[2024] KEHC 8194 (KLR)

Commissioner of Domestic Taxes v Total Kenya Limited (Income Tax Appeal E044 of 2022) [2024] KEHC 8194 (KLR) (Commercial and Tax) (4 July 2024) (Judgment)

Neutral citation: [2024] KEHC 8194 (KLR)

Republic of Kenya

In the High Court at Nairobi (Milimani Commercial Courts)

Commercial and Tax

Income Tax Appeal E044 of 2022

AA Visram, J

July 4, 2024

Between

Commissioner of Domestic Taxes

Appellant

and

Total Kenya Limited

Respondent

(An appeal from the Judgment of the Tax Appeals Tribunal dated 25th March 2022 in Tax Appeal No. 151 of 2016 Consolidated with Tax Appeal No. 16 of 2017)

Judgment

1. The Respondent, Total Kenya Limited, is a limited liability company incorporated in Kenya and a wholly owned subsidiary of Total Outre Mer (“TOM”), a company incorporated and resident in France. Its core business is sale of petroleum products. In the course of its business, the Respondent entered into a Technical Assistance Agreement with TOM for provision of technical and general assistance services. Under the agreement, the Respondent received professional services from TOM.

2. The Appellant, the Commissioner of Domestic Taxes (“the Commissioner”), carried out an audit of the Respondent’s tax affairs for the period 2011 to 2015 and found that the Respondent did not operate withholding tax (WHT) when making payments for the management and professional services to TOM. It raised tax assessments on 14th August, 2013 and 29th September, 2016, on the basis that the Respondent’s payments to TOM were taxable as they fell within the category of “other income” under Article 21(4) of the Kenya-France Double Taxation Agreement (DTA), and therefore, subject to WHT pursuant to section 35 (1) (a) of the Income Tax Act (ITA).

3. In response, the Respondent filed Notices of Objection on 12th September, 2013 and 28th October, 2016, premised on the ground that the fees paid to TOM were taxable only in France pursuant to Article 7 of the Kenya-France DTA following the deletion of Article 14 of the OECD Model Tax Convention.

4. The Commissioner issued its Objection Decisions dated 29th September, 2016 and 15th December, 2016, upholding its original assessments. Aggrieved, the Respondent filed an appeal before the Tax Appeal Tribunal (“the Tribunal”). Through its judgment dated 26th February, 2022, the Tribunal allowed the said appeal.

5. Dissatisfied with the decision of the Tribunal, the Commissioner lodged the present appeal, premised on the following grounds contained in the Memorandum of Appeal dated 4th May, 2022:-1. That the Honourable Tribunal erred in law and in fact in failing to appreciate that in every transaction, there is an income element and an expense element.2. That the Honourable Tribunal erred in law and in fact in failing to appreciate that the issue in dispute is the expense treatment of the payer of professional fees who in this case is the Respondent, and not how the French entity treats the received income in its books.3. That the Honourable Tribunal erred in law and in fact in failing to appreciate that the dispute before it was not about the treatment of professional fees by the French entity but rather how the local entity (the Respondent) is supposed to treat the payment at the point of expensing it in its books.4. That the Honourable Tribunal erred in law and in fact in failing to appreciate the obligation placed on the payers (Respondent) to withhold income tax when making a payment for professional services received under the Income Tax Act.5. That the Honourable Tribunal erred in law and in fact by relying on the provisions of the Kenya France Double Tax Agreement which relates to treatment of income and have nothing to do with treatment of expenses.6. That the Honourable Tribunal erred in law and in fact in failing to consider and determine that the Kenya France Double Tax Agreement does not provide for treatment of expenditure and only deals with treatment of income.7. That the Honourable Tribunal erred in law and in fact in failing to consider and determine on whether the Withholding Tax regime for management and professional services is provided for under the Kenya France Double Tax Agreement.8. That the Honourable Tribunal erred in law and in fact in finding that the question for determination is how professional fees income is treated under the provisions of the Kenya France DTA, when the Dispute in question was not how the Total Otto Mere Entity is to treat the professional fees in its books.9. That the Honourable Tribunal erred in law and in fact in failing to find that management and professional fees are not specifically provided for under the Articles of the Kenya France Double Tax Agreement and as such, must be dealt with under Article 22(3) of the Kenya France Double Tax Agreement.10. That the Honourable Tribunal erred in law and in fact finding that professional fees paid by the Respondent to its related entity in France constitutes business profits which are provided for and dealt with under Article 7 of the Kenya France Double Tax Agreement.11. That the Honourable Tribunal erred in law and in fact holding that the Appellant erred in demanding for Withholding Tax in respect of the payments made by the Respondent to its associate residents in France.12. That the Honourable Tribunal erred in law and in fact in ignoring and/or failing to appreciate the evidence tendered by the Appellant on the Withholding Tax treatment of management and professional fees paid by the Appellant to a related entity in France under the Income Tax Act and the Kenya France Double Tax Agreement.13. That the Honourable Tribunal erred in law and in fact in failing to appreciate the import of the Article 21(3) of the UN Model Convention and its Commentaries, in relation to the dispute at hand.14. That the Honourable Tribunal erred in law and in fact in failing to appreciate the import of the deletion or Article 14 of the OECD Model Convention and the addition of the definition of the term "business" under Article 3 of its Commentaries, in relation to the dispute at Hand.

