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Kenya: Revenue Authority and Citibank to Settle Out of Court in Tax Dispute? Print E-mail
Monday, 08 September 2008
The battle between Citibank Kenya and the Kenya Revenue Authority (KRA) over a claim of over KES857m regarding taxation of revenue earned on loans advanced by Citibank Bahrain through their Kenya operation and PAYE remittances for expatriate staff has taken a new twist as the Citibank MD has asked the KRA for a review of the amount claimed. By Albert Muriuki.

KRA Tax Claims
The Kenya Revenue Authority (KRA) claims that Citibank Kenya owes it KES837.37m in corporation taxes and KES22.1m in Pay As You Earn (PAYE) deductions for the years 1997 to 2003. The claim involves the interpretation of whether interest income earned from loans and other facilities advanced by Citibank Bahrain to local customers of Citibank Kenya should be treated as revenue for the local subsidiary for purposes of withholding and corporation taxes. KRA also charges Citibank with the wrong remittance of payroll levies for expatriate staff.

For Kenyan banks that are subsidiaries of foreign financial institutions, the dispute is of great importance on how they relate commercially with other foreign subsidiaries within the firm: Legal experts who sought anonymity as they have transacted for either party before, say that if the out-of-court settlement fails and the case has to be determined by the High Court, it will set a precedent over whether interest income from loans advanced by a foreign sister company to its Kenyan customers should be treated as revenue of the local subsidiary for purposes of taxation. 

The Managing Director and Chief Executive Officer (CEO) of Citibank East Africa, Ade Ayeyemi, has now written to the Kenya Revenue Authority (KRA) asking for a review of the amount claimed. Sources knowledgeable with the issue say that the KRA is not averse to the idea of a quiet settlement of the issue but were categorical that Citibank must first withdraw a case they had filed in the High Court. Citibank have obliged and have withdrawn the case from court to try and have the matter settled amicably. This case is another illustration of an extremely assertive KRA aiming for revenue from all corners.

Loans from Citibank Kenya or Bahrain?

According to Mr. Ayeyemi, the CEO of Citibank, the failure to account for the tax assessed arose from the belief that the lender in respect of the loans in question was Citibank Bahrain and that the interest income was income of Citibank Bahrain: "Our belief was based on our technical interpretation of the facts, the economic substance of the transaction and the legal documentation on which the loan transaction were based," he says in a letter to the Commissioner of Large Tax Payers Office.

"Primarily, our interpretation of the service agreement between Citibank Kenya and Citibank Bahrain was that Citibank Bahrain was the lender and that Citibank Kenya was merely providing a supporting administrative service for which it received a fee. Further, the fact that Citibank Bahrain bore the credit risk in relation to the loans, the fact that the loans were disbursed by Citibank Bahrain from its treasury directly to the customers and the fact that interest paid by the customers was remitted directly to Citibank Bahrain with Citibank Kenya as a mere conduit, were interpreted by us to confirm Citibank Bahrain as the lender in these transactions. In addition, our interpretation of the loan documentation executed by Citibank Kenya was that Citibank Kenya was acting on behalf of Citibank Bahrain as a mere administrative measure of ease of enforcement in the event of customer default," says Ayeyemi.

The KRA however took a different technical interpretation from Citibank, holding that the legal documentation constituted Citibank Kenya as the legal lender in respect of the loans. One of the cases that are being used to illustrate both sides of the conflict is Homegrown Kenya Limited, a horticultural business involved in the growing, marketing and distribution of cut flowers and fresh vegetables and one of the largest horticultural companies in Africa. Citibank Kenya claims that Homegrown’s USD2m (KES138m) was advanced to the company by Citibank Bahrain. However, the Commissioner of Income Tax claims the contrary. In 2004, KRA made an inquiry in connection with the payment of interest by Homegrown for advances made by Citibank Bahrain through its accounts with Citibank Kenya, following it with an in-depth inspection on Citibank Kenya in 2005, as a result of which it notified the bank that it had raised additional assessment, inclusive of penalties and interest, to KESSh859m in corporate taxes and PAYE. According to KRA, the loans made to Homegrown and other customers by Citibank Bahrain through their accounts with Citibank Kenya were in fact made by Citibank Kenya because the facility letters and securities were granted to Citibank Kenya.  

