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Executive summary

The High Court has upheld the position held by the Tax Appeals Tribunal (TAT) on the taxation of technical fees under the Kenya-France Double Tax Agreement (DTA).

The High Court held that, based on the Kenya-France DTA, technical fees are subject to income tax in the country of residence of the recipient unless they operate through a permanent establishment (PE) in the other state.

The Appellant (Commissioner of Domestic Taxes) appealed the decision of the TAT, which had ruled in favor of the Respondent (Total Kenya Ltd.) that withholding tax was not applicable on technical fees paid to a recipient who is resident in France.

The TAT made its decision pursuant to the Kenya-France DTA, which provides that business profits are only taxable in the country of residence of the recipient, unless the recipient has a PE in the other state.

Background

The Commissioner of Domestic Taxes performed an audit on the operations of the Total Kenya Ltd. (TKL). Among other matters, the Commissioner assessed TKL for failure to account for withholding tax on technical fees paid to its parent company, Total Outre-Mer (TOM), which is resident in France.

TKL appealed the assessment before the TAT, arguing that, based on the Kenya-France DTA, withholding tax was not applicable to technical fees that TKL paid to TOM. The TAT ruled in favor of TKL and the Commissioner of Domestic Taxes appealed to the Kenya High Court seeking to overturn the decision.

Issue for determination

The issue for determination was whether technical fees the Respondent paid to its French affiliate for the period under review were subject to withholding tax.

Appellant's submissions

The Appellant put forward the following arguments, among others:

• Section 35(1) of the Income Tax Act (ITA) and Article 21(4) of the DTA gave Kenya the right to impose withholding tax on technical fees paid to the French affiliate that did not have a PE in Kenya.
• Management and professional fees are not covered under the DTA and were thus taxable under the provisions of Article 21 of the DTA.
• The TAT erred in law and in fact by finding that professional fees paid by the Respondent to its related party in France constituted business profits that are provided for and dealt with under Article 7 of the Kenya-France DTA.
• The TAT was misguided in determining that technical fees fell under business profits and stating that Article 21 (3) of the United Nations Model Tax Convention (UN MTC) allows the State in which the income arises to tax such income if its law so provides.

Respondent's submission

• The Respondent argued that due to the deletion of Article 14 of the Organisation for Economic Co-operation and Development (OECD) MTC on management and professional fees and the omission of a specific article on such fees in the DTA, the technical fees it paid to TOM are taxable in France under Article 7.

Analysis and determination

The Kenya High Court observed that the DTA is modeled after both the OECD MTC and the UN MTC, which are accompanied by commentaries that are instructive in relation to the interpretation of the Articles of the MTCs.

The Court observed that technical fees fell under the category of business profits based on the definition of the term "business" in the ITA. They were thus taxable under Article 5 of the DTA. The Court disagreed with the Appellant's argument that they fell under Article 21 of the DTA.

The Court observed that Article 21 deals with miscellaneous income and provides examples in the commentary regarding alimony, lottery income and rent paid by a resident of a contracting state for the use of immovable property situated in the other state. Applying the ejusdem generis rule, management and professional fees could not reasonably fall within the same category as examples given in the commentary.

The Court therefore concluded that, based on a plain reading, the effect of the deletion of Article 14 is that income derived from professional services is dealt with under Article 7 as business profits.

It concluded that had Kenya intended to allocate itself taxing rights in the DTA it would have made an express provision for the same by including articles similar to 12A or Article 5(3)(b) of the UN MTC.