[2024] KETAT 735 (KLR)

Aaro East Africa Limited v Commissioner of Legal Services And Board Coordination (Tax Appeal E365 of 2023) [2024] KETAT 735 (KLR) (17 May 2024) (Judgment)

Neutral citation: [2024] KETAT 735 (KLR)

Republic of Kenya

In the Tax Appeal Tribunal

Tax Appeal E365 of 2023

E.N Wafula, Chair, E Ng'ang'a, M Makau, EN Njeru & AK Kiprotich, Members

May 17, 2024

Between

Aaro East Africa Limited

Appellant

and

Commissioner of Legal Services And Board Coordination

Respondent

Judgment

Background 1. The Appellant is a private limited liability Company incorporated in Kenya under the Companies Act 2015 as a subsidiary of AARO Sweden whose primary business is in software implementation and maintenance.

2. The Respondent is a principal officer appointed under and in accordance with Section 13 of the Kenya Revenue Authority Act, the Authority is charged with the responsibility of among others, assessment, collection, accounting, and the general administration of tax revenue on behalf of the Government of Kenya.

3. The Respondent issued assessment orders dated 23rd March 2023 seeking to recover Kshs. 8,286,381. 28. The Appellant objected to the Respondent’s additional assessment on 23rd April, 2023. Upon review of the objection, the Respondent issued its objection decision dated 22nd May 2023.

4. The Appellant being dissatisfied with the Objection decision lodged before this Tribunal a Notice of Appeal dated 15th June 2023.

The Appeal 1. The Appellant filed a Memorandum of Appeal dated 29th June 2023 raising the following grounds:-a.That the Respondent erred in fact by issuing an Objection decision based on a misapprehension of the Appellant’s business operations; andb.The Respondent erred in fact and in law in applying a narrow interpretation of the term ‘business Process outsourcing’ to the disadvantage of the Appellant and contrary to the contra fiscum rule.

Appellant’s Case 2. In support of its case, the Appellant relied on its Statement of Facts dated 29th June 2023 and its written submissions dated 22nd December 2023.

3. The Appellant stated that its principal activity is the implementation and maintenance aspects on the software owned and sold by AARO Sweden to various clients. It argued that the software supports group reporting processes include group accounting, financial consolidation, disclosures, compliance with IFRS, management reporting and analysis.

4. The Appellant’s parent company (AARO Sweden) sells the software to various companies across the globe and integrates the software through a six-step process that involves: data gathering, data analysis, architecture design, systems integration design, implementation and maintenance.

5. The Appellant averred that based on the six-step process outlined above, AARO Sweden is subdivided into six major departments. Each of the six department handles the various aspects of the software integration into the clients’ operations.

6. The Appellant stated that it outsourced the implementation and maintenance departments, therefore, the Appellant handles the implementation and maintenance aspects of the software integration and invoices AARO systems.

7. The Appellant averred that the Respondent carried out a desktop review of the sales declarations made by the Appellant for the period December 2022 to February 2022 based on the filed VAT returns. The Respondent demanded the Appellant to have declared Kshs 51,789,870. 47 composed of VAT at 16% as opposed to zero-rate supplies. On 23rd March 2023, the Respondent wrote to the Appellant demanding that the Appellant amends it VAT returns and settles the VAT arising therefrom of Kshs 8,286,379. 28. Subsequently, the Appellant received an assessment on 23rd March 2023.

8. In its assessment letter, the Respondent averred that the services provided by the Appellant to AARO Sweden do not qualify as exported ‘business process outsourcing’ (BPO) services which are zero rated for VAT purposes pursuant to Paragraph 23 of Part A of the Second Schedule to the Value Added Tax Act, 2013 as amended by the Finance Act, 2022. The Appellant objected to this line of reasoning through its objection of 23rd April 2023.

