Kenya vs Avic International Beijing (EA) Limited, November 2024, Tax Appeals Tribunal, Case no. TAT E786 OF 2023

Posted on | By Courts of Kenya
Category: Arm's Length Principle, Benchmark, Range and Median, Transfer Pricing Methods, Withholding Tax (WHT) | Tag: , , ,
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A Kenyan company, Avic International Beijing (EA) Limited, purchased completely knocked-down motor vehicle parts from Avic International Beijing Company Limited (China) and then assembled them into finished products and sold these products to independent buyers. To determine the pricing of the controlled transaction between Avic International Beijing (EA) Limited (Kenya) and Avic International Beijing Company Limited (China), the resale price method had been applied.

The tax authorities disagreed with use of the resale price method and instead applied a TNMM which resulted in additional taxable income, and moreover a deemed dividend distribution to which withholding taxes was applied.

An appeal was filed by Avic International Beijing (EA) Limited with the Tax Appeal Tribunal.

Judgment

The tribunal upheld the assessment regarding use of the TNMM, but the calculation of withholding taxes on the deemed dividend distribution was changed due to lack of legal basis for collecting and recovering the WHT in part of the period under review.

Excerpts on choice of method

“222.The Tribunal refers to Paragraph 2.34 of the OECD TP Guidelines which provides that the Resale Price Method may become less reliable as a result of differences between the controlled and uncontrolled transactions and parties to the transactions which materially affect the gross margin. Paragraph 2.34 provides as follows: -2.34. The resale price method also depends on comparability of functions performed (taking into account assets used and risks assumed). It may become less reliable when there are differences between the controlled and uncontrolled transactions and the parties to the transactions, and those differences have a material effect on the attribute being used to measure arm’s length conditions, in this case the resale price margin realised. Where there are material differences that affect the gross margins earned in the controlled and uncontrolled transactions (e.g. in the nature of the functions performed by the parties to the transactions), adjustments should be made to account for such differences. The extent and reliability of those adjustments will affect the relative reliability of the analysis under the resale price method in any particular case.

223.The Tribunal notes that the criteria for selection of comparables that the Appellant applied in its benchmarking analysis did not include assembly, design and fabrication of motor vehicles which is a significant function undertaken by the Appellant. The Tribunal observes that the Appellant, having selected itself as the tested party, significantly impacted the selected comparables by omitting this criterion in the search for comparables.

224.The Tribunal further refers to Paragraph 2.35 of the OECD TP Guidelines which highlights the complexity of applying the Resale Price Method where before resale, the reseller substantially adds value to the product, as follows: -“

“235.An appropriate resale price margin is easiest to determine where the reseller does not add substantially to the value of the product. In contrast, it may be more difficult to use the resale price method to arrive at an arm’s length price where, before resale, the goods are further processed or incorporated into a more complicated product so that their identity is lost or transformed (e.g. where components are joined together in finished or semi-finished goods)…”

227.Based on the pleadings and evidence of the Appellant, it is clear that the Appellant further processes the completely knocked down kits that it purchases from AIBCL, which alters the imported CKD kits to assembled vehicles. The Appellant further state, as cited above, that it owns marketing intangibles in terms of design, fabrication and customer retention. Considering that the Appellant selected itself as the tested party in the application of the Resale Price Method for the controlled transaction of purchase of product from AIBCL, the Tribunal finds that the application of the Resale Price Method to arrive at an arm’s length remuneration would lead to unreliable results.

228.Based on the foregoing, the Tribunal finds that the Appellant erred in selection of the Resale Price Method as the most appropriate transfer pricing method.

229.The Tribunal thus, concurs with the Respondent’s selection of the Transactional Net Margin Method as the most appropriate transfer pricing method in the controlled transaction of purchase of products, the Respondent’s selection of the Appellant as the tested party due to availability of the Appellant’s financial information and the benchmarking analysis it conducted to arrive at the arm’s length remuneration which the Appellant failed to rebut with evidence.

