[2024] KETAT 1242 (KLR)

Kone Kenya Limited v Commissioner of Legal Services and Board Coordination (Tax Appeal 113 of 2023) [2024] KETAT 1242 (KLR) (23 August 2024) (Judgment)

Neutral citation: [2024] KETAT 1242 (KLR)

Republic of Kenya

In the Tax Appeal Tribunal

Tax Appeal 113 of 2023

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

August 23, 2024

Between

Kone Kenya Limited

Appellant

and

Commissioner of Legal Services and Board Coordination

Respondent

Judgment

1. The Appellant is a fully owned subsidiary of KONE Finland and therefore part of the larger KONE Group. KONE Group is in the business of making and disposal of elevators and escalators around the globe and in countries where it has presence.

2. The Respondent is a principal officer appointed under and in accordance with Section 13 of the Kenya Revenue Authority Act, and is charged with the responsibility of among others, assessment, collection, accounting and the general administration of tax revenue on behalf of the Government of Kenya.

3. The Respondent issued an assessment on 22nd September, 2022.

4. The Appellant objected to the assessment on 21st October, 2022.

5. The Respondent issued its objection decision on 20th December, 2022.

6. The Appellant being dissatisfied with the objection decision, lodged the Notice of Appeal dated 17th January, 2023 and filed on 18th January, 2023.

The Appeal 7. The Appeal is premised on the following grounds as stated in the Memorandum of Appeal dated 2nd February, 2023 and filed on 3rd February, 2023:a.The Respondent erred in law and in fact by failing to understand the Appellant's business model, leading to an incorrect and unjustified segmentation of the Appellant's financial statements resulting in an excessive adjustment of its operating profits.b.The Respondent erred in law and in fact by incorrectly deeming the Appellant's third-party sales as controlled sales.c.The Respondent erred in law and in fact by incorrectly assuming that all intercompany purchases of goods only related to sales and installation of new equipment, leaving out the Appellant's service.d.The Respondent erred in law and in fact in assuming that all costs incurred by the Appellant (including finance costs) exclusively related to the sales and installation of new equipment.e.The Respondent erred in law and in fact by incorrectly considering the Appellant's revenue from maintenance and modernization sales as operating profit without taking into account the costs incurred in generating the said revenue.

Appellant’s Case 8. The Appellant’s case is premised on the following documents:a.The Appellant’s Statement of Facts dated 2nd February, 2023 and filed on 3rd February, 2023 together with the documents attached thereto.b.The Appellant’s witness statement of Ibrahim Sikhule dated 25th September, 2023 and filed on the same date; admitted in evidence under oath on 6th February, 2024. c.The Appellant’s witness statement of Diana Masila dated 25th January, 2024, filed on 26th January, 2024 and admitted in evidence under oath on 6th February, 2024. d.The Appellant’s written submissions dated 20th February, 2024 and filed on the same date together with the authorities attached thereto.

9. That between 2014 and 2018 the Appellant was in a start-up phase ramping up the new business operations and the KONE Way operational model. That the KONE Group has a consistent operational model called KONE Way which defines how it implements the strategy fast and in a common way. That its purpose is for the improvement of the customer service experience, employee satisfaction and business performance.

10. That the Appellant’s operating profit prepared in accordance with the applicable local accounting standards for the years of income 2016-2021 is reproduced below:KES'000 2016 2017 2018 2019 2020 2021*

Revenue 628,370 1,299,829 739,809 1,511,514 1,131,644 1,063,749

Cost of sales -534,056 -1,057,215 -527,499 -1,154,661 -618,832 -569,228

Gross profit 94,314 242,614 212,310 356,853 512,812 494,521

Gross profit% 15. 0% 18. 7% 28. 7% 23. 6% 45. 3% 46. 5%

Other income 165,276 112,393 145,864 0 0 8,332

Operating expenses -179,325 -240,056 -269,924 -232,278 -371,800 -336,700

Operating profit 80,265 114,951 88,250 124,575 141,012 166,153

Operating profit% 12. 8% 8. 8% 11. 9% 8. 2% 12. 5% 15. 6%

11. That there are six main value drivers in the Appellant's business as follows:a)Technology and innovative solutions;b)Global processes/tools/systems;c)Global LIS base and presence;d)Efficient delivery chain;e)Competent and committed personnel; andf)KONE Brand and reputation.

12. That KONE Corporation owns the key intellectual property (IP) within the Group and provides its global subsidiaries with access to this IP (e.g. KONE trademarks and technology) as well as certain technical information and other services. That the success of the franchisees, such as that of the Appellant, is among other things also based on the installed base of lifts in service (LIS). That this in turn is a result of KONE Corporation's technology and a strategy of building this base to expand the possibility of generating long term revenues from service and maintenance contracts.

13. That the success of the new line of products is largely dependent on the technical specifications and design of the products that are sold to final customers, which is the contribution of KONE Corporation as the developer and owner of the related IP.

14. That the Appellant's local sales force performs routine functions and is highly dependent on the bundle of IP, tools and services provided by KONE Corporation at Group level.

15. That consequently, the Appellant contributes by expanding the LIS base with the support of KONE Corporation with its competent and committed personnel whereas the other main value drivers are from the contribution of KONE Corporation.

16. The Appellant averred that it supported its grounds of appeal as follows:

a. The Respondent erred in law and in fact by failing to understand the Appellant's business model, therefore arriving at an incorrect and unjustified segmentation of the Appellant's financial statements resulting in the excessive adjustment of its operating profits. 17. The Appellant stated that it demonstrated that the Respondent failed to understand its business model, therefore arriving at an incorrect and unjustified segmentation of the Appellant's financial statements resulting in excessive adjustment of its operating profits. That it did this by availing documentation, setting up meetings with the Respondent and even providing support via documentation such as the Transfer Pricing (TP) Policy to enable the Respondent to better understand its business model. That despite this, the Respondent in its assessment has made several unfounded assumptions and it is the Appellant's belief that the Respondent failed to understand its business model which the Appellant clarified.

18. That the Appellant regards its business as homogenous and thus splitting the operating income between the new equipment business and the service business is not applicable in the case of KONE. That therefore, the Appellant has only one reporting segment, and it is therefore not possible to provide segregated financial statements for the sale of new equipment and installation and the service sales as requested by the Respondent.

19. That details of the Appellant's lines of business as follows:

a. New Equipment Sales and Installation 20. That the new equipment business (NEB) of the Appellant consists of sales/distribution and installation of new KONE elevators and escalators. That manufacturing as well as related demand and supply planning together with the global sourcing functions are all globally managed and controlled by KONE from Finland. That the Appellant purchases the new equipment mainly from a related party supply line company in China. That the intercompany purchase prices are based on cost plus pricing and supported by benchmarking studies.

21. That further, part of the Appellant's front-line entities' distribution activity, is the installation of new elevators and escalators. That in addition to using own work force, part of the installation activity has been outsourced to manage the fluctuations in the new elevator markets and as such, the installation of the equipment can be deemed as a routine function which can also be performed by an external subcontractor.

22. That KONE Corporation has developed and maintains comprehensive guidelines and instructions for the installation. That these are all availed to the front-line entities in the global database (EDMS). That furthermore, KONE Corporation arranges training to ensure sufficient competence for the installation work.

23. That the Appellant has a harmonized installation process to ensure safety, quality, productivity and customer-centric mindset in installations. That the harmonized installation process also enables the utilization of global tools and solutions provided by KONE Corporation. That Global Installation Management Solutions support productivity and mobility of installation field personnel, by allowing them to manage projects and complete activities away from office, on site. That quality is ensured by guiding employees through daily activities by KONE processes.

24. That after installation, the equipment is transferred to first maintenance and after the warranty period, a sales lead for maintenance business is generated in accordance with globally designed processes.

b. Maintenance and Modernization 25. That the Appellant's servicing activities fall into two major categories: normal preventive maintenance and repair; and "modernization", which involves substantial refurbishing, updating of existing installations and replacing of existing installations. That the service contract base, (Lifts in Service, LIS - including escalators), includes both KONE elevators and third-party elevators (equipment installed by the competitors).

26. That in the maintenance business, the local field technicians provide the service to the customer. That the Appellant performs the maintenance activities in accordance with the Modular Based Maintenance (MBM) practice developed and patented by KONE Corporation. That MBM is based on eight maintenance modules which have been harmonized in KONE's maintenance operations globally. That the modules are performed systematically and in line with optimized maintenance planning. That the MBM consists of global maintenance manuals, maintenance profiles, target times per module and audit procedures.

27. That MBM has resulted in an increase of the quality as well as the productivity of preventative maintenance. That typically, in Kenya each equipment has up to 12 planned maintenance visits in a year according to the MBM.

