' REPUBLIC OF KENYA
IN THE HIGH COURT AT NAIROBI MILIMANI
COMMERCIAL AND TAX DIVISION
INCOME TAX APPEAL NO E215 OF 2023
(CORAM: CHARLES KARIUKI – J)
ECP KENYA LIMITED… APPELLANT
-VERSUS-
COMMISSIONER OF DOMESTIC TAXES… RESPONDENT
[Being an appeal against the Judgment and decision of the Tax Tribunal in Tax Appeal Tribunal Reference Number 614 of 2022 rendered on 10th November 2023]
JUDGMENT
BACKGROUND:
The Appellant is a limited liability company incorporated in Kenya pursuant to the provisions of the Companies Act (Cap 486, Laws of Kenya) (now repealed), and whose principal activity is the collection of data from the portfolio assigned to it by its parent entity, ECP Manager LP (hereinafter referred to as ERP Manager) in consideration for a fee. ECP Manager is a limited partnership based in the United States of America. The Respondent is a principal officer appointed under Section 13 of the Kenya Revenue Authority Act, 1995. Under Section 5 (1) of the Act, the Kenya Revenue Authority (the Authority) is an agency of the Government for the collection and receipt of all tax revenue.
The Respondent issued a letter of assessment to the Appellant dated 4 February 2022, demanding the Corporation tax of Kshs - 2,521,185,943.00, inclusive of penalties and interest. The Appellant lodged a notice of objection dated 4 March
2022.The Respondent issued an objection decision dated 28 April 2022 in respect of the Appellant''s notice of objection.
The Appellant, being dissatisfied with the decision of the Respondent, notified the Respondent of its intention to appeal to the Tribunal against the said decision vide a Notice of Appeal, which was filed on the same date. After hearing the Appeal, the Tribunal concluded that the Appeal lacks merit and accordingly made the following Orders: The Appeal is hereby dismissed. The Respondent''s Objection decision dated 28 April 2022 was upheld, and each party is to bear its own costs.
The Appellant proffers this Appeal against the Judgment of the Tax Tribunal and has filed the Memorandum of Appeal through which it raises eight [8] grounds of appeal to be determined by the Honorable Court: - The Tribunal erred in its duty by solely relying on the Securities and Exchange Commission filings of the Appellant''s Holding Company, ECP Manager LP.
The Tribunal erred in law by failing to consider, without justification, the audited financial statements of the ECP manager, which set out the actual profit for the period under assessment, and consequently endorsed the Respondents'' approach to computing tax on fictitious income.
The Tribunal erred in law in upholding the Respondent''s tax demand, which was computed on the basis of the entire gross revenue earned by ECP Group outside Kenya, rather than the relevant profit attributable to the Appellant.
The Tribunal erred by disregarding the Appellant’s Transfer Pricing Policy in its decision, without justification, contrary to the provisions of Section 18(8) of the ITA, as read with the Transfer Pricing Rules, 2006.
The Tribunal erred in failing to recognize that, under the Transfer Pricing Rules 2006, the Appellant has the discretion to determine the
appropriate transfer pricing method to be used in charging services rendered to the ECP Manager, based on its business model.
The Tribunal erred by deliberately mischaracterizing the relationship between the ECP Manager and the Appellant, finding that the roles and functions were integrated, and thereby upholding the Respondent''s erroneous tax demand.
The Tribunal erred in failing to recognize and appreciate that its failure to analyze the Appellant''s evidence in its totality would result in the illegal imposition of taxes, contrary to Article 210 of the Constitution.
Parties were directed to canvass the Appeal via submissions, which they filed and exchanged.
THE APPELLANT SUBMISSIONS:
The Appellant argued an appeal on the following issues.
Whether the Tribunal erred in law, failing to consider the Appellant''s evidence and solely relying on the Securities Exchange Commission [SEC] filings of the Appellant''s holding Company, ECP Manager LP.
Whether the Tribunal erred in law by failing to consider the Appellant''s evidence in the form of the ECP Manager''s audited financial statements on the actual profits under the period of assessment.
Whether the Tribunal erred in endorsing the Respondent’s approach of tax computation based on fictitious gross revenue earned by the ECP Group outside Kenya.
Whether the Tribunal erred in disregarding the Appellant’s Transfer Pricing Policy [TP Policy] contrary to the provisions of Section 18 [8] of the ITA as read with the Income Tax [ transfer Pricing] Rules 2006.
Whether the Tribunal mischaracterized the relationship between the Appellant and the ECP Manager, thereby erroneously conflating roles and functions played by the Appellant and ECP Manager.
Whether the Tribunal upheld and sanctioned an illegal imposition of taxes contrary to Article 21 of the Constitution.
Whether the Tribunal erred in law, failing to consider the Appellant''s evidence and solely relying on the Securities Exchange Commission [SEC] filings of the Appellant’s holding Company, ECP Manager LP.
The Appellant submits that, when called upon to provide its evidence before the Tribunal, it relied on the interview with Bryce Fort, its TP Policy, and filed audited financial statements, witness statements, and its job descriptions.
2 Page 772 of the Record of Appeal.
The Tribunal erroneously upheld the Respondent’s FAR analysis of the Appellant’s role, which the Respondent had disagreed with, and disregarded the Appellant’s FAR analysis as well as its TP Policy.
The Tribunal relied on the Respondent’s FAR analysis, which was based solely on the ECP Group''s SEC filing. The ECP Group did Group 3''s SEC filing, which covers the ECP Manager LP, ECP Manager III LP, ECP Mena Management LP, Emerging Capital Advisors LLC, and ECP Manager IV LP.
In the SEC filing, it is described that the ECP is the principal investment advisor to various private funds and pooled investment vehicles. The ECP Group prepared the SEC filings to cover the various ECP US entities.
The Appellant is a subsidiary of the ECP Manager, with its functions set out in its TP Policy 4, namely, to provide technical and administrative support to the ECP Manager. The Appellant, being a 100% owned subsidiary of ECP Manager, provides services to ECP Manager and has no direct relationship to any other entity. The Appellant''s responsibilities include providing information to ECP Manager''s Ex Co, subject to assignments from the ExCo in support of ECP Manager''s Advisory Activities and undertaking support services in support of ECP Manager''s Operating Activities.