9. In support of the first ground of appeal, the Appellant stated that the Respondent erred in holding that majority of the income received by the Appellant was from Kenyan companies and would therefore not qualify as exported services relating to business process outsourcing. The Appellant averred that this was an erroneous conclusion based on a misapprehension of its business model as presented in its tax returns as well as in its engagements with the Respondent’s team. The Appellant stated that the services in question are to AARO Sweden and in fact relate to AARO and its customers outside Kenya.

10. The Appellant also stated that in Kenya, it directly sells software to Kenyan companies and it therefore, treats the revenue as a taxable local supply subject to VAT at 16%. It argued that the tax treatment for its revenue from the local sale of software is not subject to dispute. The Appellant therefore, maintained that the revenue which it has declared as zero-rated in its VAT returns is the income relating to the exported BPO services provided to AARO Sweden's customers most of whom are outside Kenya.

11. The Appellant stated that the Finance Act 2022 introduced an ambiguity to the VAT Act, 2013 and such ambiguity should be interpreted in favour of the taxpayer. According to the Appellant, effective 1st July 2022, the Finance Act, 2022 introduced an amendment to the VAT Act, 2013 relating to exported services as follows:a.It deleted Paragraph 32 of Part II of the First Schedule to the VAT Act which provided that the ‘exportation of taxable services’ is classified as an exempt supply; andb.It introduced a new Paragraph 23 to Part A of the Second Schedule to the VAT Act providing that the ‘exportation of taxable services in respect of business process outsourcing’ is a zero-rated supply.

12. The Appellant noted that the impact of the above amendments was to effectively reclassify the exportation of taxable supplies as standard-rated supplies at 16% and limited the zero-rating to the ‘exportation of taxable services in respect of business process outsourcing (BPO)’. The Appellant however averred that there is no definition of the term BPO provided under the VAT Act, 2013 and this created an ambiguity in the law as to which exported services would qualify as zero-rated BPO services.

13. The Appellant asserted that the Courts have in many instances held that if there is any real ambiguity in a taxing Act, such ambiguity may be resolved in favour of the taxpayer. The Appellant cited the Court of Appeal finding in Mount Kenya Bottlers v the Attorney General and 3 others [2019] eKLR, where the Court stated that if there is ambiguity in a tax statute, such ambiguity must be resolved in favor of the taxpayer or as is sometimes stated: the contra fiscum rule.

14. The Appellant asserted that due to the ambiguity occasioned by the lack of a definition, taxpayers are therefore only left with the option of relying on the ordinary meaning of the term. The Appellant argued that on its part, the Respondent in this case interpreted the term BPO to only cover arrangements between a business (principal) and an unrelated party (agent). The Appellant observed that based on this limited interpretation, the Respondent in its Objection decision concluded that the Appellant’s services cannot qualify as BPO services as they are provided to its parent who is a related party. According to the Appellant, the Respondent took a narrow interpretation.

15. According to the Appellant, the ordinary meaning of the term BPO is that it is the process in which an entity Contracts out some of its recurring internal operations and activities to a third party for a fee. The Appellant also stated that Gartener Dataquest defines BPO as, ‘delegation of one or more IT-intensive business processes to an external provider that, in turn, owns, administers and manages the selected process(es) based upon defined and measurable performance metrics.’

16. According to the Appellant, based on the ordinary meaning of BPO and usage, the key features of BPO arrangements are as follows:i.Outsourcing of activities of an organization - this involves the transfer by a business (the customer/principal) to a third party (the supplier/agent) of the operational responsibility for provision of a distinct business function, process or service.ii.Level of control of the supplier by the customer - the control exercised by the customer of the BPO service over the supplier is informed by the significance of the outsourced process. For services that are key to the business of the customer, they are more likely to want more control over the supplier and this may in most instances translate into the supplier being a related party to the customer.iii.Transfer of responsibility to the supplier - the supplier, in this case, takes over the outsourced processes and utilizes their resources such as staff, technology or equipment for purposes of delivery as agreed or directed by their principal/customer.iv.Remuneration for the supplier - the supplier once they meet the set milestones is remunerated by way of a service fee by the customer. It is usually the case that deliverables are measured by way of completion of a project or the manhours spent on a particular project.