6. The Commissioner prays that the appeal be allowed with costs; that the Court sets aside the decision of the Tribunal dated 25th March, 2022, and that the Court upholds its Objection Decisions dated 29th September, 2016 and 5th December, 2016.

The Appellant’s Submissions: 7. Through written submissions dated 13th February, 2023, the Commissioner submitted that pursuant to Section 35(1) of the Income Tax Act together with Article 21(4) of the Kenya - France DTA (“the DTA”), Kenya has the right to impose WHT on technical fees paid to the French non-resident person not having a permanent establishment in Kenya. It also submitted that since management and professional fees are not covered by any other Article of the DTA, the said articles therefore fall squarely under Article 21 of the DTA.

8. The Commissioner further submitted that Article 7(1) of the DTA on business profits is not applicable. It contended that it does not seek to tax TOM’s business profits, which it admitted is taxable in France because TOM does not have a permanent establishment (PE) in Kenya. It argued that its only concern was with regard to WHT, which it reiterated was chargeable on the management and professional fees.

9. The Commissioner relied on Article 7(7) of the DTA which provides that the provisions of Article 7 cannot affect other Articles which permit collection of tax on incomes which form a part of a business’ profits, in this case, Article 21 (4) which gives Kenya the withholding taxing right on technical fees. It also relied on Article 7(7) of the DTA which mirrors Article 7(4) of the OECDMTC and Article 7(6) of the UNMTC for the proposition that all of the above, namely the OECD, MTC and UNMTC operate in unison, such that, where Article 7 and Articles on WHT are both applicable, then Articles on WHT shall take precedence.

10. The Commissioner took the position that from the Tribunal's interpretation of the terms business profit and business income, the Tribunal was misguided in determining that the technical fees paid fell under business profits. It asserted that technical fees are a part of business income and not business profits, and therefore, while Article 21(4) gives Kenya the withholding taxing right on technical fees, France will retain the right to tax the business profits.

11. The Commissioner submitted that the UN MTC is applicable in interpreting Article 21(4) of the DTA as it mirrors Article 21(3) of the UN MTC. It also submitted that Article 21(3) of the UN MTC allows the State in which the income arises to tax such income if its law so provides.

12. As regards the taxation of business profits, the Commissioner highlighted that the domestic law of France read together with Article 7(1) of the DTA allows France to tax that income as business profit. These two issues have been addressed in the commentary to paragraph 21(3) at paragraph 5 of the UN MTC commentary and the DTA commentary. The elimination of double taxation has been resolved by reference to Article 23 which is reproduced by Article 22 of the Kenya-France DTA. The Kenya-France DTA at Article 22, paragraph 1(a) preferred credit method for the withholding tax paid by the French entity in Kenya.

13. The Commissioner pointed out that the UN MTC Commentary to Article 21 at paragraph 2 provides that concurrent application of the provisions of the two paragraphs may result in double taxation. In such a situation, the provisions of the Article on Elimination of Double Taxation are applicable, as in other cases of double taxation. Should any double taxation arise from France also exercising their taxing right, Article 22(1) would apply by requiring France to give their resident a credit for the tax paid in Kenya. The inclusion of taxes paid pursuant to Article 21 in Article 22 which is tax paid by a French entity outside France, clearly shows that there are taxes payable in Kenya, which the French authorities must recognize and give a relief for in France. It was asserted that the DTA provides for elimination of double taxation by the state in which the tax payer is a resident.