In addition to Kenyan statutory requirements and filings, and the maintenance of local books and records, the Appellant provides information to the ECP Manager that US regulators and tax authorities require. The TP Policy clearly indicated
that the Appellant does not participate in ECP Manager''s Fundraising Activities nor does it participate in the decisions relating to investment selection or disposal.
Further, in the interview between the Respondent and the Appellant’s Director, Bryce Fort, on 17 September 20205, it was unequivocally confirmed that local/regional offices such as the Appellant do not make any sourcing or exit decisions. It was further confirmed that there was a need to continually collect information from the portfolio companies and report back to the ECP Manager, whose role is performed by the Appellant. This interview confirmed the Appellant''s role and function as an administrative support function to its holding company, the ECP Manager. Thus, it is submitted that this role is in line with the Appellant''s TP Policy.
The Appellant, through its witnesses Daniel Beeton and Mark Gerdelman, testified about the FAR analysis undertaken by the Appellant in preparing its TP Policy. The testimony of Daniel Beeton confirmed the Appellant''s administrative support function to the ECP Manager.
Gendelman''s testimony concerned the financial statements of the ECP Manager for the period under taxation. The witness produced audited financial statements found on pages 103 to 127 of the Record of Appeal. The statements established that the ECP Manager incurred a loss for the periods 2016, 2017, and 2018, and incurred a gain for the periods 2019 and 2020. The witness confirmed that, if tax is due when the ECP Manager makes a gain and based on the Respondents'' work, it would be at a lower rate than the Tax Assessment upheld in the objection decision.
It is submitted that the Tribunal disregarded this evidence and opted to give credence to Appellant’s evidence and to rely on the foreign filings of the ECP Group. The SEC filings did not relate to the Appellant herein, as it is a distinct and separate entity from the other ECP US entities. It is a trite law that a holding company is a distinct legal entity from its subsidiary. Reliance made on the Court
of appeal case of Hannah Maina t/a Taa Flower v Rift Valley Bottlers Limited as cited in the case of RE: SOUTHARD LIMITED [1979] 3 ALL ER 565 .
The Appellant submits that the Tribunal’s reliance on the ECP Manager’s SE filings as a holding company violated the doctrine of a company''s separate legal and distinct entity, thereby resulting in an erroneous decision.
Whether the Tribunal erred in law by failing to consider the Appellant’s evidence in the form of the ECP Manager’s audited financial statements on the actual profits under the period of assessment.
The Appellant submits that it provided the ECP Manager’s audited financial statements, which show the ECP Manager''s income and actual profits for the years under assessment. The Appellant’s witness, Mark Gerdelman, testified before the Tribunal in accordance with his Witness Statement 9, in which he provided certified extracts of the audited financial statements of the ECP Manager, prepared by Deloitte & Touche LLP USA. The testimony before the Tribunal was that, if TPSM were correctly applied by the Respondent, the attribution to the Appellant and thus the subject of tax in Kenya would be profits, not income. The Appellant''s evidence before the Tribunal was that the ECP Manager incurred a loss in 2016, 2017, and 2018, while it made a profit in 2019 and 2020. 10
That, based on the audited financial statements of the ECP Manager and the computation thereunder, the Appellant''s position is that no tax would be due in Kenya from the Appellant in the event of the correct application of the TPSM method, which the Respondent/Tribunal had relied on. The Appellant''s evidence is that the application of TPSM resulted in the Appellant being declared to have low income for the period under review, taking into consideration that the ECP Manager reported significant losses from 2016 to 2018 and minimal profits in 2019 and 2020. This, when compared with the income of Kshs. 486, 781, 302/-, which the Appellant had declared in the years 2016 to 2020, and the corporate tax paid based on the TNMM method.
Thus, it submitted that, in error of its decision, the Tribunal disregarded the evidence adduced by the Appellant''s holding company, endorsed and upheld the Respondent''s tax computation based on a fictitious income. The Respondent and the Tribunal''s purported assessment was based on the assets under management by ECP for the years under review, per the ADV form of ECP Manager LP, ECP Manager III LP, and ECP Mena Management LP, as filed in the SEC, which was computed as per the Respondent''s Statement of Facts.
It is further argued that, in disregarding the Appellants'' evidence of the actual profits evidenced by audited financial statements, the Tribunal relied on the alleged assets under the management of the three entities. It is the Appellant''s submission that the assets under the respective company’s management do not constitute an income or amount to a profit to be considered in tax assessment.
Furthermore, the Tribunal, in upholding the Respondent''s tax assessment, erred in its Judgment in holding that the Appellant failed/refused to provide evidence of the financial information for the ECP Group. The Appellant adduced evidence that it is a subsidiary of the ECP Manager only, provides services to the ECP Manager, and not the ECP Manager III LP or ECP Mena Management LP. The Appellant could not obtain financial information of the other entities, which are neither its holding companies nor does it render any services to them. The Appellant, the ECP Manager III LP, and ECP Mena Management LP are distinct and separate legal entities. The Tribunal''s expectation that the Appellant should have this financial information of the entire ECP Group was erroneous.
The Tribunal, in its judgment, acknowledges that the Respondent did not have access to the required information to compute gross profit at the global level. 11 Then, one must ask, on what basis or information did the Respondent rely on to reach its tax assessment? By upholding the Objection Decision, the Tribunal affirmed the Respondent''s decision to determine the gross revenue of the ECP: ECP Manager LP, ECP Manager III LP, and ECP Mena Management LP. It is submitted that the Tribunal should have relied on the information provided by
the Appellant, namely its parent company, audited financial statements, which clearly indicated the profits/income for the years under review. Instead, the Tribunal erred and relied on a fictitious income, which the Respondent neither had access to nor could prove the existence of.
Whether the Tribunal erred in endorsing the Respondent''s approach of tax computation based on fictitious gross revenue earned by the ECP Group outside Kenya.
It is argued that the Tribunal in Paragraph 187 of the Judgment holds that, despite being requested, the Appellant refused/failed to provide the financial information for the ECP Group, which would play a key role in calculating the gross profit prior to the profit split. The Tribunal acknowledges the use of the information, as it was reconstructed from the SEC forms filed by ECP.
