ECP Kenya Limited v Commissioner of Domestic Taxes [2023] KETAT 944 (KLR)
Full Case Text
ECP Kenya Limited v Commissioner of Domestic Taxes (Appeal 614 of 2022) [2023] KETAT 944 (KLR) (Commercial and Tax) (10 November 2023) (Judgment)
Neutral citation: [2023] KETAT 944 (KLR)
Republic of Kenya
In the Tax Appeal Tribunal
Commercial and Tax
Appeal 614 of 2022
E.N Wafula, Chair, Cynthia B. Mayaka, Grace Mukuha, Jephthah Njagi & AK Kiprotich, Members
November 10, 2023
Between
ECP Kenya Limited
Appellant
and
Commissioner of Domestic Taxes
Respondent
Judgment
Background 1. The Appellant is a limited liability company incorporated in Kenya pursuant to the provisions of the Companies Act (Cap 486, Laws of Kenya) (now repealed), and whose principal activity is the collection of data from portfolio companies, processing and collating the data to respond to various tasks assigned to it by its parent entity, ECP Manager LP (hereinafter referred to as ECP Manager) in consideration for a fee. ECP Manager is a limited partnership based in the United States of America.
2. The Respondent is a principal officer appointed under Section 13 of the Kenya Revenue Authority Act, 1995. Under Section 5 (1) of the Act, the Kenya Revenue Authority (the Authority) is an agency of the Government for the collection and receipt of all tax revenue.
3. The Respondent issued a letter of assessment to the Appellant dated 4th February 2022 demanding the Corporation tax of Kshs. 2,521,185,943. 00, inclusive of penalties and interest.
4. The Appellant lodged a notice of objection dated 4th March 2022.
5. The Respondent issued an objection decision dated 28th April 2022 in respect of the Appellant’s notice of objection.
6. The Appellant being dissatisfied with the decision of the Respondent notified the Respondent of its intention to appeal to the Tribunal against the said decision vide a Notice of Appeal dated 27th May 2022 and filed on the same date.
The Appeal 7. The Appeal is premised on the following grounds as stated in the Appellant’s Memorandum of Appeal dated on 10th June 2022 and filed on 14th June, 2023 being: -a.The Respondent erred in law and fact by disregarding the Appellant’s business model and transfer pricing policy, leading to an erroneous assessment;b.The Respondent erred in law and fact in its Functions, Assets and Risks analysis of the Appellant’s support role to ECP Manager LP resulting in its erroneous conclusion that the Appellant carries out significant value adding functions in Kenya for ECP Manager LP;c.The Respondent erred in law and fact by applying an inappropriate transfer pricing method (the Transactional Profit Split Method) as the basis for computing the remuneration of the functions performed by the Appellant to ECP Manager LP;d.Without prejudice to the above, the Respondent erred in law in applying the Transactional Profit Split Method by using the number of employees as the basis of allocating ‘’profit’’; ande.Without prejudice to the above, the Respondent erred in law and fact in applying the Transactional Profit Split Method by assessing tax based on the entire gross revenue earned by ECP group instead of the relevant transactional profit attributable to the Appellant from ECP manager LP.
Appellant’s Case 8. The Appellant set out its case premised on the hereunder filed documents and proceedings before the Tribunal:i.The Appellant’s Statement of Facts dated the 10th June, 2022 and filed on 14th June, 2022. ii.The Witness Statement of Daniel Beeton dated 4th October, 2022 and filed on 5th October, 2022 and admitted in evidence on oath on 16th February, 2023. iii.The Witness Statement of Mark Gerdelman dated 3rd February, 2023 and filed on 9th February, 2023 and admitted in evidence on oath on 16th February, 2023. iv.The Appellant’s written submissions dated 23rd March 2023 and filed on 24th March 2023.
a) The Appellant and its management 9. That the Appellant is a private limited company incorporated in Kenya and is a wholly owned subsidiary of ECP Manager. The Appellant’s business involves collection of data from portfolio companies, processing and collating the data to respond to various tasks assigned to it by ECP Manager in consideration for a marked-up fee of 7%.
10. That ECP Manager is based in the USA and is registered as an investment advisor with the US Securities Exchange Commission (SEC). ECP Manager is regulated by the SEC and serves as an investment advisor to various funds, including ECP Africa Fund III PCC. The owners of ECP Manager are private individuals. While the number of owners has varied over the years, it has not exceeded seven or gone below four.
