Kenya’s Minimum Top-Up Tax Explained: Impact on Multinational Enterprises & Compliance Requirements

Introduction

The Tax Laws (Amendment) Act, 2024 introduced a minimum top-up tax payable by a “covered” person where the combined effective tax rate in respect of that person for a year of Income is less than 15%. In this article we discuss the minimum top-up tax and how it is to be applied.

Globalisation has transformed the global economy leading to enhanced innovation and access to capital. However, it has also resulted in challenges, especially in taxation. A major concern has been multinational groups’ ability for leveraging the benefits of globalisation to structure operations in a way that allows them to shift profit and achieve lower tax rates on some or all of their income. These structures have put pressure on capital importing counties to lower their corporate income tax rates and/or offer incentives to compete for capital and investment from multinationals. This measure has created a collective action problem that has led to the so-called “race to the bottom”. 
To mitigate the race to the bottom, the OECD Inclusive Framework members agreed to a co-ordinated system of Global anti-Base Erosion (GloBE) rules/ Pillar Two that are designed to ensure large multinationals pay a minimum effective tax rate of 15% on the income arising in each jurisdiction where they operate. 

Minimum Top-Up Tax

The GLoBE rules consist of a set of interlocking rules that ensure that the minimum tax is collected by:

1. the low-tax jurisdiction itself, under Qualified Domestic Minimum Top-up Tax (“QDMTT”) (what has been introduced by Kenya); or 
2. where no QDMTT applies, by another implementing jurisdiction through the imposition of either: 
   • an Income Inclusion Rule (IIR) which imposes top-up tax on a parent entity in respect of the low taxed income of a subsidiary; or 
   • an Undertaxed Payment Rule (UTPR) which denies deductions or requires an equivalent adjustment in a subsidiary jurisdiction in order to produce an equivalent incremental increase on the taxes paid by the MNE Group.

Rule Order

The collection of top-up tax under the QDMTT follows these steps:

1. The low-taxed jurisdiction has the first right to collect the top-up tax via its QDMTT.
2. If no QDMTT is implemented, the Ultimate Parent Entity (“UPE’s”) jurisdiction applies the IIR to the low-taxed Constituent Entity’s income.
3. If the UPE’s jurisdiction lacks a Qualified IIR, the next entity in the ownership chain, located in a jurisdiction with an IIR, collects the tax (i.e., an intermediate parent entity (“IPE”)).
4. Where no Qualified IIR applies, jurisdictions with a UTPR collect the tax, allocated using a substance-based allocation key

Who does the minimum top-up tax apply to?

The minimum top-up tax will apply to “covered persons” who are defined as resident persons or persons with a permanent establishment in Kenya and the entity has to be part of an MNE Group with consolidated annual turnovers at or above EUR 750 million (approximately KES 100 Billion).

The threshold amount is similar to the one used for Country-by-Country Reporting (CbCR). However, unlike CbCR which is based on an annual calculation, the revenue threshold for the minimum top-up tax is based on a four-year test. 

The MNE Group should have attained the threshold in at least two of the four years of income immediately preceding the tested year of income as demonstrated below:

There are several entities that will be excluded from the rules including public entities that are not engaged in business, pension funds, non-operating investment holding companies and sovereign wealth funds, among others.

How does it work?

• Once an entity is in scope, it should determine its effective tax rate (ETR):

ETR = (𝑠𝑢𝑚 𝑜𝑓 𝑎𝑙𝑙 𝑡ℎ𝑒 𝑎𝑑𝑗𝑢𝑠𝑡𝑒𝑑 𝑐𝑜𝑣𝑒𝑟𝑒𝑑 𝑡𝑎𝑥𝑒𝑠)/(𝑠𝑢𝑚 𝑜𝑓 𝑎𝑙𝑙 𝑛𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 𝑜𝑟 𝑙𝑜𝑠𝑠) x 100 

• If the ETR is less than 15%, say 9%, then the entity is liable to pay an additional tax (top-up tax) to KRA.
• The additional tax is imposed on the entity’s excess profits which is the income attributable to the entity after applying a substance-based income exclusion allocation key as shown below:

𝐸𝑥𝑐𝑒𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡𝑠= 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒−10% 𝑜𝑓 𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑒 𝑐𝑜𝑠𝑡𝑠−8% 𝑜𝑓 𝑛𝑒𝑡 𝑏𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑡𝑎𝑛𝑔𝑖𝑏𝑙𝑒 𝑎𝑠𝑠𝑒𝑡𝑠  

•  Using the example of an ETR of 9%, the top-up tax will be computed as:

𝑻𝒐𝒑 𝒖𝒑 𝒕𝒂𝒙=𝟔% ×𝑬𝒙𝒄𝒆𝒔𝒔 𝒑𝒓𝒐𝒇𝒊𝒕𝒔 , (where 6% = 15% (Minimum tax) – 9% (ETR))

Implications

With the introduction of the minimum top-up tax, we anticipate several implications including:

1. Higher compliance burden – in scope MNEs need to adjust their tax reporting to ensure alignment with the 15% global minimum tax, increasing administrative costs; and
2. Investment reconsideration - the additional tax may impact MNE’s cost structures, potentially discouraging investment. Incentives offered by Export Processing Zones (EPZs) and Special Economic Zones (SEZs), which traditionally guarantee lower tax rates to MNEs may lose their appeal.

Treasury may however introduce measures to manage the reduced FDI risk including:

1. Shift in incentive strategies - exploring alternative incentives, focusing on taxes outside the scope of the top-up tax. These could include personal income taxes, indirect taxes, property taxes, mineral royalties, etc; and
2. Adoption of a “defensive” QDMTT – QDMTT could be implemented defensively by applying it only when the MNE’s income is subject to the IIR or the UTPR in another jurisdiction. This is a similar approach adopted by Barbados for FY 2024.

It is expected that the Kenya Revenue Authority (KRA) will issue comprehensive guidelines to clarify the implementation of the minimum top-up tax.

This article is for informational purposes only and is not intended as tax advice or a professional opinion. For guidance specific to your situation, consider consulting your tax advisor