The Tribunal, in relying on the ECP Group''s SEC filings, used the ECP Group''s total gross revenue, including that of the ECP Manager, ECP Manager III LP, and ECP Mena Management LP. This was done instead of using the gross revenue as earned by the ECP Manager, who is the holding company of the Appellant, as required by the TPSM Guidance. Your Lordship, the Appellant is a subsidiary of the ECP Manager and provides only technical and administrative support to the ECP Manager, as evidenced by the Appellant''s TP Policy. It is restated that the Appellant does not provide any services to the ECP Manager III LP and ECP Mena Management LP. The Tribunal was erroneous in its decision to attribute the income of the ECP Manager III LP and ECP Mena Management LP to the Appellant.
The Respondent urged the Tribunal to uphold its Objection Decision and the Tax Assessment, which were based on the alleged gross profits of the entire ECP Group, comprising ECP Manager, ECP Manager III LP, and ECP Mena Management LP. The Respondent''s assessment was based on the ECP''s assets under management, as per the ECP Manager, ECP Manager III LP, and ECP Mena Management LP forms filed with the SEC.
The Tribunal relied on the above fictitious gross revenue allegedly earned by the entire ECP Group. The Respondent neither obtained nor availed the audited financial statements for the ECP Group to prove their revenue under the years of assessment. While the Tribunal faults the Appellant for failing to provide this information, the Appellant has reiterated that it is not in control of or in possession of the information for the entire ECP Group. It is a subsidiary of the ECP Manager, rendering its services only to that manager. The Appellant availed the audited financial statements for the ECP Manager, which showed the actual profits for the years under the assessment. The Tribunal, in turn, disregarded these statements and opted to rely on fictitious income generated by the Respondent.
The Respondent was insistent on basing its tax assessment on ECP Group''s fictitious gross revenue and failed to provide any supporting information for that revenue. The Tribunal''s upholding of the assessment based on a fictitious gross revenue renders the entire tax assessment invalid. The Court is urged to allow the Appeal, set aside the Judgment, and set aside the Objection decision.
Whether the Tribunal erred in disregarding the Appellant’s Transfer Pricing Policy [TP Policy] contrary to the provisions of Section 18 [8] of the ITA as read with the Income Tax [ transfer Pricing] Rules 2006 .
The Income Tax (Transfer Pricing) Rules 2006 were established pursuant to Section 18 [8] of the ITA. The purposes of these Rules are to provide guidelines for related enterprises to determine the arm''s length prices of goods and services in transactions involving them, and to provide administrative regulations, including the types of records and documentation to be submitted to the Commissioner by a person involved in transfer pricing arrangements.
Rule 4 of the Rules contemplates that the taxpayer may choose a method for determining the arm''s length price from among the methods set out in Rule 7 thereunder. These methods include the comparable uncontrolled price (CUP) method, the resale price method, the cost-plus method, the profit split method, and the transactional net margin method. The Commissioner is further
empowered to prescribe any method from time to time, where, in his opinion and in view of the nature of the transactions, the arm''s length price cannot be determined using any of the methods contained in these guidelines.
The Appellant submits that it adopted the transactional net margin method pursuant to its Transfer Pricing Policy [TP Policy], which the Tribunal and the Respondent disregarded and, in turn, adopted the profit split method [TPSM]. The Tribunal erred in holding that the Appellant''s services are integrated and that the appropriate method is TPSM. The Tribunal reasoned that the services provided by the Appellant are integrated with the services rendered by the ECP to the Funds. The integration is alleged to be such that it was difficult for the Appellant to split the exact services rendered by the Appellant and the ECP. Furthermore, the Tribunal erred in holding that the Appellant and the ECP jointly render exact services to the extent that it was impossible to evaluate each party’s exact contribution to the Funds, making it difficult to evaluate each party''s contribution to the services rendered.
It is submitted that the Tribunal erred in upholding the Respondent’s Objection decision in changing the Appellant’s TP Policy method. The Appellant is empowered by Rule 4 and 8 (2) of the Transfer Pricing Rules 2006 to apply the method most appropriate. The Tribunal and the Respondent are to accept the taxpayer’s choice.
Method. The Tribunal and the Respondent do not have the power and/or discretion to change the taxpayer''s chosen method. We take cognizance of the decision of the High Court in Kenya Fluorspar Company Limited v Commissioner of Domestic Taxes, where the Court held that: "47. I note that, under Kenyan law, both tax assessment methods may be used, depending on the specific operations and relationships among related enterprises. There are also other methods of assessing taxes. It is agreed that the choice has to be made governed by the Transfer Pricing Rules 2006 (LN67), under which Rule 4 provides as follows: 4. The taxpayer may choose a method to employ in determining the arm''s length from among the methods set out in Rule 7. Rule 7
thus, it provides various methods of choice, including the profit split method. In this regard, Rule 8(2) provides as follows: 8(2). A person shall apply the most appropriate method for his enterprise, having regard to the nature of the transaction, or class of related persons or function performed by such persons in relation to the transaction. It follows from the above provisions that the choice of the most favorable tax assessment method is for the taxpayer, not the Commissioners. In this regard, I agree with the reasoning in Unilever Kenya Ltd – vs – The Commissioner of Income Tax [2005] e KLR , where it was held that the taxpayer is entitled to choose the most favourable method to their advantage as far as liability to tax is concerned.
The main issue that has arisen herein is that instead of addressing the objection raised using the selected profit margin method, the Commissioner changed to the Transactional Net Margin Method without indicating the law that confers on the Commissioner the power to change the method. Even in this Appeal, the Commissioner has not pointed to any section of the law that gives it the right to change the taxpayer''s elected choice method.
First, there is no evidence that the mining and prospecting licenses were new assets not known in the profit split method. Secondly, even if they were new intangible assets, the Commissioner would have to back his change of method with the law, which they have not. The Commissioner had no legal power to change to a new method for the Transaction Net Margin. The Commissioner could only use the Profit Split method chosen by the taxpayer. The Commissioner was thus correct in using the Transactional Net Margin Method."
It is submitted that the Tribunal erred in law in upholding the Respondent’s decision to change the Appellant’s choice method.
The Appellant prepared its TP Policy in accordance with the Income Tax Act [ITA], the TP Rules, and the OECD Guidelines, and has consistently applied it in all its dealings with the ECP Manager. The OECD Guidelines provide the process to be followed when preparing a Transfer pricing policy and determining
the arm''s-length price for a related-party transaction. Paragraph 3.4 of the Guidelines states the following.
