Taxation of foreing investment dividend income in Kenya
Last updated September 25, 2024
Is Your Overseas Investment Income Taxed in Kenya? A Deep Dive into Cross-Border Taxation
In today’s interconnected global economy, many companies are expanding their operations beyond their home countries, creating intricate webs of subsidiaries and investments across borders. This expansion often raises complex tax questions, especially concerning cross-border dividends—income distributed by foreign subsidiaries to parent companies.
For tax practitioners and businesses alike, the challenge lies in navigating the rules governing the taxation of these dividends, balancing both local and international tax obligations, and avoiding the dreaded double taxation.
A recent tax case in Kenya — Heritage Insurance Company Kenya Limited v Kenya Revenue Authority —offers significant insight into how dividend income from foreign subsidiaries is treated under Kenyan tax law.
The case highlights critical aspects of cross-border taxation, emphasizing the principles of source-based taxation and the need for clarity in determining whether foreign-sourced dividends are subject to Kenyan income tax.
Background of the Case
Heritage Insurance Company, a Kenyan resident insurance firm, received dividends from its Tanzanian subsidiary, Heritage Tanzania Limited, in the tax years 2017 to 2019.
Following an audit by the Kenya Revenue Authority (KRA), the company was assessed for additional taxes on this dividend income. KRA’s position was that Heritage Insurance, as a Kenyan resident company, was liable to tax on its global income, including dividends from its foreign subsidiary. KRA sought to tax these dividends under Kenya’s Income Tax Act, which appeared to provide for the taxation of global income earned by Kenyan residents.
Heritage Insurance contested this tax assessment, arguing that the dividends in question were sourced and earned in Tanzania, and thus not taxable under Kenyan law.
The dispute culminated in a Tax Appeal Tribunal hearing, which resulted in a ruling that provided much-needed clarity on the treatment of cross-border dividends.
The Core Issue: Can Kenya Tax Foreign Dividends?
The crux of the dispute lay in the interpretation of Section 3(1) of the Income Tax Act (ITA), which is the cornerstone of Kenya’s tax regime. This provision mandates that tax is levied on income “accrued in or derived from Kenya.”
Heritage Insurance’s argument was simple yet powerful: the dividends they received from Heritage Tanzania were earned from operations and business activities conducted in Tanzania, not Kenya. Therefore, the income did not accrue in or derive from Kenya, and it should not be subject to Kenyan tax.
The company further argued that all necessary taxes, including withholding tax, had already been paid in Tanzania. As such, taxing the same income in Kenya would not only contradict the principle of source-based taxation but also result in double taxation, which is a situation where the same income is taxed by two different jurisdictions.
KRA’s Counter-Argument: The Global Income Approach
KRA, on the other hand, took a more expansive view of Kenya’s taxing rights. It argued that as a Kenyan resident company, Heritage Insurance was subject to tax on its global income, regardless of where the income was earned.
In this context, KRA pointed to Section 3(2) of the ITA, which allows for the taxation of “gains or profits from any business” conducted by a resident company, irrespective of whether the business is carried out inside or outside Kenya.
In KRA’s view, dividend income from a foreign subsidiary was part of the business profits of the Kenyan parent company and thus should be taxed in Kenya. The tax authority also relied on Section 7(3) of the ITA, which provides that dividends received by financial institutions (such as insurance companies) are chargeable to tax.
The court Ruling: Upholding the Principle of Source-Based Taxation
The Tax Appeal Tribunal delivered a well-reasoned ruling that sided with Heritage Insurance. The Tribunal clarified that the Kenyan tax system operates predominantly on the principle of source-based taxation, meaning that only income that accrues in or is derived from Kenya can be taxed in Kenya.
Since the dividends were generated from the operations of Heritage Tanzania Limited, a company incorporated and operating in Tanzania, the Tribunal held that the income in question did not meet the threshold for taxation under Kenyan law.
The Tribunal emphasized that Section 3(1) of the ITA is clear and unambiguous: only income that is sourced from Kenya is taxable. The dividends from the Tanzanian subsidiary, having been earned and taxed in Tanzania, were not taxable in Kenya.
This decision upheld the principle that the place of accrual and derivation of income is paramount in determining tax liability, particularly in cases of cross-border income.
Rejection of KRA’s Interpretation of Section 7(3)
The Tribunal also addressed KRA’s reliance on Section 7(3) of the ITA, which taxes dividends received by financial institutions. KRA argued that this section extended to dividends received from foreign subsidiaries.
However, the Tribunal rejected this interpretation, clarifying that Section 7(3) applies only to domestic dividends—i.e., dividends received from companies resident in Kenya. The Tribunal ruled that this section does not extend to dividends from non-resident companies, such as Heritage Tanzania Limited. Thus, KRA’s attempt to stretch the scope of Section 7(3) to include foreign-sourced dividends was deemed unfounded.
Implications for Cross-Border Businesses
This ruling has significant implications for Kenyan companies with foreign subsidiaries. It reaffirms that Kenya’s tax regime is grounded in the principle of source-based taxation and that income earned outside Kenya is not automatically subject to tax in Kenya simply because the recipient is a Kenyan resident company.
This decision is particularly important for individuals and businesses that receive dividends from subsidiaries in countries with no Double Taxation Agreement (DTA) with Kenya, such as Tanzania.
By establishing a clear boundary for the taxation of foreign-sourced dividends, the Tribunal has provided much-needed certainty for businesses navigating cross-border tax obligations. Companies can now be more confident that income earned outside Kenya, and which has already been subjected to foreign taxes, will not be taxed again in Kenya, provided that the income does not accrue in or derive from Kenya.
In Conclusion
This case serves as a landmark ruling in the realm of cross-border taxation, especially for multinational companies operating in Kenya. It reinforces the importance of source-based taxation and prevents the unnecessary overreach of KRA in taxing income that has already been subject to tax in other jurisdictions.
For tax professionals, this case highlights the need for clear documentation of foreign income sources and a solid understanding of the applicable tax laws in both the home and source countries. As global business continues to expand, the clarity provided by this case will serve as a guidepost for companies and tax authorities alike, ensuring that the taxation of cross-border dividends remains grounded in well-established legal principles.
Ultimately, the ruling reinforces the view that while companies are subject to tax on their global income, this must be balanced with the principle of fairness and the avoidance of double taxation, which could hinder international investment and growth.
Written by Joseph Wachira
The author is an International Tax Consultant and can be reached via wachira@cleartax.co.ke
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