Inside decade-long tax row on credit, debit card fees
To provide a consumer payment system, card companies operate networks that link all their members around the world.
What you need to know:
The issues of taxation in the dispute arose out of e-commerce transactions
Ten years ago, the Kenya Revenue Authority (KRA) demanded withholding tax from Barclays Bank of Kenya (Now Absa Kenya Plc) for royalties paid to global credit and debit card companies, a move that kicked off a legal storm that is yet to be settled.
In the taxation duel, which is likely to have repercussions in the banking industry, the KRA is pushing for Absa to pay the withholding tax arrears collected from clients.
The issues of taxation in the dispute arose out of e-commerce transactions. The dispute is pending at the Supreme Court having escalated through the lower courts over the years.
During the hearing of the dispute at the High Court, the Commissioner of Domestic Taxes disclosed that the bank had made a payment of Sh10,332,431 towards card business royalties withholding wax 20 per cent. It had also paid Sh6,612,756 for card business-royalties value-added tax (VAT) at 16 percent, bringing the total payment of the principal tax to Sh16,945,187.
The amount was paid by way of Real-Time Gross Settlement on December 20, 2013, which payment, in the commissioner’s view, was an admission of the fact that taxes on withholding tax on royalties and VAT were indeed due and payable by the bank.
The outcome of the legal dispute has the potential of increasing the cost of card transactions. Among the sectors that mostly use bank card transactions are tourism, transport, supermarkets, high-end clubs and hotels.
Absa argues that the payments made to the credit card companies — Visa International Services Association, Mastercard Inc, and American Express Ltd — did not constitute royalty and hence KRA had no basis for demanding withholding tax.
The cards were issued by the bank to its customers, for use to make payments using credit, debit, or pre-paid cards.
Absa is a member of networks established by three credit card companies Visa International Services Association, MasterCard Inc., and American Express Ltd. The card companies are incorporated in the United States of America.
The Card Companies’ primary purpose is to administer a worldwide consumer payment system that enables Absa’s members to provide their customers with the means of making payments for purchases of goods and services, eg at Supermarkets, with the use of credit cards, travellers’ cheques and debit cards, conveniently and securely.
To provide a consumer payment system, card companies operate networks that link all their members around the world.
This enables the bank to issue its customers with credit, debit, and pre-paid cards, which they use to pay for services and goods purchased from contracted retail outlets. In turn, the bank has entered into agreements with the outlets to accept payments through the cards.
On December 27, 2012, and January 22, 2013, the Commissioner of Domestic Taxes demanded from the bank payment of withholding tax on cash that the lender had paid the three card companies and to other banks (interchange fee).
The demand came after the Commissioner carried out an audit on the bank for the years of income 2007 to 2011.
The commissioner conducted an in-depth audit on the bank covering the following tax heads and periods — accounts audit (corporation tax) 2007-2010, pay-as-you-earn January 2007 to September 2011, withholding wax January 2007 to September 2011 and VAT January 2007 to September 2011. It disclosed that the audit took three months from May 2011.
After several meetings, exchanges of communications, and various deliberations on the issues raised, the principal tax was settled on agreed items, and the non–agreed issues were on Card Business, VAT, and Withholding Income Tax where the final assessments were confirmed on December 28, 2012.
The Commissioner took the view that withholding tax was payable on the fees paid to the card companies for the use of their systems, for facilitating transactions on behalf of the bank, and for royalties and interchange fees. He held Absa was required to deduct 20 percent as tax. The interchange fee is charged by banks for processing and accepting card-based transactions on behalf of their rivals.
The commissioner made the demand on the basis that the payments to the card companies were royalty and those to the other banks were for professional or management services.
According to the commissioner, the bank was receiving revenues from a broad spectrum of services that it provide such as installing terminals, sending out statements, operating help desk hotlines, and most important, processing transactions.
The commissioner held the view that the fee associated with transaction processing is called the merchant discount and is usually 1.5 to 3.5 percent of the purchase amount.
This rate is a percentage of sales that the merchant pays the acquiring bank to cover the cost of the transactions.
The bank, on its part, took the position that it had not paid for royalty or any professional or management services rendered.
Therefore, the commissioner did not have a basis for demanding withholding tax. It contended that the payments to the card companies did not constitute royalty as defined in Section Two of the Income Tax Act, to attract withholding tax.
In the alternative, the bank contended, even if the commissioner was entitled to collect withholding tax under the Act, none was due from or payable by it.
Absa launched the legal offensive at the Tax Appeals Tribunal and the dispute escalated to the High Court, and Court of Appeal, and is now waiting for determination at the Supreme Court where Mastercard (Mastercard Asia Pacific (PTE) Limited) and Kenya Bankers Association are participating as interested parties.
Last week, Mastercard’s replying affidavit sworn by Shafi Shaikh was expunged from the court record after judges found that it constituted new and additional evidence. The issue in a row is whether withholding tax is payable by a bank for payments it has made to credit card firms and to other banks that issue credit cards.
After the parties failed to agree on whether or not the payments demanded by the commissioner were justified, the bank moved to the High Court in February 2013 and applied for an order to quash the KRA’s demand for payment and an order of prohibition to stop the commissioner from demanding the payments.
High Court judge George Odunga in May 2015, agreed with the bank and quashed the demand, saying it did not meet the level of clarity required in tax matters.
The judge said the taxman did not identify the category in which the demanded tax fell.
The KRA was aggrieved and appealed the decision, arguing that the bank was obliged to pay withholding tax arising from its relationship and dealings with the credit card companies.
The Court of Appeal ruled in favour of the KRA by holding that the transaction fees paid to card companies by Absa amounted to a royalty hence subject to withholding tax.
The court, in its judgment delivered in November 2020, also held that interchange fees allocated by Absa to an issuing bank fitted within the definition of management or professional fees hence subject to the tax.
“We are persuaded that the evidence on record properly established that the payments paid by the bank to the card companies were royalty as defined in the Act and further that the interchange fees it paid to issuer banks were for management and professional services as defined in the Act, and therefore both payments were subject to withholding tax under the Act,” said appellate judges Wanjiru Karanja, Kathurima M’Inoti and Fatuma Sichale.
The court said the debit and credit cards issued by Absa Bank to its customers bear the distinct logos and trademarks of the respective card companies.