Step 1: Determination of the years to be covered
Step 2: Broad-based analysis of the taxpayer’s circumstances
Step 3: Understanding the controlled transaction(s) under examination, based in particular on a functional analysis, in order to choose the tested party (where needed) the most appropriate transfer pricing method to the circumstances of the case, the financial indicator that will be tested (in case of a transactional profit method), and to identify the significant comparability factors that should be taken into account.
Step 4: Review of existing internal comparable, if any.
Step 5: Determination of the available sources of information on external comparables, where such external comparables are needed, taking into account their relative reliability.
Step 6: selection of the most appropriate transfer pricing method and, depending on the method, determination of the relevant financial indicator.
Step 7: Identification of potential comparables; determining the key characteristics to be met by an uncontrolled transaction in order to be regarded as potentially comparable, based on the relevant factors identified in Step 3 and in accordance with the comparability factors set for the Section D.1 Chapter 1.
Step 8: Determination and, where appropriate, making comparability adjustments. Step 9: Interpretation and use of data collected determination of the arm’s length.
Remuneration.
It is submitted that the Appellant followed the above nine-step approach in preparing its TP Policy and in determining the arm''s length rate applied to its remuneration for the provision of its services to the ECP Manager. Therefore, based on the functions, assets, and risk analysis set out in the Appellant''s TP Policy, the most appropriate method was the TNMM with Full Costs Markup as
the Profit Level Indicator, being the correct arm''s length compensation applied. We submit that the Appellant undertook its transfer pricing analysis and provided a proper explanation and rationale for selecting TNMM, as set out in the Policy. Moreover, the Appellant, in its TP Policy, explained why the TPSM would not be a suitable method for transfer pricing on account of the routine administrative support services as provided by the Appellant.
According to the Revised Guidance on the Application of the Profit Split Method Inclusive Framework on BEPS: Action 10 July 2018 [the TPSM Guidance], the TPSM method is most appropriate where.
Unique and valuable contributions by each of the parties to the transaction; and
Highly integrated business operations.
The TPSM Guidance further states that: Contributions (for instance, functions performed, or assets used or contributed) will be unique and valuable in cases where: They are not comparable contributions made by uncontrolled parties in comparable transactions; and They represent a key source of actual or potential economic benefit in the business operations. The two factors are often linked: comparables for such contributions are seldom found because they are a key source of economic advantage.
The Appellant submits that the TPSM Guidance is clear on the circumstances in which TPSM should be applied and the conditions that are to be fulfilled. The Tribunal, in allowing the use of the TPSM method, held that the Appellant’s role extends beyond the general administrative role portrayed by the Appellant. While the Appellant provided evidence of its role and functions it undertakes as instructed by the ECP Manager, in the form of the TP Policy, the Interview by Bryce Fort15, and the witness testimony of Daniel Beeton16, the Tribunal disregarded this evidence and relied on a faulty FAR analysis.
The Appellant asserts that it performs an administrative support service role to the ECP Manager, which cannot be said to be highly integrated. The ECP
Manager’s functions, analysis, and risks are well defined, and the independent comparables for the functions provided by the Appellant are readily available in its TP Policy. We take cognizance of the TPSM Guidance on integration inter alia. Although most multinational groups are integrated to some extent, an exceptionally high degree of integration in certain business operations is an indicator for the consideration of the transactional profit method. A high degree of integration means that the way in which one party to the transaction performs functions, uses assets, and assumes risks is interlinked with, and cannot reliably be evaluated in isolation from, the way in which another party to the transaction performs functions, uses assets, and assumes risks. In contrast, many instances of integration within a multinational result in situations in which the contribution of at least one party to the transaction can, in fact, be reliably evaluated by reference to comparable uncontrolled transactions.
It is the Appellant''s submission that, based on the above, the Tribunal erred in applying the TPSM in the remuneration of the Appellant''s functions. The Appellant reiterates that it followed the required approach set out in the OECD TP Guidelines in preparing its TP policy and in determining the correct arm''s length rate for its remuneration for the provision of support services to the ECP Manager. Accordingly, based on the FAR analysis undertaken in respect of the Appellants'' Policy, the most appropriate method, which was chosen, is the TNMM as discussed above.
Whether the Tribunal mischaracterized the relationship between the Appellant and the ECP Manager, thereby erroneously conflating roles and functions played by the Appellant and ECP Manager.
In its Judgment, the Tribunal made a finding that the Respondent did not err in its Functions, Assets and Risks [FAR] analysis. The Tribunal further concluded that the Appellant described itself in its SEC filings as providing advisory services on a discretionary basis, indicating a much greater role for the Appellant than its Transfer Pricing Policy indicated.
17 Page 163 of the Record of Appeal
The Tribunal relied on the SEC filings and found that the Appellant''s personnel and the job descriptions are similar to the descriptions of the services ECP Manager sets out in the SEC filings, indicating that the services that the Appellant provides are similar to those of ECP Manager and do not carry out a supportive administrative role as indicated in its Transfer Pricing Policy.
The Respondent, in its Statement of Facts, carried out the FAR analysis shown by relying on the following:
Interview with Bryce Fort.
Documents availed by the Appellant, such as generic descriptions and a letter describing the functions of the ECP Manager and the Appellant.
ECP entities filed returns at the SEC.
SEC administrative proceedings.
The Appellant submits that in upholding the Respondent''s FAR analysis above, the Respondent and the Tribunal disregarded the Appellant''s TP Policy, which was prepared pursuant to the provisions of Section 18 [3] of the Income Tax Act and the Income Tax (Transfer Pricing) Rules, 2006. The TP Policy sets out the Appellant''s functions, assets, and risks in the provision of its services to the ECP Manager, as well as its relevant remuneration.
