February 13, 2023
Kenya High Court dismisses petitions challenging imposition of VAT on exported services
The Value Added Tax (VAT) treatment on exported services from Kenya has been a contentious topic that has been the subject of numerous disputes between the Kenya Revenue Authority (KRA) and taxpayers engaged in cross-border business.
In a recent ruling delivered on 31 January 2023 by Honorable Judge Hedwig Ong'undi, the High Court of Kenya dismissed consolidated petitions challenging the imposition of VAT on exported services under the Finance Act 2022.
The Finance Act 2022 under section 30(b) deleted para. 32 of the First schedule of the VAT Act 2013 which exempted the imposition of VAT on exportation of taxable services. This meant that exported services (except for Business Process Outsourcing (BPO)) were effectively reclassified as standard rated (16%) from the previous VAT-exempt status, effective 1 July 2022.
This move was opposed by various stakeholders on the basis that subjecting exported services to VAT would amount to double taxation since VAT is being imposed both in Kenya at 16% and at the respective destinations where the services would be consumed and used. There was also the question of whether the Finance Act 2022, as issued, was constitutional as it allegedly failed the public participation threshold.
Key positions raised by the parties
The Petitioners contended that the introduction of the impugned section 30 (b) of the Finance Act 2022 was not subjected to public participation. The petitioners asserted that this was included in the Finance Act 2022 in clear violation of the Constitution. The petitioners also asserted that given the far-reaching consequences of the impugned amendments, the proposed amendments ought to have been resubmitted to the public for their views since they were not contained in the Finance Bill before enactment.
The Petitioners contended that imposition of VAT on the exportation of taxable services results in subjecting VAT both in and outside Kenya which amounts to double taxation by multiple jurisdictions, which is an unfair burden on the taxpayer. The petitioner stated that the impugned provision is in violation of the Vienna Convention on the law of treaties (VCLT), the Organisation for Economic Co-operation and Development (OECD) International VAT and Goods and Services Tax (GST) guidelines on Neutrality, 2011 and Kenya's bilateral agreements.
The Respondents contended that public participation had been conducted even with reference to the impugned amendments because the Memorandum of objects and reasons for the Finance Bill had made clear the purpose of the Bill. They noted that the legislature was empowered to introduce amendments to Finance Bill as long as it is kept within the object of the law.
The Respondents also asserted that other than the taxes being imposed as per the law, the oppressive nature of taxation could not be deemed as a ground for invalidating the law as taxation is sanctioned by the constitution. The imposition of VAT on exported services or goods is guided by two principles, the origin principle and the destination principle. The origin principle advocates for taxation of goods or services within the jurisdiction where the goods or services are produced while on the other hand the destination principle places taxing rights on exported goods or services in the country where the recipient of the supplies is located.
With the enactment of Finance Act 2022, the Government adopted the origin principle while charging VAT on exported services. The Petitioners contested this principle as the Draft National Tax Policy states that VAT will follow the destination principle and this means that the taxing rights are with the person receiving the service, not the one offering it.
On the issue of constitutionality on the impugned amendments due to violation of public finance principles and oppressive nature the court pronounced that;
It is my humble view that allowing the petitioner's argument that the imposition of the taxes is unconstitutional when the imposition of taxes is parliament's constitutional mandate would be an error unless it is otherwise shown that due process was not followed. I, therefore, find that the inclusion of the amendments in the Finance Act 2022 was constitutional.
The court also held that the matters in question were revolving around policy issues which are mandated to the National Assembly by the Constitution and as such the Court is prohibited from making a decision revolving around political powers due to the doctrine of separation of powers.
On the issue of double taxation in multiple jurisdictions the court held that ..Kenya by virtue of Article 2 (5) and (6) of the Constitution applies the dictates of international law such as Double Taxation Agreements through Treaties to avoid double taxation at international level. As such the claim for double taxation in two jurisdictions fails.
On the issue of public participation on the impugned amendments, the court held that, new amendments can be introduced to a Bill under consideration after the First reading so long as the amendment is in line with the original intent of the purposes and objects of the Bill … . It is my considered view that the impugned amendments were in line with the set parameters of what had been presented to the public and the scope of the Finance Bill … in the circumstances I am persuaded to find that the impugned amendments did not violate the principle of public participation and are accordingly constitutional.
The implication of this ruling is that persons exporting services (except those that qualify as Business Process Outsourcing (BPO)) to other jurisdictions will become less competitive due to the additional taxes now imposed on their services. Taxpayers dealing in exportation will be required to demonstrate beyond reasonable doubt that their services qualify as BPO otherwise their services will be taxed at 16%.
This decision raises critical questions about the fairness and consistency of Kenya's tax policies and why goods for export and BPO-related services are zero rated for VAT purposes, yet other services are subjected to a 16% VAT. The OECD guidelines and The Draft National Tax Policy state that VAT should follow the destination principle, implying the person receiving the service should bear the tax burden, this ruling imposing VAT on exported services at the standard rate (except for BPO) contradicts this viewpoint by following the origin principle.
Further, the petitions principally focused on the constitutionality of the impugned amendment without clarifying the major issue in contention which is the VAT treatment of exported services. There is still uncertainty on how to treat exported services, as the definition of BPO remains unclear. Taxpayers are going to ride on varying interpretations or the meaning of BPO, as only the Export Processing Zones Act mentions what constitutes BPO. This means taxpayers will rely on the literal meaning or dictionary meaning of what constitutes BPO to classify their services. These varying interpretations have the potential of arbitrary interpretations of the term BPO as most services might be considered to fall within the confines of BPO services.
In several litigations, notably in Cooperative Bank of Kenya V Commissioner of Domestic Taxes, the Court has held that where a tax law is unclear, uncertain, and ambiguous it should be interpreted in the favor of the taxpayer. The term BPO is quite broad and the National Treasury and the National Assembly will need to issue guidance on what BPO constitutes to eliminate this uncertainty.
In conclusion, it is evident that the High Court is setting aside previous decisions in which it has ruled against such matters of unconstitutionality of tax provisions, for example the High Court decision in Association of Kenya Insurer's Petition against the impugned amendment to delete the exemption of insurance brokerage services where the petition merited on grounds of unconstitutionality due to lack of public participation.
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