[2024] KETAT 571 (KLR)

Gold Crown Foods (EPZ) Limited v Commissioner Of Domestic Taxes (Tax Appeal 1174(NRB) of 2022) [2024] KETAT 571 (KLR) (22 March 2024) (Judgment)

Neutral citation: [2024] KETAT 571 (KLR)

Republic of Kenya

In the Tax Appeal Tribunal

Tax Appeal 1174(NRB) of 2022

E.N Wafula, Chair, D.K Ngala, CA Muga, GA Kashindi, AM Diriye & SS Ololchike, Members

March 22, 2024

Between

Gold Crown Foods (EPZ) Limited

Appellant

and

Commissioner Of Domestic Taxes

Respondent

Judgment

Background 1. The Appellant is a limited liability company incorporated in Kenya pursuant to the provisions of the Companies Act, Cap 486 of the laws of Kenya and whose principal activity is the blending and packaging of tea.

2. The Respondent is a principal officer appointed under Section 13 of the Kenya Revenue Authority Act, Cap 469 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 revenue. Under Section 5(2) of the Act 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 Parts I and II 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 tax audits on the Appellant’s operations, particularly on the transfer pricing issues, based on the commercial transactions between the Appellant and its non-resident related parties.

4. On 28th April 2022, the Respondent published iTax assessment orders for the period 2015 to 2018 where the total assessed amount was Kshs. 297,763,595. 97. 00.

5. On 28th April 2022, a manual notice of assessment was also issued by the Respondent for the period 2015 to 2018 in which the summary of the tax due was computed at Kshs. 310,178,342. 00.

6. On 27th May 2022, the Appellant filed a notice of objection to the notice of assessment.

7On 29th August 2022, the Respondent issued an objection decision to the objection application.

8. Aggrieved by Respondent’s objection decision, the Appellant filed its Notice of Appeal dated 27th September 2022.

The Appeal 9. The Appeal is premised on the following grounds contained in the Appellant’s memorandum of appeal dated 7th October 2022 and filed on the 12th October, 2022:-a.The Respondent’s notice of objection invalidation decision was issued out of time.b.Without prejudice to the above, the Respondent erroneously and unlawfully adjusted the Appellant’s income.c.The Respondent had no grounds to apply the Transaction Net Margin Method (TNMM) since the Respondent did not provide any evidence to support the fact as to how the deficiencies in the Cost-Plus Method were not rectified or rectifiable.d.The Respondent erroneously applied Transfer Pricing Rules to transactions with third parties contrary to the Transfer Pricing Rules.e.The Respondent erred in rejecting the Cost-Plus method and applying the Transactional Net Margin Method.e.The Respondent has erroneously disallowed the costs of leasing equipment for income tax purposes instead of applying a lower value based on a customs entry value as the arm’s length price.e.The Respondent has erroneously applied withholding tax on lease payments made by the Appellant after the end of the ten-year EPZ tax exemption period.e.The Respondent has erroneously disallowed and adjusted the bill discounting costs of the Appellant.e.The Respondent erroneously assessed the Appellant for the financial year 2015 despite the Appellant having a tax exemption.

The Appellant’s Case 10. The Appellant’s case is as set out in its Statement of Facts dated 7th October 2022 filed on 12th October 2022.

11. The Appellant relied on the following documents in support of its Appeal:-i.Respondent’s objection decision dated 29th August 2022;ii.iTax assessment;iii.Notice of assessment dated 27th April 2022;iv.Notice of objection dated 29th August 2022;v.The Appellant’s Transfer Pricing Policy;vi.Appellant’s advocates letter dated 9th September 2022 informing the Respondent the objection decision was issued out of time;vii.reconciliation of the cost base;viii.Appellant’s margin report for 2015 to 2018;ix.Expanded cost base analysis, stock keeping unit;x.The Aldi case study, the detailed mapping of the financial statements;xi.The invoice for Camelia equipment;xi.The valuation report;xi.Third party invoices and bank facility agreements.

12. The Appellant stated that on 28th April 2022, the Respondent published iTax assessment orders for the period 2015 to 2018 where the total assessed amount was Kshs. 297,763,595. 97. 00.

13. That further, on 28th April 2022, following audit adjustments by the Respondent to the Appellant’s adjusted profit/loss, the Respondent issued a manual notice of assessment for the period 2015 to 2018 in which the summary of the tax due was computed at Kshs. 310,178,342. 00.

14. The assessments sought to make a transfer pricing adjustment on the Appellant’s earnings before interest and tax (EBIT).

15. It was the assertion of the Appellant that the controlled transactions between the Appellant and its related parties have always been undertaken in strict compliance with the Income Tax Act and the Income Tax (Transfer Pricing) Rules, 2006.

16. That the controlled transactions of the Appellant are:a.Sale of packaged tea to Typhoo Tea Ltd, Global Foods Limited, Global Crown Specialty Foods and Barsha Tea Packing and Distribution Ltd.b.Purchase of packaging materials from Global Tea and Commodities Limited UK (GTCUK).c.Leasing of equipment from GTCUK.

17. The Appellant asserted that it had at all times applied the Cost-Plus method for both sale of packaged tea and purchase of packaging material transaction. Further, that the Appellant had at all times applied a comparable uncontrolled price with respect to the lease of machinery transactions. That both are prescribed methods in the Transfer Pricing Rules.

18. That on 27th May 2022, the Appellant filed a notice of objection to the notice of assessment which the Respondent acknowledged receipt on the same date and an objection decision was issued on 29th August 2022.

19. The Appellant contended that the said objection decision was issued out of time. This is subject to the letter issued to the Respondent by the Appellant’s Advocates on record dated 9th September 2022 informing the Respondent that the objection decision dated 29th August 2022 to the notice of objection dated 27th May 2022 was issued out of time contrary to Section 51(11) of the Tax Procedures Act. No. 29 of 2015 (hereinafter ‘TPA’).

20. The Appellant further elaborated its grounds of appeal in detail as hereunder:

a. The Respondent’s notice of objection decision was issued out of time. 21. The Appellant averred that it lodged its notice of objection which was acknowledged and formally accepted as validly lodged objection via a letter dated 27th May 2022. Under Section 51(11) of the TPA, the Respondent should have issued an objection decision on or before 25th July 2022 being 60 days from the date on which the Appellant provided the supporting information. The objection decision of 29th August 2022 was thirty-four (34) days from the 60-day period.

22. That Section 51(11) of the TPA is couched in mandatory terms, as held in Morgan Air and Seafreight Logistics Kenya Limited [TAT Appeal No. 286 of 2020] where the Tribunal held that Section 51(11) of the TPA obligates the Respondent in mandatory terms no less, to render an objection decision within 60 days of receipt of the objection notice. In the event of the contrary, the objection is deemed as allowed.

23. That the Respondent did not respond to the Appellant’s Advocate letter dated 9th September 2022 that was with respect to the applicability of Section 51(11 of the TPA.

b. The Respondent erroneously and unlawfully adjusted the Appellant’s income. 24. In the alternative and without prejudice to the foregoing, the Appellant averred that the Respondent erroneously adjusted the earnings before interest and tax (EBIT) for the years 2015 to 2018.

25. That according to Section 18(3) of the Income Tax Act, CAP 470 of Kenya’s Laws (hereinafter ‘ITA’) the income of the Appellant that deals with non-resident related persons can only be assessed where that business relationship has resulted in either no profits or less than the ordinary profits which might be expected to accrue from that business if there had been no such relationship.

26. The Appellant stated that in the present case, however, there was neither a loss nor less than the ordinary profits that were accrued from the business, hence no justification for the adjustment. The Appellant’s financial statements show that it made profits from computed EBIT in the years 2015, 2016 and 2017 and the EBIT loss reported for 2018 was justifiable based on business and commercial factors.

27. That the Respondent’s computation of the Appellant’s EBIT ration is erroneous because of the wrong classification of financing costs as operating costs. Classifying foreign exchange gains, losses and bill discounting costs as operating costs instead of finance costs contravenes the International Accounting Standards or the General Accepted Accounting Principles, this is intended to depress the Appellant’s Profit Level Indicator (PLI).

