[2023] KETAT 100 (KLR)

Co-operative Bank of Kenya v Commissioner of Domestic Taxes (Tribunal Appeal 523 of 2021) [2023] KETAT 100 (KLR) (10 February 2023) (Judgment)

Neutral citation: [2023] KETAT 100 (KLR)

Republic of Kenya

In the Tax Appeal Tribunal

Tribunal Appeal 523 of 2021

E.N Wafula, Chair, Cynthia B. Mayaka, Grace Mukuha, AK Kiprotich & Jephthah Njagi, Members

February 10, 2023

Between

Co-operative Bank of Kenya

Appellant

and

Commissioner of Domestic Taxes

Respondent

Judgment

Background 1. The Appellant is a limited liability company registered in Kenya under the Companies Act and licensed under the Banking Act and a registered taxpayer. Its principal activity is providing banking services and its main sources of income are interest, fees and commissions, foreign exchange and other income.

2. The Respondents is a principal officer appointed under Section 13 of the Kenya Revenue Authority Act, Cap 460 Laws of Kenya. Under Section 5 (1) of the Act, the Kenya Revenue Authority is an agency of the Government for the collection and receipt of all tax revenue. Further, under Section 5(2) with respect to the performance of its function under subsection (1), the Authority is mandated to administer and enforce all provisions of the written laws as set out in Part 1 & 2 of the First Schedule to the Act for the purposes of assessing, collecting and accounting for all revenues in accordance with those laws.

3. The Respondent conducted a reconciliation audit on the Appellant’s VAT operation records on card services for the period between 1st January 2016 to 31st December 2017 to confirm compliance in respect of financial services offered.

4. Further to the review of VAT returns filed by the Appellant and trial balances, the Respondent issued an assessment notice relating to VAT on Merchant Service fees and Interchange fees for the period January 2016 to December 2017 on 15th December 2020 amounting to Kshs 80,745,977. 00.

5. During the review it was established that the Appellant is a member of various card companies like VISA Card. The card companies own global payment technologies through which they connect consumers, businesses, financial institutions and Governments. They serve on one hand Cardholders, Issuers and Issuer processors and on the other hand they serve Merchants, Acquirers and Acquirer processors.

6. Further to the review it was established that the Appellant is both an Issuer and an Acquirer. As an Acquirer the Appellant provides certain services to the merchants and also provides network connectivity and for the services it charges the merchants a “Merchant Service Commission” (MSF).

7. The Bank also issues cards to its customers to use as credit and debit cards to be used at the merchant’s platforms or elsewhere and consequently provides to the cardholders services in the form of authorization, settlement, clearance, etc. and for these services the bank earns “Interchange fees”.

8. As a result, the Respondent raised additional assessment taxes on Merchant Service fees and Interchange fees related to the use of the cards operated by the Appellant for the period between 1st January 2016 to 31st December 2017 including penalty and interests amounting to Kshs 80,745,977. 00 on assessment orders dated 15th December 2020.

9. The Appellant objected to the demand for the taxes via notices dated 12th January 2021 and 16th January 2021 stating that the services leading to MSF and Interchange fees are incidental to the provision of money transfer services thus in essence are financial services exempt from VAT as provided under Paragraph of Part 11 of the First Schedule to the VAT Act, 2013.

10. The Respondent reviewed the Objection in light of the provided documentation and also had consultative meetings between January and April 2021 and subsequently confirmed the assessment and issued an Objection Decision.

