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Transfer pricing considerations in your post M&A integration

By Samuel Kisuu, Director at Africa Law Partners.

At the core of any M&A transaction is the fundamental scaling and growth of the integrated business unit at a macro level or tapping into and accessing the potential of the economies of scale of the target entity at a micro level.

As such, parties to the M&A transaction often spend a bulk of the transaction phase considering and negotiating the post-transaction integration of the transacting entities with respect to matters around optimising human resource, fine-tuning management and management functions, shareholder rights (typically when there is an acquisition of minority control), exploitation of intangibles (such as intellectual property and goodwill) and a business growth strategy.

It is common that the acquiring parties to M&A transactions in Sub-Saharan Africa be entities controlled and managed from different jurisdictions. M&A transactions in Sub-Saharan Africa generally involve off-shore domiciled private equity funds or multinational entities as the acquirers and a local entity as the target. The outcome of these transactions bring the integrated unit or group within the purview of transfer pricing.

Transfer Pricing Basics

The concept of transfer pricing under Kenyan law is provided for under:

  1. the Income Tax Act (Cap 470) (the Income Tax Act);
  2. the Income Tax (Transfer Pricing) Rules, 2006; and
  3. the respective double tax treaties that Kenya is a party to.

In addition to these laws, the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the OECD Guidelines) provide persuasive guidance on the application of transfer pricing principles in:

  1. the preparation of transfer pricing policies for taxpayers;
  2. which jurisdiction taxing rights lie; and
  3. dispute resolution between taxpayers and tax authorities.

At its most basic, transfer pricing may be defined as the concept whereby a fair price (the transfer price) is determined for transactions amongst related entities of different tax residency. From a taxation context, the transfer price will affect the accounting profits of the respective entities and subsequently the taxable profits of each single entity. Section 18 (3) of the Income Tax Act provides the basis for transfer pricing as follows:

“Where a non-resident person carries on business with a related resident person or through its permanent establishment and the course of that business is such that it produces to the resident person or through its permanent establishment either no profits or less than the ordinary profits which might be expected to accrue from that business if there had been no such relationship, then the gains or profits of that resident person or through its permanent establishment or from that business shall be deemed to be the amount that might have been expected to accrue if the course of that business had been conducted by independent persons dealing at arm’s length.”

For ease of explanation:

The transfer price set for the transfer of products from Entity 1 to Entity 2 will not affect the group’s overall/combined profit but will affect the taxable profit of Entity 1. Therefore, where Entity 1 is located in a relatively higher tax jurisdiction, there is incentive within the group to reduce the transfer price in order to decrease Entity 1’s taxable profit in that high tax jurisdiction.

M&A Context

Following an M&A transaction the following factors (list not being exhaustive) tend to materialise within the integrated entities:

  1. The adoption of minority rights by the acquirer. This typically occurs where an acquirer acquires a significant minority of the target entity and obtains control in the target business and is a common acquisition strategy adopted in private equity transactions.
  2. The integration of intangibles such as intellectual property rights and goodwill. Intellectual property rights of the integrated group may be farmed out from one jurisdiction to another or assigned over various jurisdictions.
  3. The post-transaction financing of the integrated group taking the form of shareholder loans spread across multiple jurisdictions.
  4. The integration of a new management group or the involvement of the acquiring entity’s management group in the affairs of the target entities and the centralisation of certain functions such as procurement.

Inter-company agreements from the legal and commercial foundations of these post-transaction matters and relationships. Consequently, there is the natural possibility of complex financial flows between these group entities which would affect the tax base in each respective jurisdiction. A post-transaction transfer pricing analysis allows for the optimisation of the group’s tax strategy to achieve the most efficient and fair tax structure and is achievable by taking the following steps:

  1. Preparation of the inter-company agreements: being the core document establishing the legal and commercial relationship between related entities, it is vital that these agreements clearly define the roles of each party and delineate the respective group transactions.
  2. Internal restructuring: this involves the reallocation of group entity roles, the movement of real and intellectual property ownership and reorganisation of senior management.
  3. Reallocation of commercial risk: this involves the identification of economically significant risks (strategic, marketplace operational, financial and transactional risks) and the contractual or transactional reallocation of these risks to group entities that are able to absorb the risk for the benefit of the integrated group.