28. That bill discounting costs are financing costs, and they are treated as non-operating expenses as per the International Financial Reporting Standards.Below is the erroneous characterization of bill discounting costs as operating costs:PLI COMPUTATION BASED ON AUDITED FINANCIALS

2015 2016 2017 2018

Revenue 3,356,859,040 3,241,178,729 3,292,805,282 2,796,943,419

Cost of sales (2,813,912,173) (2,878,730,041) 2,996,393,106) (2,615,957,722)

Other operating income 0 2,047,251 545,536 0

Administrative expenses (140,708,205) (134,061,645) (149,071,285) (157,913,520)

Finance costs (169,270,229) (150,570,983) (80,446,433) (96,085,751)

Other operating expenses (43,788,143) (48,480,881) (43,575,328) (37,600,004)

Operating profit (EBIT) 358,450,519 181,953,413 104,311,099 (14,527,827)

Operating margin (EBIT) ratio 10. 68% 5. 61% 3. 17% -0. 52%

Finance costs (169,270,229) (150,570,983) (80,446,433) (96,085,751) PLI COMPUTATION BASED ON THE RESPONDENT’S ADJUSTMENTS

2015 2016 2017 2018

Revenue 3,356,859,040 3,241,178,729 3,292,805,282 2,796,943,419

Cost of sales (2,813,912,173) (2,878,730,041) (2,996,393,106) (2,615,957,722)

Other operating incomeTC{colspan 2|style border-right: 1pt solid #000; width: 18%}0 2,047,251 545,536 0

Administrative expenses (140,708,205) (134,061,645) (149,071,285) (157,913,520)

Other operating expenses (43,788,143) (48,480,881) (43,575,328) (37,600,004)

Foreign exchange losses (66,833,155) (57,019,892) (8,358,059) (3,386,794)

Bill discounting costs (74,120,924) (61,762,322) (53,031,959) (57,945,935)

Operating profit (EBIT) 217,496,440 63,171,199 59,637,199 (75,860,6556)

Operating margin (EBIT)ratio 6. 48% 1. 95% 1. 81% -2. 71%

29. The Appellant asserted that the recharacterization of foreign exchange gains, losses and bill discounting costs as operating costs by the Respondent has the effect of depressing the Appellant’s EBIT ratio as illustrated below:Item 2015 2016 2016 2017

EBIT ratio as per the FS 10. 68% 5. 61% 3. 17% -0. 52%

EBIT ratio as per the Respondent’s adjustments 6. 48% 1. 95% 1. 81% -2. 71%

Reduction of the Appellant’s profitability 4. 20% 3. 66% 1. 36% -2. 19%

30. That the Respondent failed to compute a statistical range of results to compare to Appellant’s results and instead adjusted the Appellant’s results against a weighted average of the comparable EBIT ratios. The Appellant averred that the EBIT Ratio results are still greater than the Respondent’s benchmark with the financial year 2018 as a result of its largest customer, Typhoo, abruptly cancelling its orders during the year, and terminating its relationship with the Appellant.

31. The Appellant asserted that its profitability was more than sufficient as tested under the Transactional Net Margin Method, meaning that the results of trading with related parties were arm’s length.

32. The Appellant further averred that the application of the weighted average as the arm’s length price (ALP) or the benchmark PLI by the Respondent is without basis in law. The Appellant asserted that the issue of the ALP is very contentious around the world for as long time. The Respondent has had the opportunity to provide directions on this matter since 2006. However, the draft Eighth Schedule of the Income Tax Bill of 2018, sought to address this lacuna.

33. That the Bill proposed under paragraph 9 of the said Schedule that, where the application of the most appropriate method results in a number of financial indicators from comparable uncontrolled transactions, the interquartile range shall be considered to be the arm’s length range and the median shall be used as the reference point.

34. The Appellant asserted that the Respondent has not only failed to provide guidance as to how to compute the ALP when using a range of data but has also failed to define what a non-compliance ALP is and prescribe how adjustments are to be made when a taxpayer’s results do not meet the ALP.

35. The Appellant asserted that the globally accepted Organization for Economic Co-operation and Development (OECD) position is that if the relevant conditions of the controlled transactions such as price or margin are within the arm’s length range, no adjustment should be made.

36. That therefore, where the Respondent has not prescribed the mode of adjustments and the taxpayer’s results are within the interquartile range of results, then no adjustment is necessary to get the taxpayer’s results into an arm’s length price.

37. The Appellant averred that, statistically, an interquartile range of observations cannot be computed with less than 4 data points (observations). The Respondent’s benchmarking study had only 3 data points for each year and cannot therefore be relied upon to compute a statistical interquartile range. Further, the Appellant averred that the three comparables selected by the Respondent for benchmarking were highly incomparable and unsuitable for comparison to the Appellant’s business.

38. Thus, there is no legal basis for the adjustments to the median, and therefore the Respondent’s actions in adjusting the Appellant’s transactions with reference to the median are unfair, unnecessary, unprocedural and capricious.

c. The Respondent had no grounds to apply the Transaction Net Margin Method (TNMM) since the Respondent did not provide any evidence to support the fact as to how the “deficiencies” in the Cost-Plus Method were not rectified or rectifiable. 39. The Appellant argued that the Respondent erred in fact and in law by rejecting the Cost-Plus method without demonstrating how the TNMM (applied as an alternative method) is the most appropriate method per the requirements of Rule 8(2) of the Transfer Pricing Rules and that like the OECD Guidelines, the Transfer Pricing Rules do not prescribe a preferred method or give a hierarchy of methods. The OECD Guidelines 2. 2 help in arriving at the appropriate method.

40. That a method becomes inappropriate or less appropriate when it suffers from an incurable deficiency for instance, where the requisite information required to apply a method cannot be procured (reliably).

41. That the Respondent did not demonstrate the incurable deficiency as far as the Appellant’s application of the Cost Plus method but only claims that the application of the Cost Plus method occasioned imperfections. The Respondent did not demonstrate how these imperfections could not be cured under the Cost Plus method preferring instead to force TNMM onto the Appellant in order to raise an assessment.

d. The Respondent erroneously applied Transfer Pricing Rules to transactions with third parties contrary to the Transfer Pricing Rules. 42. The Appellant stated that the Respondent erroneously applied the TNMM method to transactions with third parties contrary to rule 3 of the Transfer Pricing Rules. The Appellant stated that the Rules serve the purpose of providing guidelines to be applied by related enterprises in determining the arm’s length prices of goods and services in transactions involving them. The Rules shall apply to transactions between associated enterprises within a multinational entity group, where one enterprise is a non-resident of Kenya and the other a resident.

43. That the Rules define related enterprises as one or more enterprises whereby:“(a)one of the enterprises participates directly or indirectly in the management, control or capital of the other; orb.a third person participates directly or indirectly in the management, control or capital of both.”

44. That the OECD Guidelines paragraph 11 also provides that two or more enterprises are associated if one of the enterprises participates directly or indirectly in the management, control, or capital of the other. The Respondent, however, applied the Transfer Pricing Rules to the Appellant’s income which included both related and third parties’ revenues. The Appellant sells a significant portion of its products to independent (unrelated) customers with the revenue proportions ranging between 25% and 43% from third parties between 2014 - 2018.

45. The Appellant relied on paragraph 2. 78 of the OECD Guidelines which provides inter alia that costs and revenues that are not related to the controlled transaction under review should be excluded where they materially affect comparability with uncontrolled transactions and that an appropriate segmentation of the taxpayer’s financial data is needed when determining the net profits it earns from a controlled transaction.

46. The Appellant also referred to the case of Steer Engineering Pvt Ltd v Commissioner to support the need for segmenting the Appellant’s financial results so that controlled transactions and uncontrolled transactions are separated where an associated enterprise sells to third parties.

47. The Appellant also buttressed its argument with the case of Dic India Limited, Kolkata v Commissioner which stated that it is imperative to use segmented information to improve reliability. The same was argued in M/s Syniverse Mobile Solutions Pvt Ltd., Hyderabad [ts-51-ITAT-2015]. The Appellant also relied on Brigade Global Service Pvt Ltd v ITO, Hyderabad [143 ITD 59].

e. The Respondent erred in rejecting the Cost-Plus method and applying the Transactional Net Margin Method 48. The Appellant asserted that it followed the nine-step approach provided under paragraph 3. 4 of the OECD Transfer Pricing Guidelines in preparing its Transfer Pricing Policy and arriving at the arm’s length earned by the Appellant from its transactions with related parties.

49. The Appellant relied on the High Court judgment in Income Tax Appeal No. 753 of 2003 Unilever Kenya Limited v The Commissioner of Tax [2005] eKLR where it was held that in the absence of specific guidelines from the Respondent under section 18(3) of the ITA, determination of the arm’s length principle ought to be made in accordance with international best practice as represented by the OECD Guidelines.

50. The Appellant asserted that the Respondent failed to demonstrate that the Appellant entered into transactions with its non-resident related parties that it would not have entered into with independent customers.

51. That the Respondent also did not demonstrate that the pricing of those controlled transactions between the Appellant and its non-resident related parties was in any way different from the pricing of uncontrolled transactions between the Appellant and its independent parties. The Respondent also did not demonstrate that as a direct result of such pricing, the Appellant suffered either no profits or less than the ordinary profits.

52. In rejecting the claim by the Respondent in the objection decision that the Appellant’s cost bases in the benchmarking report are different from the cost of goods sold indicated in the financial statements, the Appellant stated as follows:a.The difference between the costs used in computing the margins in the benchmark report and the costs used in the financial statements arises due to the distinction made as far as attribution of costs to the customers.b.The costs in the benchmark report are production costs that can be directly attributed to a particular customer and they are direct cost of sales such as cost of tea and packaging material and selling and distribution costs such as freight costs.c.All other production costs that be directly attributed to a particular customer or order are included in secondary processing such as wages and salaries inter alia and indirect costs such as tea inspection costs inter alia.d.The Respondent erred in stating that the commercial rationale provided for the treatment of the costs has no basis in law since paragraph 1. 10 of the OECD Guidelines term production costs as pertinent factors that should be considered in comparably analysis.e.Rule 7(c) as well of the Transfer Pricing Rules state that the focus of the Cost Plus method are the costs incurred by the supplier of a product in a controlled transaction.