Contrary to the Respondent''s averment and the Tribunal’s holding, the Appellant’s function is to provide technical and administrative support to the ECP Manager. In its TP Policy 19, Clause 6.1.2, the Appellant clearly stipulates that it offers technical and administrative support to the ECP Manager. The Appellant, being a hundred percent owned subsidiary of ECP Manager, provides services to ECP Manager and has no direct relationship to any other entity. The Appellant’s responsibilities include providing information to ECP Manager''s ExCo, subject to assignments from the ExCo in support of ECP Manager''s
Advisory
[...truncated]
IN THE HIGH COURT AT NAIROBI MILIMANI
COMMERCIAL AND TAX DIVISION
INCOME TAX APPEAL NO E215 OF 2023
(CORAM: CHARLES KARIUKI – J)
ECP KENYA LIMITED… APPELLANT
-VERSUS-
COMMISSIONER OF DOMESTIC TAXES… RESPONDENT
[Being an appeal against the Judgment and decision of the Tax Tribunal in Tax Appeal Tribunal Reference Number 614 of 2022 rendered on 10th November 2023]
JUDGMENT
BACKGROUND:
The Appellant is a limited liability company incorporated in Kenya pursuant to the provisions of the Companies Act (Cap 486, Laws of Kenya) (now repealed), and whose principal activity is the collection of data from the portfolio assigned to it by its parent entity, ECP Manager LP (hereinafter referred to as ERP Manager) in consideration for a fee. ECP Manager is a limited partnership based in the United States of America. The Respondent is a principal officer appointed under Section 13 of the Kenya Revenue Authority Act, 1995. Under Section 5 (1) of the Act, the Kenya Revenue Authority (the Authority) is an agency of the Government for the collection and receipt of all tax revenue.
The Respondent issued a letter of assessment to the Appellant dated 4 February 2022, demanding the Corporation tax of Kshs - 2,521,185,943.00, inclusive of penalties and interest. The Appellant lodged a notice of objection dated 4 March
2022.The Respondent issued an objection decision dated 28 April 2022 in respect of the Appellant''s notice of objection.
The Appellant, being dissatisfied with the decision of the Respondent, notified the Respondent of its intention to appeal to the Tribunal against the said decision vide a Notice of Appeal, which was filed on the same date. After hearing the Appeal, the Tribunal concluded that the Appeal lacks merit and accordingly made the following Orders: The Appeal is hereby dismissed. The Respondent''s Objection decision dated 28 April 2022 was upheld, and each party is to bear its own costs.
The Appellant proffers this Appeal against the Judgment of the Tax Tribunal and has filed the Memorandum of Appeal through which it raises eight [8] grounds of appeal to be determined by the Honorable Court: - The Tribunal erred in its duty by solely relying on the Securities and Exchange Commission filings of the Appellant''s Holding Company, ECP Manager LP.
The Tribunal erred in law by failing to consider, without justification, the audited financial statements of the ECP manager, which set out the actual profit for the period under assessment, and consequently endorsed the Respondents'' approach to computing tax on fictitious income.
The Tribunal erred in law in upholding the Respondent''s tax demand, which was computed on the basis of the entire gross revenue earned by ECP Group outside Kenya, rather than the relevant profit attributable to the Appellant.
The Tribunal erred by disregarding the Appellant’s Transfer Pricing Policy in its decision, without justification, contrary to the provisions of Section 18(8) of the ITA, as read with the Transfer Pricing Rules, 2006.
The Tribunal erred in failing to recognize that, under the Transfer Pricing Rules 2006, the Appellant has the discretion to determine the
appropriate transfer pricing method to be used in charging services rendered to the ECP Manager, based on its business model.
The Tribunal erred by deliberately mischaracterizing the relationship between the ECP Manager and the Appellant, finding that the roles and functions were integrated, and thereby upholding the Respondent''s erroneous tax demand.
The Tribunal erred in failing to recognize and appreciate that its failure to analyze the Appellant''s evidence in its totality would result in the illegal imposition of taxes, contrary to Article 210 of the Constitution.
Parties were directed to canvass the Appeal via submissions, which they filed and exchanged.
THE APPELLANT SUBMISSIONS:
The Appellant argued an appeal on the following issues.
Whether the Tribunal erred in law, failing to consider the Appellant''s evidence and solely relying on the Securities Exchange Commission [SEC] filings of the Appellant''s holding Company, ECP Manager LP.
Whether the Tribunal erred in law by failing to consider the Appellant''s evidence in the form of the ECP Manager''s audited financial statements on the actual profits under the period of assessment.
Whether the Tribunal erred in endorsing the Respondent’s approach of tax computation based on fictitious gross revenue earned by the ECP Group outside Kenya.
Whether the Tribunal erred in disregarding the Appellant’s Transfer Pricing Policy [TP Policy] contrary to the provisions of Section 18 [8] of the ITA as read with the Income Tax [ transfer Pricing] Rules 2006.
Whether the Tribunal mischaracterized the relationship between the Appellant and the ECP Manager, thereby erroneously conflating roles and functions played by the Appellant and ECP Manager.
Whether the Tribunal upheld and sanctioned an illegal imposition of taxes contrary to Article 21 of the Constitution.
Whether the Tribunal erred in law, failing to consider the Appellant''s evidence and solely relying on the Securities Exchange Commission [SEC] filings of the Appellant’s holding Company, ECP Manager LP.
The Appellant submits that, when called upon to provide its evidence before the Tribunal, it relied on the interview with Bryce Fort, its TP Policy, and filed audited financial statements, witness statements, and its job descriptions.
2 Page 772 of the Record of Appeal.
The Tribunal erroneously upheld the Respondent’s FAR analysis of the Appellant’s role, which the Respondent had disagreed with, and disregarded the Appellant’s FAR analysis as well as its TP Policy.
The Tribunal relied on the Respondent’s FAR analysis, which was based solely on the ECP Group''s SEC filing. The ECP Group did Group 3''s SEC filing, which covers the ECP Manager LP, ECP Manager III LP, ECP Mena Management LP, Emerging Capital Advisors LLC, and ECP Manager IV LP.
In the SEC filing, it is described that the ECP is the principal investment advisor to various private funds and pooled investment vehicles. The ECP Group prepared the SEC filings to cover the various ECP US entities.
The Appellant is a subsidiary of the ECP Manager, with its functions set out in its TP Policy 4, namely, to provide technical and administrative support to the ECP Manager. The Appellant, being a 100% owned subsidiary of ECP Manager, provides services to ECP Manager and has no direct relationship to any other entity. The Appellant''s responsibilities include providing information to ECP Manager''s Ex Co, subject to assignments from the ExCo in support of ECP Manager''s Advisory Activities and undertaking support services in support of ECP Manager''s Operating Activities.