28. That additionally, in 2017, KONE Corporation launched 24/7 Connected Services, which uses Internet of Things platform and other advanced technologies to bring intelligent services to elevators and escalators enabling vast amounts of data from elevator sensors to be monitored, analyzed and displayed in real-time, improving equipment performance, reliability and safety. That when the sensor detects a defect, depending on the urgency, the technician will receive the information from analytics through KONE Field Mobility (KFM) tool developed by KONE Corporation and the service need is included in the agenda of the next maintenance visit in case of a standard service need or in case of more urgent service needs.

29. That the information is first sent to Global Technical Help Desk (THD)where the urgency can be verified and from where the service need will be forwarded to the local technician through the KFM tool. That in case the 24/7 analytics determines that immediate action is needed, the service need is automatically directed through a global 24/7 call centre to the local technician on duty. That approximately 20% of the Appellant's LIS is connected to 24/7 enabling more efficient preventive maintenance based on the data collected from the specific equipment.

30. That regardless of the preventive maintenance, if the LIS breaks down, the Appellant may be needed to visit the site on ad-hoc basis to perform repair activities and sometimes rescue entrapped passengers. That this is however, a very small part of the maintenance activities and significantly reduced after introduction of the 24/7 Connected services. That repairs are also done on planned basis before the equipment breaks down. That further, spare parts needed in the repairs of KONE elevators are purchased from KONE Supply Line in Finland.

31. That training is provided to local personnel by KONE Corporation on KONE processes, products and tools and the Appellant’s employees have full access to any know-how required in their daily work.

32. The Appellant stated that service business also includes modernization of the equipment, which ranges from replacing a single modular component to the full replacement of the equipment in an existing building. That sales leads for modernization come often from maintenance personnel and the customer base is normally the same.

33. That KONE's full replacement solutions for elevators are designed and manufactured as complete units, which makes installation easy and with minimum disruption. That full replacement is in turn expected to lead to new maintenance offerings. That the Appellant purchases components or in case of full replacement the elevator from KONE Supply Line for modernization purposes. That the components supplied are based on KONE Technology.

c. Lifecycle Business 34. That the Appellant is also engaged in lifecycle business where it serves its customers by providing solutions throughout the entire lifecycle of a product; beginning from the installation of a new equipment to the maintenance and repair and modernization during their lifecycle and finally the full replacement of the equipment. That for this line of business, the Appellant requires extensive customer relations, including deliveries of new products with long-term maintenance contracts through the use of innovation and technology as made available by KONE Corporation.

35. That due to the misunderstanding on the nature of the business of the Appellant, the Respondent has performed a segregation of the income statement of the company and attempted to separate new equipment sales and service sales as separate segments.

36. That the Respondent segregated the FY 2016-2021 income statements of the Appellant by:i.adjusting the new equipment operating profit (EBIT) to 11. 72% after considering excessive costs for this business; andii.adjusting the service-related EBIT to 100% as follows:KES'000 2016 2017 2018 2019 2020 2021*

Revenue 628,370 1,299,829 739,809 1,511,514 1,131,644 1,063,749

Cost of sales -534,056 -1,057,215 -527,499 -1,154,661 -618,832 -569,228

Gross profit 94,314 242,614 212,310 356,853 512,812 494,521

Gross profit% 15. 0% 18. 7% 28. 7% 23. 6% 45. 3% 46. 5%

Other income 165,276 112,393 145,864 0 0 8,332

Operating expenses -179,325 -240,056 -269,924 -232,278 -371,800 -336,700

Operating profit 80,265 114,951 88,250 124,575 141,012 166,153

Operating profit% 12. 8% 8. 8% 11. 9% 8. 2% 12. 5% 15. 6% The Appellant noted that finance costs should be reported below EBIT as depicted below:Year 2018 2017 2016

(Kshs '000) NEB SEB NEB SEB NEB SEB

Sales 510 940 228 869 1 110 841 188 988 461 732 166 638

Cost of sales 527 499 0 1 057 215 0 534 056 0

Gross profit -16 559 228 869 53 626 188 988 -72 324 166 638

GP Margin 96,65% 100% 4,83% 100% -15,66% 100%

Other income 56 247

112 462

174 686

Operating expenses 310 021 0 240 125 0 179 325 0

Finance costs**

40 332

33 021

EBIT -270 333 228 869 -114 369 188 988 -109 984 166 638

EBIT Margin -52,91% 100% -10,3% 100% -23,82% 100%

Adjusted EBIT@11. 72% 59 882

130 191

54115

EBIT on full entity level after proposed adjustment(%) 288 751 (39. 0%) 319 179 (24. 6%) 220 753 (35. 1%)

37. That as described above, there are no grounds for the above segregation. That the profitability of the Appellant in 2016-2021 according to local accounting standards and before any audit adjustment is illustrated in the below table:-2016 2017 2018 2019 2020 2021*

Operating profit(%) 12. 8% 8. 8% 11. 9% 8. 2% 12. 5% 15. 6%

38. The Appellant averred that the Respondent erred in stating that, the arm's length operating profit is in the range of 7. 81% to 18. 95% with a median of 11. 72%. That as can be seen from the above table, the operating profit of the Appellant has varied between 8. 2% and 15. 6% in the period 2016 to 2021, which is already within the range required by the Respondent in all the years. That thus, there are no legal or other grounds for the adjustment performed by the Respondent as the operating profit of the Appellant has, already prior to any audit adjustment, been within the interquartile range of the benchmark study and thus, at arm's length level.

39. That the segregation performed by the Respondent was not necessary since both new equipment sales and service sales are uncontrolled sales although there are controlled purchases of goods from related parties in relation to both businesses. That the Appellant is engaged in lifecycle business where all the business activities are so interconnected that they cannot be evaluated separately and thus form only one common reporting segment.

40. That additionally, the segregation performed by the Respondent results in a completely incorrect result whereby the Respondent has considered that the service business would not bear any fixed or operative expenses and thus results in 100% operating profit margin according to the Respondent. That this assumption is clearly erroneous as the Appellant employs maintenance technicians to perform the maintenance, repair and modernization activities, purchases and employs tools and materials for performing the servicing activities, maintains maintenance vehicles, purchases spare parts for these servicing activities and so on.

41. That the adjustment performed by the Respondent for the financial years 2016 to 2021 is clearly excessive as it results to operating profit margin varying between 24. 6% and 39%. That these margins are clearly above the arm’s length range.

42. That during the years 2016 to 2021, the KONE Group operating profit on global level ranged between 11. 5% to 14. 7%. That the proposed EBIT of 24. 6% - 39% for a routine distributor in the Group is clearly excessive and not sustainable. That should the Respondent demand such operating profits in Kenya, the Appellant’s ability to continue business in Kenya would be severely impacted.

b. he Respondent erred in law and in fact by incorrectly deeming the Appellant's third-party sales as controlled sales. 43. That the Appellant has two core business lines as mentioned in Section 2. 1.1 of the Respondent's 21st October, 2022 tax assessment as follows:i.The distribution of new equipment, i.e., elevators and escalators, which consists of purchase of the equipment from related party supply line and sale and installation of the equipment to external customers in Kenya; andii.Maintenance and modernization of elevators and escalators including both KONE Kenya and third-party equipment, for which spare parts are purchased from both related party global spare part supply unit as well as third parties.

44. That according to the Respondent, only “the latter is an uncontrolled transaction since it is between KONE Kenya and third-party customers”. That this statement is not correct since both businesses include purchases from related parties and sales to third-party customers and thus, both sales of new equipment as well as sales of maintenance and modernization services are uncontrolled transactions. That the intra-group purchases relating to these sales are controlled transactions and the Respondent has not challenged the arm's length nature of these purchases at any point.

45. That Paragraph 2 of Chapter 1 of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022 (OECD Guidelines) defines a controlled transaction to mean:“Transactions between two enterprises that are associated enterprises with respect to each other.”

46. That from the definition above, the Respondent's classification of the Appellant's sales to entities outside KONE Group is openly in contravention of the OECD Guidelines.

47. That the Appellant has further demonstrated that its sales to third parties are in no way influenced by KONE Corporation by demonstrating that:i.It has its own management structure and management team in charge of running day-to-day operations, thereby makes its own commercial decisions such as determining the selling price on sales made to third parties;ii.It maintains its own financial records, bank accounts and separately files its tax returns; andiii.It engages in independent business activities, such as entering into contracts and transactions with third parties, outside the control or direction of the parent company.

48. The Appellant averred that its ability to make its own independent decisions when marketing and selling to third parties means that the sale of equipment cannot be deemed as a controlled transaction.

49. That the Respondent's basis of categorizing third party sales as controlled transactions is also based on an erroneous assumption that KONE Corporation is able to control the prices to third parties by its subsidiaries through its product pricing tool - KTOC Tool.

50. The Appellant clarified that the KTOC tool is provided to the Appellant at Group levels to assist in the pricing. That it is solely the Appellant that decides and inputs the costing elements into the tool such as the labour costs and the cost of locally sourced materials as well as the targeted profit margin levels. That the listed factors mostly influenced by the local market and general business environment inform the Appellant's decisions in pricing and are certainly not external led as incorrectly assumed by the Respondent.