53. In rejecting the claim by the Respondent in the objection decision that the Appellant’s cost base for the cost-plus method should comprise the cost of goods sold indicated in the financial statements, the Appellant asserted as follows:a.The Respondent has erroneously concluded that the appropriate cost base for the application of the cost-plus method should be equal to the cost of goods in the financial statement. This assertion is erroneous since not all categories of costs comprise costs that are directly attributed to the pricing of the orders for individual customers.b.The Appellant relied on Rule 7(c) of the Transfer Pricing Rules which reads:“The cost-plus method, in which costs are assessed using the costs incurred by the supplier of a product in a controlled transaction, with a mark-up added to make an appropriate profit in light of the functions performed, and the assets used and risks assumed by the supplier”c.The Appellant also relied on paragraph 2. 45 of the OECD Guidelines which provides that the Cost Plus method begins with the costs incurred by the supplier in a controlled transaction for property transferred or services provided to an associated purchaser.d.The Appellant therefore finds no basis that the costs marked up should be equal to the cost of goods sold in Kenyan tax law as well as in international practice.

54. In rejecting the claim by the Respondent in the objection decision that the Appellant’s margins in the benchmark report and the gross profit margins indicated in the financial statements are different, the Appellant asserted as follows:i.The Respondent compared the gross margins in the benchmark report to the gross profit margin in the financial statements. Such an analysis is of no value unless the Respondent has already determined the appropriate cost base.ii.The Respondent’s analysis has no basis for transfer pricing purposes as this computation takes into account both controlled and uncontrolled transactions, it disregards comparability analysis, and it makes an assumption that the Cost Plus method can only be applied with reference to all costs in the cost of goods sold in direct contrast with the Transfer Pricing Rules.

55. In rejecting the claim by the Respondent in the objection decision that the prices of tea are not consistent from one customer to another, the Appellant asserted as follows:i.The Respondent failed to understand the economically relevant factors and how these have a bearing on the Appellant’s business.ii.The Appellant is actually a private label tea packer and not a tea trader, for this main reason;iii.The Appellant does not own the blend recipes that it packs as it packs for third party brands who own the blend recipes.iv.The Appellant earns revenue from rendering a tea packing solution and not from merely selling tea.v.The prices at which the Appellant sells packaged teas differ primarily due to packaging configurations.vi.The Respondent assumed a linear relationship between the costs for inputs for all products as though there was a common cost per kg for all products.

56. In rejecting the claim by the Respondent in the objection decision that the cost of freight should be included in the cost base, the Appellant asserted that the Respondent erroneously alleged that the cost of freight was not included in the Appellant’s cost base, yet they were included in the Appellant’s benchmarking analysis.

57. In rejecting the claim by the Respondent in the objection decision that there are certain costs that were not included in the benchmarking report such as the cost of tea and packaging material, the Appellant asserted as follows:i.Despite the treatment of the packaging costs, the cost base for purposes of the benchmark report was consistent for both related and unrelated customers for all the years under audit.ii.The Respondent has erred in law and fact in rejecting the Cost-Plus method and applying the TNMM as the appropriate method.

e. The Respondent has erroneously disallowed the costs of leasing equipment for income tax purposes instead of applying a lower value based on a customs entry value as the arm’s length price. 58. The Appellant asserted that the Respondent having selected the TNMM as the most appropriate method, the arm’s length cost of leasing of equipment and any other controlled transaction, except for financing, is already included in the operating profit computation (EBIT).

59. That the Respondent erred in adopting the import declaration value for arm’s length price for purposes of Corporation tax, since the Appellant’s profitability exceeds the benchmark profitability computed by the Respondent.

60. That the Respondent sought to apply the customs valuation for transfer pricing purposes, the Appellant thus pointed out that the subject of reconciling customs and transfer pricing has agitated the world for a while as the two bases of valuation work in different directions,

61. That Corporate tax would prefer a lower value since import is a cost that reduces the taxable income. Reference is given to paragraph 5. 4.7. 6 of the United Nations Manual on Transfer Pricing (2013).

62. The Appellant stated that although it is conceded that there should be some correlation between customs and transfer pricing valuations since both affirm the arm’s length principle, there has been no consensus on the use of customs values for transfer pricing and vice versa. The Appellant asserted that there were no import duties to pay and therefore, the value declared at the point of importing the equipment is a moot point, as it had no tax implication for the Appellant.

63. The Appellant found no basis in law for the use of a customs value for purposes of Corporation tax.

f. The Respondent has erroneously applied withholding tax on lease payments made by the Appellant after the end of the ten-year Export Processing Zone (EPZ) tax exemption period. 64. That the Respondent alleged that withholding tax should have been applied on the lease rental payments made by the Appellant to GTCUK and consequently computed the withholding tax amount to Kshs. 17,657,656. 00 relating to 2017 and 2018 years of income.

65. That this assessment by the Respondent was premised on Section 35(1)(b) of ITA which states:“Every person shall, upon payment of any amount to any non-resident person not having a permanent establishment in Kenya in respect of—b.a royalty or natural resource income;”

66. That the Respondent categorized the lease rental payment in relation to lease of equipment by the Appellant from GTCUK as a royalty payment. The Appellant asserted that it entered into an Equipment Hire Agreement in 2014 with GTCUK in relation to lease of equipment and machinery where the Appellant was required to make rental payments to the lessor (GTCUK). GTCUK retained rights in the equipment.

67. The Appellant averred that the mere leasing of equipment, therefore, did not create a royalty.

68. The Appellant relied on Section 4B of the ITA providing that where a business is carried on by an export processing zone enterprise, the provisions of the Eleventh Schedule shall apply. The Appellant asserted that one could only be taxed against clear provisions of the taxing law and entities under export processing zones can only be subjected to tax under provisions of the Eleventh Schedule.

69. Therefore, seeking to subject payments by export processing zones to a non-residential person under Section 35 of the ITA is erroneous and without any basis. The Appellant asserted that tax statutes should be strictly interpreted and there is no room for presumption.

70. The Appellant asserted that it is a registered EPZ and the specific applicable Section of the Income Tax Act that should apply to its operations is the Eleventh Schedule, which does not make any reference to Section 35 of ITA.

g. The Respondent has erroneously disallowed and adjusted the bill discounting costs of the Appellant. 71. The Appellant stated that the Respondent has without evidential basis claimed that related parties get goods on credit, but third-party customers are required to pay on sight. The Respondent has failed to make a distinction between bill discounting and factoring of receivables. The Appellant did not have a factoring arrangement in place but rather a discounting facility with an independent bank.

72. The Respondent has erred in fact by stating that only related party invoices are discounted, and erred in law by categorizing the bill discounting arrangement as a controlled transaction that should have been benchmarked. The Appellant asserted that the cost of discounting related parties’ invoices did not contravene section 18(3) of the ITA by producing either no profits or less than the ordinary expected (arm’s length) profits.

73. The Appellant further asserted that adjusting the controlled transactions for the bill discounting costs, the margins on the controlled transactions are still higher to those on the uncontrolled transactions.

h. The Respondent erroneously assessed the Appellant for the financial year 2015 despite the Appellant having a tax exemption. 74. The Respondent erroneously assessed the Appellant for the financial year 2015 despite the Appellant being tax exempt being in an EPZ.

75. The Appellant asserted that despite the Respondent’s acknowledgement that the Appellant, as an EPZ, enjoyed a tax exemption between October 2005 and October 2015, and without prejudice to the foregoing grounds, the Respondent failed to apportion the taxable income for the 2015 tax year for the sale of tea to related parties and for bill discounting.

76. It was the Appellant’s contention that the Respondent has erred in assessing the Appellant for the financial year 2015.

Appellant’s Prayers 77. In line with the above grounds the Appellant made the following prayers:a.That the objection decision of the Respondent contained in the letter dated 29th August 2022 demanding payment for corporate tax amounting to Kshs. 273,593,693. 00 be set aside.b.The appeal be allowed with costs to the Appellant.c.Any other orders that the Tribunal may deem fit.

Respondent’s Case 78. The Respondent relied on the following documents in support of its Statement of Facts dated 10th November 2022 and filed on 11th November 2022:i.A copy of the electronic mail correspondence dated 28th July 2022 providing the last set of documents to validate the objection.ii.Respondent’s objection decision.

79. In response to the grounds of appeal as contained in the Memorandum of Appeal and the Appellant’s Statement of Facts, the Respondent averred as follows:

80. The Respondent stated that the Appellant is a subsidiary of Global Tea and Commodities Ltd UK (GTC UK). In Kenya, the Appellant is related to Global Tea and Commodities Kenya (GTCK) and Gold Crown Beverages Kenya (GCB).

