[2024] KETAT 709 (KLR)

Itochu Corporation, Kenya Branch v Commissioner of Investigation and Enforcement (Tax Appeal 557 of 2022) [2024] KETAT 709 (KLR) (9 May 2024) (Judgment)

Neutral citation: [2024] KETAT 709 (KLR)

Republic of Kenya

In the Tax Appeal Tribunal

Tax Appeal 557 of 2022

E.N Wafula, Chair, Cynthia B. Mayaka, RO Oluoch, T Vikiru & AK Kiprotich, Members

May 9, 2024

Between

Itochu Corporation, Kenya Branch

Appellant

and

Commissioner of Investigation and Enforcement

Respondent

Judgment

Background 1. The Appellant is a private limited company incorporated in Kenya and is a branch office of Itochu Corporation, an international Japanese general trading firm, head-quartered in Tokyo, Japan. It trades in various products such as textiles, machinery, metals, minerals, energy, chemical foods, general products, realty, information and communication technology and finance as well as business investments in Japan and globally.

2. The Respondent is a principal officer appointed under Section 13 of the Kenya Revenue Authority Act. The Kenya Revenue Authority is an agency of the Government of Kenya mandated with the duty of collection and receipting of all tax revenue, and the administration and enforcement of all tax laws set out in Parts 1& 2 of the First Schedule to the Act, for purposes of assessing, collecting, and accounting for all tax revenues in accordance with those laws.

3. The issue in dispute in this Appeal arose when the Respondent conducted an audit on the operations of the Appellant for the period 2016-2019 and issued an assessment of Kshs 2,388,258,918. 00 on Corporate income and Pay As You Earn(PAYE) taxes on 30th September 2021.

4. The Appellant lodged its objection to the said assessments on 29th October 2021.

5. The objection was partially allowed but the assessments on transfer pricing adjustments were confirmed on 14th April 2022 for tax liability of Kshs 2,559,875,622. 00 inclusive of penalties and interests.

6. The Appellant was dissatisfied with this decision and it lodged its Appeal to the Tribunal on 13th May 2021.

The Appeal 7. The Appellant in its Memorandum of Appeal dated 27th April 2022 has set out the following grounds of Appeal, thati.The Respondent erred in law and in fact in allocating profits of Itochu Japan to the Appellant.ii.The Respondent erred in law and fact by finding that the activities of the Appellant’s General Manager, Head of Business Segments and other staff’s work permit applications indicate that the Appellant was involved in trading activities.iii.The Respondent erred in law and fact by finding that the Appellant’s staff are appraised based on numeric targets set by Itochu Japan and not the qualitative aspects of their liaison activities.iv.The Respondent erred in law and fact by finding that the Appellant utilizes assets and assumes risks that would demonstrate it is a trading entity.v.The Respondent erred in law and fact by relying on an erroneous basis to compute profits earned by Itochu Japan from Kenya and the allocation of profits.vi.The Respondent erred in law and fact by finding that the benchmarking analysis done by the Appellant was not appropriate.vii.The Respondent erred in law and fact by finding that the Appellant failed to provide relevant supporting documentation concerning its alleged general trading function.

Appelant’s Case 8. The Appellant has grounded its Appeal on its:a.Statement of Facts dated 27th May 2022 and documents annexed thereto.b.A further list of documents dated 23rd February 2022c.Witness statement by Ms. Alice Muriithi dated 27th November 2023 and admitted into evidence on the 28th day of November 2023. d.Written Submissions dated 11th December 2023

9. The Appellant stated that it is a liaison office of Itochu Japan and undertakes liaison activities such as market research, contact and communication with local clients and partners for Itochu Japan and acts as a communication and transmission channel for business inquiries.

10. That because it is related to Itochu Japan, Section 18(3) of the Income Tax Act (the “ITA”) requires it to earn the level of profit that it would have earned if it had been unrelated to Itochu Japan concerning the activities it undertakes. That this is the same as the “arm’s length profit” that it should earn for the services provided to Itochu Japan.

11. It was its view that the following steps are necessary in carrying out a TP analysis:a.Step One: Characterization of the transaction, including a review of the functional profile.b.Step Two: Selection of the appropriate TP method.c.Step Three: Application of the appropriate TP method.

12. Under step One, the Appellant stated that the Respondent incorrectly characterized the transaction between it and Itochu Japan as a trading transaction as opposed to considering it as a routine liaison service which was merely supportive of, the trading transactions which are only carried out by Itochu Japan and do not involve the assumption of any trading risks.

13. Under Step Two, the Appellant stated that the Respondent incorrectly selected a PSM as the most appropriate transfer pricing method under the guidance on the selection of methods found in Chapter II of the OECD Guidelines when there was no integration of functions or shared assumption of risks between it and Itochu Japan and it was also not bringing any unique and valuable contribution. That, moreover, the benchmarking in Itochu’s TP Documentation clearly shows that it is possible to evaluate the arm’s length nature of the routine services performed by Itochu Nairobi in isolation by reference to independent comparable enterprises under the TNMM.

14. Under Step Three, the Appellant stated that the Respondent did not follow the guidance on the application of the PSM found in that Chapter which requires a two-sided analysis to evaluate the contribution to the earning of the combined profits by both Itochu Nairobi and Itochu Japan.

15. That the Respondent had instead undertaken a one-sided analysis based on its activities in Kenya and without analyzing it in terms of the value of the functions, assets and risks of Itochu Japan. That this erroneous analysis led the Respondent to settle on an inappropriate profit split method contrary to the OECD TP Guidelines 2017, the Revised PSM Guidelines and Rule 7(d) of the Income Tax (Transfer Pricing) Rules, 2006 which provides for the use of the PSM.

16. That in contrast, it has correctly followed the three steps outlined above and selected the TNMM as the most appropriate transfer pricing method based on the characterization of the transaction as one of service provision and has followed the OECD Guidelines, in particular the nine-step compatibility analysis to compute an arm’s length range from the compensation for Itochu Nairobi’s liaison and coordination services in Kenya.

17. The Appellant argued that PSM is the most appropriate method in cases where both parties to a transaction make unique and valuable contributions to the transaction because in such a case unrelated parties might wish to share the profits of the transaction in proportion to their respective contributions. That ideally both parties to the transaction ought to have been subjected to an evaluation of the functions performed by each of the parties to the transaction, taking into account assets used and risks assumed in order to appropriately split the profits based on the contribution of each party to the transaction.

18. That it provided sufficient records to enable the Respondent to make an appropriate determination without resorting to the profit split method. That even if the profit split method was adopted, the Respondent should have benchmarked it against similar independent enterprises in a joint venture.

19. That the OECD TP Guidelines 2017 and the Revised Guidelines on the Application of the Transactional Profit Split Method released by the OECD in 2018 (“Revised PSM guidance”) highlighted the criteria to be considered in determining whether PSM is the most appropriate TP method for testing a transaction as follows:a.Whether there is the existence of a unique and valuable contribution by each party to the controlled transaction; Contributions (for instance functions performed, or assets used or contributed) will be “unique and valuable” in cases where:i.They are not comparable to contributions made by uncontrolled parties in comparable circumstances, andii.They represent a key source of actual or potential economic benefits in the business operations.b.Whether there is a high level of integration between business transactions to which the controlled transaction relates.c.Whether there is a shared assumption of economically significant risks or separate assumptions of closely related risks.

20. The Appellant averred that when applying the PSM, different approaches may be used for determining the appropriate arm’s length split of profits between the parties, namely:a.Contribution analysis which combines profits from the controlled transaction allocated between the related parties based on their relative contributions.b.Residual analysis which is a two-step approach that first allocates profits to non-unique (routine) activities and then splits the residual profit.

21. It was its view that PSM is not appropriate where one party to the transaction performs only simple functions or where all the risks relating to the transaction fall solely with one party.

22. The Appellant asserted that Paragraph 7. 31 of the OECD TP Guidelines recognizes that cost-based TNMM is often used to determine the arm’s length compensation for intra-group services. That in this case, Itochu Nairobi performed straightforward routine services (liaison, communications and market research) which are separate from, but supportive of, the trading transactions which are only carried out by Itochu Japan and do not involve the utilization of significant intellectual property or the assumption of any trading risks.

23. That the benchmarking exercise in Itochu’s TP documentation showed the existence of independent parties carrying on similar transactions with a similar risk profile enabling a comparison to be made under the TNMM to determine an arm’s length result without the need to consider the profits earned by the service recipient which was Itochu Japan.

24. The Appellant further affirmed that the classification adopted by the Respondent was flawed for the following reasons:i.Flawed functional analysis

25. It submitted under this head that a functional analysis seeks to identify the economically significant activities and responsibilities undertaken, assets used or contributed, and risks assumed by the parties to a transaction. That an accurate analysis of the functions performed, assets utilized, and risks borne was essential in appropriately characterizing the nature of the transaction and in selecting the appropriate transfer pricing method.

26. That the internal documents, procedures and transfer pricing policies governing the operations of Itochu Nairobi, characterized it as a service provider to Itochu Japan because it undertook liaison, communication, business development and market research activities to support the trading activities undertaken by Itochu Japan. That it did not undertake trading activities, trade risks or use significant Intellectual property other than the skills of its workforce in its liaison activities.

27. That having correctly carried out interviews among its senior staff to determine its functional analysis, the Respondent did not rely on the functional analysis. That it instead relied on selected descriptions in the Itochu Nairobi staff work permit applications to incorrectly characterize Itochu Nairobi staff work permit as a trader rather than a service provider. That in the end its functional analysis did not focus on what parties do in practice as is provided in Paragraph 1. 51 of the OECD Guidelines.

28. That the conclusions by the Respondent concerning both the selection of the PSM as the most appropriate method and the arm’s length application of that method to the transactions was incorrect.

29. The Appellant argued that the Respondent identified market risks and credit risks as two of the risks assumed by Itochu Nairobi but it did not explain how it arrived at such a conclusion given that the functional analysis interview notes show that Itochu Nairobi is a service provider and has not performed any functions related to the control and management of those risks.

30. Its witness, Alice Muriithi concluded that having reviewed the documentation provided including the functional analysis interviews and the Transfer pricing report, it was its view that the Appellant did not assume any market and credit risks.

31. The Appellant stated that Paragraph 1. 60 of the OECD TP Guidelines provides as follows on the steps to be followed in analyzing risk in controlled transactions:a.Identify economically significant risks with specificity.b.Determine how specific, economically significant risks are contractually assumed by the associated enterprises under the terms of the transaction.c.Determine through a functional analysis how the associated enterprises that are parties to the transaction operate about assumption and management of the specific, economically significant risks, and in particular which enterprise or enterprises perform control functions and risk mitigation functions, which enterprise or enterprises encounter upside or downside consequences of risk outcomes, and which enterprise or enterprises have the financial capacity to assume the risk.

32. It concluded under this head that the Respondent carried out a one-sided analysis when it chose and applied PSM as the most appropriate method.ii.The Respondent’s application of PSM did not meet strict criteria for the application of the PSM set out by OECD TP Guidelines.

