Withholding Tax is deductible on payments not expenses; exported services are zero rated


Withholding Tax is deductible on payments not expenses; exported services are zero rated

LG Kenya is the Kenyan branch of a company, LG Electronics Africa Logistics FZE, incorporated and registered in Dubai (LG Dubai). LG Kenya offers an extensive range of marketing services on behalf of LG Dubai, including but not limited to the creation of market awareness of LG Dubai’s branded products, carrying out marketing intelligence and other related activities.

After the audit, KRA communicated its findings through the letter dated 18.01.2018.

On the issue of VAT, KRA observed that LG Kenya is responsible for all marketing activities and advertising of LG products, including brand building and enhancement within the region comprising 16 countries. It established that LG Kenya’s functions include working with marketing and advertising firms to ensure brand visibility in the market through placing bill-boards and advertisements in newspaper, radio and TV, monitoring market share, overseeing product placement and distributor activities, local trainings on LG products to partners, activation and execution of promotions and offers in the market and supervision of merchandising staff.

KRA contended that the recipients, consumers of the messages conveyed through the marketing activities are the Kenyan public and the independent distribution companies and that part of the marketing activities are consumed locally since the target audience is in Kenya and such services are meant to influence consumers in the local market. Further, these activities carried out by LG Kenya are invoiced to LG Dubai without charging of VAT, and yet LG Kenya ought to have charged VAT on the marketing and advertising services performed in Kenya. KRA therefore charged a proportion of 54.8% of the total costs for provision of the service owing to the fact that from the information obtained, the Kenyan sales averaged about 55% of total sales in the region in that 54.8% was the actual Kenyan imports from LG Electronics by Kenyan distributors against total sales in the region. It accordingly held that the total VAT chargeable was Kshs. 325,649,691.00.

As regards WHT, KRA noted that for the services contracted to the marketing and advertising agents, WHT was not charged on their payments. That although LG Kenya explained that WHT was not operated since payment was done from Dubai and that it was LG Dubai that signed the contracts with the agents, KRA noted that all invoices for the services by the agents were addressed to LG Kenya who then forwarded them to LG Dubai for payment. That VAT was charged on the invoices, and for some of the service providers, the contracts had even been signed between them and LG Kenya. Thus, KRA charged WHT on the amounts paid to the suppliers amounting to Kshs. 16,814,187.00. KRA noted that from the financial statements and ledgers provided, legal, professional, and accounting fees paid by LG Kenya attracted WHT, but this was not charged as per the WHT ledger of LG Kenya KRA subjected these amounts to WHT of Kshs. 1,330,411.00.

LG Kenya responded to KRA’s preliminary findings by its letter dated 20.02.2018. LG Kenya stated that the claim for VAT for the period 2010-2012 was time barred, that there was an absence of supply between LG Kenya and LG Dubai and that KRA used an erroneous and excessive base to charge VAT. Further and without prejudice, it urged the activities of a branch, and its parents do not comprise supplies for Kenya VAT purposes. That should KRA determine that such supply exists, then the supply between LG Kenya and LG Dubai would constitute an export of services from Kenya and that services exported out of Kenya are taxable at the rate of zero in accordance with the provisions of Paragraph 1 of the Second Schedule to the VAT Act, 2013

On WHT, LG Kenya stated that the claim for the period 2010-2012 was statute barred by dint of section 29(1) of the TPA. As regards WHT on payments from oversees, LG Kenya stated that it did not operate WHT as the payments were made directly from Dubai to the marketing agents and that the contracts for the provision of the marketing and advertising services were entered into directly between the local agents and LG Dubai. The invoices for marketing and advertising services were addressed to LG Dubai, and in instances where they were addressed to LG Kenya, they were merely for the care of LG Kenya to be forwarded to LG Dubai. LG Kenya contended that addressing the invoice to LG Kenya’s physical address did not mean that LG Kenya has made the payment in accordance with the definition of ‘paid’ as contained in the ITA

