Kenya’s Tax Appeals Tribunal has set aside a KSh6.9 billion transfer pricing tax assessment imposed by the Kenya Revenue Authority (KRA) on a carbon credit project, delivering a significant ruling on the taxation of cross-border climate and renewable energy investments.
In the case, Bowmans acted for the appellant, a Kenyan service provider, which had been assessed additional corporate income tax and withholding tax after KRA recharacterised the structure of a carbon credit project developed by the company’s US-based parent entity.
The Tribunal’s decision underscores the critical role of transfer pricing documentation, functional analysis, and economic substance in disputes involving related-party transactions and emerging sectors such as carbon markets.
Background to the dispute
The project, undertaken in Kenya, was developed by the US parent entity, which acted as the project developer, while the Kenyan company provided operational and management support services under an intra-group arrangement.
KRA, however, rejected the group’s transfer pricing policy and reallocated most of the functions, assets, and risks associated with the project to the Kenyan service provider. On this basis, the tax authority argued that the Kenyan entity was effectively the economic owner of the project and therefore entitled to the income generated from the sale of carbon credits.
KRA contended that:
- The US project developer performed functions comparable to a holding company, which should be remunerated through dividends rather than operational income.
- The project developer was the least complex party and should have been selected as the tested party.
- A cost-plus method was the most appropriate transfer pricing approach for the intra-group services.
Based on this recharacterisation, KRA assessed KES 6.9 billion in additional taxes, comprising:
- Corporate income tax, arguing that all carbon credit revenues should have been taxed in Kenya; and
- Withholding tax, treating the transfer pricing adjustments as deemed dividends paid to the US parent.
Tribunal findings
The Tribunal rejected KRA’s assessment in its entirety, faulting the authority for disregarding documentary evidence submitted during the objection stage and relying instead on projected revenues.
In its ruling, the Tribunal held that:
- The taxpayer discharged its burden of proof by providing sufficient and relevant documentation, which KRA failed to properly consider.
- The project developer, not the Kenyan service provider, undertook the core activities of the carbon credit project and bore the associated risks.
- Key functions such as project sourcing and design, funding, marketing, sale of carbon credits, invoicing, and revenue reporting were all performed by the US entity, which also entered into the relevant project agreements.
- The Kenyan company’s role was limited to support services, as evidenced by service agreements, employment contracts, job descriptions, and the group’s transfer pricing policy.
The Tribunal further found that the transactional net margin method (TNMM) applied by the taxpayer, with a 7.5% mark-up on total costs, was appropriate and that the service fees paid were arm’s length and commercially rational.
Having invalidated the transfer pricing adjustment, the Tribunal ruled that the related withholding tax assessment was equally erroneous.
Implications for carbon credit projects
The ruling provides important guidance for carbon credit developers and investors, particularly in cross-border project structures.
The Tribunal affirmed that tax liability follows economic ownership, determined through a functions, assets, and risks analysis. In carbon markets, this means income from carbon credits should be taxed where the entity that genuinely develops, funds, and commercialises the project is located.
The decision also reinforces the expectation that:
- Transfer pricing arrangements must be properly documented and consistently applied in practice; and
- Supporting evidence such as contracts, invoices, verification reports, and employment records is essential in defending tax positions.
Message to the tax authority
In a pointed reminder to the KRA, the Tribunal reiterated that all documentary evidence submitted before an objection decision must be considered. Failure to do so, it said, results in an assessment that is legally unsound.
What next
KRA has filed an appeal at the High Court, though no orders had been issued at the time of writing. The case is expected to be closely watched by tax professionals, renewable energy developers, and multinational groups operating in Kenya.