11. The Appellant being dissatisfied with the objection decision filed the Notice of Appeal on the 17th August, 2021.

The Appeal 12. The Appeal herein is premised on the hereunder grounds as captured in the Memorandum of Appeal dated and filed on 31st August, 2021:-a.The Respondent erred in law in holding that the payments received by the Appellant as Interchange fees and Merchant Service fees constituted payment for taxable services.b.The Respondent erred in fact by stating that the Appellant provides services to acquiring banks.c.The Respondent erred in fact in failing to appreciate that as an issuing bank, the Appellant was simply facilitating a transfer of money from its customer’s account.d.The Respondent erred in law in failing to realise that money as defined in Section 2 of the VAT Act 2013 includes any amount provided by way of payment using a debit or credit card or electronic payment system.e.The Respondent erred in fact and in law in failing to appreciate that interchange fee is received by the Appellant in connection with operating its own customer’s account. The operation of an account is specifically exempted from VAT under Paragraph 1(a) of the First Schedule to the VAT Act, 2013. f.That notwithstanding and without prejudice to the foregoing, the Respondent erred in fact in failing to appreciate that the Interchange fees is received by the Appellant in relation to operating the customer’s account.g.The Respondent erred in law and fact in finding that the merchant service charge does not fall under exempt financial services offered by the bank under Part 11 Paragraph 1 of the First Schedule of the VAT Act, 2013. h.The Respondent erred in law and fact in finding that the Appellant offers the service of speedy processing of sales transactions to the merchants.i.The Respondent erred in law by concluding that merchant services are sufficiently covered under the definition of services under Section 2 of the VAT Act, 2013 and therefore deemed as taxable services.j.The Respondent failed to acknowledge that a point of sale (POS)terminal machine operates in the same way an Automated Teller Machine (ATM) operates.k.The Respondent erred in law and fact by failing to distinguish between the card companies and The Co-operative Bank of Kenya Ltd and their roles to complete a card transaction.l.The Respondent failed to recognize that merchant service fee (MSF)comprises of three components that is, interchange fees earned by the issuing bank, dues and settlement fee earned by the card company and acquiring bank fee earned by the acquiring bank.m.That the reliance on the Court of Appeal ruling in the case, Commissioner of Domestic Taxes (Large Tax payer office) v Barclays Bank of Kenya (BBK) Appeal No 195 of 2017 is out of context in that the issue under determination was whether Withholding tax was applicable on payments made by BBK. The case at hand is on VAT and relates to incomes earned by the Co-operative Bank of Kenya Ltd. Again, payment for services subject to WHT does not imply VAT obligation. Financial services are exempt in the VAT Act.n.The Respondent erred in law and in fact by failing to appreciate that the Appellant has an obligation to its customers, a principle anchored in law and precedents. The customers have acquired the creditdebit cards from the Appellant and a have a reasonable expectation that they will be able to transfer or otherwise deal with their money.o.The Respondent erred in law and in fact by failing to appreciate the fact that the Appellant carries out the services for the benefit of its customers and not the Acquiring banks.

Appellant’s Case 13. The Appellant’s case is premised on the Statement of Facts and Written submissions filed on 31st August 2021 and 22nd March 2022, respectively.

14. The Appellant submits that it’s a member of a network established by a card company known as VISA International and which network enables customers with VISA credit, debit and prepaid cards withdraw money from ATMs and or make payments for goods and services using their VISA cards. The banks that issue the cards to their customers are referred to as issuing banks within the network.

15. The network also established banks that provide Point of Sale (POS) machines to Outlets like Supermarkets, Hotels, Petrol Stations etc. to enable them accept payments from shoppers who purchase goods using credit cards, debit or prepaid cards. The retail outlets are referred to as “Merchants” and the banks that provide the POS are known as the ‘Acquiring banks” within the network. The Appellant is both an issuer and an acquirer.

16. That the process and steps followed in a typical card transaction are as follows:a.Customer applies in an issuing bank for a VISA credit, debit or prepaid cardb.The cardholder goes to a merchant e.g., Supermarket, and uses the card to make a purchase. The merchant inserts the card in a POS machine configured to accept the same.c.The cardholder then enters a PIN number. The merchant then seeks authorization through the network (such as VISAnet if the card is a VISA card)d.The network then switches the transactions from the acquiring banks to the Issuing banks. The issuing bank verifies the details of the accountholder in order to confirm whether the account has sufficient funds to satisfy the payment or to confirm that the purchase is within the cardholder’s credit limit if it’s a credit card.e.The issuing bank then sends an authorization message to the network which then relay the authorization to the acquiring bank. The authorization then acts as a commitment to settle the merchant’s funds and the issuing bank immediately debits the amount from the cardholder’s account pending settlement. Receipts are also issued to both parties to the transaction and the customer takes possession of the goods.

17. The Appellant submits that the settlement between the merchant and the acquiring bank is done and the process maybe likened to a payment via cheque, Electronic Funds Transfer (EFT) etc.

18. That upon settlement, the merchant receives the amount spent by the cardholder less an amount known as Merchant Service Fees (MSF). The MSF has three components: the interchange fees, the dues and assessment fee and the acquirer processing fees. The network allocates the Interchange fees to the issuing bank, the network retains the fees referred to as dues and assessment fees and the remaining amount known as acquirer processing fees is the allocated to the acquiring bank.

19. The bank also earns ATM acquirer fees. This relates to services that are incidental to providing withdrawal services to the bank’s customers.

20. The assessment notice dated 15th December 2020 related to the Appellant’s card transaction business whereby the Respondent was demanding Kshs 80,745,977. 00 in VAT principal tax, penalties and interest relating to merchant service fees and Interchange Commission for the period January 2016 to December 2017.