LG Kenya formally objected to the assessments through its letter dated 03.08.2018. On VAT, it maintained that transactions between LG Kenya and LG Dubai do not constitute a supply of services far VAT purposes. That even if such transactions constituted a supply of services, such services are used and consumed outside Kenya, hence taxable at 0%. That even if it was deemed that LG Kenya provided services to the local independent distribution companies, the output VAT would be zero since the consideration for the supply would be zero on the basis that LG Kenya and the independent distributors are not related.. The statutory limitation of time for KRA to issue a default assessment is five years, and hence, the purported assessment for the period 2010 to 2012 lacked any basis.

On WHT, LG Kenya still faulted KRA’s position that marketing agents provided services to LG Kenya. Thus, it was unclear what basis KRA used to arrive at the WHT. It restated that WHT is deducted upon payment to another person and that the issue of what constitutes ‘paid’ in accordance with section 2 of the ITA

KRA issued its objection decision dated 02.10.2018 . In respect of the VAT objection, KRA held that LG Dubai, through its Permanent Establishment, LG Kenya, did not register for VAT as required by the provisions of section 34 of the VAT Act, 2013. It notified the taxpayer of the assessment through the letter of 18.01.2018 and the demand letter of 05.07.2018 and that under section 31(4) of the TPA, the 5-year time limitation period is exempt in instances of gross or willful neglect, evasion or fraud where a tax payer has been notified of an assessment as in the present case.

KRA insisted that the services offered, that is, marketing services are taxable supplies and thus subject to VAT and the consumption of the services offered is in Kenya by the independent distributors and the Kenyan public, who consume by purchasing the products offered. On the base for charging VAT, KRA maintained that its request to LG Kenya for provision of sales data for the distributors in the region was not honored and that this would have enabled KRA apportion the chargeable cost for the services in Kenya. KRA contended that the tax base is the actual value of the services by LG Kenya which is the profit attributed to it for the activities it performs in the Kenyan market and KRA thus used the proportion of income attributable to the Kenyan market as the actual value of services to the same market and that this was obtained from the actual sales of Kenya as compared to the actual sales to the region. Therefore, KRA held that this proportion gave it the accurate value of service performed in Kenya for the Kenyan market and that the computation was based on Commissioner’s best judgement. Thus, it charged VAT on the taxable supplies of LG Kenya to the Kenyan market as Kshs. 80,774,657.00

On WHT, KRA maintained that the fact that payment was done by LG Dubai does not extinguish the requirement for operation of WHT on the payments made. That it should be noted that any contracts signed between LG Dubai and the service providers also bind LG Kenya and hence the reason why the service providers invoice LG Kenya which cannot contract on its own since it is not a legal entity and thus all contracts have to be legally signed between LG Dubai and the suppliers. KRA held that the suppliers do not recognize two parties between LG Dubai and LG Kenya and that the marketing agents work with the staff of LG Kenya to execute the marketing activities. For these reasons, KRA maintained that for the services performed, invoiced, and paid, WHT should be charged for the period between 2013-2016 amounting to Kshs. 3,685,144.00.

LG Kenya appealed to the TAT.

On the first issue of the VAT assessment being time barred, the Tribunal held that LG Kenya is contracted by LG Dubai to provide marketing services that increase sales for the Kenyan distributors It referred to the OECD Guidelines that the identity of the ultimate consumer is determined by the service agreement and the customer of the services that have the taxing rights over the said services. From the facts and evidence adduced, the Tribunal held that there was no contractual nexus between LG Kenya and the Kenyan distributors and that from a reading of sections 3, 29 and 31(4) of the TPA and perusal of the documents on record, it was evident that KRA notified LG Kenya of its findings through the letter dated 18.01.2018 and later issued the assessment letter dated 05.07.2018 for the tax period of year 2010-2016, which facts are not disputed. The Tribunal accepted that KRA has power under section 31(4) to amend the assessment but it was nevertheless apparent that the demand letter KRA relied on was issued outside the statutory period of five years and could not act as a timeline-cure for the assessment issued on 05.07.2018.

