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The integration of national economies and markets has increased substantially in recent years, putting a strain on international tax rules that were designed more than a century ago. Weaknesses in the international tax rules created opportunities for base erosion and profit shifting thereby resulting in tax leakages for many governments. Informational asymmetry between taxpayers and tax authorities has long been considered a major contributor to opportunities for abuse of the tax system. In this regard, the global community has been making efforts to enhance tax transparency, remove bank secrecy and facilitate robust exchanges of information between tax administrations through bilateral and multilateral instruments.
The Country-by-Country reporting (CbC Reporting) was among the various actions proposed as part of the OECD/G20 Base Erosion and Profit Shifting (BEPS) Project in the Transfer Pricing Documentation and Country-by-Country Reporting, Action 13 – 2015 Final Report. The underlying rationale of CbC Reporting is to increase the probability of detecting profit shifting as governments gain additional information on the global activities of Multinational Enterprises (MNEs). The additional information contained in the CbC reports may allow tax authorities to more efficiently allocate their (limited) resources to those MNEs that pose a high tax risk. According to the Organisation for Economic Co-operation and Development (OECD), CbC Reports can be a very important tool for the detection and identification of transfer pricing risk and other BEPS-related risks in the hands of a tax administration, used alongside other information that it holds and as a basis for further enquiries and should not be used in isolation.
In this Alert, we assess the CbC Reporting requirements from a global perspective, Kenya’s legal obligations in relation to CbC Reporting. Finally, we conclude by analysing the impact of CbC reporting on taxpayers.
With the global community in agreement that CbC reporting is a key priority in addressing BEPS risks, Action 13 was adopted as one of four minimum standards within the BEPS Action Plan. Swift progress has been made since 2015 with over 100 jurisdictions having introduced the CbC reporting filing obligations. There are also currently over 3300 bilateral exchange relationships activated with respect to jurisdictions committed to exchanging CbC Reports with the first Reports having taken place in June 2018.
Action 13 requires the ultimate parent entities of large MNE groups to file a Country-by-Country Report (CbC Report) with the tax authority in their residence jurisdiction, containing information (CbCR information) relating to the global allocation of the group’s income and taxes, together with indicators of the location of economic activity within the group. This tax authority would subsequently share the CbC Report with tax authorities in other jurisdictions where the MNE group has activities, subject to conditions including that CbCR information which may only be used for the purposes of high-level transfer pricing risk assessment, assessing other BEPS-related risks and, where appropriate, for statistical and economic analysis.
CbC reports provide tax authorities with information on the global activities of multinationals with operations in their country breaking down the group’s revenue, profits, tax and other attributes by tax jurisdiction. This information represents a great opportunity for tax authorities to understand the structure of an MNE’s business in a way that has not been possible before.
The CbC Reporting Requirements
In the BEPS Action 13 report CbC Reporting requirements are recommended as part of a standardised three-tier approach to transfer pricing documentation for MNEs which consists of the following:
a) a master file,
b) a local file, and
c) an obligation on certain MNE groups to annually file a CbC Report.
Action 13 requires that the ultimate parent entity (UPE) of an MNE group should prepare a CbC Report for each fiscal year of the group and file the report within 12 months of the end of the fiscal year with the tax authority in the jurisdiction where it is tax resident. While the OECD has set a minimum threshold for the applicability of the obligation to MNEs with a total consolidated revenue of EUR 750 million in the immediately preceding fiscal period, different countries including Kenya have set lower thresholds in line with their own domestic requirements.
CbC Reporting Obligations Introduced in Kenya
Kenya’s CbC Reporting framework is set out under the Finance Act, 2022 which amended the Income Tax Act (the ITA). Under Section 18 (D) (1) the requirement to file a CbC Report is imposed upon a UPE or a constituent entity (CE) of an MNE that is resident in Kenya and with a gross turnover of KES 95 billion on an annual basis with the Kenya Revenue Authority (KRA). This threshold is generally aligned with the OECD recommended threshold of EUR 750 million depending on the prevailing exchange rates. Under the ITA, a UPE is defined as an entity resident in Kenya for tax purposes, that is not controlled by another entity and owns or controls a multinational enterprise group.