81. That the Appellant exports its products to both related and third-party customers. The Appellant entered into controlled transactions involving the sale of tea, purchase of tea, purchase of packaging materials and leasing of assets. This instant case arose from a tax audit by the Respondent arising out of the Appellant’s commercial transactions between the Appellant and its related non-resident parties.

82. The Respondent established that the Appellant blends, packs and sells tea to its related parties as well as third parties. The controlled transaction involving sales to the related parties is benchmarked using the Cost Plus method. The Appellant provided data on sales revenue, quantities, costs of tea sold and other selling expenses for the teas sold over the period 2014 to 2018 as summarised in the Respondent’s notice of assessment dated 28th April 2022.

83. The Respondent asserted that upon review of the data provided by the Appellant, significant variances were established while compared to the financial statements. The benchmark report and the audited financial statements vary significantly.The benchmark report had a number of inconsistencies, there were also discrepancies from the invoices which indicated that the average cost price of tea per kilogram was USD 1. 7 which results in negative margins which is contrary to the Appellant’s computations.

84. That these discrepancies presented a dilemma for a consistent and reliable application of the Cost Plus method as applied by the Appellant. Thus, the Respondent concluded that for the Cost-Plus method to be considered, there was need to take into account all functions, assets and risks assumed in the transaction.

85. The Appellant sold tea on a cost and freight basis, the title of the goods thus passed to the customer at the port of destination, therefore the cost of freight ought to have been factored in the cost base for evaluation of the Cost Plus method. The Respondent therefore averred that the Cost-Plus method was unreliable and therefore applied the TNMM on the Applicant’s transactions, for reason that the Respondent evaluated the net profit relative to an appropriate base.

86. Further, TNMM can be applied to determine the arm’s length price of the transaction using operating profit on operating cost as a profit level indicator. The advantage of this method is that the net profit indicator is more tolerant to transactional and functional differences. Based on the above, the Respondent established that the transactions between the Appellant and its non-resident related parties did not meet the arm’s length range for the years 2016 to 2018.

87. That adjustments were thus made to the Appellant’s income for the said period. Subject to the 2014 Equipment Hire Agreement between GTCUK (lessor) and GCF (lessee), the Appellant had leased tea bagging machines from its parent company and for a period of four years, the Appellant had paid a total of Kshs. 247,210,500. 00 to the parent company as lease rentals for equipment that costs Kshs. 61,487,42. 00.

88. The Respondent therefore questioned whether independent parties operating at arm’s length would enter into such an agreement with the goal of achieving economic value from their respective ends. The audit also established that the Appellant did not charge withholding tax upon payment of the lease rentals. Thus, withholding tax amounting to Kshs. 16,104,919. 00 on the lease payments made to GTCUK was due.

89. That the bill discounting by the Appellant on related party invoices were economically significant activities which the Appellant did not declare. In addition, in relation to bill factoring arrangements, the Appellant neither benchmarked the transactions nor provided further information to demonstrate whether the transactions were concluded at arm’s length.

90. The Respondent therefore adjusted the income of the Appellant upwards to absorb the impact of the expensed interest at cost resulting to a corresponding aggregate amount of Kshs. 246,861,140. 00 for the period 2015 to 2018. The Appellant subsequently was issued with an assessment notice demanding tax totaling to Kshs. 246,861,140. 00 for the period 2015 to 2018 to be paid, which the Appellant objected to.

91. The Respondent considered the Appellant’s notice of objection and rendered an objection decision on the same partially accepting the application as follows:-i.The assessment was revised to correct the workings on use of EBIT.ii.All other grounds of objection were rejected in full.

92. The Respondent thus computed revised/adjusted assessments arriving at an amount of Kshs. 273,593,693. 00 as tax payable inclusive of interest and penalty.

93. The Respondent further stated as follows in its response to each ground of appeal:

a. Whether the Respondent’s objection decision was issued out of time. 94. The Respondent averred that the objection decision was issued within the statutory timelines and relied on Section 51(3) of the TPA where subsection (c) provides that a notice of objection is treated as validly lodged if all the relevant documents relating to the objection have been submitted.

95. The Respondent averred that it complied with Section 51(11) of the TPA which mandates the Commissioner to make an objection decision within 60 days from the date of receipt of a valid notice of objection.

96. In the instant case, the Respondent averred that the Appellant provided their last set of documents on 28th July 2022 hence 29th July 2022 became the first day when there was a valid notice of objection.

97. The Respondent averred that for this reason, the objection decision of 29th August 2022 was within time.

b. Whether the Respondent erroneously and unlawfully adjusted the Appellant’s income. 98. An analysis carried out by the Respondent noted deficiencies in the cost base used under the transfer pricing method adopted by the Appellant. Due to these deficiencies, the transfer pricing method adopted did not result in arm’s length pricing making the Respondent justified to adjust the income for the period under review.

99. The Appellant had asserted that the Respondent relied on earnings before tax instead of earnings before interest and tax hence making an error. The Respondent, however, averred that it did a review of the earnings and adjusted the assessment from Kshs. 310,178,344. 00 to Kshs.273,593,693. 00 based on earnings before interest and tax and the same was attached to the objection decision.

100. It is the Respondent’s position that it did not at any point act contrary to the provisions of Section 18(3) of the ITA.

c. Whether the Respondent erroneously applied Transfer Pricing Rules to transactions with third parties contrary to the Transfer Pricing Rules. 101. Contrary to the Appellant’s assertion that the Respondent erroneously applied Transfer Pricing Rules to third party transactions, the Respondent averred that the essence of applying the Rules is to attain arm’s length price for controlled transactions with related entities.

102. The Respondent noted that transactions with third parties are at arm’s length and therefore, adjusting the prices using TNMM had a negligible effect.

d. Whether the Respondent erred in rejecting the Cost Plus Method and applying the TNMM method instead. 103. The Respondent asserted that the reliable application of any method hinges on the accurate evaluation of the relative contribution of the parties to the controlled transaction by analyzing the functions performed, assets used, and risks assumed (FAR). This crucial test was thus conducted by the Respondent.

104. The Respondent stated that from the OECD Transfer Pricing Guidelines, 2017, various methods can be used to benchmark a controlled transaction subject to the FAR analysis and in the instant case, the Appellant thus formulated a transfer pricing policy based on the Guidelines and section 18(3) of the ITA.

105. That the policy was meant to ensure that the prices at which the Appellant sells to its associated enterprises are at arm’s length. The Appellant is also provided the leeway by Rule 4 of the Income Tax (Transfer Pricing) Rules, 2006 to choose a method to employ in determining the arm’s length price.

106. The Respondent averred that the Appellant thus chose the Cost Plus method, where costs are assessed using the cost incurred by the supplier of products in a controlled transaction, with a mark-up being added to make an appropriate profit in light of the FAR. This method as per the OECD Guidelines is most useful where semi-finished goods are sold between associated parties.

107. That the Respondent does not dispute that this is the most appropriate method for the Appellant but the cost base used in the method is contentious as it had several inconsistencies. The inconsistencies included, the cost base used in the benchmark report differed with the one used in the audited accounts, also based on FAR, the cost base should include direct costs, indirect costs and operating expenses that form the cost base, a detailed breakdown of each cost should have been availed and how the shared costs were allocated to each customer.

108. That based on the FAR, the Respondent therefore applied the TNMM method and found it to be the most appropriate since it is an average method that takes care of the imperfections from application of the Cost-Plus method.

e. Whether the Respondent erroneously disallowed the costs of leasing equipment for income tax purposes instead of applying a lower value based on a customs entry value as the arm’s length principle 109. The Respondent asserted that the lease rental payments ought to be treated as a financial transaction between the related parties. These were not captured by the Respondent in the TNMM adjustments, and they were assessed separately.

f. Whether the Respondent applied withholding tax in error on lease payments made by the Appellant after the end of the ten-year EPZ exemption period 110. The Respondent confirmed that it is without doubt that Section 4B of the ITA as relied on by the Appellant provides that EPZs are taxed according to the Eleventh Schedule and the exemption period is valid for ten years where in this case it lapsed in October 2015.

111. The Respondent relied on paragraph 3 of the Eleventh Schedule which exempts the EPZ entity from Corporation tax.

112. It is thus obvious that withholding tax was chargeable on any payments made to a non-resident outside the exemption period and the Respondent correctly issued withholding tax assessments in the years 2017 and 2018.

g. Whether the Respondent erroneously disallowed and adjusted the bill discounting costs of the Appellant 113. The Respondent noted that bill discounting is a financial facility whereby a trader is given short-term finance on account of invoices due on a future date. Most of the invoices discounted were for related parties which did not pay the invoices on time.

114. That the Appellant was thus incurring a cost on the short-term finance which could have been avoided had the third party paid up for the supplies made in time, thus extending an advantage to the related party and bringing the discounting arrangement under the transfer pricing ambit.