The Respondent’s Submissions: 14. In response, the Respondent filed a statement of facts dated 30th June, 2022, and written submissions dated 22nd March, 2023. The Respondent urged the Court to dismiss the appeal on the ground that due to the deletion of Article 14 of the OECD MTC on management and professional fees; and the omission of a specific article on such fees in the DTA, the technical fees it paid to TOM are taxable in France under Article 7. It relied on paragraph 77 of the Commentary of Article 7 of the OECD MTC which provides that the effect of deletion of Article 14 is that income derived from professional services is now dealt with under Article 7 as business profits. Based on the above, the Tribunal had correctly rejected the Commissioner’s contention that the fees are classified as “other income” under Article 21.

15. The Respondent submitted that grounds 1 - 6 of the Memorandum of Appeal ought to be struck out because the same are completely new grounds, not raised before the Tribunal.

16. As regards the 8th ground of appeal, the Respondent submitted that the Commissioner ought not to have raised the issue of expenses on appeal because the said issue had not been canvassed in the proceedings before the Tribunal. Accordingly, the claim was calculated to mislead the Court in relation to the nature of the said transaction.

17. It submitted that under sections 10 and 35 of the Income Tax Act (ITA), WHT is deducted from the income which accrues in or is derived from Kenya, not expenses. It faulted the Commissioner’s reasoning in so far as on one hand, it argued that the DTA was not relevant to the matter, and on the other hand, for relying on the DTA in grounds 12 and 13 of the Memorandum of Appeal; and in its submissions before the Tribunal.

Analysis and Determination 18. In determining this appeal, I am cognizant of the fact that this court is exercising appellate jurisdiction that is circumscribed by Section 56(2) of the TPA which provides that “An appeal to the High Court or to the Court of Appeal shall be on a question of law only”. This means that an appeal limited to matters of law does not permit the appellate court to substitute the Tribunal’s decision with its own conclusions based on its own analysis and appreciation of the facts (See John Munuve Mati v Returning Officer Mwingi North Constituency & 2 others [2018] eKLR and Commissioner of Domestic Taxes v Ibangua Investments Co. Ltd (Tax Appeal E093 of 2023) [2023] KEHC 26013 (KLR) (Commercial and Tax) (30 November 2023) (Judgment)).

19. Bearing the above in mind, I have considered the record of appeal, the statement of facts, the parties’ respective submissions, and the relevant authorities.

20. I have also considered the grounds raised in the record of appeal, and I note from the outset that the same does indeed contain some grounds that were never raised or pleaded at the Tribunal. I am of the view that the same may not be raised for the first time before a higher court, on appeal. Accordingly, I have not dealt with those grounds. For the avoidance of doubt, the issues raised, and pleaded by the Respondent, at the Tribunal, are captured clearly at paragraph 33 of the judgment of the Tribunal.

21. Based on the record before me, I am of the view that the only issue for determination before me is whether or not management or professional fees paid by the Respondent to (TOM) during the period under consideration was subject to WHT?

22. The Commissioner based its assessments for withholding tax on the management and professional fees paid by the Respondent to TOM on section 35(1) (a) of the Income Tax Act as read with Article 21(4) of the DTA. Section 35(1) (a) of the Income Tax Act provides as follows:-“35. (1)A person shall, upon payment of an amount to a non-resident person not having a permanent establishment in Kenya in respect of-(a)A management or professional fee or training fee....which is chargeable to tax therefrom tax at the appropriate non-resident rate…”

23. The Commissioner submitted that because management and professional fees are not dealt with in other articles of the DTA, Article 21 of the DTA which deals with items of income that are not dealt with in the other Articles is therefore applicable. The Commissioner pointed out that the wording of Article 21 (4), provides it with the authority to tax such income which has not been dealt with in the preceding Articles. The said Article reads as follows:-Articles 21(1) and (4) of the DTA:-1. Items of income of a resident of a Contracting State, wherever arising, not dealt with in the foregoing Articles of this Convention shall be taxable only in that State.2. …3. …4. Notwithstanding the provisions of paragraphs 1 and 2, items of income of a resident of a Contracting State not dealt with in the foregoing Articles of this Convention and arising in the other Contracting State may also be taxed in that other State.

24. The Respondent, on the other hand urged this court to accept the Tribunal’s finding that no WHT was chargeable on management and professional fees with effect from 1st January, 2011, when the Kenya-France Double Taxation Agreement came into force.

25. According to the Respondent, after the said effective date, Kenya no longer had taxing rights in relation to the fees payable to TOM based on Article 7 (1) of the DTA. The said argument rests on the interpretation of Article 5 of the DTA, which it submitted, is to the effect that income arising from business activities carried on in another state is taxable in the state of residence of that person; and may only be taxable in the source state if the person has a Permanent Establishment (PE) in the source state.

