SYS 2

Tax planning, avoidance, evasion and anti-avoidance rules

1Scope and legal basis

Kenyan law distinguishes three things a taxpayer may do about tax. Tax planning arranges affairs, within the letter and purpose of the law, to pay the least tax the law allows: choosing a tax-efficient business structure, timing capital expenditure to use investment allowances, contributing to a registered pension scheme, using the reliefs Parliament provides. Tax avoidance uses the letter of the law against its purpose, through artificial or fictitious arrangements whose main purpose is a tax benefit; it is lawful in the narrow sense but the Commissioner may disregard it under section 23 of the Income Tax Act and section 85 of the Tax Procedures Act, and the Finance Act 2025 introduced a specific tax avoidance penalty. Tax evasion is illegal: concealing income, falsifying records, claiming fictitious expenses or input tax, failing to register or to remit tax withheld, and it is an offence under the Tax Procedures Act with fines and imprisonment as well as penalties and interest.

2Key definitions

Tax avoidance scheme

Under section 85 of the Tax Procedures Act, a scheme or arrangement one of whose main purposes is to avoid a tax liability. Where the Commissioner determines that a person has entered into one, the Commissioner may assess the tax that would have been payable without the scheme and charge a penalty of double the amount of tax avoided.

Transaction designed to avoid liability (ITA s.23)

Where the Commissioner is of the opinion that the main purpose or one of the main purposes of a transaction was the avoidance or reduction of liability to tax, or that its main benefit was such avoidance, the Commissioner may direct that adjustments be made to counteract the avoidance. The section is Kenya's general anti-avoidance rule (GAAR).

Substance over form

The principle the courts and the Commissioner apply in deciding whether an arrangement is genuine: the legal form is respected unless it is a sham or the transaction has no commercial purpose other than the tax result (the Kenyan courts have followed the Ramsay line of English authority in disregarding pre-ordained circular steps).

Arm's length principle

The requirement, in section 18(3) of the Income Tax Act and the Income Tax (Transfer Pricing) Rules, that transactions between a resident and a related non-resident be priced as independent parties would price them; the Commissioner may adjust the profit of the resident where they are not.

Whistleblower

A person who provides information leading to the identification of unassessed tax or the recovery of tax; the Tax Procedures Act provides for a reward, and the Finance Act 2026 lists whistleblower information among the sources the Commissioner may use to raise an assessment.

3Charge, computation and rates

Specific anti-avoidance rules in the Income Tax Act

Rule	What it does	Current parameters
Transfer pricing (s.18(3), TP Rules 2006 and 2023 regulations)	Adjusts profits on related-party transactions with non-residents to arm's length; requires contemporaneous documentation on request, and for large groups a master file, local file and country-by-country report	Country-by-country reporting for groups with turnover above KES 95 billion; master and local file within six months of year end; advance pricing agreements available from 1 January 2026 for up to five years
Interest restriction (s.16(2)(j))	Limits the deduction of interest paid to non-resident lenders to 30% of EBITDA (earnings before interest, tax, depreciation and amortisation); the disallowed interest is carried forward for three years. Replaced the 3:1 thin capitalisation rule in 2021	30% of EBITDA; applies to interest on loans from non-residents; exempt for banks, insurers, micro and small enterprises and certain others
Deemed interest (s.16(5))	Treats an interest-free loan from a non-resident controlling shareholder as carrying interest at the prescribed rate, on which withholding tax is due	Prescribed rate 8% for January to June 2026; withholding tax at 15%
Significant economic presence tax (s.12E)	Charges non-residents earning income from Kenyan users through a digital marketplace on a deemed profit	30% of a deemed profit of 10% of gross turnover (an effective 3%); no minimum turnover threshold since the Finance Act 2025
Minimum top-up tax (s.12G)	Kenya's Pillar Two rule: a multinational group's Kenyan entities pay a top-up tax when the group's combined effective rate in Kenya falls below 15%	Groups with consolidated turnover of at least EUR 750 million; 15% minimum; payable by the end of the fourth month after the year end
Loss carry-forward cap	Limits the period over which tax losses may be carried forward	Five years from the Finance Act 2025, extendable by the Cabinet Secretary; investors of KES 10 billion or more before 1 July 2025 may carry losses until extinguished (Finance Act 2026)
Disallowance of related-party and non-arm's-length expenses (s.16)	Denies deductions for expenses not wholly and exclusively for the business, and for payments where withholding tax was due but not deducted	No deduction for an expense on which withholding tax was not withheld and remitted

