions earned in respect of loan should be subject to Excise duty.

Relief from excise duty paid

The Bill proposes to allow licensed persons who have paid tax on purchased internet data in bulk for resale, to offset it against the excise duty payable on internet data services supplied to the final consumer.

This proposal is timely especially for taxpayers in the internet data business. “Input” excise duty will no longer be a cost as it will be offset against “output” excise duty charged/payable.

Amendment of the list of excisable services

The Bill proposes to reintroduce excise duty on betting services at 20% of the amount waged or staked. Excise duty on betting services was introduced in 2019, repealed in 2020 and now reintroduced in 2021.

Miscellaneous Fees and Levies Act

Application of Tax procedures Act, 2015 (TPA)

The Bill proposes to amend Section 9 of the Act to bring the following under the ambit of Section 47 of the TPA:

• Application for refunds, ascertainment and repayment of fees and levies overpaid or paid in error.
• The determination by the Commissioner of penalties and interests on fees that remain unpaid.

With this amendment, refund of import declaration fee, export duty and railway development levy will be conducted as per the TPA provisions. Similarly, calculation of penalties and interest accruing on unpaid amounts shall be as per the TPA provisions.

Exemptions from Import Declaration Fes and Railway Development Levy

The Bill proposes to exempt importation of goods which the Cabinet Secretary determines to be of public interest or which promote investment (and whose value is not less than KES5b) from Import Declaration Fees (IDF) and Railway Development Levy (RDL).

This proposal is a welcome move by the Government to encourage investment in Kenya. However, it remains to be seen if the KES5b threshold is feasible. Prior to 2020, there was a similar exemption from IDF with a much smaller threshold of KES200m that attracted many potential investors.

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For additional information with respect to this Alert, please contact the following:

Ernst & Young (Kenya), Nairobi

Francis Kamau | francis.kamau@ke.ey.com

Christopher Kirathe | christopher.kirathe@ke.ey.com

Hadijah Nannyomo | hadijah.nannyomo@ke.ey.com

Grace Mulinge | grace.mulinge@ke.ey.com

Simon Njoroge | simon.njoroge@ke.ey.com

Robert Maina | robert.maina@ke.ey.com

Ernst & Young Société d’Avocats, Pan African Tax – Transfer Pricing Desk, Paris

Bruno Messerschmitt | bruno.messerschmitt@ey-avocats.com

Alexis Popov | alexis.popov@ey-avocats.com

Ernst & Young LLP (United Kingdom), Pan African Tax Desk, London

Kwasi Owiredu | kwasi.owiredu@uk.ey.com

Byron Thomas | bthomas4@uk.ey.com

Ernst & Young LLP (United States), Pan African Tax Desk, New York

Brigitte Keirby-Smith | brigitte.f.keirby-smith1@ey.com

Dele Olagun-Samuel | dele.olaogun@ey.com

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Endnotes

1. To “stand over” is a term in Kenya’s legislation that means penalties and interest stop accumulating.