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Demystifying Permanent Establishments

The definition of a permanent establishment is crucial to the taxation of profits. In most international tax conventions, the business profits of a permanent establishment are taxed at the country of source.

The business income of a non-resident person is only taxed at source upon establishment of a PE status. The model tax conventions stipulate the rules used to determine the existence of a PE and attribute profits to a PE.

They require some threshold level of presence to be reached before source taxation can be triggered. PEs have been used as a tool to carry out business in different jurisdictions without having to establish tax residency status. Companies are spending an increasing amount of time on managing the existence of a PE and the allocation of income to a PE, if in existence.

Tax authorities are also taking more aggressive positions to determine the existence of PEs.

So, what exactly is a PE?

PE commonly refers to a foreign branch. It is part and parcel of the same corporate entity as the head office, which creates the problem of double taxation. It also creates difficulties in allocating profits to different parts of the same company located in different states. Most of the PE rules require that a PE be treated as a separate legal entity for tax purposes. Transfer pricing rules apply to determine arm’s length prices for intercompany transactions.

Income Tax Act, Chapter 470, Laws of Kenya

The gains or profits of a business accrued in or derived from Kenya by a non-resident person are taxable in Kenya (section (3)(1). Thus, the business profits of a PE accrued in or derived from Kenya are taxable in Kenya.

The Finance Act 2021 expanded the definition of PE and included the exclusions to align with the model tax conventions and Action 7 of the BEPS Package.

Expanded Definition of Permanent Establishments under Kenya’s Income Tax Act

Section 2 of Kenya’s Income Tax Act (ITA) provides a detailed definition of a Permanent Establishment (PE), aligning with international tax frameworks. A PE includes:

1. Fixed Places of Business: Locations where business is wholly or partially carried out, such as a place of management, branch, office, factory, workshop, mine, oil or gas well, quarry, or any site for natural resource extraction. This includes warehouses for storage businesses, farms, plantations, or similar sites for agricultural activities, and sales outlets.

2. Construction Projects: A building site, construction, assembly, or installation project, or supervisory activities related to these, but only if they last more than 183 days.

3. Service Provision: Consultancy or other services provided through employees or personnel in Kenya for periods exceeding 91 days within any 12-month period.

4. Resource Exploration: Installations or structures used for exploring natural resources, provided the activities last at least 91 days.

5. Dependent Agents: Agents acting on behalf of a business, including those habitually concluding contracts or playing a significant role in contract formation.

However, the law excludes activities deemed preparatory or auxiliary, such as:

  • Using facilities solely for storing or displaying goods or merchandise.
  • Maintaining goods or merchandise solely for storage, display, or processing by another enterprise.
  • Operating a fixed place of business solely for purchasing goods, collecting information, or carrying out minor activities for the enterprise.
  • Engaging in any combination of the above activities.

These exclusions aim to clarify when a PE triggers tax obligation while preventing unfair tax burdens for incidental operations.

Understanding the concept of a Permanent Establishment (PE) is critical for businesses operating across borders. The definition not only determines tax obligations but also influences global business strategies and compliance efforts. By outlining clear criteria, Kenya’s Income Tax Act ensures fairness and alignment with international standards, while addressing the complexities of modern commerce.

This material is intended solely for informational purposes and should not be relied upon without seeking specific professional advice on the matter. Should you have any questions regarding this topic, please feel free to contact our team at info@ke.andersen.com or +254 20 5100263.

 

Contributors & Contact Persons

Kennedy Kiio

Senior Tax Advisor

kennedy.kiio@ke.andersen.com

 

Marco Manyenze

Associate Director

marco.manyenze@ke.andersen.com

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