21. The Appellant responded by objecting to the assessment vide its Notice of Objection dated 12th January 2021 and stating that the assessment was based on a misunderstanding that the MSF and Interchange fees were taxable under Section 5(1) of the VAT Act, 2013 and the bank should have charged VAT under Section (2)(b) of the VAT Act. The Appellant avers that the two fees are in essence financial services exempt from VAT as per Paragraph 1 of Part II of the First Schedule to the VAT Act, 2013.

22. The parties consequently held meetings and the Appellant provided documents.

23. The Respondent issued its Objection Decision vide a letter dated 16th June 2021. The said decision confirmed the VAT assessment at Kshs 80,745,977. 00 inclusive of penalties and interest and the Appellant consequently filed the Appeal.

24. The Appellant argues that Interchange fees is earned by the Appellant where the Appellant is the Issuer. The role played by the Appellant here is to facilitate accounts opening for its Customers, issue credit and debit cards to its customers, receive request via the VISA system from an acquiring bank for cardholder verification in a credit debit transaction by confirming whether the cardholder PIN is correct, Issuer of the card and sufficiency of funds in the account and sending approval or decline, debit the account holders account with the a of the amount transacted, effect money to VISA less interchange fees. The fees is only earned where the transaction is approved. The Appellant adds that the whole process above quoted amounts to “a supply of money” which is not a service for VAT purposes as per Section 2 of the VAT Act 2013. The Appellant submits that the definition of a service under Section 2 of the VAT Act 2013 excludes the supply of money.

25. The Appellant also argues that the Interchange fees retained by the Appellant is a payment for “operation of an account”. The transactions leading to Interchange fees emanates from a customer deciding to use the debit/credit card issued by the Appellant to make payment. Part 11 Para 1(a) of the VAT Act, 2013 exempts from tax the operations of Current, Deposit or Savings accounts including the provision of Statement of accounts.

26. Interchange fees or Acquiring (ATM Acquirer fees) relates to normal ATM withdrawal services. The Appellant argues that the fees relates to services that are incidental to providing withdrawal services to banks customers. In details, this relates to Acquirer fees whereby another bank’s customer runs their cards at the Appellant’s ATM. The Appellant’s switch will send instructions to the switch of the Issuing bank for verification after which approval maybe given and the cash disbursed through the Appellant’s ATM. The issuing bank retains its portion of the withdrawal fees and remits the balance through the card company’s network which is shared between the Appellant and the card company. This process, the Appellant states, is akin to normal ATM withdrawal services and exempt from VAT as per Paragraph 1 (d)of Part 11 of the First Schedule of the VAT Act 2013.

27. The Appellant relies on 4 Authorities in support of its case including High Court Tax Appeal No 8 of 2018 (Barclays Bank of Kenya v Commissioner of Domestic Taxes where it was held that: “The use of the card is exempt from VAT as per Para 1 (a) and (b) of Cap 476; Tax appeal case No302 of 2018 of Standard Chartered Bank of Kenya Ltd v Commissioner of Domestic Taxes where it was held that: “Interchange fees relates to services exempt from VAT”; TAT Case No 319 of 2018 in Bank of Africa Kenya Ltd v Commissioner of Domestic Taxes where the Tribunal held that “Services provided in money transfer related services undertaken by a bank for a customer is an exempt service under First Schedule of the VAT Act” and TAT Case No 361 of 2018 in NIC BankPLCv The Commissioner of Domestic Taxes where the Tribunal held that “Interchange fees received by Issuing banks are not subject to VAT”

28. The Appellant also argues that the MSF is earned for providing banking services. The services amount to supply of money and are excluded from the definition of a service under Section 2 of the VAT Act.

29. The Appellant further argues that the entire clearance and settlement process in the Merchant/Bank relationship is carried out by the network and not the Appellant. It adds that the MSF is consideration for services offered to the customer. The fees comprise of three components: interchange fees earned by the Issuing Bank; dues and settlement fees earned by the card company and acquiring bank fees earned by the acquiring bank. The role of the Appellant as an acquirer is akin to a customer walking to the Bank’s Ccunter or ATM, withdraws money and walks to the Merchant to pay for the goods or services.

30. The Appellant also argues that the Tribunal held in the case of KCB Ltd v Commissioner of Domestic Taxes (Case No 167 of 2018) that the ‘services provided by the Appellant and the transaction and settlement fees (MSF)are financial services exempt from VAT’.

Appellant’s Prayers 31. The Appellant prays that the Tribunal:a.Upholds the Objection filed by the Appellantb.Annuls and sets aside the Commissioner’s Objection Decision dated 16th June 2021c.Awards it costsd.Any other remedies

Respondent’s Case 32. The Respondents case is premised on the Statement of Facts and the Submissions filed on 1st October 2021 and 7th April 2022, respectively.

