A large proportion of international trade in goods and services is conducted between what are known technically as related parties. In practice, most of this trade is between different companies forming part of the same transnational corporate grouping.
This is typically highly integrated in economic and financial terms, while legally appearing as a set of separate companies incorporated in a wide range of countries. For accounting, customs and general tax purposes, any two related companies engaging in cross-border transactions need to decide the price that they will set for the goods and services they exchange – ideally they will not make a profit off each other, as would be the case with unrelated companies. Inevitably, however, these are not market prices but administered prices. The process of setting these prices is known as transfer pricing (TP). In principle there is a standard mechanism, agreed internationally, to guide transfer pricing – the arm’s length principle. This means that cross-border transactions between related parties should be booked at the prices that would have applied had these been open competitive market transactions between unrelated parties (arm’s length transactions). It can be extremely difficult – and sometimes impossible – for revenue authorities to apply the arm’s length principle in daily operations.
This paper analyses Kenya’s experience of trying to deal with transfer pricing, and looks at difficulties facing developing and middle-income countries in the application of transfer pricing rules. It discusses the course Kenya has taken in introducing TP laws, regulations, policies and administrative training in order to audit TP transactions effectively. Section 1 sets out the background to Kenya, its position in the African continent and globally, explaining why it has been selected as a case study. Section 2 sets out the historical experience of Kenya, both in developing its TP laws, regulations and procedures, as well as building capacity of its staff on issues of transfer pricing. Sections 3 and 4 reflect on the Kenyan position as set out in Section 2, and the appropriateness of some of the changes being proposed internationally by Actions 8-10 and 13 of the BEPS project of the G20/OECD.
This paper attempts to unpack the issues surrounding TP in a developing country like Kenya, and to reflect on what is really needed in the BEPS process to make it usable in developing countries. The paper concludes by stating that the issues being raised in TP have been only partially resolved through improved capacity, regulations and policy. The OECD BEPS process does not seem to resolve problems faced by countries like Kenya, but instead foists a set of complex and unwieldy rules on Kenya and other developing and middle-income countries.