Dilemma for multinationals as KRA goes for service export tax
Several multinational firms without subsidiaries in Kenya face uncertain times following a High Court decision that allows the KRA to impose levies on exported services.
Several multinational firms without subsidiaries in Kenya face uncertain times following a High Court decision that allows the Kenya Revenue Authority (KRA) to impose levies on exported services.
The courts had for about two years between 2018 and 2020 severally ruled in favour of these companies, noting that the services rendered on their behalf by their marketing departments in Kenya were not subject to the 16 percent value-added tax (VAT), which is a sales tax on goods and services sold in the country.
This saw KRA ordered to pay billions in VAT refunds to several multinationals including logistics company Total Touch Cargo Holland, internet giant Google, LG Electronics, Oracle System, beverage maker Coca-Cola, and French-based food company Danone.
All these companies were foreign-based. A few of them had subsidiaries in Kenya and registered as separate legal entities to do business in Kenya.
But most of them were just branches, which were not separate legal entities from their parents, and whose work in Kenya is to offer marketing services and liaise with customers on behalf of their parent companies.
The nature of some of these services offered by branches on behalf of their parent companies in such a way that it is difficult to tell who exactly consumed the service, leading to several legal disputes that KRA kept losing.
VAT-exempted goods
Realising that these multinationals were beating KRA in the court of law, the Treasury, under which the KRA falls, took a different route of pushing for the change in the law to remove exported services from the schedule of VAT-exempted goods.
The changes through the Finance Act 2022 expunged exported services from the first schedule of the VAT Act 2013 effectively reclassifying them from VAT-exempt status to the standard rate status, which made them taxable by the consumption tax at 16 per cent from July 1 last year.
The VAT Act defines an exported service as one that is used and consumed outside Kenya.
So now, exported goods are not zero-rated, which means traders, including professionals, such as accountants, lawyers, doctors, and engineers who also offer services to outsiders cannot claim VAT refunds.
Viva Africa Consulting Limited, a legal and financial tax advisory firm, had petitioned the High Court to declare unconstitutional the provision in the Finance Act, 2022 that introduced VAT on exported services and directed KRA to return all the monies they had collected by levying the 16 per cent VAT.
However, their argument was turned down by Justice Hedwig Ong’undi noted that imposition is the function of the National Assembly and could therefore not be declared unconstitutional unless they followed a wrong procedure. This has left a lot of multinationals in a dilemma, with experts fearing that some of them might opt to put their branches in other countries.
Ideally, both goods and services exported are not subjected to the 16 percent VAT, which was one of the arguments of Viva Africa Consulting Limited in the case in a consolidated petition in which they wanted the clause introducing VAT on exported services in the Finance Act 2022 declared unconstitutional and the KRA directed to return all the monies they had collected by taxing VAT.
Foreign exchange
Zero-rating exports is aimed at attracting critical foreign exchange. An export is a good that is produced domestically but sold to a consumer overseas. This definition fits like a glove when referring to goods, but it is not that clear for services, at least going by the many legal fights the taxman has been having with these multinationals.
The VAT Act defines an exported service as one that is used and consumed outside Kenya.
And it gets even murkier when the service being rendered does not appear like it has been consumed abroad, although it has been paid for from a foreign country.
Oftentimes, the local branches of multinationals are only in Kenya to offer marketing services and liaise with customers on behalf of their parent companies.
For marketing and advertising of their services in Kenya, these multinationals pay billions of shillings through their branches.
Their argument has always been that ultimately, the beneficiary of the marketing services —and who paid for it — is their parent company which is stationed abroad. As such, these services should not be subjected to VAT.
In the case of Google, Coca-Cola, and Oracle Systems (Kenya Branch), KRA was after the money used in Kenya to market their products, including Google Translate in the case of Internet giant Google.
Google Kenya won a tax dispute against KRA after the High Court ordered the taxman to refund Sh58.7 million for marketing services on behalf of its parent companies in the US and Ireland.
Justice Chacha Mwita agreed with Google Kenya that the services were consumed by Google Ireland even though it targeted Kenyans who would be persuaded in the future to take up Google Ireland services.
Google LLC
Google Ireland and Google LLC had contracted its Kenyan subsidiary to conduct marketing, research, and development.
The services included localisation and translation of Internet products into local dialects and other languages in contracts that were signed when former ICT Cabinet secretary Joe Mucheru was still Google’s sub-Saharan Africa and country manager.
Google Kenya had lodged four separate VAT refund claims for Sh9.8 million, Sh33.2 million, Sh14.8 million, and Sh739,106 --paid between 2010 and 2013 — which was rejected by the KRA triggering the court fight.
The KRA had argued that although the services were foreign-based, they were for local consumption and not exported services as claimed by Google Kenya. This has been KRA’s argument in all these cases: that such services are for products that would ultimately be consumed in Kenya and as such, should be subjected to VAT. This is technically known as the principle of origin.
That although it is the parent firm benefiting from the services and paying for them, it is Kenyans who will ultimately use Google Translate or drink Coca-Cola, or their argument goes.
However, according to Nikhil Hira, a tax expert, it is a no-brainer that one pays VAT on consumption, or what is known as the principle of destination and which has been agreed upon under the Organisation for Economic Cooperation and Development guidelines.
According to an advisory by PwC, an audit firm, the disputes on whether or not tax-exported services emanate from the lack of clarity in the VAT legislation on what constitutes the ‘use’ or ‘consumption’ of services outside Kenya.
“Which are critical terms in the determination of whether services are exported or not,” said PwC.