33. The Respondent upon auditing the Appellant for the period between January 2016 and December 2017 on the Appellant’s VAT operation records on card services consequently issued an assessment notice relating to VAT on Merchant Service Fees and Interchange Fees on 15th December 2020.

34. During the review it was established that the Appellant is a member of various card companies including VISA card. The companies own global payment technologies through which they connect consumers, businesses, and financial institutions and Governments. On one hand they serve cardholders, issuers and issuer processors and on the other hand they serve merchants, acquirers and acquirer processors.

35. It was also established during the review that the Appellant was both an issuer and an acquirer. The Appellant performs some functions for the merchants in the transactions and for this it charges the merchant service commission. The Appellant as an issuer provides financial services to its customers and in return charges the Interchange fees.

36. The Respondent as a result raised additional assessments taxes for specific card services of merchant fee charge and interchange fees all related to the use of credit and debit cards for the period 1st January 2016 to 31st December 2017 including penalties and interest and amounting to Kshs 80,745,977. 00 and assessment orders were issued to the Appellant.

37. The Appellant objected to the assessment stating that the two charges are not taxable under the VAT Act 2013. The Respondent reviewed the objection and upon consideration of the available information and after several consultative meetings between January and April 2021 the assessments were confirmed and Objection Decision issued to the Appellant dated 16th June 2021.

38. The Respondent submits that the Appellant upon notice of assessment was uncooperative and did not provide the necessary documents on request to support its subsequent Objection.

39. The Respondent adds that the TPA empowers it to charge a penalty on late submission returns

40. The Respondent states that Interchange fees earned constitutes management and professional fees and the same does not fall under Para. 11 sub-para 1 of the First Schedule to the VAT Act, 2013 which outlines exempt financial services. The Respondent relies on the case of Cape Brandy Syndicate v Inland Revenue Commissioner (1921) 1 KB 64 and Africa Cash and Carry Ltd v Commissioner SARS (2019).

Respondent’s Prayers 41. The Respondent prays for orders that:a.The Respondent’s objection decision be upheldb.The outstanding tax arrears of Kshs 80,745. 977. 00 are due and payable by the Appellantc.The confirmed assessments dated 15th December 2020 were proper in lawd.The appeal be dismissed with costs.

Issue For Determination 42. The Tribunal having considered the pleadings, documents and submissions filed in the matter is of the considered view that there is only one issue falling for its determination.“Whether the Interchange Fees hand The Merchant’s Service Fees (MSF) are VATable”

Analysis And Findings 43. The Appellant submits that interchange fees retained by the Appellant relates to supply of money. It goes on to show that the Appellant facilitates the accounts opening process for its customers, Issues credit/debit cards to its customers for usage in making purchases after which their accounts are debited by the Appellant.

44. The Appellant states that it also verifies the suitability of the cards in credit/debit transactions. The processes result in money transfers from the cardholders’ accounts to the merchants. That the Appellant is paid for the facilitation.

45. The Respondent claims that the Appellant earns Interchange fees because of providing- services to acquirer banks which includes facilitation fees for facilitating a medium of communication between the issuers, acquirers and merchants for confirmation of the creditworthiness of the cardholders, authorization, settlement and clearance to the acquiring bank.

46. The Appellant avers that its role in the money transaction business between cardholders, acquirers and merchants is principally a supply of money process. Cardholders verification and transfer of money by banks is not a taxable service. The Appellant avers that this is a normal banking process during the supply of money whereby, customers present themselves physically to transact over the bank counter or use a debit or credit card. However, when the customer transacts using a card the verification is done online.

47. The Tribunal has considered the Appellant’s averments above on the description of the services provided by the banks and the fees thereby consequently earned. It also observes that the supply of money by the Appellant is not a service for VAT purposes as stated under the provisions of Section 2 of the VAT Act. Section 2 of the same Act defines a taxable supply as:“a supply, other than exempt supply, made in Kenya by a person in the course or furtherance of a business carried on by the person, including a supply made in connection with the commencement or termination of business.”