17. Based on the foregoing, the Appellant, averred as follows:a.BPO services can be provided by either related or unrelated parties and its services can therefore not be disqualified as BPO services merely because the recipient of the services is a related party.b.AARO Sweden which is a company that sells software outsourced some of its ordinary business processes such as the implementation of the software to the Appellant. The Appellant utilizes its staff to provide the services to AARO Sweden’s customers and earns a fee from AARO Sweden which is the amount in question for which the Respondent has assessed VAT at 16%. The services provided by the Appellant, therefore, fall within the ordinary meaning of the term BPO services and therefore qualify as BPO services.c.The impugned services are consumed by AARO Sweden which is a company located outside Kenya and they therefore are exported services based on the destination principle.

18. The Appellant submitted that there should not be any ambiguity in the interpretation of tax legislation as it is aptly stated in the case of Cape Brandy Syndicate v Inland Revenue Commissioners [1920] as applied in T.M. Bell v Commissioner of Income Tax [1960] EALR 224 where Roland J. stated:-“in a taxing Act, one has to look at what is clearly said. There is no room for intendment as to a tax. Nothing is to be read in, nothing it to be implied. One can only look fairly at the language used... If a person sought to be taxed comes within the letter of the law he must be taxed, however great the hardship may appear to the judicial mind to be. On the other hand, if the Crown, seeking to recover the tax, cannot bring the subject within the letter of the law, the subject is free, however apparently within the spirit of the law the case might otherwise appear to be.”

19. The Appellant also relied on High Court ruling in Republic vs. Commissioner of Domestic Taxes Large Tax Payer’s Office Ex-Parte Barclays Bank of Kenya Ltd [2012] eKLR (‘Barclays case’) where Judge Majanja referred to the dictum of Lord Simonds in Russell v Scott [1948] 2 ALL ER 5 where he stated:-“My Lords, there is a maxim of income tax law which, though it may sometimes be overstressed yet ought not to be forgotten. It is that the subject is not to be taxed unless the words of the taxing statute unambiguously impose the tax upon him.”

20. According to the Appellant, to remedy an ambiguous legislation, there should be an amendment of the legislation through Parliament as stated in the case of Adamson v Attorney General (1933) AC 257 where it was held that:-“The section is one that imposes a tax upon the subject, and it is well settled that in such used, and if there is any doubt or ambiguity this defect-if it be in view of the Crown a defect can only be remedied by legislation.”

21. Further, the Appellant citied the case R v the Commissioner of Domestic Taxes ex-parte Barclays Bank of Kenya Ltd (Miscellaneous Application 1223 of 2007) in which it was noted that:-“The duty of the respondent in assessing tax is to identify transactions or payments that attract tax liability especially where there are objections to such categorization... the Respondent is obligated by law to state with clarity its claim and state how the transaction falls within the terms of the statute. The respondent cannot exercise its duty like a trawler in the deeper seas expecting all the fish by casting its net wide.”

Appellant’s Prayers 22. The Appellant urged the Honorable Tribunal to grant the following orders that:a.The Appeal be allowed with costs to the Appellant;b.The Objection decision of the Respondent demanding a total payment of Kshs. 9,032,263. 34 be set aside in its entirety; andc.Any other orders that the Honorable Tribunal may deem fit.

Respondent’s Case 23. The Respondent’s case is premised on its Statement of Facts dated 13th October 2023 and it’s written submissions dated and filed 31st December 2023.

24. The Respondent averred that it requested the Appellant to provide documents in support of the objection vide email of 27th April, 2023 but the Appellant failed to provide sufficient documents. Consequently, the Respondent made findings upon review of the Appellant’s grounds of objection and the documents that were adduced vis-a-vis what the VAT Act 2013 provides.

