Isolux Revisited: Lessons from Isolux in the Post - 2021 Permanent Establishment Era

While hindsight is often said to be 20/20, revisiting past precedents can provide valuable insight into present-day tax controversies.

This alert examines the decision of the Tax Appeals Tribunal (the Tribunal) delivered on 16 October 2020 in Isolux Ingenieria SA v Commissioner of Domestic Taxes (TAT Appeal No. 133 of 2017), a case that continues to inform the debate on the taxation of permanent establishments and the attribution of profits in Kenya.

Applying a strict interpretation of the Income Tax Act as it then stood, the Tribunal held that neither section 4 nor section 18(3) of the Act permitted the taxpayer to treat its Kenyan branch as a separate and independent enterprise for purposes of applying arm’s length profit attribution principles. Consequently, the Tribunal upheld the Kenya Revenue Authority’s position that the revenues arising from the Engineering, Procurement and Construction (EPC) contract were taxable in Kenya.

Since that decision, however, the legal and regulatory landscape has evolved considerably. Most notably, the Finance Act, 2021 introduced a broader and more explicit definition of a Permanent Establishment (PE) and the High Court made a landmark determination in Kenya Revenue Authority v MAN Diesel & Turbo SE Kenya [2021] KEHC 13347 (KLR).

While these amendments and judicial pronouncements have clarified several aspects of PE taxation, they have not eliminated the central challenge of determining the profits properly attributable to a PE. As a result, contemporary disputes are increasingly focused not on whether a PE exists, but on the appropriate attribution of profits to the activities carried on through that PE.

From an international tax perspective, the prevailing principle, reflected in Article 7 of the OECD Model Tax Convention, is that the existence of a permanent establishment does not justify attributing all revenues earned by a non-resident enterprise to the PE. Rather, only those profits that are economically attributable to the functions performed, assets employed, and risks assumed by the PE may be taxed in the source jurisdiction.

Notwithstanding the growing acceptance of this principle internationally, its practical application in Kenya has remained a matter of debate in the years following the Isolux decision. Consequently, the questions surrounding PE profit attribution continue to occupy centre stage in cross-border tax disputes.

It is against this backdrop that we revisit the Isolux decision and consider its relevance, limitations, and implications within Kenya’s current permanent establishment and transfer pricing framework

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