48. The Tribunal further observes the provisions of Para 11 Para 1 of the First Schedule to the VAT Act, 2013 which provides that“The supply of the following financial services shall be exempt supplies.a.The operation of current, deposit or savings account including the provision of account statementsb.o)”

49. The Tribunal takes into cognizance the fact that the interchange fees is not expressly listed under the abovementioned Schedule but this does not negate the fact that interchange fees are integral in the performance of financial services. This was discussed in the case of Barclays Bank of Kenya v The Commissioner of Domestic Taxes (TAT No 114 of 2015) where the Tribunal observed that:“The Tribunal does not expect the legislature intended that details of all kinds of services being offered were to be numerically specified for all services rendered as the dictates of today’s economic order would militate against this by rendering this virtually impossible as the evolving economic development spins service not earlier contemplated and or visualized”.

50. The Tribunal has also recognized the Tribunal’s holding in Appeal case No 322 of 2018, Commercial Bank of Africa v Commissioner of Domestic Taxes where the Tribunal held that Interchange fees relates to services exempt from VAT; on page 60 para. 39 where it stated as follows:“With regards to whether these services are vatable as the Respondent argues, we have had occasion to underscore the services offered by the Issuing bank are ancillary to its core mandate, which is the transfer of the funds from its customers’ accounts. Transfer of funds is express exempt from VAT as per the provisions of Paragraph 1 (a) (b) and (h) of the First Schedule to the VAT Act, 2013. In the circumstances we place reliance on our Judgement in Tax Appeal No 361 of 2018, NIC Group & NIC Bank Ltd v Commissioner of Domestic Taxes as upheld by the High Court in Barclays Bank of Kenya Ltd v Commissioner of Domestic Taxes as upheld by the High Court in Barclays Bank of Kenya Ltd v Commissioner of Domestic taxes [2020] eKLR for the position that Interchange fees charged by the Issuing Bank is not subject to VAT at the standard rate but rather it is exempt .”

51. In TAT Case No 361 of 2018, NIC Group Plc and NIC Bank Plc v The Commissioner of Domestic Taxes the Tribunal held that interchange fees received by issuing banks are not subject to VAT.

52. The Respondent claims in its submissions that merchant services qualify as a taxable service as defined under Section 2 of the VAT Act, to mean “anything that is not goods or money” and therefore does not fall under Part 11 of Para. 1 of the First Schedule of the VAT Act which outlines exempt services, and is therefore taxable.

53. The Appellant on the other hand submits that the primary purpose of engaging with the merchant is to allow the Appellant’s customers to use their cards to shop for goods and services and to obtain cash from the merchant’s outlets. The agreements between the merchants and the bank is to facilitate trade where money is transferred from the customer’s accounts to the merchant’s accounts. The issuing bank is therefore extending banking services to the customers and this service amounts to “supply of money” and this is excluded from the definition of a service under Section 2 of the VAT Act.

54. The Tribunal in TAT Case No 167 of 2018, Kenya Commercial Bank Ltd v Commissioner of Domestic Taxes held that the services provided by the Appellant and the transaction and settlement fees (merchant service) are financial services exempt from VAT under Para. 11 sub-para 1 of the First Schedule of the VAT Act, 2013. The Tribunal (While relying on TAT Case No 361 of 2018 NIC Group and NIC Bank Kenya v Commissioner of Domestic Taxes) held on page 53 Para.22 as follows:“15. The foregoing definitions invariably negates the Respondent’s contention that the card services between the Appellant as the issuing bank and the acquiring bank do not amount to transfer of money or operation of bank account, and that they are subject to value added tax under Section 5(1)& (2) of the VAT Act ,2013. We find that the service provided by the Appellant is to its customers and not the acquiring bank, it involves a money transaction and it is not considered as a service subject to the value added tax .In fact, the service of money transfer is exempt from value added tax under the provisions of the paragraphs 1 of part 11 of the First Schedule to the Value added Tax Act 2013 ”

55. In TAT Case No 137 of 2016, Barclays Bank Ltd v Commissioner of Domestic Taxes the Tribunal held that interchange fees and merchant service fees are earned from financial services provided by the bank and are not VATable.

56. The Tribunal at this point and time finds no reason whatsoever to persuade it to deviate from the earlier decisions that remain consistent.

Final Decision 57. Pursuant to the findings above, the Tribunal makes the following Ordersa.The Appeal be and is hereby allowed.b.The Respondent’s tax decision dated 16th June 2021 relating to interchange fees and merchant service fees amounting to Kshs80,745,977. 00, inclusive of penalties and interest be and is hereby set aside.c.Each party to bear its own costs.

58. It is so ordered.

DATED AND DELIVERED AT NAIROBI ON THIS 10TH DAY OF FEBRUARY, 2023. ................ERIC N. WAFULACHAIRMAN................CYNTHIA B. MAYAKAMEMBER................GRACE MUKUHAMEMBER................ABRAHAM KIPROTICHMEMBER................JEPHTHAH NJAGIMEMBER