Tax planning for foreign Chinese-invested enterprises in Kenya

In this article we look at need for tax planning for foreign Chinese-invested enterprises in Kenya.

What is a foreign Chinese invested enterprise?

Guo Shui Fa [2009] No. 82 (circular by SAT) defines a foreign Chinese invested enterprise as an enterprise

‘registered and established outside the territory of China in accordance with the laws of a foreign country with enterprise(s)or enterprise group(s) within the territory of China as the major share-holding investor(s)’.

Based Guo Shui Fa [2009] No. 82 the types of enterprises are tax resident in China where they meet the following conditions:

1. Senior management and senior management departments that are responsible  for daily production, operation and management of the enterprise perform  their duties mainly within China;

2. Financial decisions (such as money borrowing, lending, financing and financial  risk management) and personnel decisions (such as appointment, dismissal,  salary, and wages) are made or need to be approved by organizations or persons  located within China;

3. Main property, accounting books, corporate seal, and records of meetings of  the board of directors and shareholders of the enterprise are maintained in  China; and

4. One half or more of the members of the board of directors or the senior management staff of the enterprise habitually reside in China.

Overall, the tax authority in China follows the principle of substance over form to determine whether actual management of such enterprises takes place in China.

What tax rules apply to such enterprises in Kenya?

On the side of Kenya, if the enterprise is registered in Kenya it would be tax resident in Kenya. This presents a high risk of double taxation on corporate income. Of note, the China – Kenya Double Tax Treaty is not effective.

An obvious solution for the dilemma would be for the Chinese enterprises to cut all management and control from China. This may however not be an option for China State Owned Enterprises. Additionally, the China tax authorities have wide room for determining that a foreign Chinese invested enterprise is China resident.

Of note, most China-funded enterprises in Kenya are aware of their tax obligations in China. As result, most opt not to register in Kenya to avoid being tax resident in Kenya. This, however, does not work because the Permanent Establishment (‘PE’) rules under Kenya tax legislation would still capture these enterprises.

PE implications for China – funded enterprises not registered in Kenya

In brief, an entity would constitute a PE in Kenya if they have a fixed place of business for a certain period of time (for a construction or installation project it is 6 months or more) where that person wholly or partly carries on business.

Most China funded enterprises in Kenya are undertaking construction type projects, mainly under the Belt & Road Initiative (‘BRI’). Hence, if they are in Kenya undertaking the construction for 6 months or more they will constitute a PE in Kenya.

A PE is taxed in Kenya at the corporation rate of 37.5%. Moreover, certain expenses paid by the PE are disallowed for tax purposes. For instance, management & professional fees, royalties, and interest paid by the PE to the non-resident owner. Additionally, foreign exchange gains and losses with respect to net assets and liabilities existing between the PE and the non-resident owner.

Opting to not register any form of entity in Kenya to avoid double taxation is therefore not an option. The potential tax liability that accrues to China enterprises that opt not register in Kenya is substantial. This is because the liability simply piles up rather than disappears for the time that the entity operated unregistered.

Possible tax planning

Dividends paid between two Chinese resident companies are exempt from tax in China[1]. The foreign China invested company could register itself as tax resident in China. Thus, if registered in Kenya as a Limited Liability Company, dividend payments made from the Kenya company to the China owners would not be subject to tax in China. The dividends would however be subject to withholding tax in Kenya. Nonetheless, this reduces the effective tax for these enterprises.

Conclusion

We are happy to help to explore other tax planning options. If you need assistance on tax on foreign Chinese-invested enterprises in Kenya please write to mukami@yazitaxafrica.com

[1] Guo Shui Fa [2009] No. 82, Cao, Fuli (2011-07-01). Corporate Income Tax Law and Practice in the People’s Republic of China (Page 22). Oxford University Press. Kindle Edition.