"KRA's thinking must be that any interest paid is income to Citibank Kenya. If therefore any payment of interest was made to Citibank Bahrain then it was an expense, which in the circumstances was not deductible," says a Nairobi based tax consultant who has worked for the KRA but requested anonymity.

Legal Lending Limit

Mr. Ayeyemi however says the actions by Citibank were done in good faith and were meant to assist Citibank Kenya customers obtain facilities in cases where Citibank Kenya was restricted by its legal lending limit under section 10 of the Banking Act of Kenya from providing the facilities. The Banking Act limits advances to any one party to a maximum of 25% of the bank’s core capital.

"Citibank Kenya would not have entered into this arrangement if it believed that the arrangement would put it in breach of the Banking Act and the conditions of its license to carry on banking business in Kenya," says Ayeyemi. He adds that Citibank Kenya relied on the treatment of these loans as provided by Citibank Bahrain by the Central Bank of Kenya (CBK) as providing assurance with respect to the arrangement. "It has never been the intention of Citibank Kenya to avoid its lawful tax liabilities.

Indeed, even prior to the KRA audit which gave rise to the assessments, Citibank Kenya had begun to increase its capital in order to raise its legal lending limit to a level enabling it to provide the additional facilities required by its customers directly," says Ayeyemi in the letter to the KRA. The CEO says that by 2004, all loans to Kenyan customers which would previously have been funded by Citibank Bahrain were funded by Citibank Kenya and carried on its balance sheet: "Accordingly, the interest income arising from the loans has been taken into account in computing the taxable profits of Citibank Kenya and tax paid in full."

PAYE Dispute

On the incomes of the four expatriate international staff seconded to Citibank Kenya in 2003 and 2004, Ayeyemi tells the KRA that under the Citigroup Expatriate Program, international staff seconded to a particular office are not employees of and are not on the payroll of the Citibank office to which they have been seconded. However, the costs of international staff seconded to any Citibank office are recharged by the head office of that Citibank office. Accordingly, Citibank Kenya paid the costs of these expatriate staff by reimbursing the head office. "The omission in question was not a failure to pay tax, but the payment of the tax due by way of installment tax rather than through the PAYE system, resulting in a delay of three months, in respect of every monthly deduction due and payable," says Ayeyemi.

This interpretation by Citibank Kenya was based on their technical interpretation of the Income Tax Act of Kenya, which states that an employer paying emolument to an employee shall deduct from, and account for tax, to such extent and in such manner as may prescribed by the act. Citibank Kenya thus interpreted the section to mean that as the international staff did not have an employment contract with Citibank Kenya and since Citibank Kenya did not make payments directly to international staff, Citibank Kenya was not 'an employer paying emoluments to an employee' for the purposes of the Income Tax Act.

Citibank Kenya conceded that this interpretation was not correct as it failed to take into account the definition of employer in section 2 of the Income Tax Act. On becoming aware of the error, Citibank Kenya promptly accorded these payments their proper treatment through the PAYE system," says Ayeyemi. The Income Tax Act defines an employer to include any resident person responsible for the payment of, or on account of, emoluments to an employee, and an agent, manager or other representative in Kenya on behalf of a non-resident employer.

Outlook

Now that the case is out of the public domain, it is highly likely that the KRA and Citibank will reach an amicable solution to the matter. What will be interesting will be the amount ultimately paid to KRA.
But even if KRA and Citibank reach an out of court settlement, the revenue authority continues to seek clarifications of the dividing line between domestic and international business in an increasingly globalised industry. In another case against Kenya Commercial Bank (KCB), KRA also claims tax arrears from an account that KCB has with a foreign bank in another country. This case questions whether royalties, in this particular case license fees for the use of software, are subject to withholding tax and, most importantly, whether payments for interest and other incidental charges levied on nostro accounts held by bank's outside Kenya are subject to withholding tax (see Kenya: Assertive KRA Challenges KCB Tax Payment in Precedent). Should KRA win this case, the institutions is likely to become considerably more aggressive in going after money from nostro accounts held by the 45 commercial banks in Kenya.

 




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