[2024] KETAT 95 (KLR)

Prime Bank Limited v Commissioner of Domestic Taxes (Appeal 073 of 2022) [2024] KETAT 95 (KLR) (2 February 2024) (Judgment)

Neutral citation: [2024] KETAT 95 (KLR)

Republic of Kenya

In the Tax Appeal Tribunal

Appeal 073 of 2022

Grace Mukuha, Chair, E Komolo, Jephthah Njagi, T Vikiru & G Ogaga, Members

February 2, 2024

Between

Prime Bank Limited

Appellant

and

Commissioner Of Domestic Taxes

Respondent

Judgment

1. The Appellant is a private limited liability company incorporated in Kenya under the Companies Act and licensed under the Banking Act to carry out banking and related activities.

2. The Respondent is a principal officer appointed under Section 13 of the Kenya Revenue Authority Act, Cap 469 laws of Kenya (KRA Act). Under Section 5 (1) of the Act, KRA is an agency of the Government for the collection and receipt of all revenue. Under Section 5(2) of the Act with respect to the performance of its function under subsection (1), the Authority is mandated to administer and enforce all provisions of the written laws as set out in Parts I and II of the First Schedule to the KRA Act for the purposes of assessing, collecting, and accounting for all revenues in accordance with those laws.

3. The Respondent conducted a review of the tax declarations and Voluntary Tax Disclosure Programme (VTDP) applications made by the Appellant on 8th March 2021 relating to the tax periods in 2017 to 2019 and issued a notice of assessment dated 16th September 2022 demanding a total tax of Kshs. 17,361,157. 00 comprising principal tax, penalties and interest on additional Value Added Tax (VAT) on merchant purchase and interchange commission for the tax periods in January 2017 to December 2019.

4. The Respondent subsequently issued assessment orders to the Appellant for the additional VAT for December 2017, December 2018 and December 2019 on 7th October 2022.

5. The Appellant objected to the additional assessments on 14th October 2022.

6. The Respondent issued an objection decision dated 9th December 2022 where the Respondent upheld the additional assessments of VAT on merchant fees and interchange fees for the tax periods December 2017, December 2018 and December 2019.

7. The Appellant, dissatisfied with the objection decision, filed its Notice of Appeal on 6th January 2023.

The Appeal 8. The Appeal is premised on the Memorandum of Appeal dated and filed on 23rd January 2023 which raised the following grounds: -a.That the Respondent erred in law holding that the payments received by the Appellant as interchange fees and merchant service fees constituted payment for taxable services.b.That the Respondent erred in fact by stating that the Appellant provides services to acquiring banks.c.That the Respondent erred in fact in failing to appreciate that as an issuing bank, the Appellant, was simply facilitating a transfer of money from its customer’s account.d.That the Respondent erred in law in failing to realise that money as defined in Section 2 of the VAT Act 2013 includes any amount provided by way of payment using a debit or credit card or electronic payment system.e.That the Respondent erred in fact and law in failing to appreciate that interchange fee is received by the Appellant in connection with operating its own customer’s account. This operation of an account is specifically exempted from VAT under Paragraph 1 (a) of the First Schedule to the VAT Act 2013. f.That notwithstanding and without prejudice to the foregoing, the Respondent erred in fact in failing to appreciate that the interchange fees are received by the Appellant in relation to operating the customer’s account.g.That the Respondent erred in law and fact in finding that interchange fee earned constitutes fees earned for management and professional services subject to VAT.h.That the Respondent erred in law and in fact by failing to appreciate that the Appellant has an obligation to its customers, a principle anchored in law and in precedence. The customers have acquired the credit/debit cards from the Appellant and have a reasonable expectation that they will be able to transfer or otherwise deal with their money.i.That the Respondent erred in law and in fact by failing to appreciate the fact that the Appellant carries out the services for the benefit of its customers and not the acquiring banks.j.That the reliance of Court of Appeal ruling in the case, Commissioner of Domestic Taxes (Large Taxpayers Office) v Barclays Bank of Kenya (BBK) Appeal No. 195 of 2017 is out of context in that the issue under determination in that case was whether withholding tax was applicable on payments made by BBK. The case at hand is on VAT and relates to income earned by the Appellant. Again, payment for services subject to WHT does not imply VAT obligation. Financial services are exempt in the VAT Act.

Appellant’s Case 9. The Appellant’s case is premised on the following documents: -a.Its Statement of Facts dated and filed on 20th January 2023 and documents attached to it; andb.Its Written Submissions dated and filed on 11th April 2023 and documents attached to them.

10. The Appellant stated that it is a member of a network established by a card company known as VISA International (the network), and that the network enables customers with VISA credit, debit and pre-paid cards to make payments for goods and services using these cards.

11. The Appellant averred that within the network, the banks that issue cards to their customers are referred to as issuing banks. That the network establishes banks that provide point of sale (POS) machines to retail outlets such as supermarkets, hotels, petrol stations, etc. to enable them to accept payments from shoppers who purchase goods using credit, debit or pre-paid cards. That within the network, the retail outlets are referred to as merchants and the banks that provide the POS are known as acquiring banks.

12. The Appellant further stated that when a credit card is used, an advance amount is booked in the cardholder’s account by the issuing bank, whereas when a debit card is used, the issuing bank debits the cardholder’s account and in the case of a pre-paid card, the prepaid amount is reduced from the card.

13. The Appellant affirmed that the Respondent conducted a review of the tax declarations and VTDP applications made by the Appellant on 8th March 2021 relating to the tax periods in 2017 to 2019.

14. The Appellant asserted that the Respondent issued a notice of assessment dated 16th September 2022 demanding additional Value Added Tax (VAT) of Kshs. 17,361,157. 00 comprising principal tax, penalties and interest on merchant purchase and interchange commission for the tax periods in January 2017 to December 2019. The Respondent subsequently issued assessment orders to the Appellant for the additional VAT for December 2017, December 2018 and December 2019 on 7th October 2022.

15. The Appellant objected to the additional assessments on 14th October 2022 based on the below grounds:a.That the interchange fees received by the bank relate to supply of money and is therefore exempt from VAT as per Part II of the First Schedule to the VAT Act 2013. b.That the bank neither owns the VISA platform and does not maintain or develop the VISA platform. That there would be therefore no justification for the bank to receive payment in managerial, professional, contractual fees or royalty payments in this case.

16. The Appellant stated that the Respondent issued it with an objection decision dated 9th December 2022 where the Respondent upheld the additional assessments of VAT on interchange fees for the tax periods December 2017, December 2018 and December 2019.

17. The Appellant stated that the Respondent claimed in its objection decision that the Appellant earned interchange fees because of providing services to acquirer banks, including facilitation fees for facilitating a medium of communication between the issuers, acquirers and merchants for confirmation of creditworthiness of cardholders.

18. The Appellant averred that the Respondent in its objection decision concluded that the Appellant as an issuer rendered clear coordination, managerial, professional and contractual services to the acquirers for which the acquirers pay.

19. The Appellant submitted that the Respondent inaccurately relied on the Court of Appeal ruling in Commissioner of Domestic Taxes (Large Taxpayer Office) vs Barclays Bank of Kenya Appeal No 195 of 2017 that interchange fees earned constitutes management and professional fees fall under Sections 5 (1) (a) and 5 (2) (b) of the VAT Act 2013 though the issue for determination in that case was whether interchange fees were subject to withholding tax and not whether the services are subject to VAT.

20. That the Appellant lodged its appeal against the entire assessment on the following grounds:a.Interchange fees retained by the Appellant relates to supply of money.b.Interchange fees retained by the Appellant is a payment for operation of an account.c.Cardholder verification and transfer of money by the Appellant does not constitute fees earned for management and professional services and thus are not vatable services.d.The Appellant does not provide any services to the acquiring bank.

21. The Appellant submitted that the process and steps that are followed in a typical credit, debit, and pre-paid cards are as follows:a.A customer applies to an issuing bank for a VISA credit, debit or pre-paid card.b.The cardholder goes to a merchant (for example a supermarket) and uses the card to make a purchase. The merchant inserts the cardholder’s card on a POS machine configured to accept the card.c.The cardholder them enters a PIN after which the merchant seeks authorization through the network such as VisaNet if the card is a VISA card. The network then switches the transactions from the acquiring bank to the issuing bank (such as the Appellant in this case). The issuing bank confirms whether the accountholder t has sufficient funds to satisfy payment or in case of a credit card, if the funds required for the purchase are within the cardholder’s credit limit.d.The issuing bank then sends an authorisation message to the network which the relays the authorisation to the acquiring bank. The authorisation acts as a commitment to settle the merchant’s dues and the issuing bank immediately debits the amount from the cardholder’s account pending settlement. Once the payment is received, the acquiring bank sends the authorisation to the merchant who then generates two transaction slips, that is, the merchant’s copy and customer’s copy. The customer thereafter is free to take possession of the goods purchase and leave with the customer’s copy of the transaction slip.e.The settlement and clearing between the merchant and acquiring bank is done, and this may be likened to payment and clearing process of payments by cheque, electronic funds transfer (EFT) or Real Time Gross Settlement (RTGS); andf.Upon settlement and clearing, the merchant receives the amount spent by the cardholder less an amount known as merchant service fee (MSF). The MSF has three components; the interchange fee, the dues and assessment fee, and the acquirer processing fee. The network allocates the interchange fees to the issuing bank, the network retains the fees referred to as dues and assessment fees, and the acquirer processing fee (merchant fees) is allocated to the acquiring bank.

22. The Appellant stated that when a credit card is used, an advance amount is booked in the cardholder’s account by the issuing bank, whereas when a debit card is used, the issuing bank debits the cardholder’s account, and when a pre-paid card is used the prepaid amount is reduced from the card.

23. The Appellant submitted that its role as an issuing bank involves the following:a.Facilitating account opening for its customers.b.Issuing debit/credit card to its customers and facilitating payment transactions or topping up their credit for card cards.c.Receiving requests via the VISA system from an acquiring bank for cardholder verification in a credit/debut card transaction by confirming whether the keyed cardholder’s PIN is correct, whether the cardholder’s card was issued by the Appellant, and whether there are sufficient funds in the cardholder’s account, and sending approval or decline confirmation to the acquiring bank via the VISA system.d.Debiting the cardholder’s account with the amount transacted.e.Effecting money transfer to VISA less interchange fees.

24. The Appellant averred that it only earns interchange fees upon successful completion of the transaction, that is, effecting of a money transfer by debiting the customer account and remitting the payment through VISA who remit the funds to the acquirer, and that this is a supply of money. And that in the event a transaction is declined for reasons including insufficient funds, that it does not earn interchange fees.

25. It further averred that in cases where it sends a decline confirmation to the acquiring bank, that it indicates that the bank offers services to its customers and not to the acquiring bank. The Appellant argued that it does not provide any service to the acquiring bank as it only performs cardholder verification when the cardholder initiates the transaction. That it instead only acts when the cardholder wants to make a purchase and assists its customers to be able to purchase goods and services by performing cardholder verification by responding to the request from the acquiring bank via VISA to enable the merchant to release goods to a customer, who is the cardholder.

26. The Appellant stated that the Respondent’s assertion that the cardholder verification process is a distinct service separate from supply of money is incorrect. It explained that cardholder verification that occurs during supply of money cannot be separated from the supply of money since cardholder verification is a vital step in performing money transfer.

27. The Appellant referred to the decision in the case of Standard Chartered Bank and others vs CST Mumbai (Misc. Application No.93629 of 2015 and Tax Appeal Nos. 117/2010, 143 to 145/2007) where the court held that:“…where a single supply for VAT purposes consisting not of any one supply to which others were ancillary but comprised a bundle of supplies none of which predominated over others, it was necessary to identify elements which comprised the core supplies and arrive at a decision on the facts, whether taxable or exempt elements predominated.”

28. The Appellant submitted that the core supply which necessitates the receipt of interchange fees by the Appellant in this case was supply of money, which is distinct from a supply of a service according to Section 2 of the VAT Act 2013. That is was a contravention of the provisions of the VAT Act 2013 for the Respondent to claim that supply of money was a taxable service

29. The Appellant stated that credit or debit card transactions are initiated by cardholders who want to purchase goods or services and that the role played by the Appellant is to facilitate its customer, who is the cardholder, to be able to make purchases. That this involves that operation of customer’s account by performing cardholder verification and debiting the customer’s account, which is money transfer.

30. The Appellant submitted that interchange fees retained by it is a payment for operation of an account. That the transactions leading to interchange fees emanate from a customer deciding to use the debit card or credit card issued by the Appellant to make payment. That based on this, it is apparent and factual that these functions relate to the operation of an account since the key component of operation of an account is checking if the cardholder’s account status is in order to make a payment.

31. The Appellant contended that authorisation, processing, clearance and settlement is done by the network and not the Appellant as indicated by the Respondent. That the Appellant is merely a member of the network.

32. The Appellant stated that the liability and risk of declining a transaction erroneously lies with the issuing bank. That this demonstrates that the issuing bank offers services to its customers and not the acquiring bank. That the issuer, therefore, bears all the risks arising from the customer transaction at the POS, similar to a transaction at the ATM. The Appellant further averred that it can be sued by its customers for any omissions relating to these transactions, as has been witnessed in the past.

33. The Appellant submitted that cardholder verification is a banking process during the supply of money, whereby a customer presents themselves physically to transact over the bank counter or where a customer transacts using debit or credit card. That in a case where a cardholder transacts over the bank counter, they will be required to provide their identification card which the bank teller will verify to check that it relates to the owner of that account, that the signature matches the one in the bank system and is identifiable to the cardholder who has physically presented themselves.

34. The Appellant submitted that when a customer transacts using a debit or credit card, this verification can only be done online. That the role played by the Appellant in verifying cardholder information in a card transaction is a normal process in the supply of money and is a procedure before effecting money transfer.

35. The Appellant contended that it was, therefore, incorrect for the Respondent to claim that cardholder verification is a service separate from the supply of money since money transfer can only be effected upon completion of cardholder verification process.

36. The Appellant cited the case of HMRC v National Exhibition Centre Ltd (NEC) in which the court of justice of the European Union (CJEU) set out the criteria for exemption to be that the transaction should have the essential functions of a transfer, which includes the resultant effect of transferring funds which leads to 'changes in the legal and financial situation; and not just 'mere technical and physical supply' of information. The court held: -“This criterion supports the fact that interchange fees retained by the Appellant are exempt from VAT based on the following:a.NEC, as a booking agency, effected funds transfer and debited/credited the accounts concerned, a factor which was considered by the CJEU for a transaction to fall within the exemption. In their decision, the CJEU pointed out that in order to fall within the exemption, such a transaction must have the effect of transferring funds (by whatever method) and since NEC did not debit/credit the accounts concerned, it could not be regarded as executing the payment or transfer. Unlike the role played by the Appellant, NEC merely collected information, communicated that information to the merchant acquirer bank and received information which enabled it to make a sale receive the corresponding funds. The role played by NEC cannot be compared to the role undertaken by the appellant in card transactions since the appellant effected funds transfer.b.Booking fees are charged by NEC on ticket sales. However, the appellant does not charge its cardholders fees for transacting through POS, and therefore, the circumstances of NEC and the appellant are not similar; andc.The end result of a POS transaction by the appellant leads to funds transfer which ultimately changes the legal and financial situation of the cardholder, thus meeting the exemption criteria set by the CJEU.”

37. The Appellant relied on the High Court ruling in the Tax Appeal No 8 of 2018 (Barclays Bank of Kenya Vs Commissioner of Domestic Taxes) to buttress its submission that interchange fee is not for any service rendered by the issuing bank to the acquiring bank. Further, that the court stated that, the authorisation of the use of the card by the issuing bank is part and parcel of the issuing bank's operation of its customer's account. That the High Court in that case held: -

“..... The issuing bank as stated before and it was accepted by the parties before court, retains interchange fee when remitting the payment through the card company's infrastructure to pay for goods purchased from the merchant by its customers, the cardholder. I am persuaded by the submission of BBK, in as far as interchange fee is concerned, that it. relates to the relationship between the different players in a card transaction is to enable the cardholder transfer money from the cardholder's account to the merchant account. I will add to that submission that the acquiring bank is in a sense a conduit in that transfer of information in the network.it follows that the authorisation of use of the card by the issuing bank is part and parcel of the issuing bank’s operation of its customers (the cardholders) account. That being the finding of this court it follows that the said service of authorising the use of the card is a service which is exempt from VAT…” 38. The Appellant submitted that the interchange fees retained by the Appellant qualify as financial services exempt from VAT under Paragraph 1 (a), (b), and (c) of Part II of the First Schedule to the VAT Act which outline that the operation of an account and the supply of money are part of VAT exempt financial services.

39. The Appellant further contended that interchange fee it earned related to services that are incidental to providing withdrawal services to the bank's customers which form part of the operation of an account. It summarised how the bank earns interchange fees as below:-a.The acquiring bank receives acquirer fees whereby another bank's customer runs their cards at the acquiring bank's ATM. In this case, the acquiring bank does not charge the customer any ATM withdrawal fees since they do not have access to the customer’s bank account.b.The acquiring bank's switch will send instructions to the switch of the Appellant to confirm a customer's bank balance.c.The Appellant checks to confirm if the card holder has sufficient funds or the credit card is within the limits after confirmation, the Appellant sends approval via switch to the acquiring bank.d.The Appellant debits the customer's account with the amount withdrawn together with the bank charges and the cash will be disbursed through the acquiring bank's ATMe.The Appellant retains its portion of the withdrawal fee and remits the balance through the card company's network which is shared between acquiring bank and the card Company.

40. It submitted that the Respondent was factually wrong in charging VAT to the interchange fees earned by the Appellant since the interchange fee is akin to normal ATM withdrawal services which in the Appellant's view is exempt from VAT as provided for under Paragraph 1{d) of Part II of the First Schedule of the VAT Act,2013.

41. The Appellant further contended that it was unfair to levy VAT on card services, because other money transfer modes such as EFT, RTGS and mobile money transfer services offered by telecommunication companies are not subject to VAT. It further averred that the interchange fees retained by the Appellant directly linked to the operation of an account and money transfer services, which, as per the VAT Act 2013, are exempt from tax. That imposing VAT on interchange fees would be inconsistent with the intention of the VAT Act 2013 to exempt the operation of current, deposit, or savings accounts.

42. The Appellant further relied on the below cases where the Tribunal held that interchange fees received by issuing banks are exempt from VAT:-a.Tax Appeal No. 302 of 2018 In Standard Chartered Bank Kenya Ltd vs Commissioner of Domestic Taxes.b.Tax Appeal No. 361 of 2018 in NIC Group PLC and NIC Bank PLC vs the Commissioner of Domestic Taxes.c.Tax Appeal No. 167 of 2018 in Kenya Commercial Bank Limited vs Commissioner of Domestic Taxes,d.Tax Appeal No. 322 of 2018 in Commercial Bank of Africa vs Commissioner of Domestic Taxes.e.Tax Appeals Tribunal Appeal No. 319 of 2018 in Bank of Africa Kenya Limited vs Commissioner of Domestic Taxes.

43. The Appellant submitted that it would be prejudicial to the Appellant for the Respondent to demand VAT on interchange and merchant fees disregarding the numerous precedents set by the courts which have determined that the services offered by the Appellant qualify as exempt supplies.

Appellant’s prayers 44. The Appellant prayed that the Tribunal: -a.Upholds the objection filed by the Appellant.b.Annuls and sets aside in its entirety the Commissioner’s objection decision dated 9th December 2022. c.Awards the costs of this Appeal to the Appellant.

Respondent’s Case 45. The Respondent’s case is premised on the following documents:a.Its Statement of Facts dated and filed on 16th February 2023 and evidential documents attached to it; andb.Its Written Submissions dated 25th April 2023 and filed on 18th April 2023.

46. The Respondent stated on 15th December 2019 it issued an assessment notice relating to VAT merchants service fees and interchange fees for the period January 2017 to December 2019 amounting to Kshs. 17,361,157. 00 comprising principal tax of Kshs. 11,636,461. 00 and interest and penalties.

47. That the Appellant objected to the entire assessment on 14th October 2022 and that the Respondent issued its objection decision on 9th December 2022, which the Appellant appealed to the Tribunal.

48. The Respondent averred that it analysed transactions involving card services by the Appellant using VAT declarations and figures as per trial balances provided. The Respondent stated that the card services were on internet fees earned for management and professional services.

49. The Respondent stated that it charged VAT on merchant service commission and interchange fee earned based on figures posted on trial balances by the Appellant.

50. The Respondent asserted that it relied on the Court of Appeal case of Commissioner of Domestic Taxes (LTO) vs Barclays Bank of Kenya Ltd (Appeal No. 195 of 2017) in arriving at its assessment. It acknowledged that that Appeal was on whether withholding tax is payable by a bank for payments it makes to credit card companies. In that case, the court held: -“We are persuaded that the evidence on record properly established that the payments paid by the respondent to the card companies were royalty as defined in the Act and further that the interchange fees it paid to issuer banks were for management and professional services as defined in the Act, and therefore both payments were subject to withholding tax under the Act.”and“In our view, the appellant proved that those payments by the respondent in its capacity as acquirer to the issuer banks, satisfy the definition of management and professional fees as defined in section 2 of the Act.”

51. In response to the Appellant’s grounds of appeal, the Respondent averred that the objection decision to arrive at the confirmed assessments was justified and in conformity with the law under Section 30 (1) of the Tax Procedures Act, Section 5 (1) of the VAT Act 2013 and Paragraph 1 of Part II of the First Schedule to the VAT Act 2013, and reiterated its position as follows.

52. The Respondent contended that the Appellant issued credit cards to its customers. That as an issuer, the Appellant earned interchanger fees for providing services to acquirers which included fees for facilitating a medium of communication between the issuers, acquirers and merchants and for confirmation of the creditworthiness of the cardholders.

53. The Respondent submitted that the Appellant erroneously classified interchange fees as payments for supply of money. The Respondent was of the view that interchange fees are management or professional fees made in consideration for management or professional services undertaken by the issuer bank to the acquirer bank.

54. The Respondent argued that by considering how the parties in the interchange services have described or rationalised the process, there was clear coordination, managerial, professional, contractual services rendered by the Appellant as an issuing bank to acquiring customers. On this basis, it was the Respondent’s averment that the interchange fee earned constitutes fees earned for management and professional services and are subject to VAT.

55. The Respondent relied on what it referred to as the Court of Appeal pronouncement in the case of Commissioner of Domestic Taxes (LTO) vs Barclays Bank of Kenya Ltd (Appeal No. 195 of 2017) that payments to card companies constitute royalty, and the merchant fees paid to issuer banks were for management and professional services, and as such that the services are not exempt under Paragraph 1 of Part II of the First Schedule to the VAT Act contrary to the allegations by the Appellant.

56. It was the Respondent’s averment that the Appeal No. 195 of 2017 (supra) was applicable in this case as the Court of Appeal in that case was able to determine that interchange fees were payments for professional and management fees rendered by an issuing bank.

57. The Respondent averred that services that the Appellant was paid for such as facilitating a medium of communication between the issuers, acquirers and merchants, sourcing of cardholders, maintenance of their accounts, confirmation of cardholders’ creditworthiness, management of the issuing bank’s customer accounts, and advising and confirming to the acquiring banks that a cardholder in good financial standing to settle bills via a credit card, all constituted agency, technical, management and professional services.

58. The Respondent claimed that Section 2 of the VAT Act defines management and professional fee as any payment made to any person, other than a payment made to an employee by his employer, as consideration for any managerial, technical, agency, contractual, professional of consultancy services however calculated.

59. The Respondent submitted that it relied on the definition of management or professional fees as stated in Section 2 of the Income Tax Act and that the Appellant was paid interchange fees as consideration for managerial, technical, agency contractual, professional or consultancy services rendered to the acquiring banks.

60. The Respondent further argued that the services offered by the Appellant are that of verification and debiting of a customer’s account, which is not exempt from VAT as alleged by the Appellant.

61. The Respondent stated that it was critical for the Tribunal to examine the totality of the evidence on record and that interchange fees are management or professional fees and that they are therefore chargeable to VAT.

62. The Respondent submitted that it relied on a case involving Kenya Bankers Association v Kenya Revenue Authority (2021) where the court held that interchange fees were subject to VAT under the VAT Act 2013. It further submitted that the court noted that interchange fee is a fee charged by banks for their role in facilitating electronic payment transactions between merchants and customers, and that the definition is services under the VAT Act 2013 is broad enough to include electronic payment services. On this basis, the Respondent submitted that it should charge VAT on interchange fees because the services which the Appellant provided were not exempted or zero-rated under the VAT Act 2013.

63. The Respondent finally submitted that the Appellant’s claims as laid out in its Memorandum of Appeal and Statement of Facts were unfounded, not supported by evidence and without any colour of law.

Respondent’s prayers 64. The Respondent prayed that the Tribunal:-a.Dismisses the Appeal.b.Upholds the Respondent’s assessment and objection decision dated 9th December 2022. c.Awards the Respondent the costs of the Appeal.

Issue For Determination 65. The Tribunal has considered the facts of the matter and the submissions made by the parties, and considers the issue for determination as follows:Whether the objection decision dated 9th December 2022 is proper in law.

Analysis And Findings 66. Having identified the issue that calls for its determination, the Tribunal proceeds to analyse it as hereunder.

67. The Respondent conducted a review of the tax declarations and VTDP applications made by the Appellant on 8th March 2021 relating to the tax periods in 2017 to 2019 and issued a notice of assessment dated 16th September 2022 demanding a total tax of Kshs. 17,361,157. 00 comprising principal tax, penalties and interest on additional Value Added Tax (VAT) on merchant purchase fees and interchange commission for the tax periods in January 2017 to December 2019, and subsequently issued assessment orders to the Appellant for the additional VAT for December 2017, December 2018 and December 2019 on 7th October 2022.

68. The basis of the Respondent’s additional VAT assessment was that interchange fees and merchant service commission were management or professional fees and thus subject to VAT as per Sections 5 (1) and 5 (2) if the VAT Act 2013.

69. The Appellant objected to the additional assessments on 14th October 2022 stating that the services that it provides to give rise to merchant fees and interchange fees are financial services that are exempted from VAT under Paragraph 1 of Part II of the First Schedule to the VAT Act 2013.

70. The Tribunal considered the assertions by both parties and is of the considered view that the services that give rise to interchange fees and merchant fees, also known as acquirer processing fees, are financial services that fall under the exempted supplies under Paragraph 1 of Part II of the First Schedule to the VAT Act 2013.

71. These services provided by the Appellant as an issuer in case of interchange fees and as an acquirer in case of merchant fees are an integral part of a sale/purchase transaction between the merchant and the customer using a debit card, credit-card or pre-paid card. The transaction ultimately involves the movement of money from the customer’s bank account to the merchant’s bank account for the payment for goods and services purchased by the customer, and the back-office activities of the transaction are akin to those in dealing with cheques, and as such, the services are ancillary to financial services provided by the Appellant.

72. Paragraph 1 of Part II of the First Schedule to the VAT Act 2013 lists financial services that are exempted supplies. The Tribunal refers to a most recent determination by the High Court in the case of Commissioner of Domestic Taxes v Bank of Africa Limited (Civil Appeal E127 of 2020) [2023] KEHC 1036 (KLR) (Commercial and Tax) (17 February 2023) which elaborated the classification of interchange fees for VAT purposes by analysing Paragraph 1 (b) of Part II of the First Schedule to the VAT Act 2013 which provides: -“1. The following financial services—(a)the operation of current, deposit or savings accounts, including the provision of account statements;(b)the issue, transfer, receipt or any other dealing with money, including money transfer services, and accepting over the counter payments of household bills, but excluding the services of carriage of cash, restocking of cash machines, sorting or counting of money;”

73. The court in Civil Appeal E127 of 2020 (supra) analysed Paragraph 1 of Part II of the First Schedule to the VAT Act 2013 in Paragraphs 38 and 39 of the judgment by collapsing the legislation into its component parts to interpret its meaning. It held: -“38. It is of significance to note the law exempts the “issue, transfer, receipt” “or” “any other dealing with money” and then uses the word “including”. Paragraph 1(b) has two parts because of the use of the word “or” which means the paragraph should be read disjunctively. Understood that way, then financial services mean the issue, transfer and receipt of money. The second part comes in after “or” so that financial services mean “any other dealing with money.” The paragraph then uses the word “including” “money transfer services and accepting over the counter payments of household bills.”

39. It is appropriate to note that the first part of the paragraph talks about issue, transfer and receipt of money. The second part after “or” still talks about “any other dealing with money” and goes on to use the word “including” thus leaving the list of what constitutes financial services inconclusive. A holistic and literal reading of paragraph 1(b), would yield to the conclusion that financial services mean any dealing in money namely; money transfer services, accepting money over the counter and payment of household goods, among other services, excluding, however, “services of carriage of cash, restocking cash machines, sorting or counting of money.” The list of exempted financial services is, therefore, inconclusive because the legislature used the word” including” to define financial services.”

74. Further, the court in Civil Appeal E127 of 2020 (supra) found that: -“40. When interpreting the law, the court should bear in mind that the legislature was conscious of the circumstances it was legislating on and what it the law was intended to cover. Where the definition of the words is inconclusive, it creates an ambiguity.

41. In Govind Saran Gang Saran v Commissioner of Sates Tax and others 1985 AIR 1041; 1985 SCR (3) 1885, the Supreme Court of India observed that the taxing statute identifies the subject of the levy, or the taxing event, indicates the person on whom the levy is imposed, who has to pay the tax, the rate imposed and the measure or value to which the rate will be applied to compute the tax liability.

The court then stated:‘If these components are not clearly and definitely ascertainable, it is difficult to say that the levy exists in point of law. Any uncertainty or vagueness in the legislative scheme dealing with any of those components of the levy, will be fatal to its validity.’”

75. The holding by the court in Civil Appeal E127 of 2020 (supra) in Paragraph 42 of the Judgment was that because Paragraph 1 of Part II of the First Schedule to the VAT Act 2013 uses an inconclusive definition of what constitutes financial services, it is not open to the court to say that the services that banks provide to earn interchange fees are not financial services. The court opined that: -“42. Where the legislature uses an inconclusive definition of what constitutes financial services, like in this case, it is not open to this court to say that the service Bank of Africa rendered to cardholders, as the issuer, was not a financial service. If that were to be the case, then the law, as enacted, would be ambiguous which would then be interpreted in favour of the taxpayer.”

76. In its judgment, the court in Civil Appeal E127 of 2020 (supra) upheld the Tribunal’s judgment in Tax Appeal No. 319 of 2018 [2020] Bank of Africa Limited v Commissioner of Domestic Taxes on the VAT treatment of interchange fees. The court in its judgment under Paragraph 43 held: -“43. In the circumstances, I agree with the TAT that Bank of Africa rendered a financial service to cardholders when verifying their identities and eligibility to use the cards when purchasing goods or services and eventually deducted money from their accounts which was a financial service exempted from VAT.”

77. The above holding that the services that give rise to interchange fees are exempted from VAT is buttressed in the following cases:a.TAT 322 of 2018 Commercial Bank of Africa v Commissioner of Domestic Taxes [2021]b.TAT 137 of 2016 Barclays Bank of Kenya v Commissioner of Domestic Taxes [2021]c.TAT 361 OF 2018 NIC Group & NIC Bank Kenya PLC v Commissioner of Domestic Taxes [2021]d.TAT 302 of 2018 Standard Chartered Bank Kenya Limited v Commissioner of Domestic Taxes [2020]

78. The Tribunal further relies on the holding of the court in Kenya Commercial Bank Limited v Commissioner of Domestic Taxes TAT No. 167 of 2018 [2021] where the court listed the component parts of merchant service commission in paragraph 92 of its judgment, cited below:-“92. The Appellant described the card payment process which is initiated by the Merchant by uploading the transactions to the Acquirer. The fee associated with the transaction processing is called a Merchant Service Commission' which is calculated as a percentage of the value of the purchase amount. The Merchant Service Commission is made up of three components as detailed below: -

a.The fee paid to the Acquirer for the Merchant Services;b.The payment to the Issuer known as the 'interchange fees'; andc.The payment to the card companies for the network and authorisation expenses known as ‘dues' or ‘assessments fees’.”

79. In its judgment in Kenya Commercial Bank Limited v Commissioner of Domestic Taxes TAT No. 167 of 2018, the Tribunal determined that the three components of Merchant Service Commission are exempt from VAT. The Tribunal held:-“100. The Tribunal therefore finds that the merchant service charge falls under Paragraph 1 of the Third Schedule to the VAT Act Cap 476 (repealed) and Part II Paragraph 1 of the First Schedule to the VAT Act, 2013 and is therefore exempt.”

80. The Tribunal observes that the Respondent’s reliance on the judgment by the Court of Appeal in Civil Appeal No. 195 of 2017 Commissioner of Domestic Taxes (Large Tax Payer Office) v Barclays Bank of Kenya Ltd [2020] as the anchor case law to support the additional VAT assessment in this Appeal is misplaced and a misinterpretation of the facts in this Appeal and the applicable law. The tax assessment that is the subject of this Appeal is a VAT assessment, while the tax assessment in Appeal 195 of 2017 (supra) was an income tax assessment. While the court in that case classified interchange fees as management or professional fees for purposes of income tax, it is clear that the court did not classify interchange fees for purposes of VAT as the appeal before it was not a VAT matter.

81. The Tribunal observes that the classification of transactions and tax treatments of the transactions so classified under different tax laws may not be analogous. A transaction can be taxable under an income tax law, and exempt from tax under a VAT law or any other tax law. An understanding of how different tax laws treat transactions is critical in determining the applicable tax assessments.

82. The Tribunal notes that the Appellant sufficiently discharged its burden of proving that the objection decision should not have been made as required under Section 30 (b) of the Tax Appeals Tribunal Act and Section 56 (1) of the TPA. Further, the Tribunal finds that the Respondent has not sufficiently persuaded it to depart from the holdings cited above, that interchange fees and merchant fees are exempt from VAT.

83. The Tribunal finally reprises that the supply of the financial services that give rise to interchange fees and merchant fees is a supply that is exempted from VAT under Paragraph 1 of Part II of the First Schedule to the VAT Act 2013.

Final Decision 84. The upshot of the foregoing is that the Appeal succeeds, and the Tribunal accordingly proceeds to make the following Orders: -a.The Appeal be and is hereby allowed.b.The Respondent’s objection decision dated 9th December 2022 be and is hereby set aside.c.Each party to bear its own costs.

85. It is so ordered.

DATED AND DELIVERED AT NAIROBI THIS 2ND DAY OF FEBRUARY, 2024. GRACE MUKUHACHAIRPERSONDR ERICK KOMOLO JEPHTHAH NJAGI MEMBER MEMBERTIMOTHY VIKIRU GLORIA A. OGAGAMEMBER MEMBER