In addition to Kenyan statutory requirements and filings, and the maintenance of local books and records, the Appellant provides information to the ECP Manager that US regulators and tax authorities require. The TP Policy clearly indicated
that the Appellant does not participate in ECP Manager''s Fundraising Activities nor does it participate in the decisions relating to investment selection or disposal.
Further, in the interview between the Respondent and the Appellant’s Director, Bryce Fort, on 17 September 20205, it was unequivocally confirmed that local/regional offices such as the Appellant do not make any sourcing or exit decisions. It was further confirmed that there was a need to continually collect information from the portfolio companies and report back to the ECP Manager, whose role is performed by the Appellant. This interview confirmed the Appellant''s role and function as an administrative support function to its holding company, the ECP Manager. Thus, it is submitted that this role is in line with the Appellant''s TP Policy.
The Appellant, through its witnesses Daniel Beeton and Mark Gerdelman, testified about the FAR analysis undertaken by the Appellant in preparing its TP Policy. The testimony of Daniel Beeton confirmed the Appellant''s administrative support function to the ECP Manager.
Gendelman''s testimony concerned the financial statements of the ECP Manager for the period under taxation. The witness produced audited financial statements found on pages 103 to 127 of the Record of Appeal. The statements established that the ECP Manager incurred a loss for the periods 2016, 2017, and 2018, and incurred a gain for the periods 2019 and 2020. The witness confirmed that, if tax is due when the ECP Manager makes a gain and based on the Respondents'' work, it would be at a lower rate than the Tax Assessment upheld in the objection decision.
It is submitted that the Tribunal disregarded this evidence and opted to give credence to Appellant’s evidence and to rely on the foreign filings of the ECP Group. The SEC filings did not relate to the Appellant herein, as it is a distinct and separate entity from the other ECP US entities. It is a trite law that a holding company is a distinct legal entity from its subsidiary. Reliance made on the Court
of appeal case of Hannah Maina t/a Taa Flower v Rift Valley Bottlers Limited as cited in the case of RE: SOUTHARD LIMITED [1979] 3 ALL ER 565 .
The Appellant submits that the Tribunal’s reliance on the ECP Manager’s SE filings as a holding company violated the doctrine of a company''s separate legal and distinct entity, thereby resulting in an erroneous decision.
Whether the Tribunal erred in law by failing to consider the Appellant’s evidence in the form of the ECP Manager’s audited financial statements on the actual profits under the period of assessment.
The Appellant submits that it provided the ECP Manager’s audited financial statements, which show the ECP Manager''s income and actual profits for the years under assessment. The Appellant’s witness, Mark Gerdelman, testified before the Tribunal in accordance with his Witness Statement 9, in which he provided certified extracts of the audited financial statements of the ECP Manager, prepared by Deloitte & Touche LLP USA. The testimony before the Tribunal was that, if TPSM were correctly applied by the Respondent, the attribution to the Appellant and thus the subject of tax in Kenya would be profits, not income. The Appellant''s evidence before the Tribunal was that the ECP Manager incurred a loss in 2016, 2017, and 2018, while it made a profit in 2019 and 2020. 10
That, based on the audited financial statements of the ECP Manager and the computation thereunder, the Appellant''s position is that no tax would be due in Kenya from the Appellant in the event of the correct application of the TPSM method, which the Respondent/Tribunal had relied on. The Appellant''s evidence is that the application of TPSM resulted in the Appellant being declared to have low income for the period under review, taking into consideration that the ECP Manager reported significant losses from 2016 to 2018 and minimal profits in 2019 and 2020. This, when compared with the income of Kshs. 486, 781, 302/-, which the Appellant had declared in the years 2016 to 2020, and the corporate tax paid based on the TNMM method.
Thus, it submitted that, in error of its decision, the Tribunal disregarded the evidence adduced by the Appellant''s holding company, endorsed and upheld the Respondent''s tax computation based on a fictitious income. The Respondent and the Tribunal''s purported assessment was based on the assets under management by ECP for the years under review, per the ADV form of ECP Manager LP, ECP Manager III LP, and ECP Mena Management LP, as filed in the SEC, which was computed as per the Respondent''s Statement of Facts.
It is further argued that, in disregarding the Appellants'' evidence of the actual profits evidenced by audited financial statements, the Tribunal relied on the alleged assets under the management of the three entities. It is the Appellant''s submission that the assets under the respective company’s management do not constitute an income or amount to a profit to be considered in tax assessment.
Furthermore, the Tribunal, in upholding the Respondent''s tax assessment, erred in its Judgment in holding that the Appellant failed/refused to provide evidence of the financial information for the ECP Group. The Appellant adduced evidence that it is a subsidiary of the ECP Manager only, provides services to the ECP Manager, and not the ECP Manager III LP or ECP Mena Management LP. The Appellant could not obtain financial information of the other entities, which are neither its holding companies nor does it render any services to them. The Appellant, the ECP Manager III LP, and ECP Mena Management LP are distinct and separate legal entities. The Tribunal''s expectation that the Appellant should have this financial information of the entire ECP Group was erroneous.
The Tribunal, in its judgment, acknowledges that the Respondent did not have access to the required information to compute gross profit at the global level. 11 Then, one must ask, on what basis or information did the Respondent rely on to reach its tax assessment? By upholding the Objection Decision, the Tribunal affirmed the Respondent''s decision to determine the gross revenue of the ECP: ECP Manager LP, ECP Manager III LP, and ECP Mena Management LP. It is submitted that the Tribunal should have relied on the information provided by
the Appellant, namely its parent company, audited financial statements, which clearly indicated the profits/income for the years under review. Instead, the Tribunal erred and relied on a fictitious income, which the Respondent neither had access to nor could prove the existence of.
Whether the Tribunal erred in endorsing the Respondent''s approach of tax computation based on fictitious gross revenue earned by the ECP Group outside Kenya.
It is argued that the Tribunal in Paragraph 187 of the Judgment holds that, despite being requested, the Appellant refused/failed to provide the financial information for the ECP Group, which would play a key role in calculating the gross profit prior to the profit split. The Tribunal acknowledges the use of the information, as it was reconstructed from the SEC forms filed by ECP.