51. The Appellant averred that it inputs into the KTOC tool all other price components based on local market situation apart from the transfer price for the finished goods determined in accordance with the arm's length principle by applying cost plus methodology. That the KTOC tool then assists in calculating the recommended price based on the specifications of the order. That the price calculated by the tool is a recommendation for which the Appellant has the discretion to adopt, quote a higher price to the customer or provide a discount without any approvals needed from KONE Corporation.

52. That it is only the cost of equipment purchased from related party Supply Lines that that is based on Group level price lists and the pricing of the equipment purchased intra-group is supported by a benchmarking study. The Appellant attached the benchmarking study to demonstrate the Appellant's product pricing for related party transactions. That the Group product pricing does not apply to third party sales by the Appellant.

53. That it is not uncommon for routine distributors to determine or negotiate prices with third party customers using pricing guidelines and price lists adopted within the Multi-National Enterprise (MNE) group.

54. That based on the above, the Respondent's transfer pricing adjustment is punitive and does not take into account the business model of the Appellant as comprehensively described in the parties’ various correspondences.

c. The Respondent erred in law and in fact by incorrectly assuming that all intercompany purchases of goods related to sales and installation of new equipment and none to the service business by the Appellant. 55. That the Respondent in making the adjustments made an erroneous assumption that all intercompany purchases of goods related to sales and installation of new equipment and not services.

56. That the Respondent has based this assumption on the understanding that the KONE Global Customer Care Centers (KC3) has the capacity to provide emergency services and the Rescue and Repair instructions (AS) without the involvement of the Appellant's employees stationed in Kenya.

57. That similarly, the Appellant's customer interface is highly dependent on the bundle of IP, tools and services provided by KONE Corporation.

58. The Appellant clarified that the KC3 and AS systems (rescue and repair instructions)are largely dependent on the software intangible developed by KONE Corporation, the absence of which would significantly hamper the Appellant's ability to meet the needs of its customers.

59. That from the Appellant's TP policy, the KONE technology, brand, know-how and tools, methods and processes are developed by KONE Corporation. That the provision of services to the customers in Kenya is thus dependent on the seamless interaction between the IP tools provided by KONE Corporation and the local team of technicians.

60. That at the same time, KONE Corporation provides training service to the Appellant's personnel on the processes, products and tools. That the Respondent's suggestion that the local emergency teams are able to provide the services without the support from KONE Corporation is therefore unfounded.

d. The Respondent erred in law and in fact by failing to appreciate the functions performed by the Appellant, assets employed, or the risks assumed by the Appellant in performing the transactions under review. 61. That according to Paragraph 1. 34 of the OECD Guidelines, the typical process of identifying the commercial or financial relations between the associated enterprises and the conditions and economically relevant circumstances attaching to those relations requires a broad-based understanding of the industry sector in which the MNE group operates (e.g., mining, pharmaceutical, luxury goods) and of the factors affecting the performance of any business operating in that sector.

62. That it is the Appellant's view that the functions performed by the Company are those of a routine distributor as described already above. That the assertion by the Respondent that KONE Kenya would perform functions or bear risks that are not common to routine distributors is based on incorrect understanding of KONE Kenya's business. That it is clear that the Respondent has failed to understand the industry in which KONE Kenya operates in when claiming that KONE Kenya would perform functions and assume risks above those of a routine distributor which has led to the incorrect and excessive transfer pricing adjustment.

63. That the company assumes limited risks relating to marketing, sales, distribution and maintenance of the products locally. That the company utilizes bundle of IP, solutions, processes and tools developed, owned and provided by KONE Corporation for KONE Kenya to perform its routine distribution and servicing functions in accordance with the KONE Way processes and guidelines. That KONE Kenya does not own any significant intangible property. That KONE Kenya's functional profile is in line with routine distributor functions, risk and asset classification and is summarized on high level below:KONE Kenya Other KONE Company

Functions

Research and Development N/A KONE Corporation is responsible for R&D activities in the KONE Group

Manufacturing N/A KONE Supply Units are responsible for manufacturing products in accordance with the specifications/designs from KONE Corporation

Marketing, Sales and Distribution Routine function taking care of meetings with potential customers, informing the customer of the quality of KONE products and services, and bidding on customer tenders. Support from KONE Corporation

Engineering N/A KONE Corporation is responsible for all engineering activities in the KONE Group

Sourcing and Material Management Limited local sourcing and material management functions Global Sourcing and Material Management Support from KONE Corporation

Installation KONE Kenya performs installation in accordance with global guidelines and processes. Installation activities are also outsourced to third party subcontractors and thus, the function can be considered routine. KONE Corporation has developed and maintains comprehensive guidelines, instructions and processes for the installation.

After sales services KONE Kenya performs maintenance and modernization functions and utilizes processes, guidelines and tools provided by KONE Corporation. KONE Corporation provides to KONE Kenya the necessary know-how, solutions, tools and guidelines to perform the maintenance and modernization activities in safe and efficient manner.

Risks

Research and Development Risk N/A Assumed fully by KONE Corporation

Material and manufacturing Risk N/A Assumed fully by KONE Supply Line

Market Risk Shared with KONE Corporation, however, limited because of the Global TP Policy applied to KONE Kenya Shared with KONE Corporation

Inventory Risk Risk is limited as purchases are made to order KONE Corporation assist in inventory management

Product Liability Risk N/A KONE Supply Unit bears the product liability risk

Foreign Exchange Risk Moderate Hedging performed by KONE Corporation to mitigate the FX risk as necessary

Customer Credit Risk Moderate Credit risk control policies in place by KONE Corporation to mitigate the risk

Transportation Risk Limited Global insurance policy by KONE Corporation to mitigate the risk

Assets

Customer Contracts Owned by KONE Kenya N/A

Tangible Assets Limited Assets Various

Intellectual Property N/A Technology, Patents, Utility Models and Designs, KONE brand as well as tools and processes

64. That in relation to inventory risk the above summary is premised on the fact that the related party new equipment purchases by the Appellant are based on the customer order, thus the Appellant holds very limited inventory only in relation to certain key spare parts. That the Appellant also controls the inventory levels in accordance with KONE processes, with KONE material management system DBS and regular inventories.

65. That the "non-return point" referred to by the Respondent in its assessment and objection decision relates to the start of the manufacturing of the ordered product. That all KONE's distribution companies have to respect the "non return point", which means that after the production process starts in a manufacturing unit, all the cumulated costs will be invoiced to the distribution company, even in the case of order cancellation. That this is because each elevator sold is an individual product with specific finishes and drawings even in case of a standard elevator. That the products are made to order, and the use of cancelled order for another project is typically not possible.

66. That in order to mitigate any cancellations, the start of the manufacturing is mutually agreed between the KONE Supply Line and the Appellant and requires for:i.the customer confirmation and approval of shaft drawings and elevator finishesii.confirmation on shaft and site readiness survey as well asiii.receipt of advance funds from customer in accordance with project payment terms.

67. That the external customer is fully aware of its obligations at non-return point. That thus, cancellation risk is equal to none and there are no occasions where the risk would have materialized. That thus, the risk for the Appellant is low and aligned with the functional profile of a routine distributor.

68. That as the locally established company, the Appellant acts as the importer of the products to Kenya and complies with related obligations towards the external customer. That further, since typically the equipment is sold installed, the Appellant is also responsible for the installation activities.

69. That although the Appellant may be legally responsible towards its customer for product defects as the importer of the products, this does not impact the fact that the Appellant can claim compensation in full, from the KONE supply line in case product liability risk is realized. That thus, as stated by the Appellant in its response to the Respondent, it is the KONE Supply Line which fully bears the product liability risk.

70. That from the above, it is clear that the Appellant does not bear any product liability risk as has been assumed by the Respondent in its objection decision.

71. That in relation to sales, the Appellant employs a qualified sales team to source for clients while also maintaining a technical team for the installation and maintenance of the machines. That the functions performed by the Appellant's sales team leverage on existent demand in the market for KONE products. That the potential success of new line of products is largely dependent on the technical specifications and design of the products that are sold to final customers. That the engineering team under KONE Corporation holds the necessary level of technical expertise on KONE products and services to be able to serve customers with the right solutions. That the marketing services in respect of KONE's products can be provided by any other marketing firm and are therefore routine.

72. That it is therefore the Appellant’s view that the marketing and distribution activities performed by the Appellant are more limited and do not significantly enhance the goodwill or reputation associated with the trademark.

e. The Respondent erred in law and fact in disregarding the Appellant's Group Transfer Pricing model and benchmark analysis of the arm's length operating profit level 73. That according to the OECD Guidelines, the application of the arm's length principle is based on a comparison of the conditions in a controlled transaction with the conditions that would have been made had the parties been independent and undertaking a comparable transaction under comparable circumstances.

