The rules regarding the taxation of foreign and local based companies that engage in trade in two or more states has been consolidated through treaty law as a way to mitigate the possibility of double taxtion. The U.K. and Kenya have entered into such an agreement dubbed the double taxation agreement between Kenya and the United Kingdom. The agreement is also governed by the OECD Model Convention on taxation that provides the general rules of operation between countries that engage in trade with each other.1
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The tax treaty between Kenya and U.K. was signed at Nairobi on July 31, 1973 by Antony Duff (on behalf of the Government of the United Kingdom of Great Britain and Northern Ireland) and Mwai Kibaki on behalf of the Government of the Republic of Kenya. The agreement came into force:
- in the U.K. as respects income tax and capital gains tax, for any year of assessment beginning on or after 6 April, 1973 and as respects corporation tax, for any financial year beginning on or after April 1, 1973; and
- in Kenya as respects income arising for the year of income 1973 and subsequent years.2
Formation of the real estate construction advisory firm, management and control issues, residency, taxation of profits
Stefan and Hans need to consider several policy and structural concerns that affect the creation and formation of the company in question. Hans is the majority shareholder of the company but does not have a majority stake in the company since he has only one third of the voting rights in the company. Stefano despite making a lesser contributuion to the company has a right to appoint a third director who he has appointed as his wife. This, therefore, means that he has a majority vote in the company.3
Under Article 18 any directors’ fees or similar remuneration derived by any of the two, Lucia and Hans, as well as the third director appointed by Stefan, will be subject to tax by the U.K. or Kenya depending on where the respective director or member of the board of directors is resident4. The Article specifically provides for the taxation of the benefits that accrue to the directors of a company for any services rendered by them to the company. The agreement provides that these incomes are to be taxed by the other contracting state if such board of directors is a resident of the other contracting state.5
Stefan, who is responsible for the daily activities of the company, will receive management fees arising from the operations in Kenya will be taxed in Kenya inline with Article 14 of the agreement that allows the management fees to be taxed in both countries. The Article provides that the tax to be charged in Kenya be limited to 12.5 percent of the company’s gross management fees if Stefano is to be taxed in the U.K.also.
On the other hand, if the management fees are not to be taxed in the U.K. then such fees will be considered as if they were from a permanent establishment in line with Article 5 of the agreement. The tax deductible from the fees will therefore be considered as though they were profits attributable to these establishments. In effect the agreement requires that the amount of tax that is to be deducted should be limited to 75 percent of the total gross fees. This falls in line with the provisions of the OECD convention in article 14 that was later amended by Articles 2 and 3 of the protocols.
The agreement cures the double taxation burden by providing that whether or not Stefan chooses to be taxed in line with Article 5 of the agreement, the provision for double taxation for purposes of relief shall still remain. The taxation in U.K.will, therefore, be considered as net of the management fees following the deduction of the relevant expenses that may have been incurred in relation to these management fees. This stand can be sharply contrasted with the courts decision in Bayﬁne UK Products v. Revenue and Customs Commissioners6
The consultancy and management fees that will be generated by the second assignment will be taxed in Kenya. Article 16 specificaly requires that the income that is generated by a resident of another state in respect to professional services that he may have offered to the other state is to be taxed by the home state. The employee who will be sent to the construction company in Kenya is assumed to be a resident of the U.K.and should otherwise be taxed in the resident and contracting state. The Article however povides for the exception that if such a resident has at his disposal a fixed base of operation that is meant to facilitate the undertaking of his activities and duties then such income will be attriubuted to a fixed base and therefore taxed by the other state. In the alternative, if the employee of the resident country continues to operate in the other country for more than 183 days in the fiscal year in question then the income he generates will be taxed in the country in question. The second assignment grants unlimited access to the employee for a period of 12 months which is more than 183 days and can be considered as income generated from a fixed establishment and will, therefore, be taxed in Kenya.
The greatest concern for the company and enterprise will be the manner in which the profits generated will be treated. The agreement requires that the profits of a company which resides in a contracting state be taxed by the resident or contracting state. The agreement, however, in Article 8 exempts any company that carries on business in a permanent establishment as in line with Article 5 of the agreement. The arrangement between Hans and Stefan provides for the creation and maintenance of the activities of the company in Kenya despite the formation and incorporation of the same company in United Kingdom. Article 5 specifically defines a permanent establishment as a fixed place of business in which the day-to-day affairs of the company are conducted. The arrangement between the two partners has allowed the main activities of the company to be run from Kenya. This can be construed to imply that the company intends that there be a permanent establishment in Kenya within the meaning of Article 5. This, therefore, means that all the profits generated from the operations in Kenya shall be taxed in Kenya.7
The profits that will be generated from the first assignment, however, will be taxed both in Kenya and the United Kingdom. Article 8 relating to business profits only requires the taxation of profits that are attributable to the fixed establishment alone otherwise, the rest shall be taxed at the place where they are generated. The construction contract in the U.K. will, therefore, generate profits in Kenya and U.K. and these shall be taxed as so in the measures and amounts in which they accrue. Article 8 further allows the company to make the relevant expense deductions for the costs incurred in the generation of the profits in the various countries. The amount to be taxed will also be determined on a year-to-year basis for the 24 months in which the contract will be in existence.8
The method of taxation and manner of apportionment of the relevant taxable income is provided for in the agreement. It allows states to adopt their own traditional methods of apportionment and taxation in the allocation and determination of the tax burden on the profits and incomes generated from a contract that is to be taxed in the two different tax regimes9. It, however, requires that the manner and approach that the state in question adopts in the determination of the income to be taxed should not conflict or go against the provisions of the agreement10. The profits that are to accrue to a permanent establishment on the other hand are not meant to include those of mere purchase of goods by such establishment for the purposes of the company. Any acquisitions made by the permanent establishment in Kenya for the purposes of the furtherance of the construction of the first assignment will therefore not merely entitle it to a share of the profits from the assignment.
