The proposed DTA is aimed at further deepening the economic relationship between Kenya and China, which has developed significantly over the past decade. China is one of Kenya’s largest trading partners.
Key Provisions of the Proposed DTA
We highlight the key provisions of the proposed DTA below.
- Withholding tax rates
|
Nature of payment |
Non-resident rate where there is no DTA |
Rate under the Proposed DTA |
|
Dividends |
15% |
5%* |
|
Interest |
15% |
10% |
|
Royalties |
20% |
10% |
|
Technical fee (include service of managerial technical and consultancy) |
20% |
10% |
* This rate will be applicable where the beneficial owner is a resident of the other contracting states (in this case, China). However, the proposed DTA does not provide a definition for beneficial owner and does not provide for a withholding tax rate where a person is not deemed to be the beneficial owner. Therefore, the rate applicable in such an instance will be the non-resident withholding tax rate, which is currently 15%.
The application of the reduced withholding tax rates is subject to the anti-treaty shopping provisions in the Kenyan Income Tax Act as discussed below.
- Definition of a Permanent Establishment (PE)
The provisions of the proposed DTA on the crystallization of permanent establishment are largely in line with those of the OECD Model Convention but vary from the Income Tax Act as follows:
- Service PE – the furnishing of services (including consultancy services) by an enterprise through employees or personnel for an aggregate of more than 183 days would trigger a service PE under the proposed DTA. On the other hand, under the Kenyan Income Tax Act, service PE is triggered if the services continue for a period of an aggregate of more than 91 days;
- Construction PE - under the proposed DTA, activities of a building site, construction, assembly, or installation project carried on for an aggregate of more than 12 months from the date the contractor commences the work, including preparatory work, would trigger a construction PE. Under the Kenyan Income Tax Act, such a PE would be triggered if the activities are carried on for an aggregate of more than 183 days; and
- Dependent agent PE (DAPE) – the proposed DTA provides that a PE will also be triggered where the dependent agent habitually exercises the authority to conclude contracts in the name of the enterprise. Under the Kenyan Income Tax Act, such a PE is triggered where the dependent agent exercises the authority to conclude contracts or playing the principal role leading to the conclusion of contracts that are routinely concluded without material modification by a non-resident person. The DTA proposes a lower DAPE threshold
It remains to be seen whether the lower PE thresholds will be maintained once persons have provided comments and upon review by the National Assembly.
- Limitation of treaty benefits/ anti-treaty shopping provisions
Kenya has very a restrictive limitation on treaty benefits under the Income Tax Act. Section 41 of the Income Tax Act provides that a person can only take advantage of tax benefits under a double tax agreement (for example, the Kenya- China DTA) if (a) 50% or more of the underlying ownership of that person is held by a person or persons who are resident in that country (in this case, China) for the purposes of the proposed DTA; or (b) if the person is a company listed on the stock exchange in that other contracting state (in this case China). Therefore, for one to enjoy the benefits provided under the Proposed DTA, one must at least meet one of the conditions set out above.
Additionally, the DTA has a provision on the Principle Purpose Test (PPT) which provides that a benefit shall not be granted in respect of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of the arrangement or transaction that resulted directly or indirectly in that benefit.
- Method for elimination of double taxation
Both parties will apply the credit method for the elimination of double taxation whereby taxes paid on income derived from one state per the provisions of the DTA may be credited against the taxes imposed on the same income in the other state up to the amount of tax payable in the second state.
In addition, for dividends received by an entity resident in China that owns at least 20% of the shares of the paying Kenyan entity, China will grant a credit for the Kenyan tax paid on the profits out of which the dividends are paid.
Putting into perspective
DTAs are designed to facilitate cross border trade and encourage foreign direct investment whilst at the same time eliminating double taxation of income which hinders trade and investment. Currently, Kenya has 15 DTAs which are in force, and the efforts to increase the DTA network is commendable.
However, it should be noted that the last DTAs to enter into force were the DTAs with Iran, South Korea and the United Arab Emirates, all of which entered into force in the year 2017. We also note that the National Treasury similarly requested for comments for DTAs with Singapore and Barbados (both in 2020) and Ireland (in 2021). However, the current status of these DTAs is not clear. In addition, we note that the Kenya – Netherlands proposed DTA was withdrawn from ratification from the Kenyan parliament in 2021 by the National Treasury. Please see our comments on the withdrawal here.
It is also instructive to note that in March 2019, the High Court of Kenya nullified the Kenya-Mauritius DTA because it was not tabled in Parliament. Therefore, to avoid such predicaments, the National Treasury should ensure compliance with all the procedures set out in the Treaty Making and Ratification Act No. 45 of 2012.
Finally, we note that the National Treasury had identified several challenges with DTAs, with the key challenge being the lack of a framework that guides the negotiations of these important instruments. It therefore remains to be seen whether such a framework will be developed and whether this will help in the fast tracking of negotiations and the entry into force of DTAs, which is ordinarily a time-consuming process.
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