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February 19, 2021 High court of Kenya rules that transportation services for goods in transit are subject to VAT and input tax incurred in making exempt supplies is non-deductible Executive summary The High court of Kenya, on 8 January 2021, determined that transportation services for goods imported from a foreign place, through the territory of Kenya, to a foreign destination (in transit) are subject to value-added tax (VAT) and that input tax in relation to exempt supplies is not deductible. The decision follows an assessment by the Kenya Revenue Authority (KRA) that charged VAT on goods in transit, and disallowed input VAT claimed on services offered in relation to goods in transit. Detailed discussion Background of the case The Appellant, whose core business is transportation of goods in transit from the port of Mombasa to the rest of East & Central Africa region and sale of motorbikes for the period up to March 2013, filed an appeal at the Tax Appeals Tribunal (TAT) which was unsuccessful. The Appellant later appealed to the High court against the KRA. This was as a result of an assessment by the KRA dated 8 September 2015 covering VAT and corporation tax that was preceded by an audit of its financial records for the years of income 2013 to 2015. The following matters were in contention, specifically whether:
The Appellants’ position Transportation services provided in relation to goods in transit The Appellant contended that transportation services provided in relation to goods in transit fully met the definition of services exported out of Kenya as stipulated under Section 2 of the VAT Act, which provides: ‘’Service exported out of Kenya means a service provided for the use or consumption outside Kenya.” The Appellant asserted that zero rating the services was in accordance with the destination principle of VAT that provides that VAT is imposed at the point of consumption and hence exports should be zero rated and that their services should be deemed as services consumed outside Kenya. The Appellant also drew reference to Section 2 of the East Africa Community Customs Management Act (EACCMA) which defines transit as: ‘’…The movement of goods imported from a foreign place through the territory of one or more of the partner states to a foreign destination...’’ The Appellant pointed out that imposition of VAT at 16% by the Respondent would amount to double taxation as the country of destination has the right to levy tax as the jurisdiction of final consumption and that it would amount to discrimination of Kenyan companies offering similar services as their counterparts from neighboring countries would not have to bear the VAT liability in Kenya as it is not the destination of use/consumption of the goods. Disallowed input VAT for the supply of services in respect to goods in transit The Appellant pointed out that the services in question qualified as exported services and therefore were zero rated and not exempt as indicated by the Respondent. The Appellant relied on Section 2 of the VAT Act which defines zero-rated supplies as supplies listed in the second schedule. The second schedule provides that ‘’…Zero-rating shall be in accordance with the provisions of Section 7(1) of the VAT Act which states; Where a registered person supplies goods or services and the supply is zero rated, no tax shall be charged on the supply, but it shall, in all other respects, be treated as a taxable supply…" To augment the above, the Appellant insisted that Section 28(b) of the Finance Act 2014, which introduced the classification of taxable services with respect to goods in transit as exempt supplies for VAT purposes contradicted Section 5 of the VAT Act 2013, which is the charging section of the Act. Section 28(b) classifies "the supply of taxable services in respect of goods in transit" as exempt supplies. On the other hand, Section 5 requires that VAT be charged on taxable supplies. It follows therefore that the perplexing interpretation derived from Section 5 is that "taxable" supplies can only either be standard rated at 16% or zero rated but not exempt. The Appellant further contended that the status of being either ”taxable” or ”exempt” are disjunctive hence it is legally and logically incorrect to refer to a taxable service as being ”exempt.” Determination of the time of supply The Appellant also contended the Respondent disregarded Section 12(1) of the VAT Act 2013 which provides for the time of supply to be the earlier of: “the date on which the goods are delivered, or the date on which the invoice for the supply is issued, or the date on which payment for the supply is received”. According to the Appellant, payment for the motorbikes was completed in April 2013 and the actual delivery in September 2013. The VAT status of motorcycles was exempt prior to 2 September 2013 under the repealed VAT Act while the goods were taxable at a standard rate thereafter following coming into force of the VAT Act 2013. Additional Corporate Income Tax (CIT) assessment The Appellant pointed out that the expenses incurred by the company related to repairs of the trucks, costs associated to loading and off-loading of cargo, weighbridge fees, parking fees and inspection among others, all of which were wholly and exclusively incurred in the production of the Appellant’s income. The Appellant referred to Section 15(1) of the Income Tax Act, which states: "For the purpose of ascertaining the income of a person for a year of income there shall. Subject to Section 16 be deducted all expenditure Incurred in that year of income which Is expenditure wholly and exclusively incurred by him in the production of that income.” The Respondent’s position Whether transportation services for goods in transit were zero rated The Respondent relied on Section 5(1)(a) of the VAT Act 2013 which covers tax supplies made by a registered person in Kenya and this includes supply of transportation services for goods in transit. It fully relied on Section 7(2) of the VAT Act 2013 which provides that: “A supply or importation of goods or services shall be zero-rated if the goods or services, are of the description or the time being specified in the Second schedule.” The Respondent asserted that a supply not specified in the Second schedule of the VAT Act 2013 is subject to VAT at 16%. Services offered in relation to goods in transit were previously zero rated under the repealed VAT Act 2010. However, pursuant to the enactment of the VAT Act 2013 which came into force in September 2013, services in relation to goods in transit were not specified in the Schedule (zero rated supplies) thereby not accorded the zero-rated status and effectively became taxable