Transfer pricing in Kenya
In this article we will explain how transfer pricing is applicable in Kenya. In accordance with Section 18(3) of the Income Tax Act (CAP 470), Where a non-resident person carries on business with a related resident person or through its permanent establishment and the course of that business is so arranged such that it produces to the resident person or through its permanent establishment either no profits or less than the ordinary profits which might be expected to accrue from that business if there had been no such relationship, then the gains or profits of that resident person or through its permanent establishment from that business shall be deemed to be the amount that might have been expected to accrue if the course of that business had been conducted by independent persons dealing at arm’s length’.
A multi-national enterprise (MNE) is required to comply with The Income Tax (Transfer Pricing) Rules 2006, which offer guidelines on how to apply the arm’s length principle.
The Transfer Pricing rules empower the Commissioner of Domestic Taxes (KRA) to request for Transfer Pricing documentation to any Multinational enterprise operating in Kenya on transactions where Transfer Pricing is applicable.
Paragraph 4 of the Transfer pricing regulations grants the taxpayer the liberty of choice of the method to apply in valuation of the arms- length price of intercompany transactions.
The Income Tax Transfer Pricing Regulations 2006 recognizes five methods to apply in determination of the arm’s length price of transactions as outlined below:
- The Comparable Uncontrolled Price (CUP) method
- The resale price method(RP)
- The Cost plus method
- The profit split method (PSM)
- The Transactional net margin
- Such other method as may be prescribed by the Commissioner from time to time, where in his opinion and in view of the nature of the transactions, the arm’s length price cannot be determined using any of the methods contained in these guidelines.
The Comparable Uncontrolled Price (CUP) method
The Comparable Uncontrolled Price (CUP) method is a transfer pricing method used to determine the arm’s length price of a controlled transaction. Under this method, the price of a transaction between related parties is compared to the price of a similar transaction between unrelated parties. The CUP method assumes that a controlled transaction between related parties should be priced similarly to an uncontrolled transaction between unrelated parties, assuming that all other relevant factors are similar.
To use the CUP method, the following steps are typically taken:
Identify the property or service being transferred between the related parties.
Determine the terms and conditions of the related party transaction.
Identify comparable uncontrolled transactions involving the same or similar property or services.
Adjust the comparable transactions to account for any differences between them and the related party transaction.
Compare the adjusted price of the comparable uncontrolled transaction to the price of the related party transaction.
Determine if the prices are comparable and if not, make any necessary adjustments to the related party transaction price to make it comparable to the uncontrolled transaction.
The CUP method is one of several transfer pricing methods available to multinational corporations to ensure that their intercompany transactions are priced at arm’s length. However, the CUP method is generally considered to be one of the most reliable methods since it is based on actual market prices rather than subjective assumptions or estimates.
The Resale Price Method(RP)
The Resale Price Method (RPM) is a transfer pricing method used to determine the appropriate transfer price of goods purchased from a related party and then resold to an independent party. Under the RPM, the resale price is determined by deducting an appropriate gross profit margin from the resale price charged to an independent party. This method is typically used when the related party is involved in the distribution of goods and is not the original manufacturer of the goods being sold.
To use the RPM, the following steps are typically taken:
Identify the property being transferred between the related parties.
Determine the resale price of the property when sold to an independent party.
Deduct an appropriate gross profit margin from the resale price to arrive at the arm’s length transfer price.
Compare the arm’s length transfer price to the actual transfer price between the related parties.
Adjust the actual transfer price as necessary to make it comparable to the arm’s length transfer price.
In general, the RPM assumes that the gross profit margin earned by the related party is consistent with the gross profit margin earned by independent parties engaged in similar activities. The RPM is a commonly used transfer pricing method, especially when dealing with routine and standardized products with minimal value-addition activities. However, it may not be appropriate for transactions involving unique or highly specialized goods.