33. The Appellant argued that the following OECD TP Guidelines did not exist in this case to justify the application of PSM by the Respondent:a.Existence of a unique and valuable contribution by each party to the controlled transaction;b.A high level of integration between business transactions to which the controlled transaction relates; and/orc.There is a shared assumption of economically significant risks or separate assumptions of closely related risks.

34. That the Respondent has not identified any unique and valuable contributions in the value chain that it could attribute or allocate to the Appellant to justify its decisions. It was its specific argument that the alleged high level of integration between Itochu Nairobi and Itochu Japan was not supported by the facts, the internal procedures and documentation of the taxpayer or by the functional analysis interviews that it carried.

35. It was also its position that the Respondent has not demonstrated a shared assumption of economically significant risks or separate assumptions of closely related risks to justify the use and application of PSM as the appropriate TP method.

36. It was its view that it had undertaken its service functions that were separate from, but supportive of, the trading functions undertaken by Itochu Japan, and hence its conclusion that the selection of the PSM as the preferred TP method was not appropriate.iii.Respondent’s allocation of profits to Itochu Nairobi is arbitrary.

37. It was its view that the Respondent erred in holding that contribution allocation is made by comparing the nature and degree of each party’s contribution and assigning a percentage based upon that relative comparison. That this allocation contradicts paragraph 2. 126 of the OECD TP guidelines which provides as follows:“It can be difficult to determine the relative value of the contribution that each of the associated enterprises makes to the controlled transactions, and the approach will often depend on the facts and circumstances of each case. The determination might be made by comparing the nature and degree of each party’s contribution of differing types (for example, provision of services, development expenses incurred, capital invested) and assigning a percentage based upon the relative comparison and external market data.”

38. Flowing from the above arguments the Appellant contended that the letter dated 14th April 2022 demanding payment of Kshs 2,559,875,622 lacks legal and factual merit and should be set aside. It identified the following issues for determination in this Appeal:a.Whether the income of Itochu Japan earned from the exportation of goods from Japan is accrued or derived from Kenya.b.Whether the activities of the Appellant are trading activities.c.Whether the profit split method was the correct Transfer Pricing (“TP”) method for the services provided by the Appellant and Itochu Japan.d.If determined that the Respondent applied the wrong Transfer Pricing (“TP”) method, whether they indeed lacked sufficient documentation to assess the correct volumes at the time of rendering the Objection Decision, and whether the Respondent was provided with requisite documentation to arrive at a correct assessment.a.Whether the income of Itochu Japan earned from the exportation of goods from Japan is not accrued or derived from Kenya.

39. It stated that Section 3(1) of the Income Tax Act (ITA) provides that all income accrued or derived in Kenya by any person (individual or body corporate), whether resident or non-resident, is chargeable to tax, and that:a.Under Section 3(1) of ITA, income tax is only charged on profits which are accrued in or are derived from Kenya. That in simple terms this means that if profits are not accrued or derived in Kenya, those profits cannot be taxed in Kenya.b.The ITA has no definition of the phrase “accrued in or derived” from Kenya. That it is for this reason that courts in Kenya and other commonwealth jurisdictions have on several occasions determined that it is income which was “accrued in or derived” from the given jurisdiction.c.The Court of Appeal in the case of Esso Standard East African Inc. v Income tax [1971] E.A. 127 held that for income to be taxable in Kenya, the income must be accrued in or have been derived from Kenya. That the use of the alternatives “accrued in” or “derived from” does not require a separate inquiry.

40. The Appellant posited that in this case, the nature of operations that produce the profits earned from operations carried out in Japan by Itochu Japan have been wrongly assessed to the Appellant.

41. That as an exporter who concluded its sale of goods transactions in Japan and made deliveries in Japan, Itochu Japan cannot be taken to be conducting trade in Kenya.

42. It asserted that Itochu Japan, who is its supplier has its residence in Japan; the contracts are entered into in Japan and the goods were sold in Japan. That the decision of the court in Esso (Supra) applies to this Appeal to the extent that the income of Itochu Japan is not accrued or derived from Kenya.

On compliance with TP requirements 43. The Appellant invoked:a.Section 18(3) of the ITA where it stated that party dealings between a non-resident person (Itochu Japan) and its Permanent Establishment (PE) (the Appellant) should be conducted at arm’s length. It asserted that this transaction was done at arm's length.b.Rule 5(b) of the Income Tax (Transfer Pricing) Rules (“TP Rules”) provides as follows regarding transactions between related parties :“The guidelines referred to in rule 3 shall apply to….transactions between a permanent establishment and its head office or other related branches, in which case the permanent establishment shall be treated as a distinct and separate enterprise from its head office and related branches,”

44. The Appellant stated that it earned its income from providing communication support and market research activities. That in consistence with its Transfer Pricing (TP) Policy it ensured that the income from its communication support and market research service provided to Itochu Japan was taxed in Kenya. That the Respondent thus had no legal basis under Section 3(1) of Section 18(3) to allocate the profits of Itochu Japan earned outside Kenya to the Appellant.b.Whether the activities of the Appellant are trading activities

45. The Appellant contended that Respondent’s contention that its personnel were performing trading activities by referring to the work permit applications of General Manager (“GM”), Heads of Business Segments and other staff was based on a misunderstanding of the facts and documents put before it and also produced in this Appeal.

46. The Appellant responded to the issues raised by the Respondent in its response to the Appeal as hereunder:The Appelant’s response to the issue that it provided communication support services and market research services to Itochu Japan.

47. The Appellant asserted that Itochu Japan’s offices are established in compliance with the laws and regulations of Japan as well as each country of operation and engage in operations such as market research, contact and communication with local clients and partners for Itochu Japan and act as a communication and transmission channel for business inquiries.

48. That the assertion by the Respondent that a liaison office is akin to a “post office” where the persons engaged receive information and forward it, is not known to the law, is narrow and unsupported by any OECD texts, case law or even the dictionary definition.

49. The Appellant further asserted that alternative definition by the Respondent that a liaison office should undertake activities which are only “preparatory and auxiliary” is also unknown to the law because Article 5 of the OECD Model Tax Convention does not define or elaborate a liaison office or liaison activities, nor does it define what activities would be deemed to be “preparatory and auxiliary”. That the said Article only provides the rules for the determination of a PE which is not in dispute in this appeal because it is a PE of Itochu Japan as defined under Section 2 of the ITA.

50. That the Respondent’s definition of the term “liaison activities” is conjured, unsupported and not in line with the Administration Guideline for the Liaison Office. That the Tribunal should glean through its bundle of documents on pages 741 to 750 to obtain clarity as to the activities of the Appellant both in Kenya, Japan and the world outside of Japan.The Appellant’s response to the Respondent’s allegation that the activities of communication support and market research are trading activities

51. The Appellant avowed that Itochu’s Administration Guideline for the Liaison Office made provision for the functions to be performed by all liaison offices including Itochu Nairobi which relates to market research, contact and communication on behalf of Itochu Japan which specifically barred it from undertaking any trading activities. That the Administration Guidelines read in part as follows:“A liaison office refers to a liaison office…which engages in supplementary operations, such as market research, contact, and communication with local clients and partners for the headquarters under its instructions and directions, as a part of the organization of the headquarters, Therefore, the following restrictions must be considered: Trading activities are prohibited. However, a liaison office may act as a communication and transmission channel for business inquiries…”

52. The Appellant stated that in line with this TP Policy, it does not perform trading activities, nor does it have the assets nor the financial capacity to take on the risks typical to a trading entity.

53. The Appellant stated that activities of trading which include on-boarding/ registration of local business partners, order processing and procurement, risk management, company evaluation, contract review, and all necessary analysis required to make decisions on whether or not to conclude a deal are solely handled by Itochu Japan, not the Appellant.The Appellant’s response to the issue that there exists precedents and case laws set in similar disputes involving similar business models

54. The Appellant avowed that its appeal was similar to that in Sojitz India (P) Ltd. Vs. DCIT 24 ITR (Trib) 474 (Del) because it does not take any inventory, negotiate with the customers nor was it exposed to any price risk and warranty risk which are all critical risks and functions associated with trading. That in line with his case, it was apparent to it that the Respondent had erred in its claim that the Appellant’s services should be treated as trading activities.On the issue that the trading activities of Itochu Japan cannot be attributed to the Appellant.

55. It averred that the communication support services and market research services cannot be considered to be trading activities and the Respondent’s characterization of the Appellant as a trading entity lacks legal and factual merit. That furthermore, the trading activities of Itochu Japan cannot be attributed to the Appellant just because the Appellant is a registered branch of Itochu Japan and thus a PE of Itochu Japan.

56. That the issuance of a compliance certificate to the Appellant as a Branch does not in any way entitle the Respondent to tax income that is not accrued or derived in Kenya. That the trading activities of Itochu Japan were not attributable to its PE in Kenya and hence not taxable as was held in the Tribunal’s decision in TAT Appeal No. 26 of 2017- Man Diesel and Turbo SE Kenya-vs-Commissioner of Domestic Taxes.c.Whether the profit split method was the correct transfer pricing method (PSM) for the Appellant and Itochu Japan.

57. The Appellant submitted that the Respondent has undertaken egregious errors in choosing the PSM as the most appropriate method and that as a result, the assessment in dispute cannot be sustained. That the errors include:a.Failure to comply with Rule 7(d) of the TP Rules which provides for the use of PSM.b.Failure to comply with the requirements of the OECD Transfer Pricing Guidelines on the use of the PSM.c.Reliance on an erroneous basis to compute profits earned by Itochu Japan from Kenya and allocation of profits.

58. The Appellant discussed these errors as hereunder:

On failure to comply with Rule 7(d) of the TP Rules 59. That Rule 7(d) of the Income-tax(Transfer Pricing) Rules, 2006 provides as follows on PSM:“(d)the profit split method, in which the profits earned in very closely interrelated controlled transactions are split among the related enterprises depending on the functions performed by each enterprise about the transaction, and compared with a profit split among independent enterprises in a joint venture;”

60. That it would not be appropriate to apply the PSM as mandated by Rule 7(d) since the transaction between Itochu Nairobi and Itochu Japan about the provision of services by Itochu Nairobi to Itochu Japan was a very closely interrelated controlled transaction.

61. That Rule 7(d) of the Income Tax (Transfer Pricing) Rules, 2006, dictates that the split of profits be compared with a profit split among independent enterprises in a joint venture. Its interpretation of this was that the split of profits must be benchmarked to profits that would have been earned by third parties in a joint venture.

62. That the mandatory requirement to benchmark the profits under the profit split method is made clear from the use of the word “and” in Rule 7(d) of the TP Rules because “and” connotes mandatory and conjunctive nature of the requirements, contrary to the Respondent’s witness testimony assertion that these are not mandatory requirements. That this means that the condition of benchmarking must be undertaken before the PSM is applied and failure to do so would be a failure to comply with Rule 7(d) of the TP Rules.

63. That the Respondent was in error when it split the alleged profits of Itochu Japan at 39% to the Appellant, and 61% to Itochu Japan as was confirmed by the Respondent’s witness who stated that they did not compare or benchmark the 39% to 61% profit split against the profit split of any independent enterprises in a joint venture. That the Respondent’s witness has thus confirmed that they failed to comply with Rule 7(d) of the TP Rules on the application of the profit split.On failure to comply with the requirements of the OECD Transfer Pricing Guidelines on the use of the PSM.