115. The Respondent reiterated that the terms of credit differ between related parties and third parties with related parties being given more favourable terms. The Respondent stated that this is the position due to the fact that 90% of the receivables at the end of the accounting periods are related parties.

h. Whether the Respondent erroneously assessed the Appellant for the entire 2015 tax year despite the statutory tax exemption being in force for most of the year. 116. The Respondent contended that this position is factually incorrect since the said assessment for the year 2015 was adjusted for the period in which the tax exemption was still in place as could be seen from annexure 1 of the objection decision.

Parties Submissions 118. 117. The Appellant’s written submissions dated and filed on 20th March 2023 and filed on even date. The Appellant submitted as follows:

a. Whether the Respondent’s notice of objection decision was valid pursuant to Section 51 of the TPA. 118. The Appellant submitted that this is the only issue properly before the Tribunal following the decision by the Respondent not to formally concede to the consequences of not rendering an objection decision within the required time.

119. The Appellant relied on Section 51(11) of the TPA which requires the Respondent to make an objection decision within sixty days from the date of receipt of a valid notice of objection failure to which the objection shall be deemed to be allowed.

120. The Appellant submitted that its notice of objection was acknowledged and formally accepted by the Respondent as validly lodged via a letter dated 27th May 2022.

121. The Appellant relied on the case of Equity Group Holdings Limited v Commissioner of Domestic Taxes (Civil Appeal E069 & E025 of 2020) [2021] where the High Court held:-“Parliament in its wisdom deployed the word “shall” twice in section 51(11) of the Tax Procedures Act. The word "shall" when used in a statutory provision imports a form of command or mandate. It is not permissive, it is mandatory. The word shall in its ordinary meaning is a word of command which is normally given a compulsory meaning as it is intended to denote obligation.”

122. The Appellant submitted that the Respondent did not respond to the Appellant's letter through its Advocate’s letter dated 9th September 2022 on application of Section 51(11) of the TPA.

123. The Appellant further relied on the case of Morgan Air and Seafreight Logistics Kenya Limited v The Commissioner of Domestic Taxes [TAT Appeal No. 286 of 2020] where the Tribunal held:“The TPA at section 51(11) obligates the Respondent, in mandatory terms no less, to render an objection decision within sixty (60) days of receipt of an objection notice.”

124. The Appellant also relied on the case of Republic v Commissioner of Customs Services Ex-Parte Unilever Kenya Limited where the High Court held:“If the Commissioner does not render a decision within the stipulated period, the objection is deemed as allowed by operation of the law. The act requires that where the Commissioner has not made an objection decision within 60 days from the date the tax payer lodged the notice of objection, the objection shall be allowed. This means that the issues that the tax payer had raised in the notice of objection will be accepted.”

125. Further, the Appellant submitted that the court in R v The Commissioner of Domestic Taxes ex parte Fleur Investment Limited [2020] eKLR stated that:-“There is nothing before me to show that the Respondent made an objection decision as the law requires. By virtue of the clear provisions of section 51(8) and (11) of the TPA, the Respondent is deemed to have allowed the applicant’s objection. I find backing in Republic v Commissioner of Customs Services Ex-Parte Unilever Kenya Limited in which the court stated that if the Commissioner does not render a decision within the stipulated period, the objection is deemed as allowed by operation of the law. The act requires that where the Commissioner has not made an objection decision within 60 days from the date the tax payer lodged the notice of objection, the objection shall be allowed. This means that the issues that the tax payer had raised in the notice of objection will be accepted. In case of a tax assessment, it will be vacated.”

b. Whether the Respondent’s erroneously and unlawfully adjusted the Appellant's income. 126. The Appellant submitted that the Respondent erroneously adjusted the earnings before interest and tax for the years 2015 to 2018.

127. The Appellant submitted that according to Section 18(3) of the ITA, the income of the Appellant that deals with non-resident related persons can only be assessed where that relationship has resulted in either no profits or less than the ordinary profits which might be expected to accrue from that business if there had been no such relationship.

128. The Appellant submitted that in the present case, there was neither a loss nor less than ordinary profits that were accrued from the business as canvassed in its statement of facts.

129. The Appellant submitted that it made profits, computed as EBIT, in 2015, 2016 and 2017 and the EBIT loss reported 2018 was justifiable based on business and commercial factors which it explained in its statement of facts.

(c ) Whether the Respondent had grounds to apply the TNMM since it did not provide any evidence to support the fact as to how the deficiencies in the Cost-Plus method were not rectified or rectifiable. 130. The Appellant submitted that paragraph 8(2) of the Income Tax (Transfer Pricing) Rules 2006 prescribes that:“A person shall apply the method most appropriate for his enterprise, having regard to the nature of the transaction, or class of transaction, or class of related persons or function performed by such persons in relation to the transaction.”

131. The Appellant submitted that based on the OECD Guideline 2. 2 as well, a method becomes inappropriate or less appropriate when it suffers from an incurable deficiency. Guideline 2. 2 reads:“2. The selection of a transfer pricing method always aims at finding the most appropriate method for a particular case…the selection process should take account of the respective strengths and weaknesses of the OECD recognized methods…the appropriateness of the method considered in view of the nature of controlled transaction, determined in particular through a functional analysis, the availability of reliable information needed to apply the selected method(s) and the degree of comparability between controlled and uncontrolled transactions; including the reliability of comparability adjustments that may be needed to eliminate material differences between them…”

132. The Appellant further submitted that the Respondent did not actually claim that the Cost-Plus method was frustrated by an incurable deficiency, but rather, that the Appellant’s application of the method occasioned imperfections.

133. The Appellant submitted that Rule 4 of the Income Tax (Transfer Pricing) Rules 2006 provides that:“The taxpayer may choose a method to employ in determining the arm's length price from among the methods set out in rule 7. ”

134. The Appellant submitted that therefore, the discretion to choose the most appropriate method lies with the taxpayer and herein it was the Cost Plus method.

135. The Appellant relied on the case of Kenya Fluorspar Company Limited v Commissioner of Domestic Taxes TAT Appeal No.3 of 2018, where it was held that:“The main issue that has arisen herein is that instead of addressing the objection raised using the selected profit margin method, the Commissioner changed to the Transactional Net Margin Method without indicating the law that confers on the Commissioner the power to change the method…First of all, there is no evidence that the mining and prospecting licences were new assets not known in the profit split method. Secondly, even if they were new intangible assets, the Commissioner would have to back his change of method with the law, which they have not. I thus find that the Commissioner had no legal power to change to a new method of Transaction Net Margin method. The Commissioner could only use the Profit Split method chosen by the tax payer.”

136. The Appellant submitted that Chapter IV of the OECD Guidelines under paragraph 4. 9 provides that tax examiners should undertake to begin their analyses of transfer pricing from the perspective of the method that the taxpayer has chosen in setting its prices.

(d ) Whether the Respondent erroneously applied Transfer Pricing Rules to transactions with third parties. 137. The Appellant submitted that the Respondent erroneously applied the Transfer Pricing Rules to the Appellant’s entire income which includes both related parties revenues and third-party revenues contrary to Rule 3 of the Transfer Pricing Rules which reads:“The purposes of these Rules are-a.to provide guidelines to be applied by related enterprises, in determining the arm's length prices of goods and services in transactions involving them…”

138. The Appellant submitted that it sells a significant portion of its products to independent (unrelated) customers as canvassed in its Statement of Facts, thusthe TNMM cannot be applied in third party sales without segmentation of the entire profit and loss statement.

139. The Appellant relied on paragraph 2. 84 of the OECD Guidelines 2022 which states:“Costs and revenues that are not related to the controlled transaction under review should be excluded where they materially affect comparability with uncontrolled transactions. An appropriate level of segmentation of the taxpayer’s financial data is needing when determining or testing the net profit it earns from a controlled transaction.”

140. The Appellant in support of the need for segmental analysis relied on the case of Steer Engineering Pvt. Ltd v Commissioner on 14 November 2014 as below:“Paragraph 34, the Income Tax Tribunal ruled that “the Associated Enterprises ultimately sold these products to third parties. Therefore, considering whole of international segment for comparison is without basis…”

141. Further the Appellant also relied on the case of Dic India Limited, Kolkata v Commissioner where it was held that:“It is imperative to use the segmented information of the …appellant in order to improve reliability.”

142. The Appellant also relied on M/s Syniverse Mobile Solutions Pvt Ltd, Hyderabad [ts-51-itat-2015] wherein it was held:“even where there is no legal requirement to get the segmented financials audited, it is always preferable for establishing the reliability.”

