Withholding Tax is payable when Accrued Costs reflect on the Accounts
On 5th February 2019, the Court of Appeal held that withholding tax is payable upon accrual of costs, just as upon payment of costs.
The issue in the case was whether Kenya Revenue Authority (KRA) must deduct withholding tax on interest claimed as an expense in audited account under section 35 of the Income Tax Act. Sections 35(1) and (3) clearly state that tax is withheld “upon payment” and payment is a necessary prerequisite for the withholding tax to apply.
The genesis of the dispute was when an entity known as Fintel Limited engaged a third-party contractor and agreed to pay interest on late payment of contractual fees. In the course of their engagement, some payments were late and interest accrued. Fintel did not pay the contract this interest, but instead recorded the obligation to pay as a liability in its books of accounts in accordance with accounting standards.
Fintel then went ahead to use this interest owed to the third-party contractor as a tax-deductible item, which then saw Fintel’s corporate tax obligations reduce. When KRA audited their books, KRA demanded immediate payment of the withholding tax due on the accrued interest. KRA claimed that the fact that accrued interest was reflected in Fintel’s books of accounts meant that Fintel had accepted that interest was credited to the third-party contractor’s account, thus this means it had been paid as provided for under the Income Tax Act.
Section 2 of the Act defines “paid” includes distributed, credited, dealt with or deemed to have been paid in the interest or on behalf of a person and “pay”, “payment” and “payable” have corresponding meanings;
The dispute then moved to court where Fintel’s position was that “paid” can only mean physical payment or delivery of money.
The Court of Appeal found in favour of KRA’s interpretation, and stated that Fintel was bound to withhold the tax on account of the third-party contractor even though Fintel had not physically paid out the interest, because an obligation to make payment had arisen as the payment was included in its books of accounts and used as a credit which reduced Fintel’s taxable income.
What this means for private sector is that withholding tax is payable to KRA the moment accrued costs reflect in their business’ accounts, which withholding tax is due by the 20th day of the subsequent month after accrual of the costs. This will be the position on demands KRA makes to business effective the date of the Court of Appeal judgment (5th February 2019).
The case citation is CIVIL APPEAL NO. 311 OF 2013: Kenya Revenue Authority vs. the Republic of Kenya (ex-parte Fintel Limited).