On whether the marketing services provided by LG Kenya to LG Dubai are exported services, the Tribunal noted that the question before it was who is the consumer of these services. The Tribunal relied on Commissioner of Domestic Taxes v Total Touch Cargo Holland ML HC ITA No. 17 of 2013 [2018] eKLR to hold that the marketing services provided by LG Kenya are to its head office, LG Dubai and not to the Kenyan distributors and the same can therefore not be given the meaning of section 8 of the VAT Act, 2013.

As to whether LG Kenya should have accounted for WHT for the services by the marketing agents, the Tribunal noted that both parties agreed that the services rendered were marketing and advertising services with respect to LG products in Kenya and that the subject payments therefore relate to professional fees and fall under the income described in section 10 of the ITA and that the ITA does not subject payments made by non-resident persons not having permanent establishment in Kenya to withholding tax.

The Tribunal noted that since LG Kenya conceded to payment of Kshs. 202,230,104.00 in Corporation Tax, it was clear that income accrued and expense was incurred, from its books of accounts and that KRA ought to impose the relevant expenses incurred by LG Kenya to WHT in accordance with the ITA. The Tribunal further held that the penalty imposed by KRA on WHT by virtue of TPA failed.

The Tribunal allowed LG Kenya’s appeal in part by setting aside the Objection Decision on VAT. It directed KRA to impose WHT on LG Kenya’s expenses as applicable .

Both parties appealed to the High Court on the following issues:

1) The Tribunal erred in setting aside KRA’s VAT assessment of LG Kenya( Appeal by KRA)

2) The Tribunal erred in imposing WHT on LG Kenya’s expenses as applicable(appeal by LG Kenya)

In its ruling on 26/09/2023, the High Court observed that:

Tribunal did not err in holding that under section 31(4), KRA has powers to amend the assessment, but such amendment can not cure a demand that it outside the statutory limitation period of five years.

The marketing services provided by LG Kenya to LG Dubai are exported services, it was not in dispute that the marketing services performed in Kenya by LG Kenya was done for and on behalf of its head office, LG Dubai and that it was LG Dubai that paid for these services even when LG Kenya hired marketing agents.

There is no error in the Tribunal’s findings that the marketing services provided by LG Kenya are consumed by LG Dubai and not the Kenyan distributors and that the such service is deemed a service exported out of Kenya under section 2 of the VAT Act, 2013 which as per the same Act is zero-rated for purposes of VAT

Section 2 defines some of the terms subject to WHT, section 3(1) is the charging provision and states that “…. income tax shall be charged for each year of income upon all the income of a person, whether resident or non-resident, which accrued in or was derived from Kenya.” Section 10 provides that where a resident person or a person having a permanent establishment in Kenya makes a payment to any other person in respect of professional fees such as that of the marketing services offered by LG Kenya to LG Dubai, then that amount shall be deemed to be income which accrued in or was derived in Kenya provided that the said provision shall not apply unless the payment is incurred in the production of income accrued in or derived from Kenya or in connection with a business carried on or to be carried on, in whole or in part, in Kenya. The provision further states that ‘for the avoidance of doubt,’ the expression ‘non-resident person’ shall include both head office and other offices of the non-resident person.’

Based on the above, the Tribunal was correct to conclude that there is no provision for taxation of income paid by a non-resident not having a permanent establishment in Kenya. In this case, the payments were made by LG Dubai, a non-resident, to a local agent. .

There is no rationale for the Tribunal ordering KRA to impose the relevant expenses incurred against the income accrued to WHT. WHT is only applicable to payments and not expenses and that in any case, it is always charged on the ‘gross’ amount.

As such the Court Allowed LG Kenya appeal. KRA appeal was rejected

Withholding Tax is deductible on payments not expenses; exported services are zero rated



Withholding Tax is deductible on payments not expenses; exported services are zero rated

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