26. Article 7 (1) of the DTA provides as follows:“The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other Contracting State but only so much of them as is attributable to that permanent establishment."

27. The Commissioner, on the other hand contended that Article 7 (1) of the DTA is not applicable, because it cannot affect the other Articles of the DTA, which permit collection of tax on income which form a part of a business’ profits. It relied of Article 7(7) of the DTA which provides that:-“Where profits include items of income which are dealt with separately in the other Articles of this Convention, then the provisions of those Articles shall not be affected by the provisions of this Article.”

28. It is not disputed that the DTA is modelled along both the OECD MTC and the UN MTC. The MTC’s are accompanied by commentaries which are instructive in relation to the interpretation of the Articles of the MTCs. However, the parties differed in their interpretations of the said commentaries.

29. The thrust of the Respondent’s argument was that effective 29th April, 2000, the OECD MTC was revised and Article 14 which gave taxing rights to the source state in respect of management or professional fees was deleted. The effect of the said deletion was that in the absence of a permanent establishment in the source state, the income derived by a non-resident from such fees is taxed as a business profit of the non-resident in its country of residence.

30. In support of the above argument, the Respondent relied on Paragraph 77 of the Commentary on Article 7 of the OECD MTC which provides that:-“the effect of the deletion of Article 14 is that income derived from professional services is now dealt with under Article 7 as business profits.”

31. On its part, the Commissioner relied on Article 7(7) of the DTA which provides that:-“Where profits include items of income which are dealt with separately in the other Articles of this Convention, then the provisions of those Articles shall not be affected by the provisions of this Article”

32. The definition of “business profits” is not provided under the DTA. In this regard, Article 3 (2) of the DTA states:-“As regards the application of the convention at any time by a contracting state, any term not defined therein shall have the meaning which it has at that time under the law of that state for the purposes of the taxes to which the convention applies. The meaning of a term under the applicable tax laws of that state shall have priority over a meaning given to the term under other laws of that state.”

33. Reference to Section 2 of the ITA reveals that a business is defined as “any trade, profession, or vocation, and every manufacture, adventure and concern in the nature of trade, but does not include employment”.

34. Based on my reading of the definition of a ‘business’ under Article 5 and my understanding of Articles 7 and 21, I am in agreement with the holding of the Tribunal, and I am persuaded that income from management fees and professional fees fall under business profits.

35. The Commissioner’s argument that management and professional fees fall under article 21, does not appear tenable to me. I am guided by the UN and OECD commentaries, and I am in agreement with the Tribunal’s conclusion that the said article was intended for ‘miscellaneous income’ rather than management and professional fees.

36. I say so, because having read the commentary in relation to the said article, and looking at the examples of the type of income contemplated in Article 21, professional and management fees appear incongruous. The examples in the commentary include:- alimony, lottery income, and rent paid by a resident of a contracting state for the use of immovable property situated in a third state. Applying the ejusdem generis rule, I do not think management professional fees could reasonably fall within the same category as the examples provided in the commentary.

37. Additionally, the commentary on Article 7 of the OECD MTC at Paragraph 77 of the Commentary is to my mind, clear and express in terms of the effect of the deletion of Article 14. Based on a plain reading, in the ordinary and natural meaning of the words used, I am persuaded that the effect of the deletion of Article 14 is that income derived from professional services is now dealt with under Article 7 as business profits.

38. I have also considered the Respondent’s contention that Article 21 of the DTA may take precedence over Article 7 (1) which mirrors Article 7(4) of the OECD MTC and Article 7(6) of the UN MTC. I do not think there is any basis to the said argument because no such priority has been expressed in the commentary or in the DTA. Moreover, paragraph 77 of the commentary of Article 7 specifically covers management and professional fees.

39. The above interpretation has been upheld in jurisdictions beyond our own. The Tribunal quoted the below authority at Paragraph 116 of its judgement:-“116…In the Indian case of Bangkok Glass Industry Ltd v Assistant Commissioner of Income Tax [2013] 2015 Taxman 116 (Mad) the court dealt with the issue of taxation of technical services under the India-Thailand DTAA, which also did not have a separate Article for taxation of professional services. The court in that case found that in the absence of PE in India, technical fees earned by a company resident in Thailand were not taxable in India. The Court also held that technical fees could not be classified under Article 22 of the India-Thailand DTAA which covered “other income”.

