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Executive summary

The Kenyan High Court held on 20 November 2023 that value added tax (VAT) is not applicable to interchange fees that an issuing bank earned on credit card transactions.

In Commissioner of Domestic Taxes v. Commercial Bank of Africa Limited (Civil Appeal E146 of 2021) the Commissioner of Domestic taxes (Appellant or Commissioner) sought to charge VAT on interchange fees earned by the Commercial Bank of Africa Limited (Respondent or Bank) in its capacity as an issuing bank. The Bank maintained that the card transactions giving rise to interchange fees qualify as money transfer services, which encompass financial services that are VAT-exempt.

The Tax Appeals Tribunal (TAT) ruled for the Bank and the High Court affirmed.

Detailed discussion

Background

On 12 June 2018, the Commissioner issued a tax assessment to the Bank amounting to more than 304.43 million Kenyan shillings (KES 304.43m) for the period 01 January 2013 to 31 December 2013 for undeclared VAT on interchange fees. The Bank objected to the tax assessment and the TAT held that interchange fees are not subject to VAT (i.e., VAT-exempt). Thereafter the Commissioner appealed the TAT decision at the High Court.

Key positions of the parties

The Commissioner asserted that interchange fees fall under the definition of management and professional fees and thus are subject to VAT. The Commissioner relied on certain facts, including: (1) the VAT Act of 2013 did not expressly state that interchange fees were exempt financial services; and (2) services the Bank provided, which included authorization, clearing and settlement, were not exempted by the VAT Act under paragraph 1 of the Third Schedule of the repealed VAT Act. Therefore, the Commissioner concluded that the services were taxable under sections 5, 6(1) and 6(4) of the repealed VAT Act.

In its arguments to the High Court, the Respondent contended that (1) interchange fees/payments were not payment for services but rather a cost-balancing mechanism that the issuing banks incur when issuing cards and (2) the TAT did not err in holding that the issuing bank conducts the services based on the contractual relationship with the customers.

High Court determination

The question before the Court was whether VAT is applicable on interchange fees.

To answer this, the Court had to first determine what role the Respondent played as an issuing bank in a card payment network. The Court referred to the case Commissioner of Domestic Taxes v Bank of Africa Limited,¹ which reads in part:

[T]he issuer is the gate keeper to the card-holder's account from which it transfers money to the acquirer for cardholders' purchases and earns interchange fees in return. The issuer's primary service is therefore to the cardholders as customers. [T]he nature of the service the issuer renders to card holders is a financial service because the issuing bank owes cardholders a duty to verify not only their details and eligibility to use the cards but also deduct money from their accounts and pass it to the acquirer.

The High Court noted that under paragraph 1(b) of the VAT Act, transfer, receipt or any dealings with money is exempt from VAT. Because the interchange fees is earned from the process of operating the customer's account by conducting verification of the cardholder details and availability of funds, the service was exempt from VAT as a financial service.

Conclusion

The decision by the High Court upholds that interchange fees should not be subject to VAT as they fall within the ambit of financial services, which are VAT-exempt under the VAT Act.