11. That ECP Manager’s business consists of three parts: Fundraising, Advisory, and Operations:i.Fundraising Activities:a.ECP Manager employees in the US will visit global institutional financial investors and seek to convince them to allocate capital to the relevant fund. This activity is undertaken out of the US and as a condition to engaging in its activities ECP Manager is registered with the SEC.ii.Advisory Activities:a.Sourcing: ECP Manager US-based employees identify promising investment opportunities that meet the relevant fund’s criteria.b.Execution: After identifying a suitable opportunity ECP Manager performs a technical analysis and due diligence and presents an investment recommendation to the relevant fund.c.Recommending: After a technical analysis has been performed by ECP Manager, ECP Manager’s executive committee recommends deals to the relevant fund’s Investment Committee (which is a subcommittee of the relevant fund’s board).d.Monitoring and Reporting: After the relevant fund makes a decision to invest, ECP Manager is tasked to collect a variety of performance data from the investee company (financial performance, environmental and social performance, operational performance, etc) and then present that data to the relevant fund’s shareholders in formal periodic reports.e.Investee Company Advisory: In rare occasions, ECP Manager may also directly advise the companies in which the fund invests (i.e. the investee company). This work is contracted directly with the investee company and may include assistance with strategic business planning, business development, assistance with operational improvement and financial planning.iii.Operational Activities:a.Operational Activities:i.As a SEC Registered Investment Advisor, ECP Manager must comply with many regulations of the SEC. This includes reporting, record keeping, risk management marketing and other activities in the US.ii.ECP Manager undertakes standard operations activities such as human resource, finance, accounting as well as general administrative support.
12. That ECP Manager is headquartered in the US and its subsidiaries are currently in the following countries:
13. That the Appellant provides administrative support services to ECP Manager and has no direct relationship with any other ECP entity. The Appellant’s employees receive assignments from ECP Manager’s Executive Committee in the US. These assignments primarily relate to analysis and review of data to provide input for reports issued to ECP Manager. The assignments do not relate to fundraising, recommending investments, making investment decisions, or making exit decisions.
b)The Tax Assessment 14. That the Respondent issued a letter of assessment to the Appellant dated 4th February 2022 demanding the Corporation tax of Kshs. 2,521,185,943. 00 (inclusive of penalties and interest) (the Tax Assessment). The Respondent issued the tax assessment on the basis that the Appellant carries out significant functions for ECP Manager and that the operations of ECP Manager and the Appellant are highly integrated and therefore the appropriate transfer pricing method that should be used to remunerate the Appellant would be the Transactional Profit Split Method (TPSM), instead of the Transactional Net Margin Method (TNMM) with the Full Cost Mark-up as the Profit Level Indicator that is used by the Appellant as documented in the Appellant’s transfer pricing policy. On this basis, the Respondent computed corporation tax on the gross income of ECP group that it alleged was attributable to the Appellant using the TPSM.
15. That the Appellant filed a notice of objection dated 4th March 2022 objecting to the tax assessment on grounds that:15. 1The Respondent erred in law and fact in its FAR analysis and its conclusion that Appellant carries out significant value adding functions for ECP Manager in Kenya;15. 2The Respondent erred in law and fact in applying the TPSM as the basis for computing the remuneration of the functions performed by the Appellant; and15. 3The Respondent erred in law in applying the TPSM by using the number of employees as the ‘’profit’’ allocation key and using the entire gross revenue earned by ECP Manager instead of the relevant transactional profit attributable to the Appellant.
16. That the Respondent issued an objection decision dated 28th April 2022 in respect of the Appellant’s notice of objection. In the objection decision, the Respondent asserted that the Appellant carries out significant functions and cannot be classified as low value adding services. Further the Respondent alleged that the Appellant and ECP Manager make unique and valuable contributions and consequently their functions are highly integrated and the appropriate transfer pricing method to be used to remunerate the Appellant is the TPSM. On this basis, the Respondent confirmed its tax assessment for corporate tax of Kshs. 2,521,185,943. 00, inclusive of penalties and interest.
17. That the Appellant being dissatisfied with the decision of the Respondent notified the Respondent of its intention to appeal to the Tribunal against the said decision vide a Notice of Appeal dated 27th May 2022 pursuant to Sections 12 and 13 (1) of the Tax Appeals Tribunal Act, 2013, and Rule 3 (1) of the Tax Appeals Tribunal (Procedure) Rules, 2015.
c. Facts in support of the Appellant’s grounds of appeal set out in the Memorandum of Appeal i. The Respondent erred in law and fact by disregarding the Appellant’s business model and transfer pricing policy, resulting in an erroneous assessment 18. That the Respondent has gravely abused its discretion in rendering a decision based on assumptions and conclusions not borne out by the Appellant’s financial records, the transfer pricing policy (the TP Policy) or indeed any other substantive evidence.