230.As per the foregoing, the Tribunal finds that the Appellant did not discharge its burden of proof as it failed to demonstrate that the Respondent’s transfer pricing adjustment was excessive or incorrect as it is mandated by Section 56(1) of the Tax Procedures Act and Section 30 of the Tax Appeals Tribunal Act.

231.Consequently, the Tribunal finds that the Respondent was justified in making the transfer pricing adjustment amounting to Kshs. 424,914,851.00 for the years of income 2017 to 2021 and was justified in assessing Corporation tax on the same.”

Excerpts on withholding taxes on deemed dividend

“264.Based on the foregoing, the Tribunal finds that WHT was applicable to the deemed dividend distribution from the transfer pricing adjustment that the Respondent made.

265.Notwithstanding that WHT is applicable to the deemed dividend distribution, as established by the Tribunal above, the Respondent’s assessment of WHT for the tax periods before July 2018 was illegal and the same was not justified…

…
270.In view of the aforesaid analysis, the Tribunal finds that the Respondent has no legal basis for collecting and recovering the WHT which the Appellant failed to deduct from the deemed dividend distribution for the periods before 7th November 2019, and the resultant penalties and interest, as tax due and payable by the Appellant.

271.The Tribunal further finds that the Respondent was justified in assessing and demanding WHT on the deemed dividend distribution for periods commencing on 7th November 2019…”

 

Related Guidelines

TPG2022 Chapter I paragraph 1.9The arm’s length principle has also been found to work effectively in the vast majority of cases. For example, there are many cases involving the purchase and sale of commodities and the lending of money where an arm’s length price may readily be found in a comparable transaction undertaken by...
TPG2022 Chapter II paragraph 2.112A similar approach may be required when there are differences in functions performed by the parties being compared. Assume that the facts are the same as in the example at paragraph 2.44 except that it is the comparable independent enterprises that perform the additional function of technical support and not...
TPG2022 Chapter II paragraph 2.111By way of illustration, the example of cost plus at paragraph 2.59 demonstrates the need to adjust the gross mark-up arising from transactions in order to achieve consistent and reliable comparison. Such adjustments may be made without difficulty where the relevant costs can be readily analysed. Where, however, it is...
TPG2022 Chapter II paragraph 2.110See in particular paragraphs 3.18-3.19 for guidance on the tested party, paragraphs 3.55-3.66 for guidance on the arm’s length range, and paragraphs 3.75-3.79 for guidance on multiple year data....
TPG2022 Chapter II paragraph 2.109While it is not specific to the transactional net margin method, the issue of the use of non-transactional third party data is in practice more acute when applying this method due to the heavy reliance on external comparables. The problem arises because there are often insufficient public data to allow...
TPG2022 Chapter II paragraph 2.108A situation where Berry ratios can prove useful is for intermediary activities where a taxpayer purchases goods from an associated enterprise and on-sells them to other associated enterprises. In such cases, the resale price method may not be applicable given the absence of uncontrolled sales, and a cost plus method...
TPG2022 Chapter II paragraph 2.107The selection of the appropriate financial indicator depends on the facts and circumstances of the case, see paragraph 2.82. Concerns have been expressed that Berry ratios are sometimes used in cases where they are not appropriate without the caution that is necessary in the selection and determination of any transfer...
TPG2022 Chapter II paragraph 2.106“Berry ratios” are defined as ratios of gross profit to operating expenses. Interest and extraneous income are generally excluded from the gross profit determination; depreciation and amortisation may or may not be included in the operating expenses, depending in particular on the possible uncertainties they can create in relation to...
TPG2022 Chapter II paragraph 2.105Other net profit indicators may be appropriate depending on the facts and circumstances of the transactions. For instance, depending on the industry and on the controlled transaction under review, it may be useful to look at other denominators where independent data may exist, such as: floor area of retail points,...
TPG2022 Chapter II paragraph 2.104In cases where the net profit is weighted to assets, the question arises how to value the assets, e.g. at book value or market value. Using book value could possibly distort the comparison, e.g. between those enterprises that have depreciated their assets and those that have more recent assets with...

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