The contents of a CbC Report include the amount of revenue, profit before income tax and income tax paid and accrued in respect of each tax jurisdiction in which the MNE does business. MNEs are also required to report their number of employees, stated capital, retained earnings and tangible assets in each tax jurisdiction. Finally, it requires MNEs to identify each entity within the group doing business in a particular tax jurisdiction and to provide an indication of the business activities each entity engages in.
The implication of the requirements is that Kenya is obliged to collect and share CbC reports of MNEs with UPEs based in Kenya and to receive the same from other jurisdictions with MNEs operating in Kenya. The OECD has therefore established a multilateral mechanism under the Multilateral Convention on Mutual Administrative Assistance called the Multilateral Competent Authority Agreement (MCAA) for the Exchange of Country-by-Country (CbC) reports. Kenya became a signatory to this Competent Agreement on 9 September 2022 and is now well placed to engage in CbC exchanges with 94 countries globally as of the time of publication of this article. As such, Kenya has joined a league of countries globally that have committed to the automatic exchange of CbC reports.
Jurisdictions continue to negotiate arrangements for the exchange of CbC reports including through bilateral competent authority agreements for exchanges under Double Tax Conventions or Tax Information Exchange Agreements. However, it is important to note that any particular bilateral relationship under the CbC MCAA becomes effective only if both jurisdictions have the Convention in effect and have filed the required notifications under Section 8 of the MCAA listing each other as an exchange partner.
A CbC Report filed by the UPE of an MNE group with the tax authority in its residence jurisdiction is exchanged with the tax authorities in other jurisdictions where a member of the MNE group is either a resident for tax purposes or is subject to tax with respect to a business carried on through a permanent establishment. This exchange of information is subject to conditions governing the confidentiality, consistency and appropriate use of the information contained in the CbC Report.
Taken together, these three documents (master file, local file and CbC Report) will require taxpayers to articulate consistent transfer pricing positions and will provide tax administrations with useful information to assess transfer pricing risks, make determinations about where audit resources can most effectively be deployed, and, in the event audits are called for, provide information to commence and target audit enquiries.
Impact to Taxpayers
Access by tax authorities to CbC reports will certainly enhance transparency around transfer pricing and provide more scrutiny and audits in a function already considered a high source of tax controversy for most MNEs. However, there exists some scepticism about the effectiveness of CbCR in curbing profit shifting. It is well possible that the introduction of additional reporting obligations only adds a burden on businesses as it requires them to generate new data and put the necessary processes in place without raising the detection probability of profit shifting. Contrastingly, others have argued that higher costs in the event of detection will also reduce the attractiveness of tax avoidance.
Additionally, companies may be apprehensive of the risk of CbC reports becoming public which would lead to reputational damage for some companies – either because of revelations of aggressive tax planning or simple misinterpretation of the data in the court of public opinion. It has also been argued that the direct and indirect costs of CbCR may generate an incentive for companies to avoid the filing obligation by adjusting revenues to a level below the threshold as an additional unintended consequence of CbCR.
In our view, it remains to be seen how tax administrations will react to the emerging compliance challenges currently posed and whether the thresholds will invariably be lowered to capture a wider pool of MNEs. Invariably, we recommend that MNEs already meeting the prescribed thresholds must give serious thought to compliance with the CbC preparation and reporting requirements spelt out by the law.
With the KRA already providing the format for filing CbC Report notification, we expect additional guidelines on how to file the CbC Report as well as regulations governing the entire framework of sections 18 C and 18 D to follow suit. In the interim, affected companies should commence filing the CbC Report Notification, evaluate the operations for the financial year 2022 and take active steps in collecting the information required for the master file and the local file.
1. Robert Mabwa – Associate
2. Muna Abdullahi – Associate
3. Abdullahi Ali – Associate