Judgment summary
The Tribunal heard an appeal by Avic International Beijing (EA) Limited against an Objection decision of the Commissioner of Domestic Taxes dated 25th September 2023, which confirmed Corporation tax, PAYE and Withholding Tax assessments amounting to Kshs. 514,154,336.00 inclusive of penalties and interest (paragraph 6).
The dispute centred on the Commissioner's use of the Transactional Net Margin Method (TNMM) instead of the Resale Price Method for transfer pricing purposes, alleged double-charging of Corporation tax on certain 2019 revenue, PAYE assessed on expatriates and seconded personnel, and Withholding Tax on management fees, accrued interest and deemed dividends arising from the transfer pricing adjustment.
The Tribunal dismissed the Respondent's preliminary objection that the appeal was invalid for want of service of the Notice of Appeal, and proceeded to determine the substantive issues, partially allowing the appeal and varying the Objection decision (paragraph 272).
Background
The Appellant is a Kenyan company established in 2015, engaged in importing trucks, machinery and motor vehicle spare parts, and is an approved importer of Completely Knocked Down Kits and an assembler of motor vehicles (paragraph 1).
The Respondent issued a Notice of Intention to Audit dated 30th July 2021 for the period 2016 to 2021 covering Corporation tax, VAT, PAYE and Withholding Tax (paragraph 3). Pre-assessment findings were issued on 1st November 2022 for the period January 2016 to December 2020, to which the Appellant responded on 23rd January 2023 (paragraph 4).
On 29th June 2023, the Respondent raised additional assessments for Corporation tax, PAYE and WHT amounting to Kshs. 530,528,802.00 inclusive of penalties and interest (paragraph 5). The Appellant objected on 27th July 2023, and the Respondent issued its Objection decision on 25th September 2023 confirming assessments of Kshs. 514,154,336.00 (paragraph 6). The Appellant filed its Notice of Appeal dated 24th October 2023 (paragraph 7).
Core dispute
The Appellant's grounds of appeal, set out at paragraph 8, were that the Respondent erred in using TNMM as the most appropriate method rather than the Resale Price Method, resulting in an unjustified transfer pricing adjustment and Corporation tax assessment; that the Respondent erroneously assessed WHT and PAYE beyond five years, from 2017 to 2023; that Corporation tax was double-charged on Kshs. 239,469,918.00 in revenue derived from a comparison of VAT returns and audited financial statements, which the Appellant said had already been declared in 2018; that the Respondent used the wrong methodology, the Hays Asia Pay Scale Salary Guide, in assessing PAYE on expatriates and seconded personnel without considering the low value-adding services approach; that seconded personnel were subjected to both WHT and PAYE resulting in double taxation; and that WHT was erroneously deemed on primary transfer pricing adjustments.
The Respondent raised a preliminary objection that the appeal was invalid because the Notice of Appeal had not been served on it as required under Section 12 of the Tax Appeals Tribunal Act, and sought that the appeal be struck out. On the substantive issues, the Respondent maintained that TNMM was the most appropriate method given deficiencies in the Appellant's benchmarking study, that the assessments were within time, that the expatriates and seconded employees performed integral, not low value-adding, functions warranting PAYE benchmarked against the Hays Asia Salary Guide, and that management fees payable to AIBCL were correctly subjected to WHT alongside deemed dividends arising from the transfer pricing adjustment.
Court findings
On the preliminary objection, the Tribunal held that failure to serve the Notice of Appeal on the Commissioner under Section 12 of the Tax Appeals Tribunal Act does not invalidate an appeal that otherwise satisfies Section 13, and found the appeal validly before it since the Respondent suffered no prejudice (paragraphs 148 to 156).
On time-bar, the Tribunal found that under Section 31(4) of the Tax Procedures Act, the Respondent had not pleaded or proved gross or wilful neglect, evasion or fraud, and that PAYE and WHT assessments for periods before July 2018 were illegal (paragraphs 161 to 166).
On PAYE, the Tribunal found the Appellant was under a statutory obligation to deduct and remit PAYE for its own expatriate employees, Hao Fuping, Chen Zhe, Yang Zhaoxin, Wu Lin Mao and Zhang Hongmei, but not for staff seconded from its related party AIBCL or from the unrelated manufacturer Shaanxi, as no employer-employee relationship existed with the Appellant (paragraphs 176 to 178). It further found the Respondent's use of the Hays Asia Salary Guide to enhance the expatriates' declared salaries was arbitrary and unsupported by law, and that PAYE should instead be based on the remuneration in the employment contracts, for periods from July 2018 (paragraphs 183 to 188).
