ADVANCE PRICING AGREEMENTS (APA) IN KENYA
Kenya has introduced a significant change to its tax legislation with the insertion of Section 18G into the Income Tax Act (Cap. 470). This new provision, introduces the concept of an Advance Pricing Agreement (APA). This is a crucial development for businesses, particularly multinational enterprises (MNEs), operating in Kenya as it provides a new mechanism for managing transfer pricing risks.
An Advance Pricing Agreement (APA) is a binding agreement between a taxpayer and a tax authority (in this case, the Kenya Revenue Authority (KRA)) that determines, in advance, the transfer pricing method to be applied to a taxpayer’s related-party transactions over a fixed period. In simpler terms, it’s a way for a company and the KRA to agree on a fair price for goods, services, or assets transferred between different parts of the same company (e.g., a Kenyan subsidiary and its foreign parent company). This pre-approved method ensures that the transactions are conducted at an “arm’s length” basis, which is the standard for transfer pricing. The legal framework for APAs was introduced through the Finance Act, 2025, with the insertion of Section 18G into the Income Tax Act (Cap. 470). This new provision will become effective on January 1, 2026.
How an APA Works
The primary purpose of an APA is to provide tax certainty for a specified period, typically up to five years. APAs are especially important in cross-border transactions where pricing between associated enterprises may be scrutinized for potential profit shifting. By agreeing in advance on the arm’s length pricing, both the taxpayer and the revenue authority avoid lengthy audits, adjustments, and litigation. The process generally involves:
- A taxpayer initiates the process by submitting a formal application to the KRA, outlining the related-party transactions they wish to cover and proposing a specific transfer pricing methodology.
- The KRA and the taxpayer engage in a comprehensive due diligence process. The KRA reviews the proposed methodology, examines the taxpayer’s business operations, and may request additional information. Negotiations then take place to agree on the most appropriate methodology that aligns with the arm’s length principle.
- Once both parties reach an agreement, they sign a formal APA. The taxpayer must then adhere to the agreed-upon methodology for the specified period.
- The taxpayer is required to submit an annual report to the KRA demonstrating compliance with the terms of the APA. This ensures that the agreement remains valid.
The introduction of APAs is a global best practice aimed at reducing the likelihood of costly and time-consuming tax disputes. By proactively agreeing on transfer pricing methods, companies can avoid potential adjustments, penalties, and interest that often result from transfer pricing audits.
Key Provisions of the New Section 18G
Section 18G is a concise yet powerful addition to the Income Tax Act. Subsection (1) grants the KRA Commissioner the authority to enter into an APA with a person (a taxpayer) who undertakes a related-party transaction as defined in Section 18(3) or Section 18A. This is a critical provision that empowers the KRA to engage in these agreements.
Subsection (2) clarifies that the amount of income expected from a related-party transaction will be determined in accordance with the APA. This reinforces the principle that transactions between related parties should be priced as if they were conducted between independent entities, a core tenet of transfer pricing. Subsection (3) states that an APA entered under this new section is valid for a maximum of five consecutive years. This provides a reasonable timeframe for businesses to have tax certainty and plan their operations accordingly.
Subsection (4) is a crucial safeguard for the KRA. If the Commissioner finds that a taxpayer obtained an APA through misrepresentation of facts, the agreement will be deemed void. The KRA will then issue a written notice to the taxpayer, effectively revoking the agreement and opening the door for a potential audit and reassessment. Subsection (5) mandates the Cabinet Secretary to create regulations for the “better implementation” of Section 18G within six months of its commencement. This indicates that more detailed guidelines on the application process, documentation requirements, and other administrative aspects are expected soon.
Why this Matters for Your Business
The introduction of APAs in Kenya provides a valuable tool for multinational corporations and other related-party businesses. An APA eliminates the uncertainty and potential for disputes related to transfer pricing. By agreeing on a methodology in advance, you can be confident in your tax position. It significantly reduces the risk of penalties, interest, and double taxation that can arise from KRA audits and adjustments.
While the application process requires an initial investment of time and resources, it can save significant costs and management time in the long run by avoiding prolonged and expensive disputes with the tax authorities. The APA process fosters a cooperative and transparent relationship with the KRA, as both parties work together to find an appropriate transfer pricing solution.
The implementation of Section 18G marks a new era in Kenya’s tax administration, one that prioritizes proactive compliance and mutual agreement. Businesses with significant related-party transactions should consult with legal and tax professionals to assess whether an APA is a suitable strategy for their operations.
At A.O. WANGA ADVOCATES we are happy to assist you with tax related issues in Kenya. For more information contact us on info@aowangaadvocates.com or +254794600191
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