Branch Vs. Subsidiary- The Tax Question

The decision to establish a presence in Kenya often confronts enterprises with a crucial choice: should they pursue a branch or subsidiary structure? Although these terms are occasionally used interchangeably, they carry distinct legal and tax ramifications that demand careful consideration. 

A branch, functions as an extension of the foreign entity and operates within the jurisdiction of Kenya while maintaining an intrinsic connection to its parent organization. This legal doctrine was exemplified in Danone Baby Nutrition Africa and Overseas vs. The Commissioner of Domestic Taxes TAT Appeal No. 28 of 2018, where the Tax Appeals Tribunal held that branches are legally regarded as one and the same entity as the head office. Consequently, transactions between them are not recognized as dealings between separate entities. 

Conversely, a subsidiary emerges as an independent legal entity, distinct from its parent company, thereby establishing a separate legal persona. 

One of the primary legal disparities between a branch and a subsidiary lies in the issue of liability. In the case of a subsidiary, the parent company typically remains shielded from any liabilities incurred by the subsidiary, while in the case of a branch, the parent company bears accountability for the actions undertaken by the branch. 

The focal point of this article is to dissect the tax implications associated with opting for either a branch or a subsidiary in Kenya. By examining the tax obligations, our objective is to provide clarity to businesses contemplating establishment in Kenya.  

Corporate Income Tax (CIT) 

A subsidiary 

A subsidiary incorporated in Kenya is considered a resident entity and is taxed at the resident rate which is set at 30%. Resident companies are taxable in Kenya on income accrued or derived from Kenya. Where a business is carried on or exercised partly within and partly outside Kenya by a resident person, the whole of the gains or profits from such business are deemed to have accrued in or to have been derived from Kenya and therefore taxable in Kenya.  

Branch  

Branches are considered a non-resident. Non-resident companies are subject to CIT only on the trading profits attributable to a Kenyan Permanent Establishment (PE). 

Prior to January 1st, 2024, branches operating in Kenya were subject to a corporate tax rate of 37.5%. However, the Finance Act of 2023, streamlined the tax rate for branches to mirror that of resident companies, thereby reducing it to 30%. 

Moreover, an amendment was enacted, concerning the taxation of deemed profit repatriation by PEs. Under this provision, a formula delineated below was established to calculate the repatriated income: 

R = A1 + (P - T) – A2 

Where: 

• R represents the repatriated profit 

• A1 denotes the net assets at the beginning of the fiscal year 

• P signifies the net profit for the fiscal year, computed in adherence to generally accepted accounting principles 

• T represents the tax payable on the chargeable income 

• A2 indicates the net assets at the end of the fiscal year 

This amendment carries substantial implications. Firstly, it aligned the corporate tax rate for branches with that of resident companies. Secondly, the taxation of repatriated profits parallels the taxation on dividend payments, ensuring consistency and fairness in the tax regime. 

However, it’s important to note that while companies are taxed upon disbursing dividends, branches are subject to taxation based on the appreciation of their asset values, irrespective of their cash flow requirements.  

Value Added Tax  

VAT in Kenya is charged on the supply of taxable goods and services and on the importation of goods or services into Kenya. Persons whose turnover of taxable supplies is or is expected to be KES 5 million or more in a 12-month period must register for VAT. 

For supplies between a parent company and a subsidiary, The VAT Act provides that the taxable value of a supply between related parties should be the open market value of the supply.  

It is Important to note is that For VAT purposes a branch is not a distinct legal entity from its head office, hence activities performed on behalf of a parent by a branch do not constitute a supply subject to VAT as was held in Oracle Systems Limited (Kenyan Branch) vs. Commissioner Domestic Taxes. 

Withholding Tax  

Subsidiary 

Payments to the holding or parent company of a subsidiary incorporated in Kenya are subject to withholding tax as they are considered as payment to different entities. The rate of withholding tax is dependent on the payment paid out. 

Branch 

Payments to the main office are not subjected to withholding tax. This is because such payments are seen to be made within the same entity. 

Excise Duty   

Excise duty is an indirect tax that is charged on the importation, local manufacture of certain products, and supply of excisable services. The tax is levied on the producer or supplier, who passes the tax onto the consumer by including it in the product’s price. 

A branch or subsidiary will only pay Excise Duty if it deals in excisable goods or services in Kenya 

Transfer Pricing (TP) 

In Kenya, Transfer Pricing rules became effective from 1st July 2006 and borrowed significantly from the Organization for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines. Under Section 18(3) of the Income Tax Act (ITA), transactions between a resident entity and its related non-resident should be at arm's length (As though dealing with an independent party) 

Effective January 1, 2023, the scope of transactions that fall within the ambit of transfer pricing legislation include those between a Kenyan resident person and: 

1. A related resident person operating in a preferential tax regime; 
2. A non-resident person located in a preferential tax regime; 
3. An associated person enterprise of a non-resident person; or 
4. A permanent establishment of a non-resident person. 

 These rules form the basis for the determination of the arm’s length price in transactions between related parties. They entitle the KRA to adjust transaction prices where the revenue authority is of the view that the related parties did not transact at arm’s length.  

The following transactions (defined as “Controlled Transactions”) are subject to the transfer pricing rules:  

a. the purchase or sale of goods and services;  

b. the sale, purchase or lease of tangible assets;  

c. the transfer, sale, purchase or use of intangible assets;  

d. the provision of service;  

e. the lending or borrowing of money; and  

f. any other transactions which may affect the profit or loss of the enterprise involved. 

An entity that seeks to prove that the transactions between the entity and its non-resident Head Office or Parent Company is at arm’s length, is required to develop an appropriate transfer pricing policy.  

Conclusion 

Both branches and subsidiaries have different legal and tax obligations imposed on them. It is therefore important for a foreign company wishing to establish operations in Kenya to consider the tax obligations imposed on each business model against its’ structure and operations in order to settle on the suitable business model. 

How we can help          

The Corporate and Commercial Business Unit at CM Advocates LLP is well versed in matters relating to business set up advisory and registration, post incorporation registration, regulatory compliance, corporate restructuring, corporate governance, contract drafting and review. 

We assist you procure a registered office for your business and avail the services of a company secretary, contact person and a local representative where applicable. We also offer tax advisory services and procure the relevant work permits for the non-Kenyans and expatriate employees as well as their dependents. We draft and review the requisite contracts, deeds and agreements to be entered into as between parties. We take care of your regulatory and compliance issues in a constantly changing regulatory environment so that your business can focus on its substantive activities. 

Should you have any questions on this or any other matter, please do not hesitate to contact: Emily Gitau on egitau@cmadvocates.com, Maureen Odongo at modongo@cmadvocates.com or Tabitha Muchiri on tmuchiri@cmadvocates.com