Together, these steps would provide for a conclusive functional analysis (the foundation of a transfer pricing policy) of the group and subsequently provide an opportunity to adopt the most appropriate transfer pricing methods with a view towards tax optimisation of the entire group.

Whereas this write-up provides a brief overview of the salient issues to consider in your post M&A transfer pricing considerations, parties to M&A transactions ought to keep these factors as talking points at the negotiation stage of the M&A transaction on a specific and case-by-case basis.

Should you require any more information or assistance kindly contact Samuel Kisuu or your relationship partner at Africa Law Partners

This alert is for general use only and should not be relied upon without seeking specific legal or tax advice on any matter.

Opening the Floodgates to Islamic Finance in Kenya

By Walid Khan, Head of Real Estate and General Finance at Africa Law Partners.

In recent years, Islamic Finance has grown rapidly across the world. By conservative estimates, Islamic finance is estimated to have over $2.88 trillion of assets globally. It is offered in over 80 countries and is estimated to grow at around 10-15% a year. Despite a significant slowdown in 2020 due to the Covid-19 Pandemic, the market is expected to grow to $3.69 trillion by 2024.

Islamic finance also commonly referred to as Sharia-compliant finance, involves the delivery of financial services in conformity with the principles of sharia law. The fundamental principles that govern Islamic finance include the prohibition against riba (interest), gharar and maisir (contractual uncertainty and gambling), and haram industries (prohibited industries such as those related to pork products, pornography, or alcoholic beverages). Other central principles to Islamic finance include compliance with the Shariah (Islamic law), segregation of Islamic and conventional funds, accounting standards, and awareness campaigns.

Islamic finance deals with most financial services, including banking, insurance and capital markets. While it has been used to finance huge infrastructure projects, it has also been used to fund small and medium-sized enterprises thus having a positive impact on smaller businesses. In view of the massively important role played by small businesses to developing nations, Islamic finance has a far-reaching impact on the economy. Other advantages of Islamic finance include:

   1. Financial inclusion

World Bank defines financial inclusion as ‘Financial inclusion means that individuals and businesses have access to useful and affordable financial products and services that meet their needs – transactions, payments, savings, credit and insurance – delivered in a responsible and sustainable way.’ (Worldbank.org, 2017)

The conventional banking system is based on paying/receiving an interest which is strictly prohibited by Shariah Law. As such, Muslims refrain from conventional banking. This has resulted in many Muslims remaining unbanked and unable to access financial products and services. Islamic finance permits Muslims to participate and benefit in the financial system.

Despite being based on Shariah, Islamic finance is not restricted to Muslims only and is available to non-Muslims. In fact, there have been innumerable occasions where an Islamic finance product has been attractive to potential investors, even when they are not motivated by religious reasons.

   2. Financial Justice

Financial justice is a fundamental requirement in determining whether a product is shariah-compliant. Islamic finance requires that risk is shared between the bank and the customer. A lender must therefore carry a proportional share of the loss of a project if it expects to receive profits from the project. This brings about equitable distribution of income and wealth.

   3. Discourages speculation

Due to the fact that speculation is prohibited, investments are approached with a slower, insightful decision-making process with thorough audits, analyses and due diligence. This has resulted in reduction of risk and greater investment ability. This was evident during the global financial crisis when Islamic finance products proved less volatile.

While Islamic finance has been vibrant in Muslim-majority countries particularly in South-East Asia and the Middle-East, it has, in recent times, gained traction throughout the rest of the world particularly in the United Kingdom since the UK Government took a keen interest in the industry. Noting the benefits of Islamic finance, the UK Government developed a work programme to make the UK’s financial services regulations compatible with Islamic Finance. One such way was to accommodate Islamic finance products in existing legislation and regulations governing conventional financial instruments and putting Islamic products on the same tax footing as their conventional counterparts.