64. The Appellant stated that the OECD TP Guidelines and the Revised Guidance on the Application of the Transactional Profit Split Method which was released by the OECD in 2018 have highlighted indicators/criteria to be considered in determining whether PSM is the most appropriate TP method to test a transaction.

65. On whether there is the existence of a unique and valuable contribution by each party to the controlled transaction under Paragraph 2. 130 of the OECD Revised Guidance on the application of the transactional Profit Split Method, the Appellant asserted that Contributions ought to be “unique and valuable” in cases where:a.They are not comparable to contributions made by uncontrolled parties in comparable circumstances, andb.They represent a key source of actual or potential economic benefits in the business operations.

66. That a contribution ought to be unique and valuable where it cannot be benchmarked for purposes of comparing the contribution.

67. On whether there is a high level of integration between business transactions to which the controlled transaction relates under Paragraph 2. 130 of the OECD Revised Guidance on the application of the Transactional Profit Split Method, the Appellant asserted that functions, assets and risks cannot reliably be evaluated in isolation from, how the other party to the transactions performs functions uses assets and assumes risks.

68. On whether there is a shared assumption of economically significant risks or separate assumptions of closely related risks under Paragraph 2. 130 of the OECD Revised Guidance on the application of the transactional Profit Split Method, the Appellant asserted that where one party (the Appellant) does not share in the assumption of economically significant risks, the PSM cannot be considered the appropriate TP method.

69. The Appellant invoked the case of Aztec Software and Technology v ACIT 2007 107 ITD 141 Bang where the Tribunal stated as follows regarding PSM:“This method may be applicable in cases where transactions involve the transfer of unique, intangible or any multiple interrelated international transactions, which cannot be evaluated separately for determining the ALP (Arm’s Length Prices) of any transaction…The contribution of each enterprise is based upon a functional analysis and valued to the extent possible by any available reliable external market data.The functional analysis is an analysis of the functions performed (taking into account assets used and risks assumed) by each enterprise. The external market criteria may include, for example, profit split percentages or returns observed among independent enterprises with comparable functions.’’On the issue that none of the PSM criteria has been met in this case and as such cannot be an appropriate method to apply.

70. The Appellant stated it applied a reliable and comparable benchmarking analysis which was developed by KPMG. That the KPMG analysis undertook an economic analysis to test the arm’s length nature of the services provided by the Appellant including identifying comparable transactions by independent entities. That the said Benchmarking Analysis identified 7 comparable companies and it also confirmed that the services provided by the Appellant have been benchmarked and as such cannot be considered “unique and valuable’’. It then proceeded to discuss some of the said comparable as follows:

71. Firstly, that there is no unique and valuable contribution by the Respondent because it lacked a comparable or reliable benchmarking test. That its consultant had on the other hand undertaken a documented benchmarking analysis exercise.

72. That KPMG’s benchmarking Analysis also undertook an economic analysis to test the arm’s length nature of the services provided by the Appellant including the identification of comparable transactions by independent entities.

73. Secondly that the activities performed by the Appellant are broadly referred to as liaison activities and include communication support, market research and information-gathering activities. That the liaison activities performed by the Appellant cannot be reliably evaluated in isolation from the activities performed by Itochu Japan because they are highly integrated.

74. Thirdly that there is no joint performance of functions, no joint utilization of assets and no shared assumptions of risks with Itochu Japan. That this is documented in the functions, assets and risks analysis performed in the Appellant’s TP policy prepared by KMPG.

75. That where one party does not share in the assumption of economically significant risks, the PSM cannot be considered as the appropriate TP method.On the issue of arbitrary allocation of profits resulting in grossly erroneous assessment

76. The Appellant stated that the Respondent’s decision in arriving at a profit split of Itochu Japan at 39% and the Appellant at 61% was flawed and cannot be relied upon for the application of PSM.

77. That the Respondent relied on arbitrary weights to allocate profits to the Appellant without providing a rationale and thereby introducing a significant level of subjectivity to the taxpayer in determining contrary to the basic canons of taxation. That to avoid such subjectivity in the allocation of percentage contributions, the Appellant ought to have been guided by Paragraph 2. 151 of the OECD Guidelines which provides that the percentage contributions by each party must be based on external market data. That the said Paragraph 2. 151 of the OECD pricing Guidelines provides as follows on PSM:“The determination might be made by comparing the nature and degree of each party’s contribution of differing types (for example, provision of services, development expenses incurred, assets used or contributed, capital invested) and assigning a percentage based upon the relative comparison and external market data,”

78. The Appellant argued that minor differences in the profit split can lead to significantly different results for the taxpayer. That accordingly, it was incumbent on the Respondent to provide supportable information and a significant amount of analysis to substantiate the method it had adopted.On the issue of assessment based on data belonging to other entities not being Itochu Japan to arrive at the alleged profit.

79. The Appellant postulated that the Respondent computed, and allocated profits based on the total sales and purchases based on customs data even though the Appellant had provided it with transaction volume reports for the years 2015-2019.

80. That it was required that the actual profits earned by the Appellant ought to have been applied by the Respondent in adopting and applying its preferred PSM method. That this was more so because the Respondent had raised an assessment based on profits belonging to various separate and independent entities from different countries and jurisdictions that have no relation with the Appellant.

On whether TNMM is the appropriate transfer pricing method 81. The Appellant stated that paragraph 7. 31 of the OECD Transfer pricing guidelines provides as follows on the selection of the method to be applied in determining the arm’s length price for services provided to related entities:“The method to be used to determine arm’s length transfer pricing for intra-group services should be determined according to the guidelines in Chapters I, II and III. Often, the application of these guidelines will lead to the use of the CUP or a cost-based method (cost plus method or cost-based TNMM) for pricing intra-group services.”

82. That the Appellant complied with paragraph 7. 31 of the OECD TP guidelines which provides that cost-based TNMM is one of the methods prescribed for pricing services provided to related entities.d.Once determined that the Respondent applied the wrong transfer pricing method whether they indeed lacked the sufficient documentation to correctly assess the appellant at the time of rendering the objection decision, and whether the Respondent was provided with requisite documentation to arrive at a correct assessment.

83. The Respondent stated that it could not share its employee performance appraisals with the Respondent before the issuance of the Objection Decision because it is prohibited by Itochu Japan from sharing such confidential individual employee information under Japanese data protection laws.

84. That it submitted the said documents once it had ensured that they were not in breach of confidentiality laws or prejudicial to its case.

85. The Appellant stated that it shared the following documents with the Respondent before the issuance of the Objection decision:a.Sample email communications for sesame seeds purchases by Itochu Japan.b.Sample email communications between CMC Motors Group (“CMC”) and Itochu Japan.c.Sample email communications between Isuzu EA (“Isuzu”) and Itochu Japan.d.Itochu Japan transaction volume reports for the yaers 2015 – 2019e.Sample contracts and shipping documents.

86. That the Respondent's assertion in its Statement of Facts that it was not provided with documents was not contained in its Objection decision. That the Respondent had made its objection decision without examining all documents that had been submitted to it contrary to the dicta in Katsran Limited —vs- Commissioner of Domestic Taxes Appeal No.182 of 2021 and the decision of the High Court in Kenya Revenue Authority v Man Diesel & Turbo Se, Kenya [2021] eKLR.

Appellant’s Prayers 87. Based on the above assertions the Appellant prayed for orders that:a.The Respondent’s decision contained in the letter dated 14th April 2022 demanding payment of KES 2,559,875,622 be set aside in its entirety;b.The Appeal be allowed;c.The costs of and incidental to this Appeal be awarded to the Appellant; andd.Any other orders that the Tribunal may deem fit.

Respondent's Case 88. The Respondent supported its opposition to this Appeal with the aid of the following documents:a.Statement of Facts and documents attached thereof dated 24th June 2022 and filed on the same day.b.Witness statement of John Mwangi dated 10th February 2023 and filed on the same date that was adopted under oath as his testimony in chief on 28th November 2023. c.Further list of documents dated 7th February 2023 and filed on the same date.d.Written Submissions dated 11th December 2023.

89. The Respondent posited that the Legal entity being taxed in this Appeal is Itochu –Japan as is evidenced by the fact that the company has been issued with a certificate of compliance in Kenya (F.11/61) and a PIN to enable the government to tax the same on incomes derived by the company in Kenya. That the issuance of a Certificate of Compliance makes it possible for foreign entities to conduct business, own property, and pay taxes and levies in Kenya in their capacity.

90. The Appellant asserted that it had established from the work permits, emails, correspondences, job descriptions of several employees and documents reviewed that the Appellant was performing more functions than just a liaison office.

91. The Appellant stated that Itochu Japan was conducting business operations in Kenya through its duly registered branch in Kenya. That the roles of the General Manager depicted that Itochu Japan Corporation is trading in Kenya. That his work permits also indicated that the reason why he was in Kenya together with his staff was to secure business interest in Kenya for Itochu Japan Corporation.

92. That the work permit seen and reviewed by the Respondent established that the expatriates were performing functions that were more than just being in charge of a liaison office.On the issue that it had erred in law and fact by finding that the appellant’s staff are appraised based on numeric targets set by Itochu Japan and not the qualitative aspects of their liaison activities,

93. The branch refused to supply it with the appraisal documents to help it determine that the Appellant and head office were two legal entities.

94. That the Appellant did not appreciate that it was a separate legal entity and it is to be taxed separately and independently from Itochu Japan.

95. It cited Section 10 of ITA to argue that when it comes to withholding tax, then the there is no separation of branch and head, and that payments to head office are treated as payments within the same entity and thus do not attract withholding taxes. That it is on this premise that it requested Itochu Japan which had been given a certificate of compliance to supply it with documents because the Appellant had declined to share the documents.

96. That both the Appellant and its head office declined to share the signed appraisal forms to assist the Respondent in independently determining the functions performed by the employees, and it was thus compelled to rely on its best judgement and available documents as is provided in Section 31 of the TPA to arrive at its objection decision.On whether the Respondent erred in law and fact by finding that the Appellant and Itochu Japan are highly integrated,

97. The Respondent stated that it carried out a functional analysis and established that the activities of the branch and headquarters are highly integrated based on the information provided. That Appellant refused to provide the appraisal documents on the pretence that the branch and head office were two separate legal entities.

98. That this assertion was erroneous because the Appellant failed to appreciate that the branch, is treated as separate only on account of taxing income that is derived in Kenya to save it from double taxation. That this separation is not intended to hinder the Respondent in the determination of the correct taxes to be paid on income earned in Kenya.

99. That the failure by the Appellant to provide the appraisal documents which were vital in determining the functions that were performed by the staff in Kenya left the Respondent with no option other than to rely on the available information to conclude that Itochu Japan was trading in Kenya through the Appellant.On whether the Respondent erred in law and fact by finding the appellant utilities assets and assumes risks that would demonstrate it is a trading entity,

100. The Respondent averred that Itochu Japan Corporation is a foreign entity and is registered in Kenya as a foreign entity under business registration number F.11/61 as per iTax details.

101. That for a foreign entity to be able to conduct business legally in Kenya it must be given a certificate of compliance. That the said Itochu Japan is taxed in Kenya through the Appellant in line with the certificate of compliance that was issued to it.