40. The Tribunal similarly, and in my view, correctly relied on its own decision in McKinsey & Co Inc. Africa Proprietary Limited versus Commissioner of legal services and board coordination (TAT Appeal Number 1999 of 2020), the effect of which was to assign the treatment of professional and management fees as business profits in the resident state in the absence of a PE in the source state.

41. The above authorities provide useful examples of how courts in jurisdictions beyond our own have interpreted the effect of deletion of Article 14 and its effect on Article 7 in similar situations.

42. Based on the record before me, I am in agreement with the Respondent’s contention that in instances where Kenya wishes to have taxing rights over management or professional fees, Kenya has either introduced Articles in relation to the said fees in the relevant DTA by adopting Article 12 A on the UN MTC 2017 or adopting Article 5 (3) (b) of the UN MTC.

43. I find it useful to reproduce the commentaries on Article 12A below:-“1. Article 12A was added to the United Nations Model Convention in 2017 to allow a Contracting State to tax fees for certain technical services paid to a resident of the other Contracting State on a gross basis at a rate to be negotiated by the Contracting States. Under this Article, a Contracting State is entitled to tax fees for technical services if the fees are paid by a resident of that State or by a non-resident with a permanent establishment or fixed base in that State and the fees are borne by the permanent establishment or fixed base; it is not necessary for the technical services to be provided in that State. Fees for technical services are defined to mean payments for services of a managerial, technical or consultancy nature.2. Until the addition of Article 12A, income from services derived by an enterprise of a Contracting State was taxable exclusively by the State in which the enterprise was resident unless the enterprise carried on business through a permanent establishment in the other State (the source State) or provided professional or independent personal services through a fixed base in the source State. With the rapid changes in modern economies, particularly with respect to cross-border services, it is now possible for an enterprise resident in one State to be substantially involved in another State’s economy without a permanent establishment or fixed base in that State and without any substantial physical presence in that State. In particular, with the advancements in means of communication and information technology, an enterprise of one Contracting State can provide substantial services to customers in the other Contracting State and therefore maintain a significant economic presence in that State without having any fixed place of business in that State and without being present in that State for any substantial period. The OECD/G20 Base Erosion and Profit Shifting 319 Article 12A Commentary Project, Action 1: Final Report “Addressing the Tax Challenges of the Digital Economy” [2015] illustrates the difficulties faced by tax policy makers and tax administrations in dealing with the new digital business models made available through the digital economy. The Report did not recommend, for the time being, a withholding tax on digital transactions (which include digital cross border services); nor did it recommend a new nexus for taxation in the form of a significant economic presence test. However, it was recognized that countries were free to include such provisions in their tax treaties, among other additional safeguards against BEPS.”

44. In this regard, the Respondent submitted, and the Appellant did not dispute, that Kenya has adopted Article 12 A in numerous DTA’s, including DTA’s with Seychelles, and China, among others.

45. Article 5(3)(b) of the UN MTC similarly allocates taxing rights to the source states for services performed over a duration of time, even if no permanent establishment is created. The Respondent submitted, and the Appellant did not dispute, that Kenya has adopted the said Article in DTA’s with numerous other countries, including Mauritius.

46. Based on the above, it appears more probable than not, that in the event Kenya wished to allocate itself taxing rights in the present DTA nothing would have been easier than for it to make express provision for the same by including articles similar to Article 12 A or Article 5(3)(b), as it has done in the past, with several other countries.

47. Having failed to do so, and in the absence of a permanent establishment of TOM in Kenya, I find that Kenya does not have taxing rights on WHT in relation to management or professional fees. This conclusion supports the overriding principle of the DTA which is to ensure that income of the person is taxable in the state of residence of that person (resident state) and should only be taxable in the other contracting state, (source state) if the person has a permanent establishment in the source state.

48. The court is of the view that the DTA ought to be read and interpreted in a manner that supports its objectives and purpose, which includes encouraging cross-border trade, rather than stifling the same; and resolve disputes concerning interpretation of the DTA in a manner that promotes dealing with common tax concerns in the field of international juridical double taxation in a similar manner.

49. Based on the reasons above, I uphold the decision of the Tribunal and find that the appeal is without merit. The same is dismissed with costs.

DATED AND DELIVERED VIRTUALLY VIA MICROSOFT TEAMS THIS 4TH DAY OF JULY 2024. ALEEM VISRAM, FCIArbJUDGEIn the presence of;...................................For the Appellant...................................For the Respondent