74. That in the Appellant's case, the controlled transactions to be tested were the purchases of goods from related parties and payment of the franchise fee and the most appropriate method selected to test the arm's length result of these controlled transactions is the transactional net margin method whereby the operating profit earned by the Appellant in its distribution activity is compared to the operating profits earned by similar independent distribution and servicing companies.

75. The Appellant averred that in order to arrive at an arms-length position, it engaged a third-party service provider to perform a comparable company analysis to benchmark the arm's length operating profit return earned by comparable distribution, maintenance and installation companies operating on comparable industries to that of KONE. That it attached the benchmarking analysis used for the period under review to its pleadings.

76. That to benchmark the more profitable parts of the business, the comparable study focused on companies primarily involved in the servicing, maintenance and installation functions and thus earning also higher profits compared to traditional buy-sell activities only. That buy-and-sell distribution functions combined with the servicing activities are accepted in comparable companies. That thus, the comparable analysis does consider also the buy-sell activities of KONE Kenya.

77. That the global transfer pricing model, which is consistently applied to all KONE routine distribution units such as the Appellant, also ensures that the Company earns at least the arm's length operating profit margin (measured with KONE reporting IFRS figures). That the Appellant attached the global transfer pricing policy to its pleadings.

78. That it is on the above basis that KONE Corporation charges the Appellant a franchise fee for the right to use KONE Technology, brand, know-how and tools, methods and processes developed by KONE Corporation based on a Franchise Fee Agreement. That according to the Franchise Fee Agreement, the franchise fee will be calculated under the arm's length principle as a percentage of KONE Kenya's net sales, benchmarked by reference to analogous third-party arrangements. That in 2016-2021, the benchmarked franchise fee rate has been 9. 5% of net sales.

79. That the Franchise Fee Agreement, however, also states that “the fee in respect of any year shall not exceed such amount as would reduce the operating profit of the front line for that year to an amount below the arm’s length level for the year defined in Schedule 2”. That thus, the operating profit of the Appellant cannot be reduced below 5% based on the Franchise Fee Agreement.

80. That the 5% operating profit margin is based on a benchmark study by a third-party professional service provider to verify the arm's length nature of the return earned by the Appellant. That according to the benchmarks (which are regularly updated to ensure up-to-date results), the 5% operating margin is within the arm's length range in 2016-2021.

81. That however, in the KONE Global transfer pricing policy there is no mechanism to limit the operating profit margin of the Appellant to only 5% as incorrectly claimed by the Respondent. That the franchise fee rate is thus not increased even if the operating profit of the Appellant would increase above 5% and thus all operating profits earned above the maximum 9. 5% franchise fee remain as operating profit of KONE Kenya.

82. That from the above, the Respondent had no grounds to disregard the Company's benchmark analysis for the arm's length operating margin.

83. That additionally, from the most recent benchmark analysis performed, the aforementioned buy-and-sell distribution companies were also included in the analysis to see whether this would impact the results as the Respondent has claimed, i.e. resulting in higher return for the activities. That the result was that the comparable analysis resulted in a lower arm's length operating profit margin range compared to the earlier analyses where only the servicing and installation activities were considered; an arm's length range of lower quartile 1. 59% to upper quartile 6. 72%, with a median of 2. 72%. That from this perspective it is also safe to assume, that the 5% operating profit margin ensured for the company for the whole distribution activity including the service business has been within the arm's length level.

84. That furthermore, the comparable companies included in the benchmark analyses are independent, fully fledged distributors and no comparability adjustments have been performed to the financial information of the comparables to reflect the more limited risk profile of KONE Kenya and thus lower profit expectation, which would be a common practice when benchmarking such limited risk routine operations.

85. That thus, the operating margin of 5% supported by the benchmarking analysis already reflects the profit level that an independent fully fledged, integrated distributor would expect to earn. That thus, there was no legal or factual justification for the Respondent to disregard the Appellant's benchmarking analysis.

f. The Respondent erred in law and in fact in raising an erroneous tax demand based on its own benchmarking analysis which did not fulfil the independence requirements of a reliable comparable study. 86. That the Respondent based its tax adjustments and subsequent assessment on a defective comparable study.

87. That from the Appellant’s review, the Respondent's benchmark analysis does not fulfil the independence requirements outlined under Chapter 3, Paragraph 3. 1 of the OECD Guidelines for the following reasons:i.The comparability of the functions of most of the companies in the final set was not possible to be confirmed since the companies did not have web pages or any other information available.ii.Some companies included in the final set of the Respondent's comparables were subsidiaries of International Groups of companies and thus not acceptable comparable companies since transfer pricing could have distorted the results of such dependent companies.iii.Some of the companies considered by the Respondent in its benchmarking analysis did not engage in comparable business activities to those of KONE Kenya.iv.The study period of FY2015-19 included in the Respondent's analysis includes data which would not have been available during the years under audit as the external databases typically only have financial data available two years after the end of the financial year in question. That this is contrary to Paragraph 3. 74 of the OECD Transfer Pricing Guidelines which prohibits the use of that hindsight in transfer pricing analysis.

88. That based on the above, the Company is of the view that the benchmark analysis on which the Respondent has based the assessment calculations is not a reliable analysis of the arm's length range of operating profits earned by independent companies engaged in comparable activities in comparable industry as the Appellant.

89. That in any case, the Appellant is of the view that the benchmark analysis performed by the Respondent is not necessary since there are no grounds to disregard the Company's analysis anyway.

g. The Respondent erred in law and in fact by considering a one-off correction to a long-term loan in the Appellant's financial statements as forex loss. 90. The Respondent’s averment in its assessment that the Appellant remains potentially exposed to risks from foreign exchange rate fluctuations related to currency flows from revenue and expenses is not correct.

91. That from a review of the Appellant's financial statements, the Respondent has taken an erroneous view that since the Appellant purchases its goods from related parties in foreign currencies but sells its products in Kenya Shillings the Appellant is exposed to risks arising from foreign exchange rate fluctuations.

92. That on the basis of the above assumption the Respondent proceeded to make an adjustment on a long-term loan in the Appellant's financial statements claiming that it relates to forex loss.

93. The Appellant asserted that the said forex loss in FY 2018 does not relate to its distribution related transactions but a one-off correction to a long-term loan. That the Appellant attached the loan movement schedule to its pleadings.

94. The Appellant clarified that KONE Corporation assists the Appellant with some hedging and foreign exchange activities which helps minimize the forex risk loss.

h. Without prejudice to the grounds above, the Respondent's assessment is beyond the statutory assessment time limit of 5 years as clearly provided for under Section 31(4) of the Tax Procedures Act (TPA). 95. That Section 31(4)(b) of the TPA provides that:“The Commissioner may amend an assessment(a)in the case of gross or willful neglect, evasion, or fraud by, or on behalf of, the taxpayer, at any time, or(b)in any other case, within five years of(i)for a self-assessment, the date that the self-assessment taxpayer submitted the self-assessment return to which the self-assessment relates.”

96. That further, Section 2 of the TPA defines a reporting period as:“for the income tax, the year of income or, when section 27 of the Income Tax Act applies, the accounting period of the taxpayer...”

97. That in applying the above legal provisions in this case, the reporting period to which income tax relates to that the Respondent may assess, relates only to the year 2018 going forward. That therefore, the Respondent's assessment and tax demand for the 2016 to 2017 years of income is time barred.

98. That indeed, the Respondent in its assessment or objection decision has not illustrated or provided any information to show that its issuance of assessment beyond 5 years is as a result of proven gross, or wilful neglect, or tax evasion by the Appellant.

i. Without prejudice to the grounds above, the Respondent erred in law and in fact by issuing a demand covering periods in excess of the audit period without due notice to the Appellant. 99. That when the Respondent issued a notice of intention to audit to the Appellant, the period of audit according to the letter dated 27th March, 2020 was outlined as December 2015 to December 2018. That however, the Respondent proceeded to expand the assessment to the period 2016 to 2021 without any prior notice or subsequent reasons for the same.

100. That procedurally, the expectation is that the Respondent ought to communicate its intention to extend the period of the audit. That the Appellant is not aware of any notice extending the audit period post December 2018. That this is yet another clear illustration of the Appellant’s concerns around the lack of fairness of this administrative process and the Respondent's blatant disregard for procedure with respect to the audit.

101. The Appellant further averred that this extension of the period under audit without notice was done in bad faith.

102. The Appellant stated that the actions and omission of the Respondent to communicate the period of assessment amounts to unfair administrative action by the Respondent contrary to Article 47 of the Constitution of Kenya.

103. That in that regard, the Appellant refuted the assessment by the Respondent for the period 2019-2021 on the basis that it was erroneously arrived at and the Appellant was denied the right to procedural fairness as espoused within Article 47 of the Constitution.