at standard rate of 16%. Consequently, on 14 September 2014, the Finance Act 2014 amended the First schedule of the VAT Act 2013 by exempting from VAT services offered in relation to goods in transit. The Respondent submits that by virtue of transit services not being listed as exempt or zero rated under the respective schedules of the VAT Act 2013, the same was a taxable supply for the period between 2 September 2013 to 14 September 2014. Accordingly, the Respondent charged VAT on the transit services offered by the Appellant for the period between 2 September 2013 to 14 September 2014 at 16% as required under Section 5(l)(a) of the VAT Act 2013. The Respondent further submitted that the Appellant's contention that services in respect of transit goods qualify as services exported out of Kenya was therefore incorrect. The Respondent reiterated its position that the Appellant’s supply of transportation service was for goods destined for another country, that, the service is executed in Kenya and falls within the definition of a supply of services under Section 2 of the VAT Act 2013 which provides: “Anything done that is not a supply of goods or money, including:
Disallowed input VAT The Respondent contended that the services offered in relation to goods in transit were made exempt pursuant to the amendment of the VAT Act 2013 through Section 28 of the Finance Act 2014. Input tax in relation to exempt supplies is non-deductible and is disallowed under Section 17(6) of the VAT Act 2013. The Appellant's sole business for the period between 14 September 2014 to 12 June 2015 was transport services for transit goods. This service as stated above was exempt from VAT but the Appellant claimed input Tax of KShs 428,868 for the same. The Respondent disallowed the tax claimed in full in accordance with Section 17(6) of the VAT Act. Determination of the time of supply The Respondent asserted that Section 12(1) of the VAT Act 2013 on definition of time of supply was correctly applied. Despite payment for the motorbikes having been made on April 2013 as alleged by the Appellant, the goods were delivered on 11 September 2013 and the invoice issued on the same date, and therefore subject to VAT at 16%. Documentary evidence was not provided by the Appellant to show that the payments for the motorbikes were made in April 2013. Additional CIT assessment On the issue as to whether the expenses incurred by the Appellant are allowable under Section 15 of the Income Tax Act (ITA), the Respondent asserted that Section 15 of the ITA allows expenses that are wholly and exclusively incurred in the production of income. It is a general accounting principle that the expenditure must be supported by evidence. A review of the direct costs claimed by the Appellant for the audit period revealed that the motor vehicle expenses were claimed through petty cash vouchers. Other than the vouchers, the expenses were not supported by any documentary evidence despite several requests from the Respondent for the supporting documents. Decision by the High court Whether taxable services in respect of goods in transit are zero-rated services The High court and the lower tribunal both ruled that the Respondent did not err in its decision to tax income derived from transportation of transit goods. As to whether the services should’ve been entitled to zero-rated status, the same should have been specifically included in the Second schedule of the VAT Act. Whether the Tribunal was correct in agreeing to disallow the Appellant's input VAT claimed for the period September 2014 to March 2015 The High court again in agreement with the lower tribunal ruling found that the Respondent did not err in disallowing the input VAT as the services offered in relation to goods in transit were made exempt pursuant to the to the amendment of the VAT Act 2013 through Section 28 of the Finance Act 2014 and that input tax in relation to exempt supplies is not deductible and is disallowable under Section 17(6) of the VAT Act 2013. Whether the Respondent disregarded Section 12 (1) of the VAT Act 2013 which defines time of supply by holding that the payment of the motor bikes made in April 2013 and delivered on 11 September 2016 were subject to VAT at 16% The lower tribunal had determined that the appellant was not entitled to claim exempt status on the invoice dated 11 September for the sale of motor bikes because it sold them on 11 September and issued the invoice the same day. Since the VAT Act 2013 came into force on 2 September 2013 thereby removing the exempt status of the sale of motorbikes, the Appellant was not entitled to claim exempt status on the invoice dated 11 September. Documentary evidence was not provided in court to show that payment was received in April 2013. In the absence of this evidence, the High court concurred with the lower tribunal that the VAT Act 2013 imposed VAT on the supply of motorbikes effective 2 September 2013 and hence the Appellant was not entitled to claim VAT exempt status of motorbikes on the invoice dated 11 September. The basis of the decision was failure by the Appellant to provide documentary evidence showing payment was made in April 2013 and therefore earlier than the invoice date in accordance with evidence rules under Section 56 (1) of the Tax Procedures Act. Whether the expenses incurred by the Appellant are allowable under Section 15 of the ITA The High court agreed with the lower tribunal ruling that it is a general accounting principle that an expenditure must be supported by evidence to ensure its validity. A scrutiny of the direct costs revealed that considerably large amounts of money were claimed by the Appellant as motor vehicle expenses through petty cash vouchers but these transactions were not supported by any documentary evidence. The Appellant failed to discharge the burden to the satisfaction of the Commissioner by relying on petty cash vouchers instead of receipts. Next Steps This ruling solidifies the provisions of the VAT Act and provides guidance on the VAT status of services in relation to goods in transit. Where a supply is not specifically mentioned under the First or Second schedule, then VAT at the standard rate should be applicable. Also, taxpayers should ensure that expenses are fully supported and must be verifiable for deductibility purposes. ___________________________________ For additional information with respect to this Alert, please contact the following: Ernst & Young (Kenya), Nairobi
Ernst & Young Société d’Avocats, Pan African Tax – Transfer Pricing Desk, Paris
Ernst & Young LLP (United Kingdom), Pan African Tax Desk, London
Ernst & Young LLP (United States), Pan African Tax Desk, New York
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