Unilever Kenya Limited (UKL) is engaged in the manufacture and sale of various household goods including foods, detergents and personal care items. UKL is a part of the world-wide Unilever group of companies. Unilever plc., a company incorporated in the United Kingdom has a very substantial shareholding in the UKL. UKL and Unilever Uganda Limited (UUL) are related companies.
In august 1995 UKL and UUL entered into a contract whereby UKL was to manufacture on behalf of UUL and to supply to UUL such products as UUL required in accordance with orders issued by UUL. UKL supplied such products to UUL during the years 1995 and 1996. UKL manufactured and sold goods to the Kenyan domestic market and export market, to customers not related to UKL.
The prices charged by UKL for identical goods in domestic export sales were different from those charged by it for local domestic sales.
The prices charged by UKL to UUL differed from both the above sales and were lower than those charged in domestic sales and domestic export sales for identical goods. In other words, UKL charged lower prices to UUL then it charged its domestic buyers and importers not related to UKL.
The Commissioner of Income Tax raised assessments against UKL in respect of the years 1995 and 1996, in respect of sales made by UKL to UUL on the basis that UKL’s sales to UUL were not at arm’s length.
The Commissioner of Income Tax in raising such an assessment relied on Section 18 (3) of the Act which reads:- “18(3) where a non-resident person carries on business with a related resident person and the course of that business is so arranged that it produces to the resident person either no profits or less than ordinary profits which might be expected to accrue from that business if there had been no such relationship, then the gains or profits of that resident person shall be deemed to be the amount that might have been expected to accrue if the course of that business had been conducted by independent persons dealing at arms length”.
However, the important and relevant words in the said sub-section are: “The course of that business is so arranged that it produces to the resident person either no profits or less than ordinary profits which might be expected to accrue from that business if there had been no such relationship……....”
Hence the most important issue that arises for determination is whether or not the course of business between UKL and UUL was so arranged as to produce less profits.
The Commissioner of Income Tax found that as a result of special relationship between UKL and UUL the transactions between them resulted in less taxable profits to UKL. The sale of products by UKL to UUL at a price lower than the comparable prices charged to Kenyan buyers or to outside Kenya importers represents a transfer price and hence the difference becomes subject to taxation on the basis of sales at arms length prices.
Unilever Kenya Limited statet that the term “transfer pricing” describes the process by which related or connected entities set the process at which they transfer goods or services between each other and that the term “transfer pricing” therefore is simply a reference to the price at which related parties transfer goods and services to each other. The company puts forward a further argument to the effect that the prices charged by UKL to UUL are nothing but “discounted prices”.
At the time no guidelines on how companies were to comply with Transfer Pricing (TP) requirements had been issued in Kenya:-
UKL argues that in the absence of specific guidelines having been issued by Kenya Revenue Authority under section 18(3) of the Act the determination of these principles ought to be made in accordance with international best practice as represented by the OECD Transfer Pricing guidelines for Multinational Enterprises and Tax Administration Guidelines (The OECD Guidelines).
The tax administration having applied the CUP method ought to have considered whether the average price charged by UKL in Domestic Sales is a ‘Comparable Uncontrolled Price’ to that charged by UKL in the UUL sales for the purposes of section 18(3) of the Act and whether the average price charged by UKL in Domestic Export Sales is a Comparable Uncontrolled Price to that charged by UKL in the UUL sales for the purposes of section 18(3) of the Act.
The tax administation has made no adjustments to reflect the material effects of differences between Domestic Sales and UUL Sales which would materially affect the price in the open market and has made no allowances for the cost of marketing goods in Kenya with all resultant overheads as opposed to selling goods directly to UUL for UUL to market the goods in Uganda, at its (UUL’s) costs.
The tax administration disaggres with the methods suggested by UKL in arriving at arm’s length principle including references to foreign law and OECD principles etc as not applicable or even worthy of consideration as section 18(3) of our Act does not allow such references.
The court noticed that the very lengthy submissions made by UKL on guidelines adopted by other countries have been ignored by the tax administration on the basis that these simply do not apply to Kenya. Now, these guidelines do not form the laws of the countries in question. They are simply “guidelines”, guiding the world of business, that is business enterprises and the taxing authorities of those countries in arriving at proper Transfer Pricing principles for the purposes of computation of income tax.
The court is, unable to accept the argument that in view of the alleged clear wording of section 18(3) of the Act, no guidelines are necessary here in Kenya. That is rather simplistic, and devoid of logic.
Section 18(3) of the Act has used words “and the course of that business is so arranged that …”. The sub-section implies that the business so arranged must be such as to show less income to enable the tax authorities to challenge it.
The tax administration has submitted that this arrangement has been made deliberately to show lesser earnings. But is that really so? There is no evidence of tax fraud or tax cheating. The only evidence, material, is in regard to methods used for computation of tax. Use of different methods, so long as proper or lawful or rather not unlawful, is permissible and ought to be permissible so long as there is no fraudulent trading with a view to “evading” tax.
The tax administration says the sub-section is not ambiguous at all and must be read as literally as it is. Ordinarily a statute ought to be interpreted as per its wording if the wording is clear. But what when certain words or sentence is amendable to two interpretations? Was the course of business between UKL and UUL so arranged as to enable UKL to make no profits or less profits? I am unable to see such an “arrangement”.
What when several possible methods are suggested almost worldwide to arrive at arm’s length prices for the purpose of taxation? When the Act provides no guidelines, other guidelines should be looked at. In this particular case my task is to decide whether UKL’s business with UUL was so arranged as to show, deliberately, less profits. To consider this issue it the fact that if UKL charged UUL prices such as applicable to other importers or customers obviously UUL would buy from elsewhere is taken into account. The fact that UUL has its own programme for selling the products in Uganda for which it incurs expenses which expenses so far as UKL is concerned are saved is also taken into account . The court sees no special price fixing agreement so as to evade tax.
Section 18(3) of the Act does not tell tax payers what KRA will accept as arm’s length, or how to prove it to them or if they are willing to negotiate pricing arrangements. Accordingly, and for reasons outlined, the court do no think that the costs plus method used by UKL is a wrong method of arriving at an arm’s length price in the particular circumstances of this case.
The appeal is allowed with costs with the result that the assessment in question is ordered to be annulled to the extent of tax levied by the respondent in accordance with section 18(3) of the Act arising from deemed profits from UKL’s business with UUL in 1995 and 1996. It is further ordered that no tax shall be levied by the respondent in accordance with section 18(3) of the Act arising from deemed profits from the business with UUL in 1995 and 1996.