The Tribunal, in relying on the ECP Group''s SEC filings, used the ECP Group''s total gross revenue, including that of the ECP Manager, ECP Manager III LP, and ECP Mena Management LP. This was done instead of using the gross revenue as earned by the ECP Manager, who is the holding company of the Appellant, as required by the TPSM Guidance. Your Lordship, the Appellant is a subsidiary of the ECP Manager and provides only technical and administrative support to the ECP Manager, as evidenced by the Appellant''s TP Policy. It is restated that the Appellant does not provide any services to the ECP Manager III LP and ECP Mena Management LP. The Tribunal was erroneous in its decision to attribute the income of the ECP Manager III LP and ECP Mena Management LP to the Appellant.
The Respondent urged the Tribunal to uphold its Objection Decision and the Tax Assessment, which were based on the alleged gross profits of the entire ECP Group, comprising ECP Manager, ECP Manager III LP, and ECP Mena Management LP. The Respondent''s assessment was based on the ECP''s assets under management, as per the ECP Manager, ECP Manager III LP, and ECP Mena Management LP forms filed with the SEC.
The Tribunal relied on the above fictitious gross revenue allegedly earned by the entire ECP Group. The Respondent neither obtained nor availed the audited financial statements for the ECP Group to prove their revenue under the years of assessment. While the Tribunal faults the Appellant for failing to provide this information, the Appellant has reiterated that it is not in control of or in possession of the information for the entire ECP Group. It is a subsidiary of the ECP Manager, rendering its services only to that manager. The Appellant availed the audited financial statements for the ECP Manager, which showed the actual profits for the years under the assessment. The Tribunal, in turn, disregarded these statements and opted to rely on fictitious income generated by the Respondent.
The Respondent was insistent on basing its tax assessment on ECP Group''s fictitious gross revenue and failed to provide any supporting information for that revenue. The Tribunal''s upholding of the assessment based on a fictitious gross revenue renders the entire tax assessment invalid. The Court is urged to allow the Appeal, set aside the Judgment, and set aside the Objection decision.
Whether the Tribunal erred in disregarding the Appellant’s Transfer Pricing Policy [TP Policy] contrary to the provisions of Section 18 [8] of the ITA as read with the Income Tax [ transfer Pricing] Rules 2006 .
The Income Tax (Transfer Pricing) Rules 2006 were established pursuant to Section 18 [8] of the ITA. The purposes of these Rules are to provide guidelines for related enterprises to determine the arm''s length prices of goods and services in transactions involving them, and to provide administrative regulations, including the types of records and documentation to be submitted to the Commissioner by a person involved in transfer pricing arrangements.
Rule 4 of the Rules contemplates that the taxpayer may choose a method for determining the arm''s length price from among the methods set out in Rule 7 thereunder. These methods include the comparable uncontrolled price (CUP) method, the resale price method, the cost-plus method, the profit split method, and the transactional net margin method. The Commissioner is further
empowered to prescribe any method from time to time, where, in his opinion and in view of the nature of the transactions, the arm''s length price cannot be determined using any of the methods contained in these guidelines.
The Appellant submits that it adopted the transactional net margin method pursuant to its Transfer Pricing Policy [TP Policy], which the Tribunal and the Respondent disregarded and, in turn, adopted the profit split method [TPSM]. The Tribunal erred in holding that the Appellant''s services are integrated and that the appropriate method is TPSM. The Tribunal reasoned that the services provided by the Appellant are integrated with the services rendered by the ECP to the Funds. The integration is alleged to be such that it was difficult for the Appellant to split the exact services rendered by the Appellant and the ECP. Furthermore, the Tribunal erred in holding that the Appellant and the ECP jointly render exact services to the extent that it was impossible to evaluate each party’s exact contribution to the Funds, making it difficult to evaluate each party''s contribution to the services rendered.
It is submitted that the Tribunal erred in upholding the Respondent’s Objection decision in changing the Appellant’s TP Policy method. The Appellant is empowered by Rule 4 and 8 (2) of the Transfer Pricing Rules 2006 to apply the method most appropriate. The Tribunal and the Respondent are to accept the taxpayer’s choice.
Method. The Tribunal and the Respondent do not have the power and/or discretion to change the taxpayer''s chosen method. We take cognizance of the decision of the High Court in Kenya Fluorspar Company Limited v Commissioner of Domestic Taxes, where the Court held that: "47. I note that, under Kenyan law, both tax assessment methods may be used, depending on the specific operations and relationships among related enterprises. There are also other methods of assessing taxes. It is agreed that the choice has to be made governed by the Transfer Pricing Rules 2006 (LN67), under which Rule 4 provides as follows: 4. The taxpayer may choose a method to employ in determining the arm''s length from among the methods set out in Rule 7. Rule 7
thus, it provides various methods of choice, including the profit split method. In this regard, Rule 8(2) provides as follows: 8(2). A person shall apply the most appropriate method for his enterprise, having regard to the nature of the transaction, or class of related persons or function performed by such persons in relation to the transaction. It follows from the above provisions that the choice of the most favorable tax assessment method is for the taxpayer, not the Commissioners. In this regard, I agree with the reasoning in Unilever Kenya Ltd – vs – The Commissioner of Income Tax [2005] e KLR , where it was held that the taxpayer is entitled to choose the most favourable method to their advantage as far as liability to tax is concerned.
The main issue that has arisen herein is that instead of addressing the objection raised using the selected profit margin method, the Commissioner changed to the Transactional Net Margin Method without indicating the law that confers on the Commissioner the power to change the method. Even in this Appeal, the Commissioner has not pointed to any section of the law that gives it the right to change the taxpayer''s elected choice method.
First, there is no evidence that the mining and prospecting licenses were new assets not known in the profit split method. Secondly, even if they were new intangible assets, the Commissioner would have to back his change of method with the law, which they have not. The Commissioner had no legal power to change to a new method for the Transaction Net Margin. The Commissioner could only use the Profit Split method chosen by the taxpayer. The Commissioner was thus correct in using the Transactional Net Margin Method."
It is submitted that the Tribunal erred in law in upholding the Respondent’s decision to change the Appellant’s choice method.
The Appellant prepared its TP Policy in accordance with the Income Tax Act [ITA], the TP Rules, and the OECD Guidelines, and has consistently applied it in all its dealings with the ECP Manager. The OECD Guidelines provide the process to be followed when preparing a Transfer pricing policy and determining
the arm''s-length price for a related-party transaction. Paragraph 3.4 of the Guidelines states the following.