102. The Appellant stated that it arrived at the opinion that the branch utilizes a highly qualified assembled workforce, customer lists, supplier lists and that its branch managers assume market risks and credit risks in the actualization of functions based on the activities conducted by the branch based on the records that it had reviewed.On whether the Respondent erred in law and in fact by finding that the profit split method was the most appropriate Transfer pricing method,

103. The Respondent averred that the Appellant failed to provide supporting documentation as requested. In particular, the Appellant failed to provide the appraisal documents of employees, the volume of sales and purchases made by Itochu Japan concerning each business line in Kenya.

104. That this information would have been key or vital in determining the income earned or derived from Kenya by Itochu Japan Corporation. That the same income would then be apportioned to the branch and taxed accordingly.On whether the Respondent relied on an erroneous basis to compute alleged profits earned by Itochu Japan from Kenya and proceeded to allocate profits to Itochu Nairobi based on arbitrary proportions,

105. The Respondent stated that it carried out functional analysis based on information available to it as provided by the Appellant whereupon it established that the Transfer Pricing Policy had not been applied appropriately because Itochu Japan had trading activities in Kenya.

106. That the income earned and derived from all trading activities conducted in Kenya by Itochu Japan should therefore be charged to tax per Section 18 as read together with section 3 of ITA.

107. That its review of the records provided by the Respondent established the Transfer Pricing Policy did not reflect the facts of what the branch was doing and it was thus not appropriate in determining the appropriate TP method in determining the correct taxable income attributable to the branch.

108. That upon review of all records provided, circumstances of the company, customs data, and published financial statement of Itochu Corporation, it concluded that the profit split method was the most appropriate TP method to attribute taxable income earned from Kenya.

109. The Respondent averred that the Appellant failed to provide the volume of sales and purchases data to enable it to appropriately apportion the profit to be subject to tax in Kenya. That it thus invoked Section 31 of the TPA to rely on the available data (customs data) and published financial statements of Itochu J Corporation to arrive at the assessment as communicated.

110. That it was the Appellant’s duty under Section 51(3) (f) TPA to demonstrate the amendments it required when it comes to customs data in relation to Merubeni Itochu Tubular Europe Pls (“MITE”) and Marubeni Itochu Steel Inc. (“MISI”) but that information was not provided and hence its decision stood.On whether the Respondent erred in alleging that the benchmarking analysis conducted by Itochu Nairobi is inappropriate,

111. The Respondent averred that Itochu Nairobi relied on unsustainable comparable in its benchmarking analysis because it used data from companies whose activities were not similar to activities that were carried out by the Appellant.On whether the Respondent erred in fact in asserting that Itochu Nairobi failed to provide relevant supporting documentation indicating Itochu Nairobi’s involvement in trading activities,

112. The Respondent agreed that the Appellant had indeed failed to provide the supporting documentation as requested. That in particular, it failed to provide the appraisal documents of employees, volumes of sales and purchases made by Itochu Japan concerning each business line in Kenya. It was its prayer that the Appellant should be put to strict proof that this information was provided at the assessment or objection stage.

113. That it was within the law for it to request this information from the Appellant because the Appellant was under liability to follow up with Itochu Japan by dint of the fact that Itochu Japan had been issued with a certificate of Compliance with the Appellant registered as its branch.

114. That its overall assessment was that the branch activities were highly integrated with those of the headquarters and that the branch was providing a unique value to the business carried out in Kenya as concluded in the notice of assessment.

115. The Respondent affirmed that it considered the business model of the company and drew the conclusion that the profit split method was the most appropriate approach to attribute income earned from Kenya. This was done after conducting a functional analysis test.

116. The Respondent’s witness, Jackson Mwangi, reiterated the foregoing and further stated that the Appellant’s TP Policy describes it as a liaison office carrying out activities which involve liaising with suppliers, customers and distributors, managing policies, procedures and controls and as prescribed by Itochu Japan.

117. That the Appellant is remunerated based on the Transactional Net Margin Method (TNMM) at a full cost mark –of 3. 2%.

118. It was its testimony that Itochu-Japan purchases motor vehicles from Isuzu Motors Ltd and Mazda Corporation which are manufacturers in Japan and supply the same to distributors in Kenya. The distributors for Isuzu and Mazda Brands in Kenya are Isuzu East Africa Ltd (formerly General Motors East Africa) and CMC Motors respectively.

119. That Itochu Japan is a shareholder in both Isuzu East Africa Ltd (4. 5%) and Isuzu Motors Japan (6. 81%). Isuzu East Africa was incorporated in 1975 as a joint venture with the Kenyan Government and in 1977, it was established as an assembly plant in Kenya for Trucks, Buses and pickups, Isuzu Motors Japan the current majority shareholder in Isuzu East Africa with 57. 7% from the year 2017. That the auto-mobile business falls within the machinery Company segment for Itochu-Japan.

120. He also testified that Itochu-Japan sells chemicals and related commodities used for the manufacture of Polythene terephthalate (PET) bottles and foam mattresses to customers in the East Africa Region. That Itochu Japan has a contract with:a.Tullow Kenya BV and Cepsa Kenya Limited for the supply of steel pipes.b.Marubeni sells hot and cold rolled steel to various manufacturers of roofing iron sheets in the East African Region.

121. The Respondent stated that it had requested the following documents in the course of its audit with respect to the general trading functions of Itochu-Japan:a.Support documents for expenses incurred by the Appellant.b.Emails correspondences with Itochu-Japanc.Applicant for work permit for expatriates working in Kenya.d.Bonus received by expatriate and the basis of their computation.e.Basis of annual appraisal of the expatriates and filled out appraisal documents for each expatriate.f.The volume of sales and purchases made by Itochu-J concerning each business line.

122. That it also carried out interviews with the General Manager and the heads of each department to better understand the business and the functions of the Appellant whereupon it was noted that the General Manager and the heads of each division in Kenya made applications for “class D” work permit in “Form 25” which was accompanied by, among other documents, the employer’s cover letter and the curriculum vitae.

123. That it also reviewed expense documents and email correspondences and noted the following, that:a.The Appellant was actively engaged in business development such as the incubation of next-generation business for motor vehicles, appointment of new dealers, vehicle specification and price discussion with dealers.b.The Appellant was always on copy on email with respect to all orders made by Isuzu EA and CMC Motors to Itochu-Japan.c.The Appellant was also actively involved in seeking orders from suppliers in East Africa and was the link between Itochu-Japan and food suppliers in all correspondences. Itochu-Japan would visit farmers and discuss quality and price issues, hold meetings with food business customers and seek their feedback and also hold meetings with Export Trading Group (ETG), a bulk logistics facility company.d.The Appellant was engaged in promoting the sale of chemicals, evaluating credit worthiness of customers, negotiating price details, seeking new business opportunities and following up on shipments for customers in East Africa and was the link between Itochu-J and customers in all correspondences.e.The warranty extended by Itochu-Japan to any of the customers in Kenya was limited to the warranty provided by the manufacturers.f.A previous employee of the Appellant who was recruited as a technical sales representative from 1990 to April 2000 had successfully initiated and negotiated with non-Japanese manufacturers to co-work with Itochu-Japan for the first time in the East-African region leading to a major shift in the Corporate policy of Itochu and developed business in new territories of Zanzibar and Eritrea.On evaluation of Kenyan Employees and Itochu-Japan’s sales and purchase volume information,

124. The Respondent stated the Appellant has a performance management guideline in which employees are evaluated on the following objectives;a.Quantitative Objective on your business field – Objective for a transaction volume of Head Office (40%)b.Medium and long-term objectives: Related to projects and the discovery of new businesses for Head Office, for medium to long-term initiatives related to head Office business and its communication (30%)c.Self-improvement related to business (20%)d.Other Qualitative Objectives; Objectives related to the achievement of the Head Office’s or Africa Bloc’s vision to be realized and/or issues to be solved in the current year (10%).

125. It argued that the Man Diesel case that was cited by the Appellant was distinguishable from the instant case to the extent that the Appellant’s General Manager and the heads of each department had a quantitative objective relating to transaction volume as a performance metric. That such an evaluation criterion can only exist if the appraisee is aware of the transaction volume, which is a clear indicator that the Appellant was in custody of such information.

126. The Respondent posited that Section 51(2)(c) of Data Protection Act provides for exemption on processing of personal data if the disclosure is required by or under any written law. That additionally, the Japanese’s data protection laws do not apply in Kenya because Kenya is a sovereign State and the employees under investigation were also working in Kenya.

127. That it was justified to ask for and receive these documents because they were related to activities of the Appellant which were carried out by the expatriates while in Kenya, hence formed part of the documents that would ordinarily be requested as provided for under Section 59 of the Tax Procedures Act, 2015 (TPA). That the case of Federal Commissioner of Taxation v. Australia and New Zealand Banking Group Ltd (1979) 143 CLR 499 was thus not applicable in the instant case.

128. That the fact that it has now belatedly provided these appraisal documents in its Statement of Facts for the General Manager and the head of the food business for the year ended March 2020 is a clear demonstration that the information was in the Appellant’s possession.

129. That the submitted documents show that the head of the food business was responsible for the medium and long-term objectives which account for 30% of the overall business development, relationship management with business partners, and development of short, middle and long-term strategies to create new business, overall policy and promotion of food business.

130. The Respondent stated that its interviews with the General Manager and the heads of each department helped it to obtain information which was at great variances with information obtained from the documents reviewed. That for instance, whereas the expatriates indicate that they evaluated only on qualitative aspects of how well they communicate with Itochu-Japan, the filled-out appraisal form indicates a qualitative evaluation.

131. That the documents reviewed confirmed that the Appellant carries out the following functions.a.Business Development-Scouting for new business opportunities.b.Sales and Marketing concerning Automobile, Chemicals, Steel and Projects.c.Procurement with respect to the Food business.d.Supply chain management and logistics.e.Customer and supplier relationship management.

On use of the TNMM 132. The Respondent attested that:a.Section 18(3) of the ITA, as read together with Income Tax (Transfer Pricing) Rules, 2006 (“the rules”) to the ITA, requires compliance with arm’s length principle for a business carried on between a non-resident person who carries on business with a related resident person.b.Paragraph 7 of the Rules enumerates the various methods that a person may choose to demonstrate arm’s length.c.Paragraph 8(2) requires a person to apply the most appropriate method having regard to the nature of the transaction or functions performed in relation to the transaction.d.This position is consistent with Paragraph 2. 2 of the Organization for Economic Cooperation and Development Transfer Pricing Guidelines (OECD TPG).

133. The Respondent posited that the Appellant selected the Transactional Net Margin Method (TNMM) to benchmark the supplementary functions of communication support and collection of market information.

134. That TNMM examines net profit to an appropriate base that a taxpayer realised from a controlled transaction as is exhibited in Paragraph 2. 93 of the OECD Transfer Policy Guidelines which provides that;“The denominator should be focused on the relevant indicator(s) of the value of the functions performed by the tested party in the transaction under review, taking account of its assets used and risks assumed…..”

135. d that the costs incurred are the value driver of the functions performed, which is not true. That the main evaluation criteria for the Appellant’s employees by Itochu-Japan is the volume of business generated which has no nexus with the costs incurred, hence TNMM with full cost mark-up as the PLI is not the most appropriate method.

