[2023] KEHC 25487 (KLR)

Commissioner of Domestic Taxes v Commercial Bank Africa Limited (Income Tax Appeal E146 of 2021) [2023] KEHC 25487 (KLR) (Commercial and Tax) (20 November 2023) (Judgment)

Neutral citation: [2023] KEHC 25487 (KLR)

Republic of Kenya

In the High Court at Nairobi (Milimani Commercial Courts Commercial and Tax Division)

Commercial and Tax

Income Tax Appeal E146 of 2021

A Mabeya, J

November 20, 2023

Between

Commissioner Of Domestic Taxes

Appellant

and

Commercial Bank Africa Limited

Respondent

(Being an appeal from the judgment of the Tax Appeals Tribunal at Nairobi delivered on 11/6/2021)

Judgment

1. The appellant conducted an audit on the affairs of the respondent for the period between 1/1/2013 to 31/12/2013. Consequently, he issued an assessment on 12/6/2018 for Kshs 304,430,041. 60. The respondent objected to the assessment vide a letter dated 23/7/2018. The appellant issued an amended assessment on 6/9/2018 for Kshs 116,587,059. 20.

2. Aggrieved by the appellant’s decision, the respondent lodged an appeal at the Tax Appeals Tribunal and the judgment was delivered on 11/6/2021 in its favour.

3. Being dissatisfied with that decision, the appellant lodged this appeal vide a memorandum of appeal on 15/2/2022. The appeal is premised on the following grounds: -a.That the Tribunal erred in law and in fact in finding that the interchange fees received by the respondent are not subject to VAT under the VAT Act 2013 without any express provisions in the VAT Act 2013 exempting the same.b.That the Tribunal erred in law and fact in finding that the services provided by the respondent are not taxable services as provided for by sections 5,6(1) and 6(4) of the VAT Act cap 46 and sections 5(1)(a) and 5(2)(b) of the VAT Act 2013. c.That the Tribunal erred in finding that the penalty was not applicable contrary to section 84(2)(b) of the Tax Procedures Act.d.That the Tribunal erred in law and fact in vacating the demand for VAT on Visa interchange Fees amounting to Kshs 116,587,059. 20 made up of Principal Tax of Kshs 80,332,640/- shortfall penalty of Kshs 16,066,528/- and interest of Kshs 20,187,891. 20.

4. The respondent opposed the appeal vide its statement of facts dated 15/2/2022. It contended that the interchange payment was not a payment for service but rather a cost balancing mechanism which the issuing banks incur when issuing cards. That the Tribunal did not err in holding that the issuing bank conducts the services based on the contractual relationship with the customers and therefore exempt from VAT.

5. According to the respondent, its role in the card payment transaction involved verification of the customer’s card details, checking availability of money and transfer of money from the card holder’s account which services were exempt.

6. The appeal was canvassed by way of written submissions which I have considered.

7. The appellant submitted that the VATAct2013 did not expressly state that interchange fees was exempt financial services. That the services issued by the respondent which include authorization, clearing and settlement were not exempted by the VAT Act. Those services were not exempt services under paragraph 1 of the third schedule of the repealed VAT Act and therefore taxable under sections 5, 6(1) and 6(4) of the repealed VATAct. That the Court of Appeal had held that interchange fees was management/professional fees offered by one institution to another.

8. On the respondent’s part, it was submitted that the interchange fee was not a payment for the provision of services to an acquirer because it arises from the issuing bank’s activities that result in the transfer of money from the card holder’s bank account for purchase of goods or services by the account holder.

9. That in a financial transaction, the interchange fees is only earned if the cardholder has sufficient funds to pay for the goods and services. That the interface fee arose from the services that were provided by the respondent to its own customers to enable the transfer of money through the card payment network.

10. I have considered the record, the statement of facts and the submissions by Learned Counsel. The grounds of appeal can be collapsed into one, that is, whether the Tribunal erred in holding that interchange fees is not subject to VAT.

11. The appellant’s case is that the VATAct did not expressly state that the interchange fee was exempt from VAT. According to him, the respondent service as an issuer was not in the nature of issuing, transfer or receipt of money as stipulated in paragraph 1(b) of part II of the 1st schedule of the VATAct. In view of this, the appellant holds that the services rendered by the respondent were not exempted financial services.

