Treaty override and the limitation of benefits clause in the Kenya–South Africa DTA

Background 

Nairobi Bottlers Limited, a Kenyan company, paid withholding tax on technical fees and computer charges to its South African parent, Coca-Cola Sabco (Pty) Limited. As it believed this was an error, since the Kenya–South Africa Double Tax agreement (DTA) should have exempted such payments, the company sought a refund of the withholding tax paid. However, the Kenya Revenue Authority rejected the claim, arguing that Coca-Cola Sabco did not qualify for treaty benefits due to Kenya’s domestic LoB rules. 

The Legal Issue: LoB Clause 

At the heart of the dispute was section 41(5) and (6) of Kenya’s Income Tax Act, which implements the LoB clause for treaty relief. The law states that DTA benefits are not available if: 

• More than 50% of the underlying ownership of the foreign company is held by individuals who are not residents of the other contracting state (here, South Africa), unless the company is listed on a recognized stock exchange in that state. 
• In this case, the word “individuals” is controversially interpreted to be any persons who are not residents of the other contracting state and not to only a natural person.  

In this case, Coca-Cola Sabco (Pty) Limited was: 

• 67.5% owned by The Coca-Cola Company (USA) 
• 33.5% owned by Gutshe Family Investment Trust 
• Not listed on the South African stock exchange 

The High Court upheld the Tax Appeals Tribunal’s decision, finding that Coca-Cola Sabco (Pty) Limited failed the ownership test as more than 50% of the equity was held by a company resident in the USA. Specifically, the High Court agreed that “individual” as used in section 41(5) and (6) of Kenya’s Income Tax Act includes a legal entity. As a result, Nairobi Bottlers could not benefit from DTA relief, despite Coca-Cola Sabco not being held by “individuals” not resident in South Africa. 

The court also addressed the broader principle of treaty override, holding that Kenyan domestic law can restrict treaty benefits through the LoB clause, even if this appears to conflict with the DTA’s text. The court reasoned that, under the Kenyan Constitution, tax exemptions or reliefs must be grounded in domestic legislation. 

The ruling means that, in practice, only South African companies listed on the JSE, or those where the majority of shares are held by South African-resident individuals or companies, can access DTA benefits in Kenya. This outcome effectively excludes most multinational groups, as their ultimate ownership typically resides with non-resident entities or global parent companies. 

The decision also confirms that Kenyan domestic law can override treaty provisions through LoB clauses. This is a contentious development, as it contradicts the widely accepted international principle that treaties should take precedence over conflicting domestic law, unless the treaty itself provides otherwise. 

Importantly, tax residency in a treaty partner country is no longer sufficient to guarantee DTA relief. The ownership structure and strict compliance with LoB requirements have become critical considerations. This shift introduces significant uncertainty for cross-border tax planning, compelling multinational groups to carefully review their structures and ensure they meet the LoB criteria before relying on DTA benefits. 

Multinationals with Kenyan operations should urgently assess whether their group structure satisfies the LoB clause. It should not be assumed that DTA relief is available based solely on tax residency and wording in the relevant DTA. While the decision may be appealed, it currently sets a restrictive precedent for treaty relief in Kenya. 

The Nairobi Bottlers case is a landmark in Kenyan tax jurisprudence, with far-reaching implications for treaty relief and cross-border investment. It underscores the importance of LoB clauses and the potential for domestic law to override treaty provisions. Businesses must adapt to this new reality and seek professional advice to navigate the evolving landscape. Ongoing monitoring of legal developments in this area will be essential for effective tax planning in multinational groups.  

Authors: 

Nicole Erlank, Manager

Tertius Troost, Senior Manager