Is Withholding Tax Due On Payment Or On Accrual? - The Court Of Appeal Decision In KRA vs Republic Of Kenya (Ex-Parte Fintel Limited) Explained

On 5 February 2019, the Court of Appeal delivered its judgment in the judicial review case of Kenya Revenue Authority vs. the Republic of Kenya (ex-parte Fintel Limited). The Kenya Revenue Authority (KRA) had appealed a High Court judicial review decision in 2012 in which the court held that an actual payment in cash is a prerequisite for withholding tax to be applicable and an accrual of a money obligation (for example, the obligation to pay interest under a shareholder loan) would not result in withholding tax being applicable. The High Court defined payment as "the delivery of money or other valuable thing," indicating that for the application of withholding tax an actual payment must be made by a taxpayer.

In an unexpected move, the Court of Appeal overturned the High Court decision and instead ruled that withholding tax is payable upon accrual, as well as upon payment.

In this Legal Alert, we discuss the salient issues arising from the Court of Appeal decision and we set out our views on the practical implications on businesses.

Summary of the Facts

Fintel entered into an agreement with a third party contractor under which Fintel agreed to pay interest on any contractual fees paid late. As the project progressed, a number of payments due to the contractor were delayed and incurred interest. The interest was not actually paid by Fintel to the contractor, but the obligation to pay was recorded as a liability in Fintel's books of accounts in accordance with accounting standards.

As interest is a business expense, Fintel used the interest as a tax deductible item thereby reducing its corporation tax liability. Following an audit of Fintel's books of accounts, the KRA demanded immediate payment of the withholding tax due on the accrued interest. A tax dispute ensued in which the KRA claimed that by recognising accrued interest as a liability in its books of accounts, Fintel acknowledged that interest was credited to the account of the third party and therefore fell within the definition of the term "paid" as defined in section 2 of the Income Tax Act (the ITA). In KRA's view, the accrual was therefore subject to withholding tax pursuant to the provisions of the ITA. The High Court disagreed with KRA's interpretation, holding that "tax is withheld upon payment and payment is a necessary prerequisite for WHT to apply."

Submissions at the Court of Appeal

The crux of the KRA's case was that the term ''payable'' in relation to withholding tax...