19. That the Respondent has disregarded the Appellant’s TP Policy on the basis that it is misleading based on the Respondent’s assertion that there is no registered entity in the US known as ECP Manager. That it is surprising for the Respondent to make this assertion noting that the Respondent has relied on various filings made by ECP Manager, ECP Manager III LP, ECP Mena Management LP (ECP US Entities) at the SEC (the SEC Filings) which clearly refer to ECP Manager as an entity registered in the US. In addition, Section 1 of the Appellant’s TP Policy clearly states that the Appellant is a wholly owned subsidiary of ECP Manager. The Respondent’s disregard of the Appellant’s TP Policy is therefore without any factual or legal basis.
20. That the Respondent has reached an erroneous conclusion that the Appellant carries out high value adding services to ECP Manager. This conclusion was based on an erroneous function analysis based on the SEC Filings and the Form ADV Part 2A-Emerging Capital Partners Brochure (the ECP Brochure) with total disregard to the Appellant’s TP Policy and the functional analysis interview with Bryce Fort (Bryce). The fact which the Respondent has disregarded is that the Appellant provides administrative support functions to ECP Manager which are clearly identified in the Appellant’s TP Policy.
21. That the Respondent has relied on SEC Filings including the ECP Brochure and alleged that the risks set out in the ECP Brochure, which in fact relate to ECP’s global fund advisory business, are borne by the Appellant. That the correct position is that the highlighted risks are only borne by the investors, and the ECP US advisory business entities which are specifically identified under Item 4 of the Brochure as ECP Manager LP, ECP Manager III LP, ECP Mena Management LP, ECP Manager IV LP, and Emerging Capital Advisors LP. The Appellant is not mentioned as one of the entities which bears the alleged risks. That the Respondent has blatantly disregarded the Appellant’s TP policy which states that the only risk borne by the Appellant in undertaking its support functions is the credit risk, and also describes the Appellant’s business model in detail. The Appellant notes that the Respondent only introduced the ECP Brochure for the first time in its objection decision and has based all its arguments relating to the Appellant’s alleged functions on this document.
22. That similarly, in the SEC filings, the Respondent has not taken into consideration that the filings are made to a foreign regulator by way of standard forms, and the information declared in the filings would therefore need to be viewed in a particular context, as it relates to US regulatory affairs and not tax or accounting matters. That for example, since the SEC filings relate to the global ECP advisory business, there is a requirement to indicate all the offices across the world where ECP has offices, and while the SEC filings make reference to locations where ECP undertakes ‘’Investment Advisory Business’’ the Respondent has misapplied this to mean that the Appellant provides advisory services in Kenya, while disregarding that the Appellant provides support services, which although are an integral component of the investment advisory value chain, are low value adding services. That the Appellant’s TP Policy had addressed all these issues in detail, but the Respondent has disregarded the TP Policy in its entirety, without any valid reason, and instead opted to rely on SEC filings made by third parties, without understanding or investigating the context in which the SEC filings are made.
ii.The Respondent erred in law and fact in its Functions, Assets and Risks analysis of the Appellant’s support role to ECP Manager resulting in its erroneous conclusion that the Appellant carries out significant value adding functions in Kenya for ECP Manager 23. That in an attempt to attribute the income of ECP Manager to the Appellant, the Respondent carried out an erroneous Functions, Assets and Risks (FAR) analysis in respect of the Appellant’s provision of services to ECP Manager and concluded that the Appellant carries out significant value adding services to ECP Manager. The Respondent further concluded that the operations of ECP Manager and the Appellant are highly integrated and therefore the appropriate transfer pricing method to be used to remunerate the Appellant would be the TPSM, instead of the TNMM Method that is applied by the Appellant pursuant to its TP Policy.
24. That the Respondent has stated in the objection decision that it carried out the FAR analysis by relying on the following:-a.interview with Bryce, one of the then directors of the Appellant;b.documents provided by the Appellant such as job descriptions and a letter describing the functions of ECP Manager and the Appellant;c.returns filed by ECP entities at the SEC; andd.Sec administrative proceedings.
25. That based on the above information, the KRA undertook FAR analysis which concluded the following as the functions, assets and risks borne by ECP Manager and the Appellant:FAR According to KRA
Description ECP Manager ECP Kenya
Functions
Sourcing for investors √
Sourcing investment opportunities √ √
Evaluating Investment opportunities √ √
Selection of Investment opportunities √ √
Negotiation of Investment opportunities √ √
Committing to Investments √ √
Monitoring Investments √
Disposing Investments √ √
Participate as Board Members of Investee Companies √
Develop and Support portfolio company strategies √
Provide periodic reports for portfolio companies √
Assets
Advisory Personnel √ √
Investment Funds √ √
Risks
Political Risk √ √
Legal Risk √ √
Environmental Risks √ √
Market Risks √ √
Long Term Investments and Illiquid securities √ √
Competition √ √
26. That in arriving at the FAR analysis above, the Respondent disregarded the Appellant’s TP Policy which it prepared pursuant to Section 18 (3) of the ITA and the Income Tax Act (Transfer Pricing) Rules, 2006. That the TP Policy sets out the functions, assets and risks carried out by the Appellant in provision of its services to ECP Manager and the appropriate remuneration for the Appellant. The Appellant asserts that contrary to the Respondent’s averment, its function is to provide administrative support to ECP Manager as illustrated under Section 6. 1.2 of the Appellant’s TP Policy.