143. The Appellant finally relied on Brigade Global Service Pvt. Ltd v ITO, Hyderabad [143 ITD 59] where it was held:“We have considered the arguments of both the parties. In our considered view for computing the net margin of the assessee for the purpose of transfer pricing only the cost related to the transaction with the AEs has to be considered, and accordingly we agree with the argument that segmented financial data is to be considered for purposes of arriving at the net margin on an international transaction with the assessee’s enterprises in respect of transactions carried on by the assessee.”

f. Whether the Respondent erred in rejecting the Cost-Plus method and applying the Transactional Net Margin Method. 144. The Appellant submitted that it followed the nine-step approach in the OECD Transfer Pricing Guidelines in preparing in Transfer Pricing Policy and arriving at the arm’s length earned by the Appellant from its transactions with related parties. The Appellant relied on the case of Unilever Kenya Ltd v Commissioner of Income Tax [2005] eKLR where the court held that in the absence of specific guidelines from the Respondent under section 18(3) of the ITA, determination of the arm’s length principle ought to be made in accordance with international best practice as represented by the OECD Guidelines.

145. The Appellant also relied on the Fluorspar Company Limited case (supra) in asserting that the Respondent had no legal power to change the Cost-Plus method chosen by the Appellant to TNMM.

146. The Appellant submitted that the Respondent rejected Cost Plus method used by the Appellant for the reasons canvassed in the Appellant’s Statement of Facts, which the Appellant disputed in the said Statement of Facts.

146. The Appellant submitted that the Respondent has erred in law and in fact in rejecting the Cost Plus method and applying TNMM.

g. Whether the Respondent has erroneously disallowed the costs of leasing equipment for income tax purposes by applying a lower value based on a customs entry value as the arm’s length price. 148. The Appellant submitted that the Respondent, having selected the TNMM, the arm’s length cost of leasing of equipment and any other controlled transaction, except for financing, was already included in the computation of the operating profit (EBIT). The Appellant therefore submitted that to separately assess any other transaction, therefore, would be to subject the same transaction to an assessment twice.

149. The Appellant reiterated its arguments in its Statement of Facts in arguing that there were no import duties to pay, and therefore, the value declared at the point of importing the equipment is for purely statistical purposes.

150. On this issue, the Appellant submitted that there was no basis in law for the use of a customs value for purposes of Corporation tax.

h. Whether the Respondent has erroneously applied withholding tax on lease payments made by the Appellant after the end of the ten-year EPZ tax exemption period. 151. The Appellant reiterated its arguments in relation to the Equipment Hire Agreement it had with GTCUK and stated that royalty payment often comes about when a person exploits the right to use over an intellectual property for certain gains.

152. The Appellant submitted that the mere leasing of equipment does not create a right to use or to exploit intellectual property for gains that would result to a royalty payment.

153. The Appellant relied on Section 4B of the ITA which reads:“Where a business is carried on by an export processing zone enterprise, the provisions of the Eleventh Schedule shall apply.”

154. The Appellant submitted that seeking to subject payments by the EPZ to a non-resident person under Section 35 of the ITA was erroneous and without any basis in law.

155. The Appellant therefore submitted that it was registered as an EPZ and the applicable Section to its operations was the Eleventh Schedule.

i. Whether the Respondent has erroneously disallowed and adjusted the bill discounting costs of the Appellant. 156. The Appellant submitted that the Respondent had without evidential basis claimed that related parties get goods on credit, but third-party customers are required to pay on sight. The Appellant submitted that it discounts invoices for both related and unrelated customers.

157. The Appellant reiterated its arguments in its Statement of Facts in submitting that the Respondent erred in law and fact by disallowing and adjusting legitimate bill discounting costs.

j. Whether the Respondent erroneously assessed the Appellant for the financial year 2015 despite the Appellant having a tax exemption. 158. The Appellant submitted that despite the Respondent’s acknowledgment that the Appellant enjoyed tax exemption as an EPZ between October 2005 and October 2015, the Respondent failed to apportion the taxable income for 2015 for the following tax headers: the sale of tea to related parties and, bill discounting.

159. Thus, the Appellant submitted that the Respondent erred in assessing the Appellant for year 2015.

160. In its written submissions dated 28th February, 2023 and filed on the even date, the Respondent identified Six (6) issues for determination which it analysed as outlined hereunder:

(a) Whether the objection decision was issued out of time 161. The Respondent submitted that the provisions of Section 51(11) of the TPA were amended by section 44(d) of the Finance Act, 2022 which provides that:“The Commissioner shall make the objection decision within sixty days from the date of receipt of a valid notice of objection failure to which the objection shall be deemed to be allowed.”

162. The Respondent submitted that prior to 1st July 2022, the Section read as follows:“The Commissioner shall make an objection decision within 60 days from the date of receipt ofa.the notice of objection orb.any further information the Commissioner may require from the taxpayer, failure to which the objection decision shall be deemed to be allowed.”

163. The Respondent submitted in this case, the applicable law will be the law which was in force at the time the notice of objection was lodged which was on 27th May 2022. At the time, the Respondent was obligated to issue a notice of objection decision within sixty (60) days from the date of receipt of any further information the Commissioner may need from the Appellant.

164. The Appellant lodged its objection on 27th May 2022, the Respondent requested to be provided with further documents and the Appellant provided its last set of documents on 28th July 2022 hence 29th July 2022 was the first day of having a valid notice of objection.

165. The Respondent also relied on Section 51(3) of the TPA which reads:“A notice of objection shall be treated as validly lodged by a taxpayer under subsection (2) if—a.the notice of objection states precisely the grounds of objection, the amendments required to be made to correct the decision, and the reasons for the amendments;b.in relation to an objection to an assessment, the taxpayer has paid the entire amount of tax due under the assessment that is not in dispute or has applied for an extension of time to pay the tax not in dispute under section 33(1); andc.all the relevant documents relating to the objection have been submitted.”

166. The Respondent relied on the case of Evan v Bartlam [1973] 2ALL ER 649 to buttress its argument on why the Appellant provided further documents vide the electronic mail dated 28th July 2022 in support of its objection assuming that the objection lodged by the Appellant was valid? The case held that:“The doctrine of approbation and reprobation requires for its foundation inconsistency of conduct, as where a man, having accepted a benefit given him by a judgment cannot allege the invalidity of the judgment which conferred the benefit.”

167. The Respondent submitted that the objection decision of 29th August 2022 was valid.

c. Whether the Respondent erroneously and unlawfully adjusted the Appellant’s income. 168. The Respondent relied on Section 18(3) of the ITA to rebut the averment by the Appellant. The section reads:“Where a non-resident person carries on business with a related resident person and the course of such business is such that it produces to the resident person or through its permanent establishment either no profits or less than the ordinary profits which might be expected to accrue from that business if there had been no such relationship, then the gains or profits of such resident person or through its permanent establishment from such business shall be deemed to be of such an amount as might have been expected to accrue if the course of that business had been conducted by independent persons dealing at arm’s length.”

169. The Respondent submitted that the bone of contention was whether the Appellant’s transactions with related non-residents resulted in either no profits or less than the ordinary profits which might be expected to accrue from that business if there had been no such relationship.

170. The Respondent submitted that it identified deficiencies in the cost base used under the transfer pricing method adopted by the Appellant which orchestrated a drastic reduction in the profits realized vis-à-vis what would be expected if the Appellant did not have such relationship. This discrepancy was seen from a comparison of the audited financial statements and the benchmark report.

171. The Respondent submitted that the appropriate cost base for application of the Cost Plus method should be equal to the cost of goods sold in the financial statements. The Appellant submitted that this criterion was however not satisfied as the Respondent found that the transaction between the Appellant and its non-resident related parties did not meet the arm’s length test from the period 2016 to 2018, thus making the adjustments subject to section 18(3) of the ITA.

d. Whether the Respondent erred in employing the TNMM over the Cost Plus method proposed by the Appellant. 172. The Respondent submitted that it appreciated the Appellant’s compliance with Section 18(3) of the ITA and the Income Tax (Transfer Pricing) Rules 2006 by formulating a transfer pricing policy.

173. The Respondent relied on Paragraph 1 of Article 9 of the OECD Model Tax Convention which reads:“Where conditions are made or imposed between the two associated enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, by reason of those conditions, have not so accrued, may be included in the profits of the enterprise and taxed accordingly.”

174. The Respondent further relied on Rule 4 of the Income Tax (Transfer Pricing) Rules 2006 giving the Appellant leeway to choose the appropriate method to determine the arm’s length price, and thus chose the Cost-Plus method. The Respondent submitted that the Appellant chose the Cost-Plus method where costs are assessed using the cost incurred by the supplier of a product in a controlled transaction, and this is most useful where semi-finished goods are sold between associated parties.

175. The Respondent submitted that considering discrepancies identified in the data renders the results unreliable for application of the Cost Plus method. The Respondent further submitted that based on the FAR analysis, the cost base should include the direct costs, indirect costs and the operating expenses that form the cost base.

176. The Respondent submitted that it applied the TNMM on the Appellant’s transactions as it found this as the most appropriate method. The reason for this is that the TNMM can be applied to determine the arm’s length of the transaction using operating profit on operating cost as a profit level indicator.