Appellant’s Prayers 104. The Appellant prayed that this Tribunal:a.Vacates the assessment relating to the periods 2016 and 2017 in the first instanceb.Sets aside the Respondent’s objection decision dated 20th December, 2022 in its entirety with costs to the Appellant.c.Be pleased to issue any other remedies that the Honourable Tribunal deems just and reasonable.

Respondent’s Case 105. The Respondent’s case is premised on the hereunder filed documents:-i.The Respondent’s Statement of Facts dated 24th February, 2023 and filed on the same date together with the documents attached thereto.ii.The Respondent’s bundle of documents dated 5th February, 2024 and filed electronically on the same date.iii.The Respondent’s witness statement of George Nzoka dated 8th September, 2023, filed on 11th September, 2023 and admitted as evidence under oath on 6th February, 2024.

106. The Respondent stated that the Appellant officially commenced its operations in Kenya in August 2014 after a successful acquisition of Marryat and Scott (Kenya) and Marryat East Africa (Uganda). That Marryat and Scott was at the time the sole and routine distributor of KONE products in East Africa since late 1999. That however, following the acquisition, the Appellant has grown to become one of the fastest-growing elevator and escalator companies in East Africa, currently serving over 600 clients. That its services include providing industry-leading elevators, escalators, and innovative solutions for maintenance and modernization of the equipment.

107. That the Appellant's main customers for its new equipment business are developers, main contractors, architects and other contributors in the construction sector. That the Appellant also provides maintenance services (after-sales) to its customers and to this end has secured contracts for maintaining the already installed equipment.

108. The Respondent averred that the Appellant's right to distribute KONE's products in the region is authorized via the Franchise Agreement dated 1st January, 2018 between the Appellant and KONE Finland a related party.

109. That from the Appellant's audited financial statements for FY2016 to FY2018, it is indicated that it made intercompany purchases totaling to Kshs. 1. 2 billion. That however, over the period, the Appellant returned negative operating margins. That this necessitated compensation from KONE Finland amounting to Kshs. 423M over the period. That it is this position that precipitated the transfer pricing audit of the Appellant to ascertain whether the transactions with its related parties were at armlength.

110. The Respondent stated that the transfer pricing audit was carried out for the period 2016 to 2018 with an outcome whose uniform methodologies were applied for the subsequent assessment issued for the period 2016-2021.

111. That in arriving at the assessment, the Respondent undertook a benchmarking analysis and computed the profit margins of the Appellant using comparable 3rd parties in similar business.

112. The Respondent reiterated that in arriving at the assessment, the Appellant's business model was well appreciated, Functions, Assets & Risks (FAR) considered and the consequent adjustments were justified. That this is corroborated by the following facts:a.An analysis of the Franchise Agreement dated 1st January, 2018 with KONE Finland reveals that the Appellant has been granted a nonexclusive license to use KONE technology, knowhow, show-how, trademarks and IT systems for the conduct of frontline business. That the Appellant has also been granted rights to use 3rd party systems for the conduct of its business, receives various services from Kone Finland in a bid to improve performance efficiency etc. That further terms of the Agreement are summarised in the notice of preliminary audit findings, assessment and the objection decision.b.That upon review of the Appellant's Transfer Pricing Policy, it was established that its transaction with related parties was not at arm’s length and the model used by the Appellant to arrive at the transfer price was thus unacceptable. That the audit revealed that the applied 5% operating margin compensation to the Appellant relates to a routine distributor which does not apply to the Appellant. That to the contrary, the Appellant is in fact an integrated distributor bearing more risks as opposed to the routine distributor. That accordingly, the margin adopted did not remunerate the Appellant its fair share of return based on the functions it performs, assets employed and risks assumed in the transaction leading to erosion of the Kenya's tax base and shifting of profits. That this position is corroborated by the following:i.The Appellant does not routinely sell / distribute the equipment to the customers in their imported original form. That customers enter into contracts with the Appellant to get a finished and functional product. That as such, the sale entails the product cost as well as installation. That the installation ensures that the Group products (machines) are functional. That this is corroborated by the packing list to the custom declarations/ documentation which invariably demonstrates that the equipment is not imported as single unit but rather as parts making up the unit. That it is then that the parts are assembled by the Appellant, sold and installed to a specific customer hence the value addition by the Appellant.ii.That the Appellant has employed qualified personnel to source for clients/customers and technicians to conduct installation and maintenance services to its customers. That accordingly, its role is not merely to distribute but equally to expand the market base of customers. That the Appellant engages in sales and marketing to push the product into the market with uncompensated set targets from the Group. That indeed, the growth of the Group and the expanded market share in Kenya is largely attributed to the robust roles the employees and the Appellant play.iii.That the Appellant bears significant inventory risk under the 'non- return point' transfer policy which provides that all affiliates purchasing machines from the Groups manufacturing units bear all costs for production as long as the manufacturing process has begun. That in the event, a customer turns down an order, the Appellant bears the loss incurred in such instances. The Respondent noted that the Appellant admitted to having measures put in place to moderate risks and gave explanations on the same, which confirms that the Appellant bears full risks arising from cancellation of an order by a customer.iv.That the Appellant also bears forex risks as it purchases its goods from related parties in foreign currencies (EURO, RMB, and USD) but sells its products in Kenya Shillings. That it is thus exposed to risks arising from foreign exchange rate fluctuations related to currency flows from revenues and expenses. That further, there are credit risks incurred by the Appellant where a customer fails to pay for the work done and in relation to loans taken.v.That the prices charged to customers are not at the Appellant's own discretion but purely determined by the Group billing system (KTOC Tool). That by using this tool, Kone Corporation is able to control the prices to third parties by its subsidiaries. That the single objective of using this tool is to squeeze the Appellant's profit margins in Kenya.

113. That from the foregoing, it is clear that the Appellant does not have control of prices to third parties, has qualified staff for various areas (sales, technical and installation) and equally bears all the risks involved. That based on the above, the Appellant could not be treated as routine distributor since the services offered went beyond the conduct of a routine distributor but that of a non- routine distributor.

114. That the Appellant's model was therefore at variance with the independent third-party companies (Maryatt & Scott) which was initially engaged by the Group and whose business terms demonstrated routine Distributorship Agreement. That relevant clauses of the Maryatt & Scott Group Distributorship Agreement supporting this position are 2. 1, 2. 2, 3. 2 and 3. 4. That the KONE Group acquired the business of Maryatt & Scott principally to own the market as a Group and not through a 3rd party company.

115. That it was thus clear that the business terms and model adopted between the Appellant and the group was solely meant to reduce taxable profit in Kenya. That consequently, the Respondent was justified to adjust the prices in order to reflect the arm’s length price payable.

116. The Respondent stated that in arriving at the adjustment, it was able to differentiate between the Appellant's controlled transactions and third-party transactions. That the Respondent’s main focus was on the controlled transaction being the purchase of equipment from related parties for resale. That contrary to the Appellant's position therefore, no third-party sales were considered as controlled transactions.

117. In regard to bench-marking, the Respondent averred that bearing in mind that the Appellant's margins of 5% failed to take into account the FAR as highlighted above, the Appellant was requested to provide segregated financial statements and sales invoices to its customers/ 3rd party invoices to enable the Respondent delineate the transactions so as to establish the appropriate transfer pricing method and determination of the correct arm’s length margins.

118. That however, the Appellant neglected, failed and ignored the request and the same has not been provided even to the Tribunal. That the Appellant therefore cannot aver that the margins used by the Respondent were erroneous but equally fail to provide information that would justify its position. That in the absence of such information, the Appellant has not demonstrated the Respondent's misapplication of the benchmarking report.

119. That Section 59 of the Tax Procedure Act states that:“(1)For the purposes of obtaining full information in respect of the tax liability of any person or class of persons, or for any other purposes relating to a tax law, the Commissioner or an authorised officer may require any person, by notice in writing, to-(a)produce for examination, at such time and place as may be specified in the notice, any documents (including in electronic format) that are in the person's custody or under the person's control relating to the tax liability of any person;(b)furnish information relating to the tax liability of any person in the manner and by the time as specified in the notice; or(c)attend, at the time and place specified in the notice, for the purpose of giving evidence in respect of any matter or transaction appearing to be relevant to the tax liability of any person.”

120. That the Tax Procedure Act places the onus of proof on the Appellant who in this case failed to avail evidence that would support a contrary position to the assessment or that would have guided the Respondent at arriving to a different objection decision.

121. That Section 56 of the Tax Procedures Act provides as follows:-“In any proceedings under this Part, the burden shall be on the taxpayer to prove that a tax decision is incorrect.”

122. The Respondent posited that the Appellant's Transfer Pricing Policy was indeed considered and based on the said Policy and the Franchise Agreement entered into with its parent, the Appellant falls within the ambit of an integrated distributor/ non-routine rather than a routine distributor. That accordingly, the benchmarking analysis adopted cannot be faulted and the burden falls on the Appellant in any case to demonstrate otherwise by providing credible evidence.