On Corporation tax, the Tribunal found the Respondent had erred in reversing its earlier Objection decision of 31st March 2022 in respect of Kshs. 182,261,528.81 already reconciled, but found the Appellant had not discharged its burden of proof over the remaining unsupported variances totalling Kshs. 57,208,389.13 (paragraphs 195 to 201).
On the transfer pricing method, the Tribunal found that the Appellant's own selection of itself as the tested party was flawed given its acknowledged marketing intangibles and further processing of CKD kits, making the Resale Price Method unreliable, and upheld the Respondent's selection of TNMM and the resulting transfer pricing adjustment of Kshs. 424,914,851.00 (paragraphs 223 to 231).
On Withholding Tax, the Tribunal found the imputed management fees for staff seconded from AIBCL were not justified under Section 18(3) of the Income Tax Act, since AIBCL had not charged the Appellant any management fees and there was no reduction in profits (paragraphs 250 to 253). It upheld WHT on accrued interest on intra-group loans, as unchallenged by the Appellant (paragraphs 255 to 256). On deemed dividends under Section 7(1)(b)(v) of the Income Tax Act, the Tribunal found the provision effective from 1st July 2018, not 1st January 2019 as argued, but held that WHT could not be collected for periods before 7th November 2019 due to the deletion of Section 35(6) of the Income Tax Act by the Finance Act 2016 (paragraphs 262 to 271).
Outcome
The Tribunal found the appeal partially merited and partially allowed it, varying the Objection decision dated 25th September 2023 (paragraph 272).
It set aside PAYE assessments on expatriate employment income for periods before July 2018, set aside PAYE assessments for seconded employees, and directed recomputation of PAYE for expatriates from July 2018 using their contractual remuneration.
It revised the undeclared revenue figure for 2019 to the unsupported variances only, being Kshs. 4,209,696.41, Kshs. 32,833,770.35 and Kshs. 20,164,922.37.
It set aside WHT on management fees and on deemed dividend distributions for periods before 7th November 2019, while upholding WHT on accrued interest expense and on deemed dividend distributions from 7th November 2019 onward.
The Respondent was directed to recompute the assessments accordingly within thirty days, and each party was ordered to bear its own costs.
Tp method highlighted
The controlled transaction concerned the Appellant's purchase of Completely Knocked Down motor vehicle parts from its related party, Avic International Beijing Company Limited (China) (AIBCL), which itself sourced the parts from independent manufacturers without adding value.
The Appellant applied the Resale Price Method, selecting itself as the tested party, using Gross Margin as the profit level indicator and an interquartile range of 7.31% to 13.23% with a median of 9.09% derived from comparable companies on the OneSource Database.
The Respondent instead applied the Transactional Net Margin Method (TNMM), citing deficiencies in the Appellant's benchmarking study including mismatched comparables (light versus heavy vehicles), untranslated agreements, differing incoterms between Shaanxi and AIBCL, absence of AIBCL's full financial information, and the Appellant's further processing of goods which transformed their identity. The Respondent selected the Appellant as the tested party, used Net Profit Margin at EBIT as the profit level indicator, and derived an interquartile range of 5.17% to 16.58% with a median of 10.95%, resulting in a transfer pricing adjustment of Kshs. 424,914,851.00 in additional revenue for 2017 to 2021.
The Tribunal found that the Appellant itself had acknowledged an oversight in selecting itself, rather than AIBCL, as the tested party, given its ownership of marketing intangibles in design, fabrication and customer retention, and that the Appellant's further processing of CKD kits made the Resale Price Method unreliable. The Tribunal therefore upheld the Respondent's selection of TNMM as the most appropriate method and the resulting adjustment.
Major issues / areas of contention
- Whether the appeal should be struck out for failure to serve the Notice of Appeal on the Commissioner.
- Whether the Respondent's Corporation tax, PAYE and WHT assessments were time-barred under Section 31(4) of the Tax Procedures Act.
- Whether the Respondent erred in assessing PAYE on expatriates, nominee directors and seconded personnel using the Hays Asia Salary Guide.
- Whether the Respondent erred in assessing Corporation tax on undeclared revenue derived from a comparison of VAT returns and audited financial statements.
- Whether the Transactional Net Margin Method or the Resale Price Method was the most appropriate transfer pricing method for the Appellant's purchase of CKD parts from AIBCL.
- Whether the Respondent erred in assessing Withholding Tax on management fees, accrued interest and deemed dividends arising from the transfer pricing adjustment.