177. The Respondent submitted that the advantage of this method is that the net profit indicator is more tolerant to transactional or functional differences, that is, prices are likely to be affected by differences in products, and gross margins are likely to be affected by differences in functions, but net profit indicators are less adversely affected by such differences.

178. The Respondent submitted that it carried on a database search for comparable companies engaged in the blending and packaging of tea, on the Orbis database for the period 2015 to 2018 with EBIT as the profit level indicator. The said database search yielded margins of 8. 67%, 4. 75%, 5. 35% and 4. 03% for the years 2015, 2016, 2017 and 2018 respectively and these resulting EBIT margins have been applied as the benchmark to arrive at the transfer pricing adjustment.

179. The Respondent thus established that the transactions between the Appellant and its non-resident related parties did not meet the arm’s length range for the years 2016 to 2018 and therefore adjustments were made to the Appellant’s income for 2015 to 2018.

e. Whether the Respondent erred in disallowing the cost of leasing equipment for income tax purposes instead of applying a lower value based on customs entry value as the arm’s length price. 180. The Respondent submitted that there was a 2014 Equipment Hire Agreement between GTCUK and the Appellant, subject to which the Appellant had leased tea bagging machines from its parent company GTCUK, as canvassed in the Respondent’s statement of facts. The Respondent further submitted that the equipment in question is a capital asset used for manufacture which under the provisions of section 15(2)(b) of the ITA qualifies for full capital allowance deduction in the first year of use.

181. The Respondent submitted that in the circumstances, these are related party transactions, and they are choreographed in such a way as they produce to the resident person, less than the ordinary profits which might be expected to accrue from its business if there had been no such relationship, thus applicable to section 18(3) of the ITA.

182. It was the Respondent’s submission that the lease rental payments ought to be treated as a financial transaction between the related parties. These were not captured in the TNMM by the Respondent and were in fact computed separately.

183. Thus, the Respondent acted within the law by disallowing the excessive costs not undertaken at arm’s length.

f. Whether the Respondent erroneously applied withholding tax on lease payments made by the Appellant after the ten (10)-year EPZ tax exemption period. 184. The Respondent submitted that the 10-year tax exemption period of the Appellant expired in October 2015. The Respondent relied on paragraph 3 of the 11th Schedule to the ITA which provides as follows:“During the period in which an export processing zone enterprise is exempt from corporation tax according to paragraph 2(f) of the Third Schedule—a.the enterprise shall be deemed to be a non-resident subject to a non-resident rate of withholding tax on payments made to such an enterprise and, where such payments are made by a person who is not an export processing zone enterprise, the tax shall be a final tax; andb.payments by an export processing zone enterprise to any person other than a resident person shall be deemed to be exempted from tax.”

185. The Respondent submitted that withholding tax was chargeable on any payments made to a non-resident outside the ten-year period therefore correctly issuing withholding tax assessments in the years 2017 and 2018.

186. As the Appellant had contended that lease payments made were not subject to withholding tax, the Respondent submitted that the definition of royalty as espoused under section 2 of the ITA which provides as follows:“"royalty" means a payment made as a consideration for the use of or the right to use—a.any copyright of a literary, artistic or scientific work; orb.any cinematograph film, including film or tape for radio or television broadcasting; orc.any patent, trade mark, design or model, plan, formula or process; ord.any industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific equipment or experience, and any gains derived from the sale or exchange of any right or property giving rise to that royalty;”

187. The Respondent further relied on the case of Kenya Commercial Bank v Kenya Revenue Authority [2008] eKLR in defining royalty where it was stated:“the definition given to royalty is wide which I think is an indication of the extensive range of underlying transactions giving rise to a royalty that the Income Tax Commissioner would target. The width of the definition is also important because in my view, it gives the Commissioner the right to seek withholding tax made on payments made offshore…”

188. The Respondent relied on section 35(1)(b) of the ITA which provides as follows:“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…..;b.a royalty;…”

189. The Respondent submitted that withholding tax was charged in accordance with the law as monies were paid as consideration for the use of or right to use the industrial equipment by the Appellant.

g. Whether the Appellant ought to have been assessed for the financial year 2015 during which they had a tax exemption. 190. The Respondent submitted that the assessment for the year 2015 was adjusted for the period which the tax exemption was still in place.

Issues For Determination 191. Having gleaned through the pleadings, documents and submissions of both the Appellant and the Respondent, the Tribunal identified Six (6) issues for determination as follows: -a.Whether the notice of objection decision was issued out of time.b.Whether the Respondent had grounds in applying the TNMM and rejecting the Cost-Plus method applied by the Appellant.c.Whether the Respondent erred in disallowing the cost of leasing equipment for income tax purposes instead of applying a lower value based on customs entry value as the arm’s length price.d.Whether the Respondent erroneously assessed the Appellant for the year 2015 while the Appellant had an exemption.e.Whether the Respondent erroneously applied withholding tax on lease payments made by the Appellant after the ten year EPZ tax exemption period.f.Whether the Respondent has erroneously disallowed and adjusted the bill discounting costs of the Appellant.

Analysis And Findings (a) Whether the notice of objection decision was issued out of time. 192. For the Tribunal to establish whether the objection decision by the Respondent is following Section 51(11) of the TPA, it is imperative for it to have an appreciation to the specific wording of the section.

193. The Tribunal takes judicial notice that the provisions of section 51(11) of the TPA were amended by the Finance Act 2022 under Section 44(d) taking effect on 1st July 2022. Prior to the amendment, the Section provided as follows:“The Commissioner shall make an objection decision within 60 days from the date of receipt of (a) the notice of objection or (b) any further information the Commissioner may require from the taxpayer, failure to which the objection decision shall be deemed to be allowed.

194. The objection was lodged before 1st July 2022, and therefore the law applicable at the time applies in this case.

195. The Tribunal notes that the Respondent requested for further documents and received the same before rendering its objection decision. This means that the statutory period in Section 51(11) of the TPA started to run after the documents were received which is on 29th July 2022. The decision was rendered on 29th August 2022 which is well within the statutory period allowed.

196. The Tribunal, therefore, finds that the objection decision was rendered on time as per the then applicable law.

b. Whether the Respondent had grounds in applying the TNMM and rejecting the Cost Plus method applied by the Appellant. 197. The issue of the transfer pricing method applicable to the Appellant’s transactions is at the heart of this case.

198. Section 18(3) of the ITA was relied upon by the Respondent to adjust the Appellant’s income based on the TNMM. The Appellant also relied on the same section to explain that in the present case, there was neither a loss nor less than the ordinary profits to allow the adjustments made by the Respondent. Section 18(3) of ITA provides as follows:“Where a non-resident person carries on business with a related resident person and the course of such business is such that it produces to the resident person or through its permanent establishment either no profits or less than the ordinary profits which might be expected to accrue from that business if there had been no such relationship, then the gains or profits of such resident person or through its permanent establishment from such business shall be deemed to be of such an amount as might have been expected to accrue if the course of that business had been conducted by independent persons dealing at arm’s length.”

199. The Tribunal must therefore determine if the Respondent could apply a different transfer pricing method other than that applied by the Appellant to determine what amounts might have accrued if the business that been conducted by independent persons dealing at arm’s length.

200. The Appellant has formulated its own Transfer Pricing Rules in line section 18(3) of the ITA, the Income Tax (Transfer Pricing) Rules of 2006 and the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations of 2022.

201. The Transfer Pricing Policy of the Appellant under paragraph 4. 1.1 provides that with respect to the sale of tea sale, the accepted method is the Cost-Plus method, which is applied by ensuring the gross mark-up on the sale of tea to related parties is comparable to the mark-up on the sale of tea to unrelated parties. The application of the Cost-Plus method is outlined in 4. 2.1 of the Policy.

202. The Cost-Plus method was selected by the Appellant as the most appropriate method for the reason that there was internal comparable data for the gross mark-up earned for the sale of tea to unrelated parties. In addition, Paragraph 4. 1.2 of the Policy provides that in the case of lease of machinery, the unspecified method is used due to the inability to apply any of the prescribed methods as they were less appropriate to the facts and circumstances.

203. The Cost-Plus method is defined under Rule 7 of the Income Tax (Transfer Pricing) Rules, 2006 as follows:“in which costs are assessed using the costs incurred by the supplier of a product in a controlled transaction, with a mark-up added to make an appropriate profit in light of the functions performed, and the assets used and risks assumed by the supplier;

204. Rule 4 of the Income Tax (Transfer Pricing) Rules, 2006 allows the taxpayer to choose the method of comparability to be applied in determining the arm’s length mature of the transaction. It reads:“The taxpayer may choose a method to employ in determining the arm's length price from among the methods set out in rule 7. ”

205. Rule 8(2) further provides as follows:“(2)A person shall apply the method most appropriate for his enterprise, having regard to the nature of the transaction, or class of transaction, or class of related persons or function performed by such persons in relation to the transaction.”

206. The Appellant could choose the transfer pricing method. However, the Respondent has the mandate to review the method chosen to confirm that it is in accordance with the Law and the transfer pricing policy.