136. It was its view,that the General Manager is evaluated on cost management, hence the lesser the costs, the better the score. That the costs incurred are therefore not an indicator of the value driver of the functions performed.

137. Additionally, the Respondent urged that the selected comparable companies in the benchmarking study were engaged in activities of call centres, market research and public opinion polling. That these functions are not comparable to the functions of the Appellant.

138. That in any event, even the Appellant’s proposal that its functions are ‘supplementary’ in nature attracting a mark-up on total costs at 3. 1% is less than the recommended mark-up of 5% for low value-adding intra-group services by the OECD Transfer Pricing Guidelines.

139. That Paragraph 7. 45 of the OECD Transfer Pricing Guidelines provides as follows regarding supplementary functions:“Low value-adding intra-group services for the purposes of the simplified approach are services performed by one member or more than one member of an MNE group on behalf of one or more other group members which;a.Are of a supportive nature.b.Are not part of the core business of the MNE group (i.e. not creating profit-earning activities or contributing to economically significant activities of the MNE group).”

140. The Respondent asserted that the Appellant performed more functions than the purported ‘supplementary’ functions. That the functions of the Appellant have a direct impact on the volume of business generated in Kenya as clearly captured in the appraisal documents and the application for work permits.

On use of profit split method 141. The Respondent averred that the Profit Split Method (PSM) is one of the methods that can be used to establish arm’s length outcomes or test reported outcomes for controlled transactions to approximate the results that would have been achieved between independent parties engaging in a comparable transaction or transactions.

142. That Paragraph 2. 119-2. 122 of the revised Guidance on the Application of the Transactional profit Split Method (Revised Guidance), which is the report by the Inclusive Framework on Base Erosion and Profit Shifting (BEPS) Action 10 provides the following as the strengths of PSM;a.It can offer a solution for cases where both parties to a transaction make unique and valuable contributions.b.Can also provide a solution for highly integrated operations in cases for which a one-sided method would not be appropriate.c.It can offer flexibility by taking into account specific, possibly unique, facts and circumstances of the associated enterprises that may not be present in independent enterprises.d.All relevant parties to the transaction are directly evaluated as part of the pricing of the transaction, that is, the contributions of each party to the transaction are specifically identified and their relative values are measured to determine an arm’s length compensation for each party concerning the transaction.

143. That the above guidance provides the following as the instances when PSM is likely to be the most appropriate method;a.Unique and valuable contributions by each of the parties to the transaction.b.Highly integrated business operations.c.Shared assumption of economically significant risks and separate assumption of closely related risks.

144. That the revised guidance does not prescribe the existence of all the above situations concurrently for PSM to apply.

145. That in this case the activities of the Appellant and the activities of Itochu-Japan are highly integrated. That for instance, Itochu-Japan relies on the expertise of the Appellant’s employees to ensure profitable buying and selling in Kenya. That based on this reason and based on the functional analysis, PSM was chosen as the most appropriate method.

146. That PSM first identifies the profits to be split from the controlled transactions and then splits them between the associated enterprises on an economically valid basis that approximates the division of profits that would have been agreed at arm’s length as is encapsulated in Paragraph 2. 147 of the Revised Guidance which states that;“Under the transactional profit split method, the relevant profits are to be split between the associated enterprises on an economically valid basis that approximates the division of profits that would have been anticipated and reflected in an agreement made at arm’s length. In general, the determination of the relevant profits to be split and of the profit splitting factors should:a.Be consistent with the functional analysis of the controlled transaction under review, and in particular, reflect the assumption of the economically significant risks by the parties, andb.Be capable of being measured in a reliable manner.”

147. That the profits can therefore be split either through a contribution analysis or residual analysis. That under the contribution analysis, the division of profits is based on the relative value of contribution taking into account the functions, assets and risks as proxy. That determination is made by comparing the nature and degree of each party’s contribution and assigning a percentage based on the relative comparison.

148. The Respondent stated that it thus developed a functional analysis and allocated weights to the functions, assets and risks between the Appellant and Itochu-Japan based on their relative contributions. The resultant percentage contribution to profits was 39% for the Appellant and 61% for Itochu-Japan.

On distinguishing of case laws 149. The Respondent further stated that it reviewed the case of Aztec Software and Technology v ACIT 2007 107 ITD 141Bang, and noted that the issue in dispute was whether TNMM was the most appropriate method to determine the arm’s length price paid by Aztec India to Aztec US for provision of software development and marketing services. That the Tribunal did not consider the application of PSM, rather, it was mentioned as one of the recommended transfer pricing methods by Section 92C of the India Income Tax Act and Income-tax Rules 10A and 10B and 10C, which were in tandem with OECD Transfer Pricing Guidelines PG. It was its view that the Aztec case therefore does not provide any additional guidance on the use of PSM compared to the Revised Guidance on Profit Split Method or the OECD Transfer Pricing Guidelines.

150. The Respondent highlighted the facts of the case of Commissioner of Income Tax vs Marubeni India Pvt. Ltd to be as follows:a.Maubeni India Pvt. Ltd was a wholly-owned subsidiary of Marubeni Corporation, japan (“MCJ”).b.The taxpayer was engaged to provide agency and marketing support services to MCJ and other group companies. The taxpayer was also coordinating the import and export of goods and services and was also independently engaged in trading.c.The taxpayer was compensated based on MNMM at cost plus a mark-up for the agency and marketing support services. The Transfer Pricing Officer (TPO) sought to change the method to the Profit Split Method.d.The TPO did not tender any document showing the taxpayer’s task was anything beyond mediating between the AEs and customers/vendors in India neither did the TPO elaborate any critical function or decision of the taxpayer relating to MCJ except saying that the taxpayer was engaged in arranging for feasibility studies, industry analysis and project evaluation for potential projects identified by AEs. For these reasons, the appeal was dismissed.

151. The Respondent stated that the Marubeni case is distinguishable from the instant case because the Appellant, in this case, is involved in trading by use of various documents such as the application for work permits, annual appraisals, email correspondences and expense documents. That these documents indicate that;a.The Appellant was responsible for strategy and ensuring profitability of the Itochu-Japan business in Kenya. The employees were also appraised based on transaction volumes which were contracted at the beginning of the year.b.The Appellant was responsible for business development such as searching for new business opportunities, market surveys, getting more aggressive offer bids, maintaining and expanding existing businesses, and relationship management with the strategic partners among others.

On determination of combined profits 152. The Respondent averred that Itochu-Japan is a listed company in Japan, and each year, it publishes its financial statements with corresponding segmented accounts for each business line. That using the profit margin for each business segment in Kenya and the data derived from Customs on imports from and exports to Itochu-Japan it computed the profits to be split and applied a ratio of 39% to determine the taxable income attributable to the Appellant.

153. That the Appellant provided the transaction volume by Itochu-Japan to and from Kenya. However, upon review, the Respondent could not rely on it to compute the combined profits for the following reasons;a.Only data relating to the sale of Motor Vehicles was provided for the period 2015 to 2019. b.Data on the Food Business, Steel and Chemicals division was not provided.c.Only sample agreements were provided.

154. The Respondent identified the following issues for determination in its submissions.i.Whether the Respondent rightly chose the Profit Split Method as the most appropriate Transfer Pricing Method remunerates the Appellant.ii.Whether the Respondent rightly applied the Profit Split Method in apportioning the profit to the Appellant.

155. It proceeded to analyse these identified issues as follows:i.Whether the Respondent rightly chose the Profit Split method as the most appropriate Transfer Pricing Method.

156. The Respondent stated that the Appellant was engaged in activities that went beyond what was described by the Appellant as simple duties of a liaison office.

On work Permits 157. The Respondent averred that the Appelant’s stated that its function were liaison activities. That however, the General Manager’s application showed that he was coming to work in Kenya to carry out the following tasks, among others, as part of his job description:a.To make, review and implement short, medium and long-term strategic plans.b.To develop new business operations such as trade, and joint venture investment in auto mobile, food, and mineral areas but not limited to these.c.To play a leadership role in developing profitable auto-mobile business.d.To develop and create new business in these areas and assist as a General Manager in the administration of business in general, identification and evaluation of acquisition candidates.

158. That the Head of the Auto-mobile Business was to perform the following tasks among others:a.To incubate new business schemes in auto-mobile field such as CASE (Connectivity/Autonomous/Sharing/Electric) related business, logistics plat-formers, leasing, rental, and consumer finance, utilizing business methods which are advanced in Japanese auto-mobile business.b.To co-work with local auto-mobile distributors/dealers to develop their marketing and after-service activity, transferring know-how of Japanese leading auto-mobile manufacturers.c.To develop and create any new business and assist the General Manager in the administration of business.

159. That the Head of the Food Business was to perform the following tasks among others:a.Maintain and develop relationships with Japanese customers and suppliers in Kenya and EA, and by thoroughly understanding their needs and capabilities, ensure the profitable buying/selling/delivery of products/commodities/services to customers.b.Develop and implement budgets and plans aimed at identifying, evaluating and exploiting opportunities to expand profitable relationships with existing customers as well as with new customers, thereby ensuring the continued profitable growth of the business.c.Play a leadership role in developing a profitable food business.d.Develop and create new business in these areas and assist the General Manager in the administration of business in general, identification and evaluation of acquisition candidates.

160. It was the view of the Respondent that these skills did not comprise the simple knowledge and abilities required to perform liaison functions like passively transmitting messages between Itochu Japan and its clients and suppliers. That if that were the case, such skills would be readily available in the Kenyan market. That its decision is buttressed by the fact that for 61 years of its existence in Kenya, the Appellant, has not found any Kenyan national able to occupy the General Manager’s position or head any of its divisions.

161. That the Appellant has stated that its activities are preparatory or auxiliary in nature. It stated that the concept of preparatory or auxiliary activities is aptly captured under paragraph 5(4)(f) and the corresponding commentaries of the Organization for Economic Cooperation and Development Model Tax Convention (hereafter referred to as OECD MTC) which states;“Notwithstanding the preceding provisions of this Article, the term ‘permanent establishment’ shall be deemed not to include:a.The use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise;b.The maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery;c.The maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;d.The maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise;e.The maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activityf.The maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs a) to e), provided that such activity or, in the case of subparagraph f), the overall activity of the fixed place of business, is of a preparatory or auxiliary character.”

162. That by stating that the activities of the Appellant are preparatory or auxiliary in nature, it means that such activities are not the ones that would ordinarily lead to the creation of a permanent establishment whose activities would be taxable in Kenya, which is a contradiction to the facts given that the Appellant has had taxable profits, albeit minimal for the period of its existence in Kenya. It also noted that the activities of the Appellant went beyond what is preparatory or auxiliary.

163. Additionally, the Respondent stated that the guidance on the Attribution of Profits to Permanent Establishments is contained in the (OECD) Base Erosion and Profit Shifting (BEPS) Report on Action 7 (BEPS Action 7 report), which contains changes to prevent the exploitation of the specific exceptions to the PE definition introducing anti-fragmentation rule which provides that;“Given the ease with which multinational enterprises (MNEs) may alter their structures to obtain tax advantages, it is important to clarify that it is not possible to avoid PE status by fragmenting a cohesive operating business into several small operations in order to argue that each part is merely engaged in preparatory or auxiliary activities that benefit from the exceptions of Art. 5(4)”

164. That the underlying principle in the BEPS project was that profits should be taxed where economic activities take place and value is created, and that in this case, the activities of the Appellant are part of the trading activities of the Itochu Japan.

