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May 31, 2024

Kenya Tax Appeals Tribunal rules certain fund management activities can trigger a PE

  • The Kenya Revenue Authority contended that a foreign private equity Fund had a permanent establishment (PE) in Kenya because it carried out its business through the employees of an entity that was incorporated in Kenya.
  • The Tax Appeals Tribunal ruled that the Appellant indeed created a PE for a foreign Fund, and it was liable to corporate income tax on gains derived from sale of shares by the foreign Fund.
  • The judgment highlights the importance of active management of a PE risk by foreign fund managers.

Executive summary

In a recent decision, the Tax Appeals Tribunal (TAT or Tribunal) ruled in favor of the Kenya Revenue Authority (KRA), sustaining an assessment of corporate income tax on gain that a foreign fund derived from the sale of shares.

The ruling highlighted that the relationship between a Mauritius fund (Fund) and a local fund manager could create a permanent establishment (PE) in Kenya with the attendant tax risks.

This decision also reiterated that tax laws are country-specific.

Detailed discussion

The tax dispute related to the disposal of the Fund's investment in a company incorporated in Mauritius (Company M). The Fund was registered in Mauritius while Company M owned 100% stake in another company that was domiciled in Kenya (Company K).

The taxpayer (also referred to as the Appellant) has as its principal activity the collection, processing and collating of data from portfolio companies to respond to various tasks assigned to it by its parent entity (Parent), which serves an investment advisor to the Fund in consideration for a fee.

The KRA issued a corporate income tax assessment to the Appellant on 29 September 2021, assessing the gain that the Fund had realized on the sale of shares in Company M.

The KRA asserted that the Fund established a PE in Kenya because two of the Appellant's employees who were directors of the Fund made investment and disposal decisions for it, all while sitting at the Appellant's offices in Kenya. As such, the proceeds of the sale of Company M ought to have been fully taxed in Kenya, the KRA contended.

The Appellant countered that none of its employees were directors of the Fund, buttressing this point with evidence consisting of the Fund's board of director minutes and directors' register.

Appellant's arguments

The Appellant asserted, in part, that the KRA had erred in concluding that the Appellant had discretionary control of the Fund because it made decisions concerning the investigation, evaluation, selection, negotiation, structuring, commitment, monitoring and disposition of investments of the Fund.

Based on this assertion, the profit that the Fund derived from the sale of its stake in Company M was attributed to the Fund manager and the Appellant and therefore taxable in Kenya.

The Appellant further argued, without prejudice to its position that the Fund did not have a PE in Kenya, that income earned from the sale of Company M was not subject to corporate income tax in Kenya, but rather constituted capital gain subject to capital gains tax.

Respondent's arguments

On appeal, the KRA indicated that the Appellant had both direct and indirect control of the transactions of the Fund.

The KRA further stated that, because the Fund was in the business of buying and selling of shares in companies, it therefore follows that the income derived thereon should be subjected to corporate income tax in Kenya.

Finally, the KRA contended that because the Appellant managed the Fund, the profits earned by the Fund are directly attributable to its input from Kenya.

Tribunal determination

The Tribunal, having considered the Appeal, determined that the fund manager had contracted with the Appellant to identify new opportunities, negotiate and structure transactions as well as monitor and execute the exit strategy for the Fund. The Tribunal held that the Appellant was in fact carrying out the business of the Fund from its premises through its employees. The Appellant was unable to prove that this was not the case.

Additionally, the averments that the Appellant was carrying out routine functions were not well supported, particularly because the Fund in did not have staff needed to carry out the Fund's core functions.

The Tribunal then addressed whether the income earned from the sale of shares in Mauritius could be attributed to and taxable to the Appellant. It noted that ordinarily, income earned from the sale of shares is treated as capital gain. However, in this case, the Respondent averred that the income earned was business income. The Tribunal observed that, based on the badges of trade, and particularly the motivation to make a profit, the income at issue qualified as business income and thus was subject to corporate income tax.

Having established that the Appellant created a PE in Kenya for the Fund and that the income earned was business income, the Tribunal found that the Respondent was justified in apportioning a percentage of the income derived from the sale to the Appellant in Kenya.

Next steps

Kenya has already instituted tax measures to bring into the ambit of capital gains tax certain gains from indirect transfers of shares. However, private equity firms and other investment corporations should closely monitor their activities in Kenya to help mitigate potential tax risks.

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Contact Information

For additional information concerning this Alert, please contact:

Ernst & Young (Kenya), Nairobi

Ernst & Young LLP (United Kingdom), Pan African Tax Desk, London

Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor