[2023] KETAT 301 (KLR)

Sunpower International Limited v Commissioner of Customs and Border Control (Appeal 179 of 2022) [2023] KETAT 301 (KLR) (12 May 2023) (Judgment)

Neutral citation: [2023] KETAT 301 (KLR)

Republic of Kenya

In the Tax Appeal Tribunal

Appeal 179 of 2022

RM Mutuma, Chair, D.K Ngala, EN Njeru, EK Cheluget & RO Oluoch, Members

May 12, 2023

Between

Sunpower International Limited

Appellant

and

Commissioner Of Customs And Border Control

Respondent

Judgment

1. The Appellant is a private limited liability Company incorporated in Kenya. Its main form of business is in the installation and servicing of industrial solar plants, fiberglass-reinforced PPR piping systems, and photovoltaic solar systems.

2. The Respondent is a principal officer appointed under Section 13 of the Kenya Revenue Authority Act, 1995. Under Section 5 (1) of the Act, the Kenya Revenue Authority is an agency of the Government for the collection and receipt of all revenue. Further, under Section 5(2) of the Act with respect to the performance of its functions under subsection (1), the Authority is mandated to administer and enforce all provisions of the written laws as set out in Part 1 & 2 of the First Schedule to the Act for the purposes of assessing, collecting and accounting for all revenues in accordance with those laws.

3. The Respondent conducted a desk review of customs entries of other importers of solar water heating systems for the period November 2016 to October 2020.

4. The Respondent found that the solar water heating systems imported by the Appellant have an electric component and are therefore dual water heating systems classifiable under tariff code 8516. 10. 00.

5. The Respondent issued a demand notice to the Appellant for Kshs. 6,498,693. 79 with Kshs. 3,715,511. 06 being import duty, Kshs. 1,132,256. 34 being VAT and Kshs. 1,650,926. 40 being 2% interest.

6. The Appellant applied for a review vide a letter dated 20th November 2021 which was rejected by the Respondent upholding its position on the reclassification of the tariff vide a letter dated 11th January 2022.

7. Being dissatisfied with the review decision, the Appellant filed a Notice of Appeal dated 24th February 2022.

The Appeal 8. The Appeal is premised on the following grounds as listed in the Memorandum of Appeal dated 23rd February 2022 and filed on 24th February 2022:-a.The Respondent’s demand notice dated 25th November 2021 and the review decision dated 11th January 2022 is arbitrary, unlawful, and therefore null and void.b.At the time of the importation of the dual water heating systems, the taxpayer correctly classified the dual water heating system under the tariff code no. 8419. 19. 00 and accordingly, the Commissioner erred in law and fact in classifying the dual water heating system under tariff code no. 8516. 10. 00. c.There is no dispute that the dual water heating system is majorly and almost exclusively designed to operate on the solar system as its main component. Therefore there is no basis whatsoever as to why the Commissioner has chosen to employ HS code no 8516. 10 slotted for electrical components. Accordingly, the Respondent erred in law and fact in classifying the dual water heating system as electrical instead of solar.d.The Respondent erred in law and fact in failing to recognise that the East Africa Community Common External Tariff 2017 version does not provide any HS Code for the dual water heating system and that it is trite law that where there is a lacuna in the tax code the issue must be resolved in favour of the taxpayer.e.The Commissioner’s decision leading to the demand is contrary to established principles of interpreting the tax code and the Respondent erred in law and fact in failing to resolve the issue in favour of the taxpayer by employing HS code no. 8416. 19. 00 which is zero-rated.f.The Commissioner erred in law and fact in relying on Explanatory Notes from the World Customs Organization which were issued way after the Appellant purchased and sold the dual water heating equipment, and which interpretation has no force of law.g.The Respondent erred in law and fact by purporting to retrospectively rely on the Explanatory Notes of the World Customs Organization contrary to the general rule that statutes and laws and rules cannot operate retrospectively.h.The Respondent erred in law and fact in failing to hold that the dual water heating panel did not fall among those equipment classified under Chapter 85 of the East Africa Community Common External Tariff 2017 version and that even if the Respondent wanted to employ the ejusdem generis rule still the imported goods could not be grouped among those specified in Chapter 85. i.The Respondent erred in law and fact in failing to recognize that the fresh assessments and demands made will exert unnecessary and illegal expenses on the Appellant who already sold the goods based on a zero-rated coding.j.The Respondent erred in law and fact by ignoring the fact that the main component in the dual water heating system is the solar panel and not the electrical element and that the electrical element was an option in the event the solar panel failed. The ‘option’ cannot take precedence over the ‘principal’.k.The Respondent erred in law and in fact by holding without any expert evidence and contrary to the proper interpretation of the goods, that ‘without the electrical element, the system will not be effective in heating water when solar energy is inadequate’ and that ‘the system will work perfectly without the solar component’ when the fact is the reverse is true.l.The Respondent erred in law and in fact by failing to consider that its conduct of re-coding the items meant that Kenya will adopt its special unique HS coding contrary to the universal standard set by the Harmonised Commodity Description and coding system developed by the World Customs Organisation (WCO) and accordingly, its conduct is discriminatory since the Appellant is assessed on a different scale as compared to every other person across the globe.m.The Respondent erred in law and fact by imposing a principal tax of Kshs 6,498,693. 79.

The Appellant’s Case 9. The Appellant’s case was premised on its Statement of Facts dated 23rd February 2022 and filed on 24th February 2022.

10. The Appellant stated that the Respondent’s review decision is arbitrary, unlawful, and therefore null and void and that at the time of the importation of the dual water heating systems, the taxpayer correctly classified the dual water heating system under tariff code no. 8419. 19. 00 and accordingly, the Commissioner erred in law and fact in classifying the dual water heating system under tariff code no. 8516. 10. 00.

11. It averred that the dual water heating system is designed to operate predominantly and almost exclusively on the solar heating system as the major operating system and that the electric heating system may only be used where the solar power is insufficient which means that the electric heating system is an alternative and may not be used for the entire life of the heating system.

12. It contended that the East Africa Community Common External Tariff 2017 does not provide any HS Code for the dual water heating system using both solar and electrical.

13. It averred that the HS code 8516. 10. 00 is only for electric water heaters while the explanatory notes provide for dual water heating systems using only electrical and fuel leaving a gap in the HS code which does not provide for dual systems using solar and electrical systems.

14. It stated that it is trite law that where there is a lacuna in the tax code, the issue must be resolved in favour of the taxpayer by employing HS Code no. 8416. 19. 00 which is zero-rated.

15. It further averred that even if explanatory notes were to be used, the explanatory notes cannot operate retrospectively on goods imported and sold in 2017 since they were issued on 3rd November 2021.

16. It quoted Chapter 85 of the East Africa Community Common External Tariff 2017 version which states;-“Electric instantaneous or storage water heaters and immersion heaters; electric space heating apparatus and soil heating apparatus; electro-thermic hair-dressing apparatus (for example, hair dryers, hair curlers, curling tong heaters) and hand dryers; electric smoothing irons; other electro-thermic appliances of a kind used for domestic purposes; electric heating resistors, other than those of heading 85. 45. ”

17. It averred that the products it imported were not electrical only and does not fall in that category and that even if the Respondent was to use the ejusdem generis rule the products still would not fit under HS code 8516 because it is not an electric instantaneous or storage water heaters and immersion heaters.

18. It asserted that the goods were imported and sold taking into account the cost of the goods including the taxes imposed.

The Appellant’s prayers 19. The Appellant consequently prayed that the Honourable Tribunal:-a.Allows this appeal and sets aside the Review Decision dated 11th January 2022;b.Finds that the Appellant is not liable to pay any taxes with regards to the Respondent’s impugned assessment and Demand for the tax;c.The Respondent to be condemned to bear the cost of this Appeal; andd.Be pleased to issue any other order favourable to the Appellant as it may deem just and fair to issue.

The Respondent’s Case 20. The Respondent’s case is premised on its Statement of Facts dated and filed on 25th March 2022 and the written submissions dated and filed on 1st November, 2022.

21. It stated that the solar water heating systems have an electric component and are therefore dual water heating systems classifiable under tariff code 8516. 10. 00. That without the electrical element, the system would not be effective in heating water when the solar energy is inadequate but the system would work perfectly without the solar component.

22. It reiterated that the Appellant had incorrectly classified solar water heaters under tariff 8419. 19. 00 instead of 8516. 10. 00 which attracts both import duty at a rate of 25% and VAT while the former tariff code attracts VAT only and that in accordance with GIR 1 and Explanatory Notes, the items are classified under 8516. 10. 00.

23. It relied on the case of Export Trading Company Limited & Another v. Commissioner of Customs and Excise [2018] eKLR where Justice Ng’etich observed that: -“It is not disputed that Kenya is a member of World Customs Organization. One of the organization’s roles is to develop a Harmonized commodity description and coding system generally referred to as “Harmonized System” or simply “HS”. It is an international standard classification system for commodities. Harmonization is crucial for fair international trade. The role of a member state is to make the correct interpretation through its tax authority guided by General Interpretation Rules (GIR) of Harmonized Systems (HS); to ensure that correct classification of a product has been adopted. In the event of doubt on classification of a commodity, the Respondent is at liberty to seek assistance from the World Customs Organization.”

24. The Respondent averred that GIR 1 provides that classification shall be determined according to the terms of the headings and any relative section or chapter notes, provided the headings and notes do not require otherwise, according to GIRs 2 through 6.

25. It quoted GIR 6 which provides:“For legal purposes, the classification of goods in the subheadings of a heading shall be determined according to the terms of those subheadings and any related Subheading Notes and, mutatis mutandis, to the above Rules, on the understanding that only subheadings at the same level are comparable. For the purposes of this Rule, the relative Section and Chapter Notes also apply, unless the context otherwise requires.”

26. It stated that the Harmonised Customs Commodity Description and Coding System Explanatory Notes together with the additional notes constitute the official interpretation of the Common External Tariff and provide the scope of each heading under the EAC CET. in accordance with GIR 1 and Explanatory Notes, the items are classified under 8516. 10. 00.

27. It quoted Heading 85. 16 which covers electric instantaneous or storage water heaters and immersion heaters; electric space heating apparatus and soil heating apparatus; electro-thermic hair-dressing apparatus (for example, hair dryers, hair curlers, curling tong heaters) and hand dryers; electric smoothing irons; other electro-thermic appliances of a kind used for domestic purposes; electric heating resistors, other than those of heading 85. 45.

28. The Respondent further quoted Heading 8419 which covers machinery, plant or laboratory equipment, whether or not electrically heated (excluding furnaces, ovens, and other equipment of heading 85. 14), for the treatment of materials by a process involving a change of temperatures such as heating, cooking, roasting, distilling, rectifying, sterilising, pasteurising, steaming, drying, evaporating, vaporising, condensing or cooling, other than machinery or plant of a kind used for domestic purposes; instantaneous or storage water heaters, non-electric.

29. It contended that the Explanatory Notes to the Harmonised Commodity Description and Coding System, Note (A) 3 to heading 8516 classifies dual system heaters in heading 8516, in which the water is heated either electrically or by connection to a fuel-heated hot water system. They are often equipped with thermostatic control to operate them electronically only when the alternative means is insufficient.

30. It added that the Explanatory Notes to the heading 8419 state that machinery covered under this heading may be heated by any system (coal, oil, gas, steam, electricity, etc) except in the case of instantaneous or storage water heaters which are classified in heading 8516 when heated electronically.

31. It further averred that Note (I) to heading 8419 concludes that the apparatus described in the note is essentially used industrially, but the heading also covers non-electric instantaneous water heaters and storage water heaters, including solar water heaters, domestic or not. If electrically heated, such appliances are excluded.

32. It stated that the Appellant’s products have an electric component and are therefore considered dual water heating systems meaning that they can operate under both solar power and electricity hence they fall squarely under tariff code 8516. 10. 00 and the demand notice of Kshs. 6,498,693. 79 is lawful and justified.

The Respondent’s prayers 33. The Respondent prayed for orders that:-a.This Appeal be dismissed with cost to the Respondent as the same is without merit; andb.The demand notice issued to the Appellant on 25th November 2021, requiring the taxpayer to pay extra taxes of Kshs. 6,498,693. 79 be upheld.

Issues For Determination 34. After perusing the pleadings and documentation produced before it, the Tribunal is of the opinion that the following is the issue for determination:a. Whether the Respondent erred in law in classifying the Appellant’s imports under HS Code 85. 16.

Analysis And Findings 35. The Tribunal wishes to analyse the issues as herein under.

a. Whether the Respondent erred in law in classifying the Appellant’s imports under HS Code 85. 16. 36. In the instant case, the Respondent found that the Appellant had wrongly classified its imports under HS Code 8419. 19. 00 which provide for ‘machinery, plant or laboratory equipment, whether or not electrically heated (excluding furnaces, ovens and other equipment of heading 85. 14), for the treatment of materials by a process involving a change of temperatures such as heating, cooking, roasting, distilling, rectifying, sterilising, pasteurising, steaming, drying, evaporating, vaporising, condensing or cooling, other than machinery or plant of a kind used for domestic purposes; instantaneous or storage water heaters, non-electric.’ instead of HS code 8516. 10. 00. which provides for ‘Electric instantaneous or storage water heaters and immersion heaters’.

37. The Appellant argued that the water heater should be classified under HS 8419. 19. 00. However, the Respondent on the other hand maintains that the goods as dual water heating systems and should be classified under HS 8516. 10. 00, and on this basis, the Respondent demanded additional taxes from the Appellant.

38. The Tribunal notes that there is no dispute between the parties that solar water heaters which rely solely on solar energy to heat the water are classifiable under HS 8419 and that water heaters that use electricity or electricity and another fuel are classifiable under HS 8516. It is also noted that there is no dispute as to the identity of the subject goods; they are solar water heaters that have been modified to use electricity when solar energy is not available.

39. These solar water heaters can be classified as either active or passive depending on the mode of fluid circulation. Active systems use mechanical pumps and differential controllers to regulate and direct the flow of the heat-transfer fluid or water from the solar collector to the tank. Some pumps run on mains electricity (line electricity), and others operate on electricity generated by a solar photovoltaic panel. On the other hand, passive systems rely on gravity rather than electricity using a thermosiphon configuration that uses gravity and convective heat flows.

40. In the current dispute, the water heating systems are solar water heaters with heat collectors running either an active or passive system and also fitted with electric immersion heaters therefore can function as electric water heaters. The challenge then is how the water heaters are properly classified in the HS.

41. The objective classification of goods under the HS is guided by rules of interpretation commonly known as GIR. In the instant case, the relevant rules of interpretation are as follows:

42. In the first instance, Rule 1 provides that:“The titles of Sections, Chapters and sub-Chapters are provided for ease of reference only; for legal purposes, classification shall be determined according to the terms of the headings and any relative Section or Chapter Notes and, provided such headings or Notes do not otherwise require, according to the following provisions.”

43. However, the impugned solar water heaters are fitted with an auxiliary electric immersion heating element to enable them to use electricity when solar energy is down. Note 1A(2)to Heading 8419 provides that:“… the heading also covers non-electric instantaneous water heaters and storage water heaters, including solar water heaters, domestic or not. If electrically heated, such appliances are excluded (heading 85. 16).”

44. Water heaters that use electricity are correctly classifiable under HS 8516. 10 which provides as follows:“8516 10 00- Electric instantaneous or storage water heaters and immersion heaters.”

45. The solar water heating system with an electric immersion heating element cannot be deemed as a dual system because according to the explanatory notes to this heading, the dual-system heaters of this heading are those in which the water is heated either electrically or by connection to a fuel-heated hot water system; they are often equipped with a thermostatic control to operate them electrically only when the alternative means which must be of a fuel source is insufficient. In the instant case, the impugned solar water heaters cannot be considered as a fuel-heated hot water system.

46. However, the explanatory notes to HS 8516 state that:-“The Assemblies consisting of immersion heaters permanently incorporated in a tank, vat or other vessel are classified in heading 84. 19 unless they are designed for water heating only or for domestic use, in which case they remain in this heading. Solar water heaters are also classified in heading 84. 19”

47. Based on the foregoing, the impugned goods are potentially classifiable under two headings 8419 and 8516. As presented, the goods can function as a solar heating system and also electric water heaters. They have all the characteristics of a solar water heater and also all the characteristics of an electric water heater. Rule 1 cannot be used to classify the goods because it results in two possible classifications.

48. It is a well-considered view that the heaters are a combination of the two types of heaters and therefore may be classified using rule 2(b) which provides as follows:“Any reference in a heading to a material or substance shall be taken to include a reference to mixtures or combinations of that material or substance with other materials or substances. Any reference to goods of a given material or substance shall be taken to include a reference to goods consisting wholly or partly of such material or substance. The classification of goods consisting of more than one material or substance shall be according to the principles of Rule 3. ”

49. To choose which of the two possible codes is applicable, guidance is therefore sought from Rule 3 which provides as follows:“When by application of Rule 2 (b) or for any other reason, goods are prima facie, classifiable under two or more headings, classification shall be effected as follows:(a)The heading which provides the most specific description shall be preferred to headings providing a more general description. However, when two or more headings each refer to part only of the materials or substances contained in mixed or composite goods or to part only of the items in a set put up for retail sale, those headings are to be regarded as equally specific in relation to those goods, even if one of them gives a more complete or precise description of the goods.b)Mixtures, composite goods consisting of different materials or made up of different components, and goods put up in sets for retail sale, which cannot be classified by reference to 3 (a), shall be classified as if they consisted of the material or component which gives them their essential character, as far as this criterion is applicable.”

50. The heaters cannot be classified according to Rule 3(a) because none of the two codes gives a more specific description of the imported goods than the other. Consequently, the goods must be classified according to Rule 3(b). The question then to be asked is what gives the heaters as imported, their essential character? That is what are“the prominent characteristics which serve to distinguish the heaters”?

51. Based on the parties’ pleadings, the essential characteristics of these heaters that distinguish them are the solar collectors commonly fitted to all solar water heaters. They are offered for sale as solar water heaters and must essentially be fitted in a location where they are able to collect solar heat. They mainly function as solar water heaters and revert to electric only when there is an outage of solar heat. The immersion heaters which is a characteristic of electric heaters form only a small percentage of the system. Furthermore, the electric component is fitted in Kenya as a Regulatory requirement rather than for engineering expedience.

52. Based on the material presented, the heating system has the appearance and character of a solar heating system. It is a considered view that the systems are not electric water heating systems fitted with solar components but solar systems fitted with an electric accessory to enable them to function as electric heaters.

53. Consequently, by dint of GIR 3(b), the subject solar water heaters as imported are most appropriately classifiable under HS 8419.

Final Decision 54. The upshot to the foregoing is that the Appeal is meritorious and the Tribunal consequently makes the following orders; -i.The Appeal be and is hereby allowed;ii.The Respondent’s review decision dated the 11th January, 2022 be and is hereby set aside; andiii.Each party to bear its own costs.

55. It is so ordered

DATED AND DELIVERED AT NAIROBI THIS 12TH DAY OF MAY, 2023. ..............................................ROBERT M. MUTUMACHAIRPERSON..............................................DELILAH K. NGALA ELISHAH N. NJERUMEMBER MEMBER..............................................EDWIN K. CHELUGET RODNEY O. OLUOCHMEMBER MEMBER