On expense documents and emails 165. The Respondent averred that it also reviewed expense documents and email correspondences and noted the following among other issues;a.The Appellant was actively engaged in business development such as the incubation of next-generation businesses for motor vehicles, appointment of new dealers, vehicle specification and price discussion with dealers.b.The Appellant was always on copy on email with respect to all orders made by Isuzu EA and CMC Motors to Itochu-J.c.The Appellant was also actively involved in seeking orders from suppliers in East Africa and was the link between Itochu-Japan and food suppliers in all correspondences. Itochu-Japan would visit farmers and discuss quality and price issues, hold meetings with food business customers and seek their feedback and also hold meetings with Export Trading Group (ETG), a bulk logistics facility company.d.The Appellant was engaged in promoting the sale of chemicals, evaluating the worthiness of customers, negotiating price details, seeking new business opportunities and following up on shipments for customers in East Africa and was the link between Itochu-J and customers in all correspondences.e.The warranty extended by Itochu-J to any of the customers in Kenya was limited to the warranty provided by the manufacturers.f.A previous employee of the Appellant who was recruited as a technical sales representative from 1990 to April 2000 had successfully initiated and negotiated with non-Japanese manufacturers to co-work with Itochu-J for the first time in the East-African region leading to a major shift in the Corporate policy of Itochu and developed business in new territories of Zanzibar and Eritrea.

On quantitative evaluation of the Kenyan employees 166. The Respondent stated that it noted that the Appellant has a performance management guideline in which employees are evaluated on criteria including quantitative objectives:a.Quantitative Objectives on business field activities which catered for a score of 40%.b.Medium- and long-term Objectives: Related to projects and the discovery of new businesses for Head Office, for medium to long-term initiatives related to Head Office business and its communication which catered for 30%.c.Other Qualitative Objectives; Objectives related to the achievement of the Head Office's or Africa Bloc's vision to be realized and/or issues to be solved in the current year which catered for 10%.

167. That under the quantitative objective which carries a weight of 40%, the Appellant was required (for the year ended March 2020) to achieve a transaction volume of USD 249. 4 Million (approximately Kshs 24. 94 Billion), out of which USD 246. 4 Million (approximately Kshs 24. 64 Billion), which represents 99% of the target, was achieved. The head of the food business was commended for achieving a transaction volume of 114% on sesame, the highest ever for the Nairobi office.

168. That it thus inferred that the Appellant’s transaction volumes were used to evaluate the employees and that this went beyond liaison activities. That only trading activities translate to an increase in volumes.

169. The Respondent asserted that from the foregoing observations, it rightly inferred that the Appellant was undertaking functions of greater importance than that of a liaison office. Such functions include business development in the form of scouting for new business opportunities, sales and marketing concerning the automobile, chemicals, steel and projects, procurement with respect to the food business, supply chain management and logistics and customer and supplier relations management.

On burden of proof 170. The Respondent avowed that Section 56 of the TPA places the burden of proof in tax matters on the Appellant. That this burden was not discharged by the Appellant in this case. It supported its position with the case of Kenya Revenue Authority vs Man Diesel and Turbo Se Ken [2021] eKLR.

On the wrong application of the Transactional Net Margin Method 171. The Respondent asserted that the TNMM was wrong for the following reasons:a.The Appellant used as benchmarks establishments that provided very simple services such as market research, public opinion polling and acting as call centres while the Appellant's functions were more profound and were aggressively aimed at increasing the volume of transactions including creating new business opportunities to increase profitability.b.Under the Bureau Van Dijk database (hereinafter “BvD”) Independence Indicators, only companies with no known shareholding with more than 25% ownership are considered as independent. Of the 7 establishments used as comparable none qualified as independent; three had an identified shareholder with over 50% direct majority ownership, two had known shareholders with more than 25% ownership, one had an unknown degree of independence and the other one, there was no information available as to its ownership. The concept of independence in BVD is synonymous with “control” as defined under the Income Tax Act, where a body corporate is controlled (therefore not independent) if there exists a shareholder with more than 25% ownership.c.The Appellant’s employees were evaluated by Itochu Japan based on the volume of business generated. As such use of the TNMM with full cost mark-up as the Profit Level Indicator is not the most appropriate method. That this is further buttressed by the fact that the General Manager is evaluated on cost management, which means that the lesser the costs, the better the score. The costs incurred are therefore not an indicator of the value of the functions performed.d.The mark-up rate used was below the recommended mark-up rate of 5% in paragraphs 7. 45 to 7. 47 of the Guidelines for low-value-adding services.

On chosing the Transactional Profit Split Method 172. The Respondent avowed that it was guided by:a.Paragraph 2. 119 of the OECD Transfer Pricing Guidelines 2022 in deciding that PSM was most suitable for the transaction under appeal. The said Paragraph 2. 119 of the OECD Transfer Pricing Guidelines 2022 provides as follows:“The main strength of the transactional profit split method is that it can offer a solution for cases where both parties to a transaction make unique and valuable contributions (e.g. contribute unique and valuable intangibles) to the transaction.”b.Paragraph 2. 120 of the Transfer Pricing Guidelines which provides thus:“The transactional profit split method can also provide a solution for highly integrated operations in cases for which a one-sided method would not be appropriate.”c.Paragraph 2. 145 of the Transfer Pricing Guidelines which provides for the common assumption of economically significant risks. That it also provides that the absence of any one or more of the indicators should not prevent its use if the circumstances otherwise require.

On the high integration of activities 173. The Respondent stated that the Appellant was engaged in business development in Kenya spanning very diverse fields from Food, to Chemicals and Equipment and even the auto-mobile industry. As such no independent company would be functionally comparable to the relationship between the Appellant and Itochu Japan, which prompted the shift from TNMM to PSM.

174. That the activities of the Appellant and the activities of Itochu Japan are highly integrated as is provided in Paragraph 2. 133 of the OECD Pricing Guidelines which provides as follows:‘Although most MNE groups are integrated to some extent, a particularly high degree of integration in certain business operations is an indicator for the consideration of the transactional profit split method. A high degree of integration means that the way in which one party to the transaction performs functions uses assets and assumes risks is interlinked with, and cannot reliably be evaluated in isolation from, the way in which another party to the transaction performs functions, uses assets and assumes risks. In contrast, many instances of integration within an MNE result in situations in which the contribution of at least one party to the transaction can be reliably evaluated by reference to comparable uncontrolled transactions. For example, where complementary but discrete activities are undertaken by the entities, it may be the case that it is possible to find reliable comparable since the functions, assets and risks involved in each discrete stage may be comparable to those in uncontrolled arrangements. This needs to be borne in mind in considering which transfer pricing method is the most appropriate in a particular case.”

175. That the Appellant and Itochu Japan were highly integrated because Itochu Japan relies on the expertise of the Appellant’s employees to ensure profitable buying and selling in Kenya and an increase in transaction volumes. That one cannot evaluate Itochu Japan’s functions performed, assets used and risks assumed concerning the trading business transacted in Kenya without taking into account what the functions the Appellant performs, the assets it uses and the risks it assumes. That furthermore, the integration between the Appellant and Itochu Japan takes the form of high interdependency as the activities of the Appellant are part of a cohesive operating business of Itochu Japan, which is general trading.

176. That the fact that expatriates employed are those that Itochu Japan consents to, that they have to be highly qualified, that their cover letters indicate that they were to undertake duties such as making long-term strategic plans, market development, sales and marketing, customer and supplier relationship management, developing profitable business and that their performance was evaluated based on the volume of transactions generated all indicate that Itochu Japan’s business in Kenya cannot be evaluated without taking into account the contributions the Appellant is making.

177. That furthermore, the Appellant also develops new market opportunities while relying on the fact that Itochu Japan will provide the commodities when required while Itochu Japan only delivers supplies with the assurance that the Appellant has sufficiently marketed the relevant product to ensure a complete transaction and that ultimately increase in transaction volumes and profits will be observed.

178. That the second concept is that, for normally integrated Multinational Enterprises, in contrast to highly integrated ones, the contribution of at least one of the parties to the transaction can be reliably evaluated by reference to comparable uncontrolled transactions.

179. That the non-existence of comparable uncontrolled transactions is one of the single threads that run throughout the indicators for the use of PSM. That the Appellant acknowledged this when it stated that its relationship with Itochu Japan is unique and can only be found within the seven trading Japanese trading houses.

180. Based on the above, the Respondent affirmed that that there were no comparable enterprises that had a comparable relationship to the Appellant and offered marketing, sales, market development, and customer relationship services in such diverse fields and industries ranging from Food and Agriculture, Chemicals and Projects to Auto-mobile Business. That given the unique nature of the relationship and the lack of comparable, the Tribunal finds that there was a high degree of integration of the operations between the Appellant and Itochu Japan.

181. The Respondent supported its position with case of Judgment- TAT Appeal No. 614 of 2022 – ECP Kenya Ltd Vs Commissioner of Domestic Taxes .ii.Whether the Respondent rightly applied the Profit Split Method in apportioning the profit to the Appellant.

182. The Respondent stated that after settling on the PSM, it was hereafter guided by Paragraph 2. 154 of the OECD Pricing Guidelines which provides that:“…In determining the relevant profits, it is therefore essential to first identify and accurately delineate the transactions to be covered by the transactional profit split method, and from this identify the relevant income and expense amounts for each party about those transactions.”

183. That it was provided with data on the total volume of purchases and sales relating to the sale of Motor Vehicles in Kenya for the period of 2015 to 2019 but it was not provided with data related to the food business and steel and chemical divisions, both for Kenya and the rest of East African region for which it was responsible for. As such it was its view that this data was incomplete.

184. The Respondent stated that under such circumstances it was forced to base its estimations of on a different set of data which in its best judgement it considered more complete as is provided in Section 31(1) of the TPA.

185. That having determined the profit it proceeded to determine how the profit was to be split whereupon it was guided by Paragraph 2. 149 of the Guidelines which states that;“There are a number of approaches to the application of the transactional profit split method, depending on the characteristics of the controlled transactions, and the information available. As has been described above, the method seeks to split the relevant profits from controlled transactions on an economically valid basis, in order to approximate the results that would have been achieved between independent enterprises in comparable circumstances. This may be done by considering the relative contributions of each party (a “contribution analysis”). Where the transactional profit split method is the most appropriate method but at least one party also makes some less complex contributions which are capable of being benchmarked by reference to comparable, uncontrolled transactions, a two-stage “residual analysis” may be appropriate.”

186. That to approximate the profits attributable to the Appellant, it took into account the functions, assets and risks utilized by both the Appellant and Itochu Japan and proceeded to determine the relative contribution by each party to the transaction by using functions, assets and risks as a proxy for the division and as guided by Paragraph 2. 150 of the OECD Pricing Guidelines.

