Finance Act, 2022 now in effect
Kenya’s Finance Act, 2022, gazetted on 23 June 2022, contains a number of measures that affect companies, including new rules on transactions with entities located in countries with preferential tax regimes, a withholding tax on gains made by nonresidents from financial derivatives and the expansion of transfer pricing reporting requirements. However, the proposed increase in the rate of the digital service tax (DST) was dropped.
Unless otherwise noted, the following changes will apply as from 1 January 2023:
- The capital gains tax rate will be increased from 5% to 15%, although the 5% rate will remain applicable for investments valued at KES 5 billion or higher and made before 1 January 2023 by firms certified by the Nairobi International Financial Centre (NIFC) Authority and where the investment is transferred within five years.
- A reduced corporate income tax rate of 15% will apply to companies operating a carbon market exchange or emission trading system and shipping companies for the first 10 years of operations.
- Gains derived by nonresidents from financial derivatives will be subject to a 15% withholding tax. The Finance Act defines a financial derivative as a “financial instrument the value of which is linked to the value of another instrument underlying the transaction which is to be settled at a future date.” Gains arising from financial derivatives that are traded on the Nairobi Securities Exchange will continue to be exempt.
- The types of entities that are exempt from the EBIDTA-based interest expense limitation rules are expanded to include non-deposit-taking microfinance businesses, entities licensed under the Hire Purchase Act and others to the exempt businesses, effective 1 July 2022. Previously, only small and medium-sized enterprises and banks and financial institutions licensed under the Banking Act were exempt. The EBIDTA-based rules, introduced in Finance Act 2021, restrict the deduction of interest expense to 30% of a taxpayer’s EBIDTA—any interest exceeding 30% is nondeductible.
- The deductibility of donations is expanded as from 1 July 2022 to include donations to any charitable organization (previously, only donations to charitable organisations registered under the Societies Act or the Non-Governmental Organisations Coordination Act were deductible). Further, donations no longer need to be made in cash.
- Transactions between domestic entities and entities operating in jurisdictions with preferential tax regimes will be required to be on arm’s length terms, regardless of whether the parties are related or unrelated. The Kenya Revenue Authority (KRA) is empowered to issue a transfer pricing tax assessment on transactions that are not on an arm’s length basis. A regime will be deemed to be preferential for these purposes if it:
- Has an income tax rate lower than 20%;
- Does not have a framework for the exchange of information;
- Does not allow access to banking information; or
- Lacks transparency on corporate structures, ownership of legal entities, beneficial owners of income or capital, financial disclosure or regulatory supervision.
- As from the 2022 year of income, CbCR requirements apply to the ultimate parent company of a multinational group with consolidated gross turnover of KES 95 billion or more and a constituent company of a multinational group, where such a group has consolidated gross turnover of KES 95 billion or more. CbC reports must contain a breakdown of revenue, profits, taxes and other indicators of economic activities for each jurisdiction in which the multinational group operates. The CbC report must be filed within 12 months after the financial year-end.
- Master and local filing requirements also apply as from the 2022 year of income. The reports must be filed within six months after the close of the accounting year-end. Where more than one constituent entity exists in Kenya, the group may designate one as the surrogate parent company. The surrogate may be exempt from CbCR if the ultimate parent is required to file a CbCR report in its country of residence; the country of the ultimate parent has an effective international agreement and a competent authority agreement; and the KRA has not notified the resident constituent entity in Kenya of any systemic failure.
- The DST was proposed to increase from 1.5% to 3% in the Finance Bill released in April 2022. However, a decision was made to retain the 1.5% rate and the proposal for the increase was dropped.
- Nonresidents with a permanent establishment in Kenya are exempt from the 1.5% DST as from 1 July 2022 because PEs are already subject to tax in Kenya.
- Effective 1 July 2022, manufacturers with at least KES 3 billion of investment in the three years preceding that date are eligible to be appointed by the KRA Commissioner to withhold 2% of the taxable value of VAT standard-rated supplies.
Several of the above measures will increase compliance obligations for companies. For example, the expanded scope of transactions subject to the transfer pricing rules to include transactions with entities in jurisdictions operating a preferential tax regime will place more pressure on businesses when selecting corporate structures and business partners. CbCR obligations will enhance the transparency of businesses’ financial results and other metrics, leading to increased scrutiny from the KRA and an increased likelihood that transfer pricing policies may be questioned. The master files will be provided to other tax authorities, so affected companies should ensure they have complete and accurate information that is collated well in advance of the relevant deadlines.