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The Joint Venture Guidelines Under the Competition Act

The Competition Authority of Kenya to Clarify the Rules and Filing Requirements of Joint Venture Arrangements.

The Competition Authority of Kenya has published draft joint venture guidelines. The Guidelines aim to provide clarity, transparency and predictability about joint venture arrangements that require CAK approval.

The Guidelines specifically clarify the CAK’s position on what consists of a Full Function Joint Venture, a Greenfield Joint Venture; and lays out the process for notifying and filing a joint venture with the CAK, as well as how the CAK reviews a joint venture’s impact on competition.

The Guidelines are still open to review and amendment, with the CAK inviting comments by Friday, March 5th, 2021. However, the following are the main implications of the proposed Guidelines:

Full Function Joint Venture

The Guidelines define a Full Function Joint Venture as a joint venture undertaking that performs all the functions of an autonomous economic entity for ten years or more including:

i. operating on a market and performing the functions normally carried on by undertakings operating in the same market; and

ii. having a management dedicated to its day-to-day operations and access to sufficient resources including finance, staff and assets in order to conduct for a long duration its business activities within the area provided for in the joint-venture agreement.

Full Function Joint Ventures constitute a merger under the Competition Act and will require notification and filing with the CAK. However, it should be noted that a joint venture established for a purposefully finite period will not be viewed as having a long duration and will not qualify as a Full Function Joint Venture.

Greenfield Joint Venture

The Guidelines set out Greenfield Joint Ventures as joint venture undertakings in which local or foreign entities collaborate with other locally domiciled entities to develop a new product separate from the products and services provided by the parent entities.

Typical distinguishing features of a Greenfield Joint Venture include: a new joint venture vehicle formed by the parties for the purpose of the transaction, undertakings in new areas for the parties in the joint venture, and the transaction entailing entry into a new business area or enhancement of an existing business.

The Guidelines recommend that parties potentially entering into a Greenfield Joint Venture should seek the advisory opinion of the CAK as Greenfield Joint Ventures are reviewed on a case-by-case basis.

Process for Filing a Joint Venture With CAK

The Guidelines set out the registration requirements for a Full Function Joint Venture. The CAK requires the parent entities to separately submit documents relating to the transaction by filling the Merger Notification Forms as Joint Venture Parents, and if a joint venture vehicle exists as a part of the undertaking it will also be required to file the MNF.

In situations where the joint venture parties have no separate joint venture vehicle, the parent entities will only need to separately submit documents by filling the MNF as Joint Venture Parents.

Determination of Impact on Competition

The Guidelines specify how the CAK determines the competition impact a Full Function Joint Venture transaction is likely to have in a market. The CAK considers the turnover and asset figures of all the parents to a joint venture, including the entities directly or indirectly in the control of the joint venture parents and the joint venture vehicle where applicable. In addition, the CAK looks at the terms of the joint venture agreement, public interest factors and whether the efficiency benefit of the joint venture brings more economic gains compared to the competition detriment.

If the CAK makes a finding that a joint venture transaction has negative competition and public interest impacts, it may engage the joint venture parties to come up with remedies to mitigate against the harm. Additionally, the CAK will direct on which of the joint venture parties as well as the joint venture vehicle will be impacted by the mitigating factors.

The draft joint venture guidelines aim to further clarify the rules and reduce the confusion surrounding the competition regulations on joint ventures.

Transfer Pricing Considerations in Your Post M&A Integration

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, exploitation of intangibles 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 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 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 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 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 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 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

Africa Law Partners was founded in 2019. The law firm is a boutique practice whose area of focus is corporate and commercial law in Kenya.

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 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, gharar and maisir, and haram industries.

Other central principles to Islamic finance include compliance with the Shariah, 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.’

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 United Kingdom’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 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, Rwanda and Morocco 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.

Disclosure of Beneficial Ownership

The Companies Act, 2015 was amended by the Companies Act, 2017 to include, amongst other things, the concept of “beneficial ownership” by including section 93A of the Principal Act. The Amendment Act establishes a register in order to record the information of beneficial ownership and control of Kenyan companies.

The Companies Regulations were promulgated under Legal Notice 12 of 2020. The concept of beneficial ownership was established as part of Kenya’s efforts to battle corruption and increase transparency in the ownership and control of legal entities.