123. The Respondent also stated that in its tax computations in the assessment, the Appellant’s assessed income (Earnings Before interest and Tax), excluded all allowable deductions including interest expense arising from finance costs on loans.

124. That Section 31(1) of the TPA states that:“Subject to this section, the Commissioner may amend an assessment (referred to in this section as the "original assessment") by making alterations or additions, from the available information and to the best of the Commissioner's judgement, to the original assessment of a taxpayer for a reporting period.”

125. That further Section 31(4) of the TPA provides thus:“The Commissioner may amend an assessment-(b)in any other case, within five years of -(i)for a self-assessment, the date that the self-assessment taxpayer submitted the self-assessment return to which the self-assessment relates; or…”

126. The Respondent additionally stated that the Appellant filed its self-assessment for the year 2016 in March 2019 and for the period 2017 was filed in August 2019. That going by this, the Respondent was within the statutory limit of five years since the Appellant filed its self-assessment in 2019 and the notice of assessment was issued on 22nd September, 2022. That accordingly, the Respondent was well within the statutory limits in issuing the assessment.

127. That in its objection and Appeal, the Appellant has not demonstrated how the assessments for the period 2019-2021 were in any way erroneous or excessive as the same were based on the Respondent's ‘best of judgment’.

128. The Respondent reiterated that any variance between the assessment issued through the iTax system and manually was well explained in the objection decision.

129. That the objection decision, which is the subject matter to the Appeal before the Tribunal, was with respect to the assessment for the period 2016-2018 and it is the same period that the Appellant had lodged an objection on. That the period of the assessment was therefore well clear to the Appellant from the time of audit and entries in iTax, which is an administrative tool, and cannot be used as a basis of challenging the validity of an assessment. The Respondent further reiterated the provisions of Section 78 of the TPA.

Respondent’s Prayers 130. The Respondent prayed for orders that:a.This Tribunal upholds the Respondent's decision dated 22nd December, 2022 confirming the assessment of Kshs. 57,168,070. 00b.This Appeal be dismissed with costs to the Respondent as the same is devoid any merit.

Issues for Determination 131. The Tribunal has considered the pleadings, submissions and witness statements filed by both parties and is of the view that the issues falling for its determination are:-i.Whether the Respondent’s assessments were within the five year statutory limit prescribed under Section 31(4)ii.Whether the Respondent’s assessment was justified

Analysis and Findings 132. The Tribunal having established the issues falling for its determination, proceeds to analyse them as hereunder.

i. Whether the Respondent’s assessments were within the five year statutory limit prescribed under Section 31(4) 133. The Appellant argued that the Respondent issued assessments beyond the five year statutory limit while the Respondent argued that the assessments were within time.

134. The Tribunal reviewed the parties’ pleadings and established that the assessments issued by the Respondent related to the years 2016 to 2021.

135. Section 31(4) of the Tax Procedures Act provides as follows in regard to the amendment of a self-assessment return by the Commissioner:“The Commissioner may amend an assessment—(a)in the case of gross or wilful neglect, evasion, or fraud by, or on behalf of, the taxpayer, at any time; or(b)in any other case, within five years of—for a self-assessment, the date that the self-assessment taxpayer submitted the self-assessment return to which the self-assessment relates; or…”

136. The Tribunal notes that the Respondent stated that the Appellant filed its self-assessment for the year 2016 in March 2019 and for the period 2017 in August 2019. This particular allegation by the Respondent was not rebutted by the Appellant in its pleadings. The Appellant only claimed that the reporting period that the Respondent should have assessed related to the year 2018 going forward; hence relying on calendar dates in defining the limit of five years.

137. The Tribunal seeks to clarify the provisions of Section 31(4) which relate to the statutory limit of an amendment of an assessment by the Commissioner. Section 31(4)(ii) expressly states that the timeline is directly related to the date that the self-assessment taxpayer submitted the self-assessment return to which the self-assessment relates. Therefore, the five year timeline only counts from the date the taxpayer makes a self-assessment declaration/ return.

138. Going by this, and the fact that the Appellant did not rebut the Respondent’s allegation that it filed its 2016 and 2017 returns in 2019, the Tribunal can only conclude that the Respondent was within the statutory limit of five years since the Appellant filed its self-assessment for the years in question in 2019 and the notice of assessment was issued on 22nd September, 2022 which is well within five years.

ii. Whether the Respondent’s assessment was justified 139. The genesis of this dispute was the imposition of transfer pricing adjustments by the Respondent on the Appellant’s transactions.

140. The Appellant averred that the Respondent erred in failing to understand the Appellant's business model, leading to an incorrect and unjustified segmentation of the Appellant's financial statements resulting in erroneous assessments.

141. The Respondent on its part argued that in arriving at the assessment, the Appellant's business model was well appreciated, Functions, Assets & Risks (FAR) considered and the consequent adjustments were justified. That further, the Appellant does not have control of prices to third parties, has qualified staff for various areas (sales, technical and installation) and equally bears all the risks involved. That based on the above, the Appellant could not be treated as a routine distributor since the services offered went beyond the conduct of a routine distributor but that of a non-routine distributor

142. The Tribunal reviewed the parties’ pleadings and the witnesses’ testimonies and proceeded to review the confirmed assessment based on the following areas identified in the pleadings of the parties.

i. The role of the Appellant and its risk analysis 143. The Franchise Fee Agreement between KONE Corporation and KONE Kenya provides the following terms of engagement:a.Under the preamble to the Agreement, that KONE Kenya Limited desires to obtain from KONE Corporation, and KONE Corporation is willing to grant KONE Kenya Limited, a non-exclusive licence (or sub-licence as the case may require) for the duration of this Agreement to use KONE technology, Know-How, tools and processes developed by KONE, Trade Marks as well as technical assistance and training and certain management and support services as included, but not limited, in this Agreement to be used in relation to sale, installation, maintenance and modernization and repair of elevators, escalators, autowalks and automated doors in the Territory as defined in this Agreement.b.That under Clause 4. 1, KONE Corporation hereby grants to KONE Kenya Limited a non-exclusive license(or sub-license as the case may be) for the duration of this Agreement to use the:i.KONE Technology;ii.Know-How;iii.Show-How;iv.Trade Marks; andv.IT systemsfor the conduct of the Front Line's business and in accordance with the terms of this Agreement.

144. The Appellant maintained that it assumes limited risks relating to marketing, sales, distribution and maintenance of the products locally. That the company utilizes bundle of IP, solutions, processes and tools developed, owned and provided by KONE Corporation for KONE Kenya to perform its routine distribution and servicing functions in accordance with the KONE Way processes and guidelines. That KONE Kenya does not own any significant intangible property.

145. The Respondent, in its pleadings argued that the Appellant is in fact an integrated distributor bearing more risks as opposed to the routine distributor. That accordingly, the margin adopted did not remunerate the Appellant its fair share of return based on the functions it performs, assets employed and risks assumed in the transaction leading to erosion of Kenya's tax base and shifting of profits.

146. Chapter I, Paragraph D 1. 2 of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017 and 2022 provide as follows regarding functional analysis:“1. 51. In transactions between two independent enterprises, compensation usually will reflect the functions that each enterprise performs (taking into account assets used and risks assumed). Therefore, in delineating the controlled transaction and determining comparability between controlled and uncontrolled transactions or entities, a functional analysis is necessary. This functional analysis seeks to identify the economically significant activities and responsibilities undertaken, assets used or contributed, and risks assumed by the parties to the transactions.”

147. Further, the above guidance states that the analysis focuses on what the parties actually do and the capabilities they provide. Such activities and capabilities will include decision-making, including decisions about business strategy and risks. That while one party may provide a large number of functions relative to that of the other party to the transaction, it is the economic significance of those functions in terms of their frequency, nature, and value to the respective parties to the transactions that is important.

148. Paragraph 1. 34 of the aforementioned Guidelines provides that the typical process of identifying the commercial or financial relations between the associated enterprises and the conditions and economically relevant circumstances attaching to those relations requires a broad-based understanding of the industry sector in which the MNE Group operates (e.g. mining, pharmaceutical, luxury goods) and of the factors affecting the performance of any business operating in that sector.

149. Further, Paragraph 1. 36 of the Guidelines provides that:“The economically relevant characteristics or comparability factors that need to be identified in the commercial or financial relations between the associated enterprises in order to accurately delineate the actual transaction can be broadly categorized as follows: The contractual terms of the transaction (D.1. 1).

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 (D.1. 2).

The characteristics of property transferred or services provided (D.1. 3).

The economic circumstances of the parties and of the market in which the parties operate (D.1. 4).

The business strategies pursued by the parties (D.1. 5).”

150. The Tribunal established from the KONE Group Contribution Analysis document that KONE Corporation undertakes all risks related to products and their installation which is actively controlled and inspected by KONE Group’s subcontractors, research and development, technological innovations, patents and trademarks, its Information Technology(IT) environment by centralization of IT operations, and manufacturing and sourcing of elevator components through its global sourcing functions. This is expressly provided for under Clauses 2. 6, 3, 4 and 5 of the KONE Group Contribution Analysis document provided in the pleadings.