25. The Respondent noted that the VAT returns for the period covered indicated that the majority of the services are consumed within the Country (Kenya) by clients such as KCB, I & M Bank, Unga Group, Platinum credit Ltd among others.

26. Apart from that, the Respondent also established that the Appellant related to AARO Sweden and that the services undertaken and invoice to the Appellant do not qualify as business outsourcing.

27. The Respondent stated that outsourcing occurs when a third-party or non-related party is contracted to offer services. The Respondent stated that from the self-assessments returns it was evident that the services were consumed locally. Therefore, the services do not qualify as exported services.

28. The Respondent stated that the Appellant’s services ought to have been charged VAT at a rate of 16%. Further, it argued that prior to 30th June 2021, exported services were zero-rated but the services became exempt as from 1st July 2021 through an amendment brought by the Finance Act 2021.

29. Exported Business Process Outsourcing (BPO) was introduced under Paragraph 23 of the Second Schedule as a zero rated supply on 1st July 2022.

30. The Respondent relied on Section 56 (1) of the Tax Procedure Act, Section 107 of the evidence Act and cited Kenya Revenue Authority vs Man Diesel & Turbo Se, Kenya [2021] eKLR and Wiliam O'Dwyer, Sloan O'Dwyer v Commissioner of Internal Revenue,266 F.2d 575 Mulherin vs Commissioner of Taxation [2012] FCAFC 115 to submit that in any proceedings, the burden is on the taxpayer to prove that a tax decision is incorrect.

31. The Respondent submitted that it issued assessments to the best of its judgment within the meaning of Section 29 (1) and Section 31 (1) of the Tax Procedures Act.

32. Finally, the Respondent relied on the case of Digital Box Limited vs Commissioner of Investigations and Enforcement, Appeal No.115 of 2017 in which the Tribunal stated:-“The Tax Procedures Act in granting the Respondent powers to assess taxpayers does not specify the methods that may be used instead the law provides that the best judgment must be exercised.”

Respondent’s prayers 33. The Respondent prayed that the Tribunal:a.Be pleased to uphold the objection decision of the Respondent dated 22nd May, 2023 as proper in law;b.That the assessment was proper in law and in conformity with the provisions of the Value Added Tax Act, 2013;c.That the short levied taxes being an additional assessment of Kshs 9,032,263. 34, resultant penalty and interest are due and payable by the Appellant.d.That the Appeal lacks merit.

Issues For Determination 34. The Tribunal having evaluated the pleadings and submissions of the parties is of the view that there is a single issue that calls for its determination; Whether Appellant’s services were exported services that are zero rated

Analysis And Findings 35. The Tribunal having determined the issue falling for its determination proceeds to analyse the same as hereinunder.

36. Whereas the Appellant argued that it exported its services to its related entity, AARO Sweden domiciled in Sweden while the Respondent argued that the services that the Appellant provided were consumed locally. The question then is, what are the tests in establishing whether services are exported?

37. Section 2 of the VAT Act with regards to export of services provides as follows:-“Service exported out of Kenya" means a service provided for use or consumption outside Kenya.”

38. On the other hand, Regulation 13 (1)(b) of the Value Added Tax Regulations as revised in 2022 provides as follows:-“(1)An exportation shall be a taxable supply— in the case of services, when the taxable supply involves the services being provided to a recipient outside Kenya for use, consumption, or enjoyment outside Kenya irrespective of where the payment is made from:Provided that the exportation of services shall not include—a.Taxable services consumed on exportation of goods unless the services are in relation to transportation of goods which terminates outside Kenya.”

39. From Section 2 of the VAT Act and Regulation 13 (1) (b) of the Value Added Tax Regulations as revised in 2022, it is clear that the applicable test is the location of the recipient of the services. The Recipient has to be outside Kenya.

