JUDGMENT - BAKER HUGHES EHO LTD TAT NO. 1189 OF 2022

Key Facts

Tax Type

Issues

• The Respondent erred in law and fact by disallowing Value Added Tax (VAT) expensed by the Appellant on legitimate business costs based on a misinterpretation of deductibility provisions under the Income Tax Act.
• The Respondent erred in law and fact by adjusting the deductible lease rental expense without considering the existing transfer methodology and operation model of the Appellant.
• The Respondent erred in law and fact by levying additional tax on foreign gains and losses reported in the Appellant's financial statements without fully considering all documentation.
• The Respondent erred in law and fact by adjusting the Wear and tear allowance claimed by the Appellant based on incorrect values and analysis contrary to what was contained in the financial statements.
• The Respondent erred in law and fact by demanding additional corporate income tax on the disposal of used assets by employing a flawed transfer pricing adjustment.
• The Respondent erred in law and fact by disallowing the cost of scrap assets written off, which has already been accorded the correct tax treatment by the Appellant, resulting in double taxation.
• The Respondent erred in law and fact by disallowing deductible business expenses related to stock obsolescence and bad debts provisions despite the Appellant providing necessary supporting documentation.
• The Respondent misapplied the law by demanding tax that was excessive, prejudicial, punitive, and beyond the ability of the Appellant to pay contrary to the cannons of taxation.
• The Respondent erred in law and fact by imposing withholding tax on deemed interest (arising from intra-group advances) based on a misinterpretation of deeming provisions in the Income Tax Act.
• The Respondent erred in law and fact by disallowing management fees paid by the Appellant without fully taking into consideration all the documentation and explanations provided supporting their deductibility.

Tax Years

• 2016
• 2015
• 2017

Holdings

• The Tribunal upheld the Respondent's decision to disallow the unjustified assignment of the tested party, finding that the Appellant did not provide necessary documentation to support its claims under this heading.
• The Respondent's decision to disallow the expensed VAT and WHT penalties was upheld, as input VAT is governed by the VAT Act and not the ITA, making it non-deductible under the latter.
• The Respondent's decision to disallow the write-off of obsolete inventory was upheld, as the Appellant failed to supply supporting documents and policies for these provisions.
• The Tribunal upheld the Respondent's decision to disallow management fees from related parties, as the Appellant did not provide evidence of the services' necessity, value, or arm's length pricing.
• The Respondent's decision to disallow wear and tear claims on capitalised rental assets was upheld by the Tribunal, as the Appellant did not provide specific purchase documents for each claim.
• The Tribunal upheld the Respondent's decision to disallow claims of deemed interest on interest-free loans from related parties, as the Appellant was a resident and such interest is subject to WHT.
• The Tribunal set aside the Respondent's decision to disallow gains/losses from the disposal of assets, ruling that the benchmarking method used was not a like-for-like comparison and required a correct model.
• The Tribunal upheld the Respondent's decision to disallow the Appellant's claims for wear and tear on capital assets, as the Appellant failed to provide sufficient evidence regarding the assets' depreciation and related documentation.
• The Tribunal upheld the Respondent's disallowance of the Appellant's bad debt provisions, as the Appellant did not prove the debts were uncollectable under the specified legal guidelines.
• The Tribunal directed the Respondent to perform a fresh benchmark analysis using the correct comparison model for the gains/losses from asset disposal.
• The Tribunal upheld the Respondent's decision to disallow the expensed costs of scrap assets written off, as the Appellant did not provide the necessary policy and valuation documents.

Remedies

• The Tribunal partially allowed the Appellant's appeal, varying the Respondent's objection decision on several matters including the disallowance of certain claims and directing a fresh benchmark analysis.
• The Tribunal ordered that each party bear its own costs associated with the appeal.
• The Tribunal varied the Respondent's objection decision, upholding disallowances related to wear and tear, scrap assets, and bad debts, while setting aside the disallowance on gains/losses from disposal of assets and directing a fresh benchmark analysis using the correct comparison model.

Tax Issue Category

• Gaar / Anti-Avoidance
• Capital Vs. Revenue
• Input Vs. Output Vat
• Deductibility / Allowances
• Transfer Pricing
• Withholding-Tax Characterisation

Legal Principles

• The Tribunal disregarded the Appellant's form of transactions (e.g., management fees and forex gains/losses) due to insufficient evidence of their substance. This included a lack of documentation to prove services were rendered, values were arm's length, or policies were applied consistently.
• The Tribunal applied the OECD Transfer Pricing Guidelines, requiring that related-party transactions adhere to the arm's length principle. The Respondent's use of benchmarking with new equipment companies was deemed flawed, as the Appellant's transactions involved used/depreciated assets, necessitating a correct comparison model.
• The Tribunal emphasized that the Appellant failed to meet its statutory obligation to provide requested documents (e.g., invoices, financial statements, and transfer pricing policies) under Sections 23(1)(b) and 59(1)(a) of the Tax Procedures Act. This failure justified the Respondent's use of best judgment to confirm the assessment, as outlined in Section 31(1) of the TPA.
• The Respondent disallowed deductions (e.g., wear and tear, management fees) under the Income Tax Act's anti-avoidance provisions. The Tribunal upheld these disallowances, citing the Appellant's failure to demonstrate compliance with statutory requirements and the potential for double taxation or excessive claims.

Disputed Tax Amount

Precedent Name

• Republic vs Kenya Revenue Authority, Proto Energy Limited (exparte) [2022] KEHC 5 (KLR)
• TAT No. 555 of 2021: Atronix Ltd vs. Commissioner of Domestic Taxes
• HCITA No. 121 of 2021: Commissioner of Domestic Taxes vs. Metoxide Africa Ltd
• Shreeji Enterprises (k) Ltd v Commissioner of Investigations and Enforcement 58 & 186 of 2019

Cited Statute

• Companies Act
• Legal Notice No. 37 of 2011
• Income Tax Act
• Tax Appeals Tribunal Act
• Tax Procedures Act, 2015
• Value Added Tax Act

Judge Name

• Abraham K. Kipr otich
• Eunice Ng'anga
• Bernadette Gitari
• Cynthia B. Mayaka
• Dr. Rodney Oluoch
• Eric Nyongesa Wafula

Passage Text

• ix. Disallowed management fees... In essence, the documents provided by the Appellant did not meet the OECD guidelines of Transfer Pricing. The Respondent was therefore justified in disallowing the amounts claimed as inter-company management fees in the period under review.
• ix. Withholding Tax on Deemed interest arising from advances from related parties... The Tribunal holds that the Respondent did not fall into error when it computed deemed interests on the amounts advanced and further subjecting it to WHT.
• iv. Disallowed Gain/loss from disposal of assets... The method used by the appellant in determine the gains /loss of the assets was also flawed to the extent that the Appellant did not explain how it carried out its benchmarking exercise to show that its preferred methodology was consistent with the arm's length principle.