151. Further, under the First Schedule to the Franchise Fee Agreement, KONE Corporation undertakes all marketing activities and all brand and trademark enhancement activities.

152. The distributors, of which the Appellant is one, are responsible for distributing KONE products in the local markets through their own sales forces. This includes the negotiation of prices with the customers. This is provided for under Clause 5. 1 to the KONE Group Contribution Analysis document.

153. Paragraph D.1. 2.1. of Chapter 1 of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017 and 2022 states as follows regarding analysis of risks in commercial or financial relations:“1. 63. Risk management is not the same as assuming a risk. Risk assumption means taking on the upside and downside consequences of the risk with the result that the party assuming a risk will also bear the financial and other consequences if the risk materializes. A party performing part of the risk management functions may not assume the risk that is the subject of its management activity, but may be hired to perform risk mitigation functions under the direction of the risk-assuming party. For example, the day-to-day mitigation of product recall risk may be outsourced to a party performing monitoring of quality control over a specific manufacturing process according to the specifications of the party assuming the risk.”

154. It is clear to the Tribunal, based on the foregoing references to the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017 and 2022 and the KONE Group Contribution Analysis document that the Appellant undertakes limited risks in relation to the business and these are sales, distribution and maintenance of the products locally.

155. On the other hand, KONE Corporation undertakes all risks related to products and their installation, research and development, technological innovations, patents and trademarks, Information Technology (IT) systems, manufacturing and sourcing of elevator components, through its global sourcing functions as well as tangible assets (manufacturing equipment, IT systems, amongst others) and intangible assets (including intellectual property including Technology, Patents, Utility Models and Designs, KONE brand as well as tools and processes).

156. In relation to inventory risk, the Tribunal notes that new equipment purchases by the Appellant are based on the customer order, thus the Appellant holds very limited inventory and only in relation to certain key spare parts. The Appellant controls the inventory levels in accordance with KONE processes with KONE material management system DBS and regular inventories as outlined in the KONE Group Contribution Analysis document.

157. In view of the foregoing, the Tribunal found that the Appellant was classifiable to be a routine distributor based on the limited risks it undertook. Further, the Tribunal is satisfied that the Respondent was not justified in concluding that the Appellant bears the product liability risk that would therefore effect an increase in the level of remuneration accorded to it in the transaction.

ii. Product pricing 158. The Tribunal has established that the Appellant uses a KTOC tool that provides data handling ability and speedy price resolution/ quotations.

159. That in relation to third party maintenance, in the Appellant’s “KONE Group Contribution Analysis” document, it is well stated that KONE 3rd party Competence Centers create competencies for third party equipment maintenance on a global basis. That when negotiating with the customer, the local sales entities will then define the exact customer price for the defined solutions and services based on the global pricing model using global pricing tools. That this modularization minimizes the scope for inappropriate scoping and pricing to customers by local affiliates.

160. The Tribunal thus notes that the KTOC tool is used by applying all price components based on the local affiliates’ assessment of local market conditions. The tool then calculates a recommended price based on these local market specifications. Notably, while the tool produces a recommended price, Clause 5. 1 of the KONE Group Contribution Analysis document provides that the local entities are mandated with price negotiation with end consumers.

161. The Tribunal further notes that Clause 6. 1.4 of the “KONE Group Contribution analysis” document states, inter alia, as follows in regard to “Control of Global SEB Unit”:“The economic situation (the marketplace), local and regional regulations, competitors and the customers are strong forces that impact KONE's business environment in the service business.To control the above factors and grow profitable business (including both winning contracts), KONE Corporation (Global SEB Management) carefully controls key pricing decisions through globally available pricing data and frequent pricing reviews. Price rises must be made by local entities in a timely manner to ensure maintenance portfolio (e.g. by customer segment, by contract type, by equipment type) can be reviewed using the tools provided by Global SEB.”

162. The aforementioned document further states under Clause 6. 1.4 as follows:“The other focus area of global control by KONE Corporation is to improve the SEB Management undertakes invoicing reviews of local sales entities to ensure all know the contract scope. The purpose of these reviews is also to reduce the issuing of unnecessary credit notes.”

163. The Tribunal additionally notes that the Respondent provided an Agreement that was between KONE Corporation and Maryat and Scott which outlined the terms of the former contract that KONE Corporation has with the previous local entity that traded in its products.

164. In contrast to the pricing terms in the current Franchising Agreement between KONE Corporation and KONE Kenya Limited, Clause 3. 4 of the aforementioned Agreement stated as follows:“The Distributor shall be free to establish and revise its resale prices provided that the competitiveness of the products is maintained…”

165. It is apparent therefore to the Tribunal that the current pricing decisions by the local Kenyan affiliate are partially controlled by KONE Corporation to ensure that local affiliates maintain certain pricing parameters in their businesses.

iii. Group transfer pricing and benchmark analysis of the arm’s length operating level 166. Paragraph D.1 of Chapter 1 of the 2017 OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations guides that the application of the arm's length principle is based on a comparison of the conditions in a controlled transaction with the conditions that would have been made had the parties been independent and undertaking a comparable transaction under comparable circumstances.

167. The Appellant stated that in its view, the controlled transactions to be tested were the purchases of goods from related parties and payment of the franchise fee and the most appropriate method selected to test the arm's length result of these controlled transactions is the transactional net margin method whereby the operating profit earned by the Appellant in its distribution activity is compared to the operating profits earned by similar independent distribution and servicing companies.

168. The Appellant averred that in order to arrive at an arms-length position, it engaged a third-party service provider to perform a comparable company analysis to benchmark the arm's length operating profit return earned by comparable distribution, maintenance and installation companies operating on comparable industries to that of KONE Kenya. That it attached the benchmarking analysis used for the period under review to its pleadings.

169. The Respondent argued that in reference to the Franchise Agreement dated 1st January, 2018 between the Appellant and KONE Finland, the overall operating margins for KONE Kenya should not exceed or go below 5%. That in a case where the margins go below 5% the company would pay a franchise fee which, according to the Respondent, has not been paid to date.

170. The Respondent further stated that the assessing team identified the purchase of equipment as the inherent intercompany transaction from related parties. That this was contrary to the Appellant’s assertion that the selling price to third parties was used as the controlled transaction.

171. Due to the dispute as to the identity of the controlled transaction in this dispute, the Tribunal referred to the Income Tax (Transfer Pricing) Rules, 2006 which define a controlled transaction to mean a transaction which is monitored to ensure payment of an arm’s length price for goods or services.

172. The Tribunal having analyzed the pleadings of the parties established that the transactions that are considered to be controlled in the instant dispute are the intra-group purchases of equipment and parts. It is further clear that the disputed transaction by the Respondent is the resale price of equipment to end consumers. In its assessment, the Respondent categorically stated that maintenance contracts of the distributed KONE equipment is an uncontrolled transaction since it is between KONE Kenya and third parties. It however specifically identified/ segregated equipment installation and maintenance business as the controlled transaction.

173. The Tribunal notes that the benchmarking study undertaken by the Appellant focused on comparable companies primarily involved in the servicing, maintenance and installation functions and thus earning higher profits compared to traditional buy-sell activities only.

174. The Tribunal further notes that the study encompassed entities undertaking similar transactions as the Appellant and its related entity including repair and installation of various kinds of machinery and equipment. It also factored in independence/ ownership, operating revenue/ turnover and operating profit/loss. It thereafter considered the profit level indicators and determined the arm’s length range to be a median of 2. 72% while the inter-quartile range was between 1. 59% and 6. 72%. The operating margin levels were determined to range between 0. 01% and 15. 10%.

175. The Respondent in its assessment segregated the two transactions: intra-group purchases of equipment and parts from the sales to and maintenance services offered to end consumers, to arrive at its assessment.

176. From the pleadings, the Tribunal further notes that the operating profits of the Appellant ranged between 8. 2% and 15. 6% in the years 2016 - 2021.

177. On its part, the Respondent stated that it determined the arm’s length operating profit to be in the range of 7. 81% to 18. 95% with a median of 11. 72% based on its conclusion that the Appellant was a fully-fledged distributor performing all the sales and distribution functions from marketing to inventory management and bearing the associated risks. This is based on the tax assessment dated 22nd September, 2022 and the comparables provided by the Respondent.

178. Paragraph 3. 60 of the OECD TP Guidelines provides as follows in regard to selecting the most appropriate point in the range:“If the relevant condition of the controlled transaction (e.g. price or margin) is within the arm’s length range, no adjustment should be made.”

