21 Mar The tax point of withholding tax: Court of Appeal decision

On 5th February 2019, the Kenyan Court of Appeal delivered a judgement to the effect that an accrual of an expense in the books of accounts fall within the meaning of the word “paid” for Income Tax purposes therefore making withholding tax due upon such accrual.

Facts of the case

Fintel Ltd (the respondent in the appeal) entered into an agreement with a Chinese contractor for the construction of a rental building. It was a term of the contract that Fintel Ltd would pay the contractor interest on any contract fees outstanding after the due date. In the course of the contract, Fintel experienced difficulties in settling the outstanding fees to the contractor on due dates. In accordance with accounting practices, Fintel recorded the interest amount due to the contractor as a liability in its books of accounts and claimed the same as an expense in its audited accounts. Kenya Revenue Authority (KRA, the appellant) carried out an audit on Fintel’s books and issued a withholding tax assessment and demanded the immediate payment of the withholding tax on the interest which had already been claimed as an expense in the audited accounts.

Fintel filed an objection to the assessment, which the Commissioner of Income Tax considered and rejected. Fintel then proceeded to challenge KRA’s position at the High Court. The High Court found in favor of Fintel and ruled that “paid” in Section 2 of Income Tax Act (ITA) assumes its ordinary meaning and the use of the word “includes” is merely illustrative of the kind of activities that constitute payment. The court held that payment implies delivery of money or some other valuable thing, and that payment in a prerequisite for withholding tax to become due, and withholding tax would only become due upon actual payment or settlement of obligation.

The KRA appealed the ruling and on 5th February 2019, the Court of Appeal overturned the High Court decision. The main issue of contention was the use of the words “paid” and “upon payment” as provided in Section 2 and Section 35 of the ITA. The court of appeal adopted a contextual interpretation of the words by using the definition of “paid” in ITA to interpret the words “upon payment”. “Paid” has been defined to include distributed, credited, dealt with or deemed to have been paid in the interest or on behalf of a person. The court held that the sense in which the word “deduct” is used for withholding tax purposes, does not require physical movement but includes book entries, considering the income tax regime is based on accrual system. Therefore, payment is deemed to be made even where no money has passed over, and therefore the words “upon payment” in Section 35 of the ITA includes accruals.

Our View

The ruling reverses the previously prevailing practice of withholding tax on actual payments. The decision sets a precedent which will be relied on going forward by the High Court and the Tax Appeals Tribunal on matters with similar facts.

The ruling will require taxpayers to deduct and remit withholding tax at the point of accrual. This will have negative cashflow impact on taxpayers.

Where accrued amounts do not match the actual invoiced amounts, there will be challenges accounting for withholding tax on iTax, which pay result in overpayment or underpayment of withholding tax. The taxpayer will need to consider reconciling the correct withholding tax position as iTax does not allow one to offset tax amounts, and there is currently no refund process for withholding tax. Taxpayers should therefore ensure any accruals accurately reflect the payment obligation and also consider the timing of the accruals.

There will also be the challenge of mismatch where the taxpayer has made accruals in their books but the supplier has neither issued an invoice nor recognized the income in their books. This could trigger the KRA conducting audits on suppliers where such mismatch arises.

Conclusion

The overall impact on taxpayers will be adverse as they will be required to make upfront tax payments coupled with challenges of accurately accounting for withholding tax.

Taxpayers should review their compliance status and accrual policies in the light of this ruling. Withholding tax should be accounted for once expenses are accrued in the books of account. Withholding tax should be paid to the KRA by the 20th day of the subsequent month after accrual of the expense.

Should you to discuss this further with us, kindly contact us through the below contacts.

By ,

Godwin Ouma

CEO, GSL International Consulting Limited