207. In this case, the controlled transaction was benchmarked using Cost Plus method. The Respondent submitted that it reviewed the data between 2014 – 2018 and this yielded significant variances between the financial statements and the benchmark report. In 2014 the financial statements had 13% margin and the benchmark report had a margin of 64%. In 2015, financial statements had 16% margin and the benchmark report had a margin of 42%. In 2016, financial statements had 11% margin and the benchmark report had a margin of 34%. In 2017, financial statements had 9% margin and the benchmark report had a margin of 26%. In 2018, financial statements had 9% margin and the benchmark report had a margin of 16%.

208. The variances and discrepancies pointed out by the Respondent through the benchmark report are significant. They included first, the fact that the cost of tea in the benchmark report differed significantly, with that in the financial statements, secondly the cost bases used in the benchmark were significantly low in comparison with costs booked in the financial statements and finally that due to the fact that the sales of tea were in various forms namely; tea bags, flavoured tea, envelopes, laminated foil and so on, the cost base for each type of sale was different since the different ways in which tea is packed attracts different costs.

209. The Tribunal finds that the Respondent had grounds for applying the TNMM and rejecting the Cost-Plus method applied by the Appellant.

(c) Whether the Respondent erroneously assessed the Appellant for the year 2015 while the Appellant had an exemption. 210. The Appellant was an EPZ enterprise between October 2005 and October 2015 and neither party contested this fact. Pursuant to Section 29 (c) of the Export Processing Zones Act Cap 517 of Kenya’s Laws the Appellant is exempt from income tax for a period of ten years after it begins its sales as an EPZ entity. The said section provides as follows:“(2)Subject to subsection (1) and without prejudice to any other written law, the export processing zone enterprise, export processing zone developers and the export processing zone operators shall be granted the following exemptions—c.exemption from the payment of income tax as specified in the Income Tax Act (Cap. 470) for the first ten years from the date of first sale as an export processing zone enterprise, except that income tax rate will be limited to twenty-five percent for the ten years following the expiry of the exemption granted under this paragraph.”

211. Accordingly, the Tribunal finds that the Appellant’s income was exempt from corporation tax pursuant to Section 4B read in tandem with the Eleventh Schedule of the ITA.

212. The Tribunal notes that, in respect of the 2015 year of income, the Respondent in its objection decision provided an analysis of its assessment wherein it adjusted the assessment by excluding the tax exemption period. It is notable that the tax exemption expired in October, 2015.

213. The Tribunal finds that the Appellant was not assessed for the period during which it operated as an Export Processing Zone (EPZ) entity. Accordingly, the Respondent correctly assessed the Appellant in respect to the 2015 year of income and more particularly, in respect of the period in that year when the Appellant was exempt.

d. Whether the Respondent erroneously applied withholding tax on lease payments made by the Appellant after the ten-year EPZ tax exemption period. 214. The Tribunal finds that pursuant to Section 29(d) of the Export Processing Zones Act, Cap 517 of Kenya’s laws, EPZ entities are exempt from paying withholding tax for the period the entity is exempted from paying income tax. The provision of the Section reads as follows:-“(2)Subject to subsection (1) and without prejudice to any other written law, the export processing zone enterprise, export processing zone developers and the export processing zone operators shall be granted the following exemptions—……..d.exemption from the payment of withholding taxes on dividends and other payments made to non-residents during the period that the export processing zone enterprise is exempted from payment of income tax under paragraph (c)……”

215. The Tribunal finds that the exemption from payment of withholding tax applied to the Appellant between October 2005 and October 2015 when it operated as an EPZ entity. The Respondent could therefore assess the Appellant for withholding tax for the years 2017 and 2018.

216. The Tribunal finds that the Appellant contended that the lease payments made by it did not amount to royalties and were therefore not subject to withholding tax. Both parties recognized the Equipment Hire Agreement 2014 between GTCK and GTCUK in relation to leasing tea bagging machines by the Appellant from its parent company, however, the document was not reviewed by the Tribunal as it was not provided by either party. According to the Appellant, the Agreement clearly demonstrated that this was a leasing transaction and not one that created the existence of a royalty.

217. Royalties are subject to section 35(1)(b) of the ITA and they are defined under section 2 of the ITA to mean inter alia, a payment made as a consideration for the use of or the right to use any industrial equipment. The Tribunal notes, based on the facts presented, that the Equipment Hire Agreement relates to leasing of the equipment and was not for the purpose of establishing a right of use. The lease payments could not therefore be considered to be royalty payments. The payments received by GTCUK for hiring the equipment did not therefore amount to income for the use of property subject to sections 6 and 35 of the ITA.

218. The Tribunal finds that even though the Respondent could assess and claim withholding tax from the Appellant as the EPZ exemption period had expired, withholding tax did not apply to the lease payments made by the Appellant since the same did not amount to royalty payments.

219. In view of the foregoing, the Tribunal’s finding is that the Respondent erroneously applied withholding tax on lease payments made by the Appellant after the ten-year EPZ tax exemption period.

e. Whether the Respondent erred in disallowing the cost of leasing equipment for income tax purposes instead of applying a lower value based on customs entry value as the arm’s length price. 220. The Tribunal notes the Appellant’s argument that the Respondent, having selected the TNMM method as the most appropriate method of determining the arm’s length price, the cost of leasing of equipment and any other controlled transaction (except for financing) was already included in the computation of the operating profit (EBIT). The Appellant also argued that to separately assess any other transaction would be to subject the same transaction to an assessment twice.

221. The Tribunal further notes the Appellant’s further argument that the Respondent erred in adopting the import declaration value for purposes of determining the arm’s length price and that the Appellant had the equipment appraised by its manufacturer to ascertain its value.

222. The Tribunal notes that the Respondent submitted that there was a 2014 Equipment Hire Agreement between GTCUK and the Appellant, subject to which the Appellant had leased tea bagging machines from its parent company GTCUK. The Tribunal further notes the Respondent’s contention that the equipment in question is a capital asset used for manufacture which qualifies for full capital allowance deduction in the first year of use pursuant to the provisions of Section 15(2)(b) of the ITA.

223. The Tribunal also notes the Respondent’s submission that in the circumstances, these are related party transactions choreographed in such a way as they produce to the resident person, less than the ordinary profits which might be expected to accrue from its business if there had been no such relationship, thus applicable to Section 18(3) of the ITA.

224. The Tribunal further also notes the Respondent’s submission on the issue of the assessment having been included in the TNMM, that the lease rental payments ought to have been treated as a financial transaction between the related parties. These were not captured in the TNMM by the Respondent and were in fact computed separately.

225. The Tribunal has carefully considered the arguments of both parties on this issue and is of the view that the Respondent correctly adopted the import declaration value of the equipment in question as this was a self-declared value made by the importer. Additionally, as the payments were not captured in the TNMM, the issue raised by the Appellant for double assessment does not arise. In any event, the Appellant did not demonstrate that such double assessment occurred.

226. In view of the foregoing, the Tribunal finds that the Respondent did not err in disallowing the cost of leasing equipment for income tax purposes and instead applied a lower value based on the customs entry value in determining the arm’s length price.

f. Whether the Respondent has erroneously disallowed and adjusted the bill discounting costs of the Appellant. 227. The Tribunal finds that another issue in contention related to bill discounting.The Tribunal notes the Appellant’s submission that the Respondent without evidential basis claimed that related parties purchased goods on credit and that third-party customers on the other hand, were required to pay on sight. The Tribunal notes that the Respondent adjusted the Appellant’s income on the basis of this claim. The Tribunal also notes the Appellant’s submission that it discounted invoices in respect of both related and unrelated customers.

228. The Tribunal notes the reply by the Respondent in which it stated that related parties formed 90% of the receivables and as a result, related parties were extended an advantage thereby bringing the discounting arrangement into the sphere of a controlled transaction for which the Arm’s length principle was applicable.

229. The Tribunal having considered the arguments by both parties finds that indeed, 90% of the beneficiaries of the discounting arrangement were related to the Appellant and therefore the Appellant and its related parties were the beneficiaries of the discounting arrangement.

230. The Tribunal therefore finds that the Respondent correctly disallowed the adjusted bill discounting costs of the Appellant.

Final Decision 231. In view of the foregoing analysis, the Tribunal finds the Appeal herein partially succeeds and accordingly proceeds to make the following final Orders:-a.The Appeal be and is hereby partially allowed.b.The Respondent’s Objection decision dated 29th August, 2022 be and is hereby varied to the extent that the assessment in relation to withholding tax be and is hereby set aside.c.Each party to bear its own costs.It is so ordered.

DATED AND DELIVERED AT NAIROBI THIS 22ND DAY OF MARCH, 2024. ERIC NYONGESA WAFULA - CHAIRMANDELILAH K. NGALA - MEMBERCHRISTINE A. MUGA - MEMBERGEORGE KASHINDI - MEMBERMOHAMED A. DIRIYE - MEMBERSPENCER S. OLOLCHIKE - MEMBER