12. According to section 5 of the VATAct, VAT is charged on a taxable supply. Section 2 of the VATAct defines a taxable supply as a supply other than an exempt supply.

13. Under paragraph 1, the listed services that were exempt from VAT include: -“(a)the operation of current, deposit or savings accounts, including the provision of account statements;(b)the issue, transfer, receipt, or any other dealing with money, including money transfer services, and accepting over the counter payments of household bills, but excluding the services of carriage of cash, restocking of cash machines, sorting or counting of money.(c)issuing credit and debit cards.(d)automated teller machine transactions excluding the supply of automated teller machines and the software to run it.”

14. In order to establish whether the interchange fee is payable on VAT, the Court has to determine the role played by the respondent as an issuing bank in a Card payment network. In the case of Commissioner of Domestic Taxes v Bank of Africa Limited (Civil Appeal E127 of 2020) [2023] KEHC 1036 (KLR) (Commercial and Tax) (17 February 2023), the court stated as follows: -“In that capacity, the issuer is the gatekeeper to the cardholders’ accounts from which it transfers money to the acquirer for cardholders’ purchases and earns interchange fee in return. Taken in that context, the issuer’s primary service is to the cardholders as customers. This is so because once a card is issued to customers/cardholders, the issuer will continuously monitor the cardholders’ accounts to ensure that they have sufficient funds to cover the costs of each transaction. The service to the acquirer is secondary to the service the issuer renders to cardholders.The nature of service the issuer renders to card holders is, in my view, a financial service. This is because the issuing bank owes cardholders a duty to verify not only their details and eligibility to use the cards but also deduct money from their accounts and pass it to the acquirer, thus enabling them complete their purchases. Verification of cardholders’ details and eligibility to use the cards, precedes the decision to allow the cardholder to purchase goods which is later followed by transferring money from the cardholders’ accounts to the merchant through the acquirer. In this respect, I agree with the TAT’s holding that Bank of Africa, as issuer, rendered service to the cardholders.”

15. In echo the foregoing. From it, it is evident that the services offered by the issuing bank to the customer include, inter alia, the transfer of money from the customer’s account to the acquiring bank which subsequently is transferred to the merchant. The issuing bank therefore acts as a medium for the exchange of money on behalf of the customer. It is a fee charged out of the relationship between the merchant and the issuing bank due to the cards issued to the account holder and cannot be said to be payment of services to the respondent.

16. Under paragraph 1(b) of the VAT Act, transfer, receipt or any dealings with money is exempted from VAT. Since interchange fee is earned from the process of operating the customer’s account by conducting verification of the card holder’s details, the availability of funds in the account of the card holder before transferring funds for the transaction, the Court finds that transaction is exempted from VAT.

17. This was the position that was upheld in the case of Commissioner of Domestic Taxes v Barclays Bank of Kenya Limited Income Tax Appeal No. E023/2021 where the court stated that: -“My view is that in establishing whether the service given by the issuing bank is subject to VAT, the role played by the issuing bank in the transaction is crucial. In this case, the parties have not disputed that the issuing bank upon receiving instruction from the acquiring bank, establishes whether money is available in the Cardholders account and therefore payable to the transaction and approves or declines the same.While it is clear that the VAT Act precludes financial services for transfer of money from payment of VAT, can this transaction solely be limited to transfer of money? My take is that one ought to look at the big picture and that is the business of the issuing bank. In this case, the issuing bank acts as a medium for exchange of money and its principal service is to transfer the money to the required destination ie the acquirer bank.The upshot of this is that the benefit derived from the compensation of the issuing bank amounts to transfer of money and the same is not subject to VAT.”

18. Accordingly, the Court finds that the assessment by the appellant was wrong in charging VAT on interchange fee. Consequently, the Court finds no merit in the appeal and dismisses the same with costs.

It is so decreed.

DATED AND DELIVERED AT NAIROBI THIS 20TH DAY OF NOVEMBER, 2023. A. MABEYA, FCI ArbJUDGE