The latest Islamic Finance Country Index (2019) ranks the UK 17th of 48 countries in terms of its overall Islamic finance offering. This puts it in first place in Europe and in first place among non-Muslim-majority nations. Many firms, Islamic and non-Islamic, see London as an important Islamic finance global centre to such a great degree that products developed in London are being marketed in Muslim majority countries in the Middle East.

Kenya’s Islamic finance industry is regarded as somewhat developed with immense potential for growth. Kenya has made some legislative amendments and new regulatory frameworks that have brought about the development of Takaful Retirement Benefits Schemes, shariah-compliant finance products and taxation exemption for Islamic finance products. However, it seems that Kenya needs to do more to further stimulate the market. Per the Islamic Finance Country Index 2019 rankings, Kenya ranks 24th of the 48 countries. This is a drop from the 2018’s rankings which had Kenya at 21st. This appears to be a noteworthy setback as Kenya, East Africa’s largest economy, would want to position itself as the region’s Islamic banking hub to profit from its apparent benefits and provide its 5.2 million Muslims with better access to Islamic finance services.

Further, in order to meet the Big 4 Agenda and Vision 2030, Kenya should hasten structural, legal and regulatory reforms to further enable Islamic finance services and also begin issuing sukuks at the earliest possible time. Sukuk also referred to an Islamic bond, is an instrument for raising capital and is tradeable on the securities exchange. Sukuk may be used to finance projects around Vision 2030 and the Big 4 Agenda, such as infrastructure and health projects.

Enabling an Islamic finance environment will enable Kenya consolidate its status as the leading trade hub in the region and the gateway to East Africa. Kenya has already made significant strides at enhancing the ease of doing business in the country. The World Bank’s Ease of Doing Business Index 2020 ranked Kenya at number 56. This is an improvement from 2019, 2018, 2017 and 2016 where Kenya was ranked 61st, 80th, 91st and 108th respectively. Mauritius (13), Rwanda (38th) and Morocco (53rd) are the only African countries ranked ahead of Kenya.

There is need to open the floodgates to Islamic finance in Kenya. Industry stakeholders and regulators ought to collaborate to demystify Islamic finance by way of regular training and workshops on Islamic finance concepts. Kenya also requires supportive Government policies to create a fiscal and regulatory framework to broaden the market for Islamic finance products.

Africa Law Partners is well placed to advise on Islamic finance matters. For any assistance, please contact Walid Khan.

The Nairobi Securities Exchange Launches New Trading Platform

On 17 December 2020, the Nairobi Securities Exchange (the NSE) launched an Unquoted Securities Platform (the USP). The USP will function in accordance with its operational guidelines (the Guidelines) published on 11 December 2020. The Guidelines are available here.

The USP is an over the counter securities platform that utilises broker-dealer networks for the trade of securities. It has less stringent listing requirements and issuer obligations have opened a viable alternative for unlisted companies to access capital markets and long-term funding as issuers are enabled to raise finance through private placements. The USP also provides a boost to institutional and retail investors as it provides investors on the platform an accurate free-floating price of the securities of unlisted companies.

Key Considerations for Issuers

For admittance onto the USP, prospective issuers of the USP securities must meet the eligibility requirements of the Management Committee appointed by the NSE. The eligibility requirements are listed in the Guidelines, with the key requirements being, among others, the incorporation status of the issuer, articles of association amenable to USP securities and details of the board and management of the issuer. However, the eligibility requirements are non-exhaustive and the Management Committee may request further criteria as deemed necessary.

A prospective issuer will also need to appoint a registrar, to maintain a record of beneficiary holders of securities, and a custodian (licensed by the Central Bank of Kenya) for the safekeeping of USP securities, cash and other assets on behalf of the investors. Once the application documents have been submitted, the Management Committee will relay their decision to the prospective issuer within twenty-one (21) days.