The Companies Registry of Kenya recently issued a notice stating the operationalisation of the beneficial ownership registry from 13 October 2020.

The effect of registering a “beneficial owner” has numerous implications across different spheres of practice. The following commentary aims to outline these effects in practice.

Who is a Beneficial Owner?

A beneficial owner under the Regulations must be a natural person and not a legal person. In order to be classified as a Beneficial Owner, a natural person must:

  • holds at least ten per cent of the issued shares in the company either directly or indirectly;
  • exercise at least ten per cent of the voting rights in the company;
  • hold a right to directly or indirectly appoint or remove a director of the company; or
  • exercise significant influence or control over the company.

This definition includes persons who may hold significant influence or control as a result of a variety of commercial arrangements or instruments such as provisions in the company’s constitutional documents, the rights attached to the shares or securities which a person holds, shareholder agreements or other agreements resulting in giving such person material influence over the company and its affairs.

Obligations of a Company

The Regulations place the following obligations on companies:

      1. A company shall take reasonable steps to identify its beneficial owners and enter their details into a register of beneficial owners which is different from the register of members;

      2. The following information will be included in the register of beneficial owners;

         a. the full name;

         b. full name;

         c. birth certificate number;

         d. national identity card number or passport;

         e. Kenya Revenue Authority personal identification number;

         f. nationality;

         g. date of birth;

         h. postal, business and residential address;

         i. telephone number;

         j. email address;

         k. occupation;

         l. nature of ownership or control; and

         m. date on which a person became a beneficial owner.

      3. The Regulations require a company to file with the Registrar of Companies, within 30 days of preparation, a copy of the company’s register of beneficial owners. Furthermore, if there is any change in the composition of the company’s beneficial ownership, these changes shall be made on the register of beneficial ownership and filed with the Registrar as soon as the change occurs.

      4. Where a company believes that a person is a beneficial owner it is the company’s duty to investigate and notify the potential beneficial owner. Once notified, the beneficial owner must furnish their particulars within days, failure to which the company must issue a “warning.”

      5. Once a warning has been registered against a beneficial owner’s interest and the beneficial owner persists in omitting their particulars a restriction is placed on the beneficial owner’s interest in the company and is registered in the company’s beneficial ownership register as well as with the Registrar.

Restrictions

The net effect of a restriction on a beneficial owner’s interest in a company is the inability to transact or benefit from the proceeds of their interest in the company. In practice, the restriction against a beneficial owners interests would mean that;

      (i) the beneficial owner would not be able to exercise any rights in respect of their interest;

      (ii) the beneficial owner would not be able to transfer their interest in the company; and

      (iii) no payments from the company can be made to the Beneficial Owner as a result of their interest.

Disclosure of Beneficial Ownership and Data Protection

Although companies have a duty to gather information regarding beneficial ownership, its disclosure is limited to the beneficial owner, the company and the Registrar. It must be noted that the information is not public information, and as such cannot be disclosed for the general public’s consumption. The company is prohibited from disclosing information gathered from a beneficial owner save for if the disclosure is;

      (i) required by the Regulations;

      (ii) for effecting communication with the beneficial owner;

      (iii) in compliance with a court order; or with

      (iv) the written consent of the beneficial owner.

Disclosure of information provided by a beneficial owner in any manner other than in compliance with the Regulations is punishable by a fine not exceeding Kenya Shillings twenty thousand or imprisonment for six months or both.

Disclosure of Beneficial Ownership and Nominee or Trustee Shareholding

Companies, for a variety of reasons, have had interests of shareholders held through nominees and trust arrangements. In order to comply with the Regulations, companies will need to disclose who the beneficial owner under a nominee arrangement is and who the ultimate beneficiary is under a trust arrangement.

In these instances, the beneficial owner would be the person that derives the true economic benefit from the legal interest in the company.

Conclusion

Transparency in the beneficial ownership of companies in Kenya is a reality. This will inevitably have an effect on ownership through nominees and trust arrangements. This poses additional considerations when structuring transactions where the non-disclosure of a beneficial owner is key.

This would need careful consideration, on a case by case basis of the optimal structure to adopt.