187. That the unique nature of the relationship between the Appellant and Itochu Japan meant that there was no comparable external data that could be used as a guide to split the profits hence the reliance on information internal to the Itochu group.

Respondent’s Prayers 188. The Respondent’s prayer was for orders that the Tribunal finds that:-a.The Respondent’s confirmation of assessment be upheld.b.The taxes due and unpaid together with interest thereon be paid to the Respondent.c.That this Appeal be dismissed.d.That the Appellant be compelled to pay costs to the Respondent.

Issues for Determination 189. Having looked at the detailed pleadings, documents filed, the testimonies of the witnesses and the submissions of both parties, the Tribunal has identified the following as the two broad issues falling for determination:-i.Whether the Respondent erred in choosing the Profit Split Method as the most appropriate Transfer Pricing Method for the Appellant and Itochu Japan.ii.Whether the Respondent erred in its tax assessment of the Appellant.

Analysis and Determination 190. The Tribunal having identified the issues falling for its determination proceeds to analyze the issues separately as hereunder.i.Whether the Respondent erred in choosing the Profit Split Method as the most appropriate Transfer Pricing Method for the Appellant and Itochu Japan.

191. The crux of this dispute lies in the appropriate arm’s length TP method to apply for the transaction between the Appellant and Itochu Japan. The Appellant prefers Transactional Net Margin Method (“TNMM”) while the Respondent prefers the Profit Split Method (PSM). The facts, law and basis from where their divergence emerges have been well captured in detail in the Appellant and Respondent’s cases herein-above. The Tribunal shall thus not rehash those arguments here.

192. The Appellant holds the view that it carries out liaison services for Itochu Japan which does not involve the utilization of significant intellectual property or the assumption of any trading risks and hence the reason why it thinks that TNMM is the most appropriate method to apply regarding its relationship with Itochu Japan.

193. On the other hand, the Respondent holds the view that the Appellant is evaluated on its trade volume performance and it also carries out trading activities which are integrated with the activities of Itochu Japan thereby exposing it to the the trade risks of Itochu Japan, and hence its decision to apply the PSM method in determining the Appellant’s tax liability.

194. Section 18(3) of the ITA states as follows regarding the application of the arms-length principle:“Where a non-resident person carries on business with a related resident person or through its permanent establishment and the course of that 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 that resident person or through its permanent establishment or from that business shall be deemed to be the amount that might have been expected to accrue if the course of that business had been conducted by independent persons dealing at arm's length.”

195. The OECD Transfer Guidelines have provided for various ways of ensuring that transactions among related parties are carried out at arm’s length. The transactional profit methods provided under the guidelines are PSM and TNMM. Both methods are thus recognized in law, the only difference is that the suitable transactional method that may be used to determine an arms-length transaction would depend on the facts and obtaining circumstances of each case.

196. Paragraph 2. 1 of the OECD has provided the following guidance on what is to be considered in selecting an appropriate Transfer Pricing method:a.the respective strengths and weaknesses of the OECD-recognized methods;b.the appropriateness of the method considered given the nature of the controlled transaction, determined through a functional analysis;c.the availability of reliable information (on uncontrolled comparable) needed to apply the selected method and/or other methods; andd.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.

197. To augment Paragraph 2. 1 of the OECD Guideline, Paragraph 1. 35 and 1. 36 of the OECD Guidelines provide as follows regarding comparable factors for the establishment of an appropriate Transfer Pricing method:“1. 35. …Before making comparisons with uncontrolled transactions, it is therefore vital to identify the economically relevant characteristics of the commercial or financial relations as expressed in the controlled transaction.1. 36 The economically relevant characteristics or comparability factors that need to be identified in the commercial or financial relations between the associated enterprises to accurately delineate the actual transaction can be broadly categorized as follows:i.The contractual terms of the transaction;ii.The functions performed by each of the parties to the transaction, taking into account assets used and risks assumed, including how those functions relate to the wider generation of value by the MNE group to which the parties belong, the circumstances surrounding the transaction, and industry practices;iii.The characteristics of property transferred, or services provided;iv.The economic circumstances of the parties and of the market in which the parties operate; andv.The business strategies pursued by the parties.”

198. When read together Paragraphs 1. 35, 1. 36 and 2. 1 of the OECD Pricing Guidelines, affirm the following as the main and relevant issues to consider in determining the appropriate TP method in this case:a.The availability of reliable information (on uncontrolled comparable) is needed to apply the selected method and/or other methods.b.The contractual terms of the transaction.c.The functions performed by each of the parties to the transaction, taking into account assets used and risks assumed, including how those functions relate to the wider generation of value by the MNE group to which the parties belong, the circumstances surrounding the transaction, and industry practices.

199. The Tribunal finds and holds as follows regarding these identified issues:a.On the availability of reliable information (on uncontrolled comparable) needed to apply the selected method and/or other methods.

200. The parties were in agreement that the Appellant did not provide crucial appraisal documents which were vital in helping the Respondent determine the functions that were performed by the staff in Kenya. The Appellant stated that the same was not provided because the Japanese data protection law prohibited it from sharing that information.

201. The Tribunal finds and holds that this was a convenient excuse proffered by the Appellant to excuse its failure or refusal to supply the documents. This is confirmed by the fact that:a.The specific law that prohibited this action was not particularized.b.The documents in question were eventually supplied and the Appellant did not explain why it had opted to engage in an ‘illegality’ by sharing these private documents.c.No logical reason was provided for its refusal to supply documents which were in possession of its main office which had also been registered for compliance in Kenya, and was thus expected to supply relevant documents required of it.d.The documents in question-related to Kenyan employees who were working in Kenya. The Tribunal could thus not understand how Japanese laws on data protection were applied to Kenyan residents working for the Appellant who was based in Kenya.e.The Applicable law to Kenyan resident taxpayers is Section 51(2) (c) of the Data Protection Act and Section 59 of the TPA which allows the Respondent to access relevant documents that it requires to facilitate its assessment.f.The documents that were eventually provided were not signed by the Appellant, Itochu Japan or employees to verify their ownership, veracity and authenticity.

202. That flowing from these inadequacies, the Tribunal is of the view that the Appellant intentionally refused to share these documents as was required of it under Section 59 of the TPA.

203. Moreover, the Appellant did not explain why it did not supply the Respondent with the following documents that it had requested in the course of its audit exercise vide the letter dated 24th June 2021:a.Support documents for expenses incurred by the Appellant.b.Emails correspondences with Itochu-Japanc.Applications for work permit for expatriates working in Kenya.d.Bonus received by expatriate and the basis of their computation.e.Basis of annual appraisal of the expatriates and filled out appraisal documents for each expatriate.f.The volume of sales and purchases made by Itochu-J concerning each business line.

204. The Tribunal also notes that the emails shared with the Appellant did not relate to commercial communications.

205. That Section 30 of the TAT Act places the burden of proof on tax cases on the Appellant. It provides as follows:“In a proceeding before the Tribunal, the appellant has the burden of proving —a.where an appeal relates to an assessment, that the assessment is excessive; orb.in any other case, that the tax decision should not have been made or should have been made differently.”

206. Section 30 imposed a burden on the Appellant to supply the Respondent with relevant documents and information if it required the Respondent to reconsider its assessment. The Respondent was thus justified to rely on information available to settle on the TNMM.

The contractual terms of the transaction. 207. The contractual terms of the contract between the Appellant and Itochu Japan and third parties are crucial in offering guidance on the appropriate TP method to apply for this specific transaction.

208. The Appellant in this case did not share these contracts. It instead picked a few sample contracts and shared them with the Tribunal.

209. The Tribunal finds and holds that a decision on the appropriate method can only be arrived at if the Respondent is supplied with all contracts that relate to the transactions in question. Sharing sparse sample contracts would thus not aid the Appellant in dislodging the decision of the Respondent and or in persuading the Tribunal to hold that the TP method adopted by the Respondent was not justified. How can that be when the Tribunal has not sighted all contractual agreements related thereto to help it appreciate the type of business transaction that the Appellant was engaging in with Itochu Japan?

210. The Respondent was thus justified to rely on information available to settle on the TNMM.b.On the functions performed by each of the parties to the transaction, taking into account assets used and risks assumed, including how those functions relate to the wider generation of value by the MNE group to which the parties belong, the circumstances surrounding the transaction, and industry practices.

211. The Appellant has persisted that its activities are merely liaison offices. The Respondent has however submitted sufficient evidence before the Tribunal to show that it is involved in the trading activities and has also assumed some risks from Itochu Japan.

212. This was sufficiently proved:a.By using the sample appraisal forms which were shared by the Appellant. These forms confirmed that the Respondent had a performance management guideline in which employees are evaluated on criteria including quantitative objectives which carries a weight of 40%, and from where the Appellant was required (for the year ended March 2020) to achieve a transaction volume of USD 249. 4 Million (approximately Kshs 24. 94 Billion), out of which USD 246. 4 Million (approximately Kshs 24. 64 Billion), which represents 99% of the target, was achieved. The head of the food business was commended for achieving a transaction volume of 114% on sesame, the highest ever for the Nairobi office. This assertion was not traversed by the Appellant through its Statement of facts or documents produced in support of its case.b.When the Respondent confirmed that the work permits, emails, correspondences, job descriptions of several employees and documents reviewed including verbal interviews with the employees showed that the Appellant was conducting business operations in Kenya through its duly registered branch in Kenya. That for example the roles of the General Manager depicted that Itochu Japan Corporation is trading in Kenya and his work permits also indicated the reason why he was evaluated on cost management. So that the lesser the costs the better the score. This assertion was not traversed by the Appellant who only averred that the Respondent had misunderstood the contents of the said work permits which were written in black and white.c.When the Respondent interviewed the General Manager and the heads of each department where it obtained information which was at great variances from information obtained from the documents provided by the Respondent. For example, whereas the expatriates indicated that they were evaluated only on qualitative aspects of how well they communicated with Itochu-Japan, the filled-out appraisal form indicated a qualitative evaluation. This variance was not explained and or disproved by the Appellant.

213. The Tribunal takes the position that the Appellant had the duty to discharge these assertions by the Respondent. Its failure to provide evidence to displace these assertions implies that they have been sufficiently proved as was held in the case of Alfred Kioko Muteti vs. Timothy Miheso & Another [2015] eKLR where the court held that:-“…a party can only discharge its burden upon adducing evidence. Merely making pleadings is not enough”. In reaching its findings, the Court stated that: “Thus, the burden of proof lies on the party who would fail if no evidence at all were given by either party…. Pleadings are not evidence....”

214. In the circumstances, the Tribunal finds and holds that functions performed by the Appellant for Itochu Japan made it to assume risks of Itochu Japan and to also participate in the wider generation of value under the Itochu Japan umbrella.