If an application is accepted by the Management Committee, the issuer will have continuing obligations to the NSE, including disclosure requirements, which entail the disclosure of all material information in relation to the issuers business, financial statements and copies of notice of AGMs and EGMs. Additionally, issuers will be under an obligation to avoid the events of default under the Guidelines, such as: failure to distribute declared dividends and non-payment of interest of USP securities in accordance with the published timetable. Failure to meet continuing obligations may result in the suspension or expulsion of the issuer from the USP.

Key Considerations for Investors

To start trading on the USP, investors must be registered to an NSE authorised USP Trading Participant Agent (broker). In order to register with a broker, individual investors will be required to provide the broker of their choice with their full name, identity documents, contact details and passport (if they are foreign nationals). Investors that are entities will need to provide the broker with documents, such as, among others, the legal status and constitutive documents of the entity, board resolutions allowing the entity to invest and the identities of the directors.

Each investor authorised to trade on the USP is furnished with a unique USP securities trading account with a unique Trade Identification Code. The USP is open for trading on working days from 0900Hrs to 1500Hrs and investors can trade freely within this period. Trades made after the closing of the USP will be transacted at the next opening of the platform.

Investors will need to consider the maximum order size as trades over this limit will require prior disclosure with the NSE. In accordance with the Guidelines, trade volumes that exceed 20% of the total free float of an issuers USP securities will have to be disclosed to the NSE a day prior to the transaction.

For further information please contact Benedict Nzioki or Walid Khan.

BTI Consulting Group Recognises Eversheds for Superior Client Service

Eversheds Sutherland is pleased to announce that it has been named to the elite 2021 BTI Client Service 30, a list of law firms recognised for delivering superior client service. The rankings are based on unprompted client feedback from general counsel at some of the world’s largest organisations.

The BTI Client Service 30 is a subset of the organisation’s larger client survey, The BTI Client Service A-Team 2021: The Survey of Law Firm Client Service Performance, which evaluates individual law firm performance through thousands of client interviews conducted over the span of 20 years.

This year’s analysis is a result of 350 independent, candid, one-on-one interviews with corporate counsel; firms cannot lobby or self-nominate to be added to the list. Of the 282 law firms recognised in The BTI Client Service A-Team 2021, Eversheds Sutherland ranked among the top 30.

Additionally, Eversheds Sutherland was recognised as a “Leader” in unprompted communication, anticipating client needs, commitment to help, client focus, understanding business, value for the dollar and quality products. The firm also achieved recognition in all three of BTI’s newest categories in the 2021 report: mobilising resources, fielding the absolute best team and quickly assessing the client’s situation.

“We greatly appreciate the confidence of our clients and peers, and are very grateful that they continuously entrust us with some of their most important matters and objectives,” said Eversheds Sutherland Co-CEO Mark D. Wasserman. “We take great pride in meeting the highest standards of service, and it is extremely rewarding to be singled out for this honour.”

About BTI Consulting Group

The Boston-based consulting group is the leading provider of strategic market research to law firms and professional services firms. BTI conducts the only continuous benchmarking market study in the legal services industry based on independent interviews with general counsel and key decision makers who hire law firms.

About Eversheds Sutherland

As a global top 10 law practice, Eversheds Sutherland provides legal services to a global client base ranging from small and mid-sized businesses to the largest multinationals, acting for 70 of the Fortune 100, 61 of the FTSE 100 and 128 of the Fortune 200.

With more than 3,000 lawyers, Eversheds Sutherland operates in 69 offices in 32 jurisdictions across Africa, Asia, Europe, the Middle East and the United States. In addition, a network of more than 200 related law firms, including formalised alliances in Latin America, Asia Pacific and Africa, provide support around the globe.

Eversheds Sutherland provides the full range of legal services, including corporate and M&A; dispute resolution and litigation; energy and infrastructure; finance; human capital and labour law; intellectual property; real estate and construction; and tax.