Step 1: Determination of the years to be covered
Step 2: Broad-based analysis of the taxpayer’s circumstances
Step 3: Understanding the controlled transaction(s) under examination, based in particular on a functional analysis, in order to choose the tested party (where needed) the most appropriate transfer pricing method to the circumstances of the case, the financial indicator that will be tested (in case of a transactional profit method), and to identify the significant comparability factors that should be taken into account.
Step 4: Review of existing internal comparable, if any.
Step 5: Determination of the available sources of information on external comparables, where such external comparables are needed, taking into account their relative reliability.
Step 6: selection of the most appropriate transfer pricing method and, depending on the method, determination of the relevant financial indicator.
Step 7: Identification of potential comparables; determining the key characteristics to be met by an uncontrolled transaction in order to be regarded as potentially comparable, based on the relevant factors identified in Step 3 and in accordance with the comparability factors set for the Section D.1 Chapter 1.
Step 8: Determination and, where appropriate, making comparability adjustments. Step 9: Interpretation and use of data collected determination of the arm’s length.
Remuneration.
It is submitted that the Appellant followed the above nine-step approach in preparing its TP Policy and in determining the arm''s length rate applied to its remuneration for the provision of its services to the ECP Manager. Therefore, based on the functions, assets, and risk analysis set out in the Appellant''s TP Policy, the most appropriate method was the TNMM with Full Costs Markup as
the Profit Level Indicator, being the correct arm''s length compensation applied. We submit that the Appellant undertook its transfer pricing analysis and provided a proper explanation and rationale for selecting TNMM, as set out in the Policy. Moreover, the Appellant, in its TP Policy, explained why the TPSM would not be a suitable method for transfer pricing on account of the routine administrative support services as provided by the Appellant.
According to the Revised Guidance on the Application of the Profit Split Method Inclusive Framework on BEPS: Action 10 July 2018 [the TPSM Guidance], the TPSM method is most appropriate where.
Unique and valuable contributions by each of the parties to the transaction; and
Highly integrated business operations.
The TPSM Guidance further states that: Contributions (for instance, functions performed, or assets used or contributed) will be unique and valuable in cases where: They are not comparable contributions made by uncontrolled parties in comparable transactions; and They represent a key source of actual or potential economic benefit in the business operations. The two factors are often linked: comparables for such contributions are seldom found because they are a key source of economic advantage.
The Appellant submits that the TPSM Guidance is clear on the circumstances in which TPSM should be applied and the conditions that are to be fulfilled. The Tribunal, in allowing the use of the TPSM method, held that the Appellant’s role extends beyond the general administrative role portrayed by the Appellant. While the Appellant provided evidence of its role and functions it undertakes as instructed by the ECP Manager, in the form of the TP Policy, the Interview by Bryce Fort15, and the witness testimony of Daniel Beeton16, the Tribunal disregarded this evidence and relied on a faulty FAR analysis.
The Appellant asserts that it performs an administrative support service role to the ECP Manager, which cannot be said to be highly integrated. The ECP
Manager’s functions, analysis, and risks are well defined, and the independent comparables for the functions provided by the Appellant are readily available in its TP Policy. We take cognizance of the TPSM Guidance on integration inter alia. Although most multinational groups are integrated to some extent, an exceptionally high degree of integration in certain business operations is an indicator for the consideration of the transactional profit method. A high degree of integration means that the way in which one party to the transaction performs functions, uses assets, and assumes risks is interlinked with, and cannot reliably be evaluated in isolation from, the way in which another party to the transaction performs functions, uses assets, and assumes risks. In contrast, many instances of integration within a multinational result in situations in which the contribution of at least one party to the transaction can, in fact, be reliably evaluated by reference to comparable uncontrolled transactions.
It is the Appellant''s submission that, based on the above, the Tribunal erred in applying the TPSM in the remuneration of the Appellant''s functions. The Appellant reiterates that it followed the required approach set out in the OECD TP Guidelines in preparing its TP policy and in determining the correct arm''s length rate for its remuneration for the provision of support services to the ECP Manager. Accordingly, based on the FAR analysis undertaken in respect of the Appellants'' Policy, the most appropriate method, which was chosen, is the TNMM as discussed above.
Whether the Tribunal mischaracterized the relationship between the Appellant and the ECP Manager, thereby erroneously conflating roles and functions played by the Appellant and ECP Manager.
In its Judgment, the Tribunal made a finding that the Respondent did not err in its Functions, Assets and Risks [FAR] analysis. The Tribunal further concluded that the Appellant described itself in its SEC filings as providing advisory services on a discretionary basis, indicating a much greater role for the Appellant than its Transfer Pricing Policy indicated.
17 Page 163 of the Record of Appeal
The Tribunal relied on the SEC filings and found that the Appellant''s personnel and the job descriptions are similar to the descriptions of the services ECP Manager sets out in the SEC filings, indicating that the services that the Appellant provides are similar to those of ECP Manager and do not carry out a supportive administrative role as indicated in its Transfer Pricing Policy.
The Respondent, in its Statement of Facts, carried out the FAR analysis shown by relying on the following:
Interview with Bryce Fort.
Documents availed by the Appellant, such as generic descriptions and a letter describing the functions of the ECP Manager and the Appellant.
ECP entities filed returns at the SEC.
SEC administrative proceedings.
The Appellant submits that in upholding the Respondent''s FAR analysis above, the Respondent and the Tribunal disregarded the Appellant''s TP Policy, which was prepared pursuant to the provisions of Section 18 [3] of the Income Tax Act and the Income Tax (Transfer Pricing) Rules, 2006. The TP Policy sets out the Appellant''s functions, assets, and risks in the provision of its services to the ECP Manager, as well as its relevant remuneration.
Contrary to the Respondent''s averment and the Tribunal’s holding, the Appellant’s function is to provide technical and administrative support to the ECP Manager. In its TP Policy 19, Clause 6.1.2, the Appellant clearly stipulates that it offers technical and administrative support to the ECP Manager. The Appellant, being a hundred percent owned subsidiary of ECP Manager, provides services to ECP Manager and has no direct relationship to any other entity. The Appellant’s responsibilities include providing information to ECP Manager''s ExCo, subject to assignments from the ExCo in support of ECP Manager''s
Advisory
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