215. The Appellant has thus failed to align its business operation within the ambit of Paragraphs 1. 35, 1. 36 and 2. 1 of the OECD Pricing Guidelines,

216. Paragraph 2. 64 of the OECD Guidelines provides as follows regarding the application of the TNMM method:“The transactional net margin method examines the net profit relative to an appropriate base (e.g. costs, sales, and assets) that a taxpayer realizes from a controlled transaction (or transactions that are appropriate to aggregate under the principles of paragraphs 3. 9 -3. 12). Thus, a transactional net margin method operates like the cost plus and resale price methods. This similarity means that to be applied reliably, the transactional net margin method must be applied in a manner consistent with how the resale price or cost-plus method is applied.This means in particular that the net profit indicator of the taxpayer from the controlled transaction (or transactions that are appropriate to aggregate under the principles of paragraphs 3. 9 -3. 12) should ideally be established by reference to the net profit indicator that the same taxpayer earns in comparable uncontrolled transactions, i.e. by reference to “internal comparables” (see paragraphs 3. 27-3. 28). Where this is not possible, the net margin that would have been earned in comparable transactions by an independent enterprise (“external comparables”) may serve as a guide (see paragraphs 3. 29-3. 35). A functional analysis of the controlled and uncontrolled transactions is required to determine whether the transactions are comparable and what adjustments may be necessary to obtain reliable results. Further, the other requirements for comparability, and in particular those of paragraphs 2. 74 -2. 81, must be applied.”

217. Paragraph 2. 119 provides as follows regarding the application of PSM:“The main strength of the transactional profit split method is that it can offer a solution for cases where both parties to a transaction make unique and valuable contributions (e.g. contribute unique and valuable intangibles) to the transaction.”

218. Paragraph 2. 120 of the OECD TP Guidelines provides as follows:“The transactional profit split method can also provide a solution for highly integrated operations in cases for which a one-sided method would not be appropriate.”

219. At the heart of paragraphs 2. 64, 2. 119 and 2. 120 is whether the Appellant is a liaison office or it is so integrated with the Itochu Japan that it assumes the risks of the head office.

220. The evidence on record, as discussed in the foregoing paragraphs indicates that the Appellant is carrying out duties that go beyond the listed liaison duties of market research, contact and communication with local clients and partners from Itochu Japan.

221. The performance appraisal forms, work permits and a letter of employment from its General Manager Mr. Nobuyasu Hagiwara show that it is involved in moving the stock of Itochu Japan based on set appraisal targets. This makes it integrate itself into the operations of Itochu Japan from where it assumes the risk of the main office because failure to achieve the targets may attract some form of sanction.

222. It is not in dispute that the Appellant’s TP Policy is clear on its limited role as a liaison office. However, the reality of the actual work and responsibilities which it has undertaken exceeds its role as a liaison office.

223. The guidelines have also made it clear that the TNMM operates like the cost plus and resale price methods. This means that it can only be applied by reference to the net profit indicator that the same taxpayer earns in comparable uncontrolled transactions, using “internal comparable”.

224. The sum total of the testimony presented before the Tribunal showed that both parties and more so the Appellant were not able to table evidence before the Tribunal to present any entity that is comparable to the Appellant and whose pricing model could thus be adopted by the Appellant in its operation under the TNMM method.

225. This came out clearly from the following pieces of evidence presented before the Tribunal where;a.The Appellant stated on page 3 of its response to the preliminary tax audit dated 12th May 2021 that its business model known as Sogososha is unique and it was unlikely that a comparable business that resemble its relationship with Appellant could be found.b.The data from the Bureau Van Dijk database show that out of the 7 establishments used as comparable none qualified as independent; three had an identified shareholder with over 50% direct majority ownership, two had known shareholders with more than 25% ownership, one had an unknown degree of independence and the other one, there was no information available as to its ownership. In essence, this data showed that no company was comparable to the Appellant.c.The Appellant did not provide or refer the Tribunal to any company that could be compared with the Appellant. The companies identified in the benchmarking study were engaged in activities of call centers, market research and public opinion polling. These functions are not comparable to the functions of the Appellant.

226. Paragraph 2. 143 of the OECD TP Guidelines provide as follows:“In general, it will tend to be the case that the presence of factors indicating that a transactional profit split is the most appropriate method will correspond to an absence of factors indicating that an alternative transfer pricing method – one which relies entirely on comparables – is the most appropriate method, determined in accordance with paragraph 2. 2 of these Guidelines. Put another way, if the information on reliable comparable uncontrolled transactions is available to price the transaction in its entirety, it is less likely that the transactional profit split method will be the most appropriate method. (Emphasis ours)

227. Paragraph 2. 115 of the OECD Transfer Pricing Guidelines states:“― The main strength of the transactional profit split method is that it can offer a solution for highly integrated operations for which a one- sided method would not be appropriate… A transactional profit split method may also be found to be the most appropriate method in cases where both parties to a transaction make unique and valuable contributions (e.g. Contribute unique intangibles) to the transaction because in such a case, independent parties might wish to share the profits of the transaction in proportion to their respective contributions and a two-sided method might be more appropriate in these circumstances than a one-sided method. In addition, in the presence of unique and valuable contributions, reliable comparable information might be insufficient to apply another method.”

228. Additionally, Paragraph 3. 20 of the OECD Guidelines states that,“―In order to select and apply the most appropriate transfer pricing method to the circumstances of the case, information is needed on the comparability factors in relation to the controlled transaction under review and in particular on the functions, assets and risks of all the parties to the controlled transaction, including the foreign associated enterprise(s).” (Emphasis ours).

229. Considering that:a.The Appellant failed to supply the Respondent with sufficient documents and data to enable it consider the adoption and use of a different TP method including TNMM that was preferred by the Appellant.b.The quantitative functions and roles performed by the Appellant’s General Manager and Senior Managers which set sales targets amounted to trading activities which integrated seamlessly with the services rendered by Itochu Japan, and also went beyond the basic liaison services that were pleaded by the Appellant.c.The totality of the facts of this case showed that the senior employees of the Appellant carried out quantitative duties and function which surpassed what was contained in their employment letters and their jurisdictional limit of liaison services.d.The Appellant shared appraisal form documents which showed that Itochu Japan had set for it numeric targets which go beyond the liaison services such as market research, communication and inquiry.e.The the Appelant’s work permit application for its top employees like the General Manager and the heads of each division “class D” indicated that the skills required for these top managers was not, and has not been available in Kenya for the last 61 years. This also confirmed that the skills required to operate the affairs of the Appellant went beyond the basic common skills required that had been listed for its for its liaison activities of market research, communication and inquiry.

230. In addition to the foregoing considerations, the Tribunal also noted that the testimonies of the witnesses and documents provided before the Tribunal showed on a balance of probability that:-a.The Appellant performed and offered services like procurement, scouting for new businesses with set minimum targets and sales and marketing which went beyond basic liaison services.b.The skills and qualifications that was required of its top managers also depicted a picture of an entity that was steeped in employing persons whose qualification who were more trade oriented as opposed to being concentrated on the listed liaison activities.c.The unctions performed by the Appellant especially in its sales operations and the target appraisal contracts of its senior employees integrated it with Itochu Japan and also made it assume risks that should have been solely born by the Itochu Japan.

231. The above cited activities as discerned by the Tribunal has also led it to the conclusion that it is indeed true that the activities of the Appellant were highly intergrated with the activities of the parent company. And that the Appellant also assumed risks which was tied to the perfomance of the parent company which had set for it perfomance targets on output and profitability.

232. Accordingly, considering the high integration and the risks that have been assumed by the Appellant in this transaction, the Tribunal relies on Paragraph 2. 120 of the OECD Guidelines which provides as follows in situations where a related company has assumed risks and is also highly integrated with the parent company:“The transactional profit split method can also provide a solution for highly integrated operations in cases for which a one-sided method would not be appropriate.”

233. The Tribunal also relies on the provision of Paragraph 3. 20 of the OECD Guidelines which dictate that in order to apply and select the most appropriate TP method the Tribunal should in particular consider the information on the functions, assets and risks of all the parties to the controlled transaction, including the foreign associated enterprise(s).

234. The fact that the Appellant carried out activities which were integrated with its parent company of Itochu Japan when it assumed some of the risks of Itochu Japan and also performed some core functions which went beyond its liaison activities has thus led to the Tribunal to the conclusion that the Respondent’s choice of PSM method to determine the arm’s length transaction for the parties in this Appeal was not erroneous.

235. The Tribunal’s decision is fortified by the provisions of Paragraph 2. 120 as read with and supported by Paragraphs 2. 143, 2. 115. and 3. 20 of the OECD Guidelines which have aptly provided that the best PSM method for the relationship between the Appellant and the Respondent was the PSM method.

236. Flowing from the above analysis, the Tribunal holds and finds that the Respondent was justified in choosing PSM method to foster the existence of an arm’s length transaction between the Appellant and Itochu Japan as is envisaged under Section 18 of the ITA.ii.Whether the Respondent erred in its tax assessment of the Appellant.

237. The Kenyan tax system is pegged on a source basis under Section 3 of the ITA which provides as follows:“(1)Subject to, and in accordance with, this Act, a tax to be known as income tax shall be charged for each year of income upon all the income of a person, whether resident or non-resident, which accrued in or was derived from Kenya.”

238. This means that any income which accrued or was derived in Kenya shall be taxed in Kenya irrespective of whether the person who has such an income is a resident or a non-resident.

239. The Appellant’s alternative argument was that the key functions that led to generation of revenue are performed by Itochu-Japan was in Japan because the Appellant merely performed liaison functions. That from this argument, it followed that its income was accrued in Japan because it is the place where the relevant profits were generated. It concluded by asserting that the fact that these incomes accrued in Japan meant that the Respondent’s decision to allocating profit was erroneous.

240. The Respondent on its part stated that Itochu has a fixed place of business in Kenya from where it partly carried out its business in Kenya, hence the gains and profits derived from Kenya are taxable. That it reviewed the the business transcations between Itcohu Japan and the Appellant and arrived at an arms length profit allocation of 39%: 61% based on the functional analysis of each entity.

241. That its decision was also based on its best judgment because the Respondent Appellant refused to give it documentation for purchases of motor vehicles made by Itochu Kenya to help it determine the sales made to by Itochu Kenya.

242. The gravamen in this issue revolves on whether the appropriate TP method which supported an arm’s length transaction was applied in determining whether the whole or a portion of the Appelant’s income accrued in or was derived in Kenya. This would answer the question as to whether all of Itochu Japan income accrued in Japan or whether a portion of it accrued in or was derived from Kenya.

243. Having held that the Respondent applied the correct TP method in its assessment, it follows that the profit allocation of 39% to 61% under the PSM method as was stated by the Respondent is the most appropriate method of determining profit allocation between the Itochu Japan and the Appellant.

244. Accordingly, 39% of the Itochu japna’s income was correctly held to have been accrued in or derived from Kenya. Thus the Tribunal hereby finds and holds that the Respondent did not fall into error in its tax assessment of the Appellant.

Final Decision 245. The upshot of the foregoing analysis is that the Appeal lacks merit and the Tribunal accordingly proceeds to make the following Orders:-i.The Appeal be and is hereby dismissed.ii.The Respondent‘s Objection decision dated 14th April 2022 be and is hereby upheld.iii.Each party is to bear its own costs.

246. It is so ordered.

DATED AND DELIVERED AT NAIROBI THIS 9TH DAY OF MAY, 2024ERIC NYONGESA WAFULA - CHAIRMANCYNTHIA B. MAYAKA - MEMBERDR. RODNEY O. OLUOCH MEMBERTIMOTHY B. VIKIRU - MEMBERABRAHAM K. KIPROTICH - MEMBER