The agreement (in Article 26) eliminates the double taxation that may arise in an assignment of this nature by providing that any such tax that may have been paid in Kenya by the company in relation to an income profit or gain that is to be taxed in the U.K., such tax shall be allowed as a credit to the taxation in the U.K. Article 26, therefore, gives a credit to the company of any taxation that it may have paid in Kenya for any such income or profit that is due for taxation in the U.K. The provisions in as far as dividend is concerned requires that the credit to be granted takes into account any such tax that is to be paid by the recipient of the dividend in specific relation to any other tax that they have paid. The agreement does not, however, provide for special forms of exemption from taxation in Kenya and any such application is to be made to the relevant taxation authorities in Kenya.11
Sale of Shares
The gains attributed to the sale of shares can be considered as a capital gain to the company. Article 15 concerning the taxation of capital gains specifically requires that the gains from separable movable property that can be attributed to a permanent establishment are to be taxed by the state in which they exist in. On the other hand, any other capital gains that are attributable to properties other than movable and immovable properties are to be taxed only in the contracting state.
Article 26 also requires that where a resident in Kenya generates any income that can be attributed to sources within the U.K. and that falls within the various sources allowed by the agreement, such income shall be exempted from taxation in Kenya. This, however, will only apply to the extent of the income taxed in the U.K. alone and the remaining income is to be taxed at the normal Kenyan tax rate.
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If on, the other hand, the income is derived from the U.K. and is to be taxed in both countries, then such income shall be allowed as a deduction in the calculation of the taxable income in Kenya only to the extent of the amount of tax that such an individual has paid in the U.K.12
Subsequently, the capital gains from the disposal of the shares of the construction company by the two directors will be taxed in the U.K. This amount will be exempted from taxation in the calculation of the taxable income of Hans by the Kenyan authorities.
The taxation regime in both countries is harmonized to allow and motivate stable and consistent business environment13. Double taxation exemptions plays a big role in ensuring that enterprises maintain a fair margin of profit and that they break even.14
Chisik, R and Davies, B. (2004) Gradualism in Tax Treaties with Irreversible Foreign Direct Investment. International Economic Review, Vol. 45, No. 1, pp. 113-139.
Davies, B. (2003) The OECD Model Tax Treaty: Tax Competition and Two-Way Capital Flows. International Economic Review.Vol. 44, No. 2, pp. 725-753.
Her Majesty’s Revenue and Customs (HMRC). (2011) Double Taxation Relief Manual (Kenya). Web.
Huber G, et al. (2003) Government Strength, Power Dispersion in Governments and Budget Deficits in OECD-Countries. A Voting Power Approach Public Choice, Vol. 116, No. ¾, pp. 333-350.
Shome P. and Schutte, C. (1993) Cash-Flow Tax Staff Papers – International Monetary Fund, Vol. 40, No. 3, pp. 638-662.
Weichenrieder, J. (1996) Transfer Pricing, Double Taxation, and the Cost of Capital. The Scandinavian Journal of Economics, Vol. 98, No. 3, pp. 445-452.
Ziliak, P and Kniesner J. (2005) The Effect of Income Taxation on Consumption and Labor Supply. Journal of Labor Economics, Vol. 23, No. 4, pp. 769-796.
- Huber G, et al. (2003) Government Strength, Power Dispersion in Governments and Budget Deficits in OECD-Countries. A Voting Power Approach Public Choice, Vol. 116, No. ¾, pp. 333-350.
- Article 32 of the Double Tax Convention between Kenya and the U.K. Web.
- Chisik, R and Davies, B. (2004) Gradualism in Tax Treaties with Irreversible Foreign Direct Investment. International Economic Review, Vol. 45, No. 1, pp. 113-139.
- Kanjee Nazanjee v Income Tax commissioner (1964) E.A 257 at 262 H
- Her Majesty’s Revenue and Customs (HMRC). (2011) Double Taxation Relief Manual (Kenya). Web.
- UK, SCITD 19 Nov. 2008, (cf. m.no. 12) were the income of a UK unlimited company was taxable both in the United Kingdom in the hands of the UK unlimited company itself and in the United States in the hands of the parent company of the UK unlimited company, since the latter was classiﬁed as a disregarded entity for US income tax purposes. The income of the UK unlimited company was thus attributed to different persons by the two states. The United Kingdom stated that double taxation relief is not to be granted to the UK unlimited company under the UK–US DTC.
- Shome P. and Schutte, C. (1993) Cash-Flow Tax Staff Papers – International Monetary Fund, Vol. 40, No. 3, pp. 638-662.
- Davies, B. (2003) The OECD Model Tax Treaty: Tax Competition and Two-Way Capital Flows. International Economic Review.Vol. 44, No. 2, pp. 725-753.
- Kanjee Nazanjee v Income Tax commissioner (1964) E.A 257 at 262 H.
- Unilever Kenya Ltd Vs Commissioner of Income Tax.
- Unilever Kenya Ltd Vs Commissioner of Income Tax.
- Weichenrieder, J. (1996) Transfer Pricing, Double Taxation, and the Cost of Capital. The Scandinavian Journal of Economics, Vol. 98, No. 3, pp. 445-452.
- Unilever Kenya Ltd Vs Commissioner of Income Tax.
- Ziliak, P and Kniesner J. (2005) The Effect of Income Taxation on Consumption and Labor Supply. Journal of Labor Economics, Vol. 23, No. 4, pp. 769-796.