TAX APPEALS TRIBUNAL RULES THAT WITHHOLDING TAX IS NOT APPLICABLE ON PAYMENTS OF MANAGEMENT AND PROFESSIONAL FEES BY KENYAN RESIDENTS TO SOUTH AFRICAN RESIDENTS
On 1 April 2021, the Tax Appeals Tribunal (TAT) confirmed that pursuant to the provisions of the Kenya South Africa Double Tax treaty (DTT), withholding tax is not applicable on payments made by Kenyan resident persons (or non-resident persons with a permanent establishment in Kenya) to South African resident persons.
The TAT delivered its judgment in McKinsey and Company Inc. Africa Proprietary Ltd v. Commissioner of Legal Services and Board Coordination (Appeal No. 199 of 2020).
The appeal related to an assessment raised by the Kenya Revenue Authority (the KRA) for withholding tax on payments made by the Kenyan branch of McKinsey and Company Inc. Africa Proprietary Ltd (McKinsey Kenya Branch), a company incorporated in South Africa, to a related South African resident entity (McKinsey SA) for consultancy services provided to the McKinsey Kenya Branch.
In its appeal, McKinsey Kenya Branch argued that withholding tax should not be applicable on the payments for the consultancy services since:
- the DTT does not provide for withholding tax on payments of management and professional fees and thus, the payment should be subject to tax as business profits in South Africa under Article 7 of the DTT; and
- pursuant to Article 7 of the DTT, the profits of McKinsey SA should be taxable only in South Africa unless McKinsey SA carries on business in Kenya through a permanent establishment situated in Kenya.
Since McKinsey SA does not have a permanent establishment in Kenya, its business income should be subject to tax in South Africa.
On the other hand, the KRA argued that Kenyan withholding tax should be applicable on the consultancy payments made by McKinsey Kenya Branch since:
- the services comprised management and professional fees under the Kenyan Income Tax Act and should thus be subject to withholding tax at the rate of 20% (which is the rate applicable to payments made to non-resident persons without a permanent establishment in Kenya);
- the DTT does not contain an Article specifically addressing management and professional fees. Accordingly, such income should be taxed under Article 22 (3) of the DTT, which provides that items of income of a South African resident not specifically covered under other Articles of the DTT may also be taxed in Kenya; and
- Article 7(7) of the DTT gives precedence to all other Articles within the DTT, which have provided for the item of income in question. KRA’s argument was that, as consultancy services would be covered under Article 22 (other income), then Article 7 (business profits) would not apply to the consultancy services.
The TAT’s Judgment
The TAT dismissed the KRA’s assessment for withholding tax and held that:
- the consultancy fees should be taxed as business profits under Article 7 of the DTT since the services provided would fall within the definition of “business” under the Income Tax Act.
The TAT relied on the definition of “business” under the Income Tax Act since the DTT does not contain a definition for the term;
- since the KRA had not established that McKinsey SA has a permanent establishment in Kenya, the right to tax the consultancy fees is in the country of residence of McKinsey SA, in this case South Africa; and
- taxation as other income under Article 22 would only arise where taxation of the income has not otherwise been dealt with in the DTT. In this case, taxation of the consultancy services had been dealt with under Article 7 of the DTT and accordingly taxation under Article 22 would not be applicable.
Putting it into perspective
The TAT judgment brings some much needed clarity on a matter that has long been in dispute between the KRA and taxpayers on taxation of management and professional fees paid by Kenyan resident persons (or non-resident persons with a permanent establishment in Kenya) to non-resident persons under the Kenya-South Africa DTT, the Kenya-France DTT and the Kenya-Netherlands DTT (yet to come into force) which do not include articles expressly addressing management and professional fees.
It remains to be seen whether the KRA will appeal the judgment or grant refunds to (a) non-resident persons who have been subjected to withholding tax deductions on the basis of an erroneous interpretation of the above DTTs, or (b) Kenyan taxpayers (Kenyan resident persons or non-resident persons with a permanent establishment in Kenya) who have been subjected to penalties and interest for failure to deduct withholding tax on such payments based on the KRA’s erroneous assessment. This would also have an impact on Kenyan taxpayers who have borne such withholding taxes under contracts with gross up provisions.
Going forward, Kenyan persons entering into contracts for the provision of services with South African or French resident persons, should consider whether there is any need for gross up provisions in such contracts (since withholding tax will not be applicable on payments under such contracts).