40. Guideline 3. 1 of the Organisation for Economic Co-operation and Development (OECD) International VAT/GST Guidelines provides that, “for consumption tax purposes internationally traded services and intangibles should be taxed according to the rules of the jurisdiction of consumption.” On the other hand, Guideline 3. 2 provides that, “for business-to-business supplies, the jurisdiction in which the customer is located has the taxing rights over internationally traded services or intangibles.” These guidelines are in line with Regulation 13 (1)(b) of the Value Added Tax Regulations as revised in 2022 as discussed herein above that the customer who receives the service has to be outside Kenya.

41. The OECD Guidelines are considered as acceptable international best practices. The Court in Unilever Kenya Ltd v Commissioner of Income Tax [2005] eKLR stated as follows with regards to the application of OECD Guidelines:‘‘We live in what is now referred to as a “global village”. We cannot overlook or sideline what has come out of the wisdom of tax payers and tax collectors in other countries. And especially because of the absence of any such guidelines in Kenya, we must look elsewhere. We must be prepared to innovate, and to apply creative solutions based on lessons and best practices available to us. That is indeed how our law will develop and our jurisprudence will be enhanced. And that is also how we shall encourage business to thrive in our country. I have no doubt in my mind that the OECD principles on income and on capital and the relevant guidelines such as “Transfer Pricing” principles, the CUP method adopted for calculations of what ought to be the income, the Cost Plus Return method as well as Resale Minus Method adopted for looking into compliance with arm’s length principles are not just there for relaxed reading.’’

42. In expounding on the meaning of use and consumption, the High Court in the case of Commissioner of Domestic Taxes Versus Total Touch Cargo Holland Income Tax Appeal No. 17 of 2013 while citing the case of FH Services Limited Vs Commissioner of Domestic Taxes stated as follows:-“To our mind, it is immaterial where the place of performance of the service takes place, it can be China, in Latin America, in Ireland, in Mesapotamia, in Asia, in Europe, or even here in Kenya. What is material is where the use and consumption of the service takes place, not the place of services.”

43. From Section 2 of the VAT Act and Regulation 13 (1) (b) of the Value Added Tax Regulations as revised in 2022, and from the jurisprudence from the aforementioned case laws, it is clear that the applicable test is the location of a recipient of the services.

44. For the Tribunal to determine whether having established that the recipient of the services has to be outside Kenya, the next issue to be determined is the identity of the consumer. This Tribunal has on several occasions held that the recipient being outside Kenya on its own is not sufficient in matters like this.

45. The identity of the customer who receives exported services from Kenya should be legally connected to the service provider such as through business agreement. Guideline 3. 3 of the OECD provides that “the identity of the customer is normally determined by reference to the business agreement.”

46. The guidelines provide for elements of the business agreement that, the “Business agreements consist of the elements that identify the parties to a supply and the rights and obligations with respect to that supply. They are generally based on mutual understanding.”

47. Based on the above, apart from establishing that the services were issued to a customer outside Kenya, the taxpayer has a burden to demonstrate that there exists a legal agreement for supply of exported services and which identifies the consumer. It is not enough to state without evidence that the consumer is outside Kenya. It is the Tribunal’s view that doing so will mean that any taxpayer can allege that it offered exported services to an entity outside Kenya.

48. In the instant Appeal, the Appellant has not provided any Agreement to identify the concerned parties and services to be provided. There is no agreement to demonstrate that there is a connection between the Appellant and AARO Sweden or, AARO Sweden’s customers. Therefore, the Tribunal has not had the opportunity to evaluate the relationship between the Appellant and AARO Sweden in relation to the alleged exported services.

49. This issue is governed by the law and requires the taxpayer to provide evidence confirming supply of services to the entity outside the Country.

50. Rule 13(2) of the Value Added Tax Regulations in relation to proof of exports provides as follows:“The documentation relating to a supply required as the proof of an exportation of goods or services shall be—(a)a copy of the invoice showing the recipient of the supply to be a person outside Kenya;(b)Proof of payment for the supply; and(d)For services, such other documents as the Commissioner may require as proof that the services had been used or consumed outside Kenya.”