Common planning techniques the exam expects

Choice of vehicle: a sole trader or partner pays graduated rates up to 35% with the personal relief; a company pays 30% and its shareholders 5% withholding on dividends (exempt above 12.5% holdings); a small business may prefer turnover tax at 1.5% of gross if margins are high, or the normal regime if losses or capital allowances are expected.
Timing of expenditure and use of investment allowances: acquiring qualifying plant before the year end to claim the first-year allowance; locating manufacturing outside Nairobi and Mombasa (or in an SEZ) to access the 100% or 150% investment allowance and the SEZ rates of 10% and 15%.
Employee remuneration design: benefits with favourable valuation rules (employer pension contributions within the KES 360,000 annual limit, medical cover, tax-free per diem of KES 10,000, non-cash benefits under KES 60,000 a year, gratuity under a contract of three years or more), rather than higher cash salary at 35%.
Financing: debt versus equity, within the 30% EBITDA limit and the deemed interest rule; local borrowing is outside the interest cap.
Group structuring: exemptions on intra-group transfers and reorganisations for capital gains tax and stamp duty, dividend exemption above 12.5% holdings, and the anti-avoidance limits on all of them (a transfer to a third party within the restructuring loses the exemption).
Use of double taxation agreements to reduce withholding tax on cross-border payments, subject to the beneficial ownership and limitation of benefits tests, and the SEP and minimum top-up rules that sit above treaty planning.

Evasion and its consequences

Evasion attracts the civil penalties of the Tax Procedures Act (a tax shortfall penalty of 75% of the shortfall where the understatement is deliberate, 20% otherwise, plus interest at 1% a month, and double the tax for a fraudulent return), and criminal liability: offences of failing to keep records, making false or misleading statements, fraud in relation to tax, obstructing officers, and aiding and abetting, punishable by fines (up to KES 10 million for some offences) and imprisonment of up to ten years. A tax agent who prepares a false return commits a separate offence and may lose the licence. The KRA's Intelligence and Strategic Operations department, third-party data (bank, mobile money, land registry, motor vehicle, customs and eTIMS records) and the prepopulated returns the Finance Act 2026 authorises are the practical enforcement tools.

4Compliance: returns, payment and penalties

Transfer pricing: a taxpayer with related-party cross-border transactions must have a transfer pricing policy and documentation available on request; groups over the country-by-country threshold file the master file, local file and CbC report within six months of the year end and give notification by the year end; an advance pricing agreement, once concluded, binds both sides for its term.
The GAAR: an assessment under section 23 or section 85 is an appealable decision; the taxpayer objects within 30 days under the Tax Procedures Act and may appeal to the Tax Appeals Tribunal. The Finance Act 2026 lets the Commissioner assess independently on concluding that a person participated in a tax avoidance scheme, and expands the information sources for doing so.
The tax avoidance penalty is double the tax avoided; the tax shortfall penalties are 75% (deliberate) or 20% (other); interest runs at 1% a month on unpaid tax, and the penalties for evasion offences are set by the TPA and the Finance Acts.
Voluntary disclosure and amnesty: the Finance Act 2026 provides an amnesty on penalties and interest for periods up to 31 December 2025 where the principal tax is paid in full by 31 December 2026 (applied from 1 January 2027), following the earlier amnesties that ran to 30 June 2025; a taxpayer who discovers an error should amend the return and pay before an audit begins, when the shortfall penalty is reduced or waived.

5Examinable focus

What KASNEB tests

Every paper carries 'distinguish tax evasion, tax avoidance and tax planning, with examples' and, in Advanced Taxation, a scenario on a group with a Mauritian finance company charging interest and management fees to a Kenyan subsidiary: identify the transfer pricing, deemed interest, 30% EBITDA and withholding tax issues, and the treaty position. Know section 23 and section 85 by number, the double-tax penalty, the 75%/20% shortfall penalties, and the SEP and minimum top-up rules as the modern anti-avoidance layer. Planning questions reward concrete, lawful techniques with the current limits (KES 360,000 pension, KES 10,000 per diem, KES 60,000 non-cash benefits, 12.5% dividend exemption); vague 'reduce salary' answers score nothing.