179. Paragraph 3. 62 provides further as follows:“In determining this point, where the range comprises results of relatively equal and high reliability, it could be argued that any point in the range satisfies the arm’s length principle. Where comparability defects remain as discussed in paragraph 3. 57, it may be appropriate to use measures of central tendency to determine this point (for instance the median, the mean or weighted averages, etc., depending on the specific characteristics of the data set), in order to minimize the risk of error due to unknown or unquantifiable remaining comparability defects.”

180. In view of the foregoing, the Tribunal notes that the operating profit as provided by the Appellant in its pleadings was computed and found to fall between 8. 2% and 15. 6% as per the table below depicting the Appellants pre-operating profits for the years under dispute:KES'000 2016 2017 2018 2019 2020 2021*

Revenue 628,370 1,299,829 739,809 1,511,514 1,131,644 1,063,749

Cost of sales -534,056 -1,057,215 -527,499 -1,154,661 -618,832 -569,228

Gross profit 94,314 242,614 212,310 356,853 512,812 494,521

Gross profit% 15. 0% 18. 7% 28. 7% 23. 6% 45. 3% 46. 5%

Other income 165,276 112,393 145,864 0 0 8,332

Operating expenses -179,325 -240,056 -269,924 -232,278 -371,800 -336,700

Operating profit 80,265 114,951 88,250 124,575 141,012 166,153

Operating profit% 12. 8% 8. 8% 11. 9% 8. 2% 12. 5% 15. 6% Notably, this range in the years under dispute is within the Respondent’s range of 7. 81% to 18. 95% and as guided in Paragraph 3. 62 of the OECD TP Guidelines highlighted in the previous paragraphs, satisfies the arm’s length principle.

181. In this regard, the Tribunal finds no justification for the adjustments made by the Respondent on the operating profits as declared by the Appellant.

iv. Brand and trademark enhancement 182. In regard to the Respondent’s claim that the Appellant should be able to benefit from activities that enhance the Group’s brand and trademark in the region as per Paragraph 6. 78 of the OECD TP Guidelines, the Tribunal notes that the said Paragraph provides as follows:“When the distributor actually bears the cost of its marketing activities (for example, when there is no arrangement for the legal owner to reimburse the expenditures), the analysis should focus on the extent to which the distributor is able to share in the potential benefits deriving from its functions performed, assets used, and risks assumed currently or in the future. In general, in arm’s length transactions the ability of a party that is not the legal owner of trademarks and other marketing intangibles to obtain the benefits of marketing activities that enhance the value of those intangibles will depend principally on the substance of the rights of that party….” (Emphasis ours)

183. The Tribunal notes that from the First Schedule to the Franchise Fee Agreement, the obligation to undertake brand development and reputation management, events and fairs, as well as developing KONE’s strategic messages such as People Flow was the mandate of KONE Corporation and not KONE Kenya Limited.

184. In this regard, the Tribunal finds that there was no justification by the Respondent for an adjustment on the basis of brand and trademark enhancement by KONE Kenya Limited.

v. Franchise fee 185. The Tribunal has reviewed the Appellant’s Franchise Fee Agreement and its global transfer pricing model, which was attached to its pleadings.

186. The Tribunal has established that KONE Corporation charges the Appellant a franchise fee for the right to use KONE technology, know-how, show-how, trademarks, IT systems, methods and processes developed by KONE Corporation based on the Franchise Fee Agreement.

187. The Franchise Fee Agreement provides that the franchise fee will be calculated under the arm's length principle as a percentage of KONE Kenya's net sales and operating profits that are based on the attainment of an arm’s length level in each year. That in 2016-2021, the benchmarked franchise fee rate has been 9. 5% of net sales.

188. The Franchise Fee Agreement also states that "the fee in respect of any Year shall not exceed such amount as would reduce the Operating Profit of the Front Line for that year to an amount below the arms' length level for the Year defined in Schedule 2".

189. It follows therefore that the franchise fee is tied to the operating profits in any given year. In this regard, with the Tribunal having found that the Respondent was not justified in making adjustments to the operating profits of the Appellant, it further finds that the Respondent was not justified in making adjustments in relation to the franchise fees.

vi. Loan corrections in Financial Year 2018 190. The Respondent’s averred, in its assessment, that the Appellant remains potentially exposed to risks from foreign exchange rate fluctuations related to currency flows from revenue and expenses is not correct.

191. The Appellant on its part argued that, from a review of its financial statements, the Respondent has taken an erroneous view that since the Appellant purchases its goods from related parties in foreign currencies but sells its products in Kenya Shillings the Appellant is exposed to risks arising from foreign exchange rate fluctuations.

192. That on the basis of the above assumption the Respondent proceeded to make an adjustment on a long-term loan in the Appellant's financial statements claiming that it relates to forex loss.

193. The Tribunal notes that the Appellant asserted, in its Statement of Facts, that the said forex loss in FY 2018 does not relate to its distribution related transactions but a one-off correction to a long-term loan. The Appellant stated that it attached the loan movement schedule to its pleadings.

194. The Tribunal has reviewed the Appellant’s pleadings as well as the attachments and notes that the Appellant provided the following documents to support the one-off foreign exchange adjustment in FY 2018:i.An in-house bank account agreement between itself and Kone Corporation, Finland dated 20th January, 2015. ii.An amendment agreement to the in-house bank account Agreement dated 19th December, 2017. iii.A term loan agreement between the Appellant and Kone International N.V. Belgium dated 18th June, 2014. iv.A computation showing the loan revaluation, interest expenses and foreign exchange adjustment in FY 2018. v.A loan movement schedule covering the years 2014 through 2019.

195. A review of the above listed documents confirmed that indeed the Appellant undertook an adjustment to its long term loan in FY 2018 that resulted in foreign exchange adjustments that resulted in a forex loss of Kshs. 89,616,387. 00. Specifically, the computation on the adjustment is as depicted the below:-Kone Kenya Ltd Corporate Loan

Amount in 000s

2018

Loan principle (USD) 1,200

Loan principle (USD) 4,800

Total loans (USD) 6,000

Kshs. Value (per AFS ) 611,686

Revaluation Cumulative (65,420)

Finance Costs per (AFS)

Int. Exp. 40,122

Net FX (gains)/ Losses 89,617

129,739

196. Based on the provided information, the Tribunal confirms that indeed the Appellant made a one-off correction to its long term loan which resulted in a variation of its interest expense and the forex loss in the year 2018.

197. Section 30 of the Tax Appeals Tribunal Act provides as follows regarding burden of proof in tax disputes:“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; or(b)in any other case, that the tax decision should not have been made or should have been made differently.”

198. Section 56 of the TPA further states as follows regarding burden of proof in tax appeals:“(1)In any proceedings under this Part, the burden shall be on the taxpayer to prove that a tax decision is incorrect.”

199. While it is settled that the burden of proof in tax cases lies with the Appellant as is encapsulated in Section 30 of the TAT Act, this onus may, however, shift to the Respondent if the Appellant has made a prima facie case. In this case, the onus may then shift to the Respondent to rebut the prima facie case failure to which the taxpayer succeeds.

200. This position was explained in the case of Kenya Revenue Authority v Maluki Kitili Mwendwa [2021] eKLR, where Mativo J ( as he then was) adopted the doctrine in the Canadian Supreme Court case of Johnston v Minister of National Revenue where the court {1948} S.C.R. 486 where the court decided that:“… the onus is on the taxpayer to “demolish the basic fact on which the taxation rested.” Again, the Supreme Court of Canada provided guidance on this issue in Hickman Motors Ltd. v Canada which held that the onus is met when a taxpayer makes out at least a prima facie case. Prima facie is another legal term that literally means “on its face.” To prove a case “on its face” you must provide evidence that, unless rebutted, would prove your position. According to the said decision, a prima facie case is made when the taxpayer can produce unchallenged and uncontradicted evidence. Once the taxpayer has made out a prima facie case to prove the facts, the onus then shifts to the Revenue Authority to rebut the prima facie case. If the Revenue Authority cannot provide any evidence to prove their position, the taxpayer will succeed…”

201. It follows therefore, in regard to the forex loss in 2018, the Appellant discharged its burden of proof as required under Section 30 of the Tax Appeals Tribunal Act and Section 56 of the Tax Procedure Act.

202. As a result, the Tribunal concluded that the Respondent was not justified in raising the assessment in relation to the forex loss in FY 2018.

Final Decision 203. The upshot of the foregoing analysis is that the Appeal is merited. Consequently, the Tribunal makes the following Orders: -a.The Appeal be and is hereby allowed.b.The Respondent’s Objection decision dated December 20, 2022 be and is hereby set aside.c.Each Party to bear its own costs.

204. It is so ordered.

DATED AND DELIVERED AT NAIROBI THIS 23RD DAY OF AUGUST, 2024. ERIC NYONGESA WAFULA - CHAIRMANCYNTHIA B. MAYAKA - MEMBERDR. RODNEY O. OLUOCH - MEMBERABRAHAM K. KIPROTICH - MEMBERDR. TIMOTHY B. VIKIRU - MEMBER