51. The Appellant has not provided evidence that is required under Rule 13(2) of the Value Added Tax Regulations. Whereas the Appellant provided invoices labeled as Appendix 6, the said invoices are directed to East African Breweries Limited; Equity Bank (Kenya) Limited; Platinum Credit Kenya Limited; SGA Holdings Kenya Limited; and I&M Bank. Just to confirm that the said invoices are not directed to AARO Sweden, the Appellant stated as follows at paragraph 19 of its Statement of Facts: ‘‘The Appellant further notes that in Kenya, it directly sells software to Kenyan companies and it correctly treats the revenue as a taxable local supply subject to VAT at 16%. The Appellant, therefore, notes that the tax treatment for its revenue from the local sale of software is not subject to dispute. (The sample invoices to the Kenyan clients are annexed as Appendix 6. )’’ Paragraph 19 of Appellant’s Statement of Facts is self-explanatory and confirms that the Appellant provided services to Kenyan entities.

52. Section 13(2)(b) of the Tax Appeals Tribunal Act requires an Appellant to file a Statement of Facts. The Tribunal adds that the statement of facts should support and expound the contents of the memorandum of appeal. The statement of facts should explain why and how the Respondent’s decision is incorrect as provided for under Rule 5 of the Tax Appeals Tribunal (Procedure) Rules, 2015.

53. Rule 5 of the Tax Appeals Tribunal (Procedure) Rules, 2015 provides as hereunder:“(1)Statement of fact signed by the appellant shall set out precisely all the facts on which the appeal is based and shall refer specifically to documentary evidence or other evidence which it is proposed to adduce at the hearing of the appeal.(2)The documentary evidence referred to in paragraph (1) shall be annexed to the statement of fact.” (Emphasis added)

54. The Appellant ought to have annexed the evidence under Rule 13(2) of the Value Added Tax Regulations but it failed to do so.

55. For a taxpayer to validly place its claim under Paragraph 23 Part A of the Second Schedule to the VAT Act, the taxpayer must provide relevant evidence which in this case is lacking. Consequently, in the absence of relevant evidence, the issue of ambiguity of the statute as claimed by the Appellant cannot arise.

56. The Tribunal is of the position that the Appellant herein has a statutory duty under Section 56(1) of the Tax Procedures Act and Section 30 of the Tax Appeals Tribunal Act to prove that the Respondent’s decision is incorrect.

57. The High Court in Tumaini Distributors Company (K) Limited v Commissioner of Domestic Taxes [2020] eKLR held that the taxpayer has the burden to prove that the tax decision is wrong. Similarly, this Tribunal in the case of Digital Box Limited v Commissioner of domestic investigations and Enforcement [2020] affirmed that the burden to prove that the Commissioner’s decision is wrong falls on the taxpayer.

58. In the instant Appeal, the Tribunal finds that the Appellant did not adduce evidence to support its assertions. Therefore, the Appellant has failed to discharge the burden of proof.

59. The Tribunal therefore finds that there is no evidence to indicate that the Appellant supplied exported services which were zero-rated. Consequently, the Tribunal concludes that the Appellant did not supply exported services which were zero-rated.

Final Decision 60. The upshot to the foregoing analysis is that the Tribunal finds that the Appeal lacks merit and consequently makes the following Orders; -a.The Appeal is hereby dismissed;b.The Respondent’s Objection decision dated 22nd May 2023 is hereby upheld; andc.Each party to bear its own cost.

61. It is so ordered.

DATED AND DELIVERED AT NAIROBI THIS 17TH DAY OF MAY, 2024ERIC NYONGESA WAFULA - CHAIRMANEUNICE NG’ANG’A MUTISO MAKAU - MEMBER MEMBERELISHAH NJERU ABRAHAM K. KIPROTICH - MEMBER MEMBER