Eversheds Sutherland comprises two separate legal entities: Eversheds Sutherland (International) LLP (headquartered in the UK) and Eversheds Sutherland (US) LLP (headquartered in the US), and their respective controlled, managed, affiliated and member firms.

Eversheds Successfully Defends Representative in SEC Appeal

Eversheds Sutherland is pleased to announce that the firm successfully defended registered representative David Tysk in an appeal to the US Securities and Exchange Commission (SEC) of a disciplinary proceeding brought by Financial Industry Regulatory Authority (FINRA).

In 2013, the firm was hired to defend Mr. Tysk against FINRA’s charges that he acted unethically and violated arbitration procedures. Before this successful appeal, FINRA had ordered him to pay a $50,000 fine and suspended him from the securities industry for one-year, essentially ending his career in the securities industry.

After several years of appeals, including two appeals to the SEC, the SEC found in favour of Mr. Tysk, overturning FINRA’s findings.

Eversheds Sutherland Partner Brian Rubin led the team with support from Litigation Partner Lee Peifer.

Mr. Rubin said, “This is the first time in at least five years that the SEC has completely ruled against FINRA in an appeal of a disciplinary hearing. This case is a great example of how and when to push back against regulators.”

The SEC’s decision can be found here.

About Eversheds Sutherland’s Securities and Enforcement Litigation team

Eversheds Sutherland defends broker-dealers, investment advisers, public companies, accounting firms and individuals in securities exams, investigations, enforcement actions, arbitrations and related securities litigation, including class actions. With a comprehensive understanding of the financial regulatory landscape and an appreciation of our clients’ business needs, we know what it takes to make cases go away—whether that means shutting cases down early, negotiating reasonable settlements or litigating.

About Eversheds Sutherland

As a global top 10 law practice, Eversheds Sutherland provides legal services to a global client base ranging from small and mid-sized businesses to the largest multinationals, acting for 70 of the Fortune 100, 61 of the FTSE 100 and 128 of the Fortune 200.

With more than 3,000 lawyers, Eversheds Sutherland operates in 68 offices in 32 jurisdictions across Africa, Asia, Europe, the Middle East and the United States. In addition, a network of more than 200 related law firms, including formalised alliances in Latin America, Asia Pacific and Africa, provide support around the globe.

Eversheds Sutherland provides the full range of legal services, including corporate and M&A; dispute resolution and litigation; energy and infrastructure; finance; human capital and labor law; intellectual property; real estate and construction; and tax.

Eversheds Sutherland is a global legal practice and comprises two separate legal entities: Eversheds Sutherland (International) LLP (headquartered in the UK) and Eversheds Sutherland (US) LLP (headquartered in the US), and their respective controlled, managed, affiliated and member firms. The use of the name Eversheds Sutherland is for description purposes only and does not imply that the member firms or their controlled, managed or affiliated entities are in a partnership or are part of a global LLP. For more information, visit eversheds-sutherland.com.

Chambers Global 2021 highlights our cross-border strengths

Norton Rose Fulbright ranked first among all law firms with 18 ranked lawyers in the Chambers Global 2021 global-wide practice rankings, as well as standing in the top 10 for total number of global-wide departmental practice rankings, practice rankings across all categories and lawyers ranked overall.

The firm earned 22 global-wide practice rankings, and was ranked in 185 practice areas across all categories, including global-wide and country-specific. The 185 practice area rankings include 16 top tier rankings in China, Greece, Malaysia, Morocco, Myanmar, the United Kingdom, the United Arab Emirates and the United States.

A total of 234 Norton Rose Fulbright lawyers were individually ranked as leaders in their field. The firm also picked up six new departmental rankings in Africa, Latin America, Russia, the United Kingdom and United States.

In its analysis, Chambers cited clients who provided feedback on the firm’s work, praising its extensive global reach.

“The (Norton Rose Fulbright) international network has become an increasingly important component of their service delivery as cross-border business grows,” one client told Chambers. Another praised the firm’s “ability to function seamlessly with team members in different offices and across time zones.”

A full list of our rankings is available online.