27. That a summary of the FAR analysis that was carried out by the Appellant in coming up with the TP Policy is set out below.ECP Manager ECP Kenya
Provide investment management advisory to investment funds Monitoring investments
Strategic Business Review Provide management and technical support services to investee companies
Business development
Fund Raising and Capital Structuring
Financial Accountability
Assist in ESG and ESOPs
Generate and evaluate exit opportunities and search for potential purchasers.
28. That as highlighted above, the Appellant notes that the Respondent has referred to the ECP Brochure, which sets out the risks associated with ECP US’ Investment Advisory business and attributed those risks to also apply to the Appellant. The Appellant asserts that the highlighted risks are not borne by the Appellant as the risks are only borne by the investors and the ECP US advisory business entities which are specifically identified under Item 4 of the Brochure as ECP Manager LP, ECP Manager III LP, ECP Mena Management LP, ECP Manager IV LP, and Emerging Capital Advisors LP. That the Respondent has blatantly disregarded the Appellant’s TP Policy which sets out under Section 6. 2 that the risk borne by the Appellant in undertaking its functions is the credit risk only.
29. That the table below sets out the risks borne by ECP Manager, and the Appellant as set out on the TP Policy.Risks ECP Manager ECP Kenya
Liquidity Risk √
Inflation Risk √
Credit Risk √
30. That in addition, in the interview between Bryce and the Respondent of 17th September 2020 (the interview), it was unequivocally confirmed by Bryce that local/regional offices such as the Appellant do not make any sourcing or exit decisions, and specifically, Bryce confirmed that in relation to the private equity fund industry ‘’Sourcing is done from the head office say in London or New York, but the regional offices are usually for monitoring especially when there is a huge portfolio of investments’’. That it is unfortunate that the KRA deliberately misquoted Bryce and interpreted this to mean that ECP Manager has offices in New York and London yet Bryce was giving an illustration of global structures of PE fund managers. In the said interview, Bryce also confirmed that there is need to continually collect information from the portfolio companies and report back to ECP Manager and this is the role performed by the Appellant.
31. That Section 6. 1.2 of the TP Policy sets out the administrative support functions carried out by the Appellant for ECP Manager. An example of the type of administrative support provided by the Appellant to ECP Manager, as set out in the TP Policy, is as follows:“when ExCo assigns employees of ECP Kenya the task of visiting a company in South Africa to enable ECP Manager to determine whether it is suitable for an investment. The team (which would likely include employees from other ECP offices in addition to Kenya) would visit the target company, meet management, ask for data and analyse it. It would undertake a preliminary analysis and present its findings back to the ExCo for further analysis and decision making.”A further example of administrative support services is as follows: “…would be requiring the ECP Kenya employees to fill out HR review forms to giving an opinion on the performance of senior and junior professional staff. Such information would be used by ECP Manager for purposes of making appropriate decisions in relation to personnel matters.”
32. That this is further evidenced by the interview where Bryce stated the following as his daily role:“His main role is monitoring the investment portfolio and, in this regard, he ensures that his team collects all the information relating to the investment portfolio as required by ECP Manager. His team compiles reports in the appropriate format based on tasks assigned by ECP Manager from time to time, which he then submits to the Washington office. The Washington office will then undertake further reviews of the analysis and use the reports received from ECP Kenya to prepare more comprehensive reports which may subsequently be circulated to the investors in the Fund. This is about 90 percent of his team’s role in Kenya.”
33. That based on the above, it is clear that the Appellant’s functions are purely support functions and are consistent with the Appellant’s TP Policy. In this regard, ECP Manager employees regularly send follow up emails to local country team members (including the Appellant’s employees) requesting them to meet the report submission deadlines for the respective administrative tasks assigned to them.
34. The Appellant further notes that the Respondent erred in relying on the template job descriptions of an ECP Managing Director, Vice President, and Associates to conclude that the Appellant’s functions are significant value adding services. The Respondent had requested for what would ordinarily be the job descriptions of key staff of ECP and it was forwarded via email, template job descriptions of ECP staff at the global level. The job descriptions are merely general descriptions, but in fact, the functions performed by the Appellant’s employees are materially different as was evident from the Interview highlighted above.
35. That the Respondent undertook one functional analysis interview, with Bryce, and has not provided any correspondence to corroborate the assertion that the Appellant denied it the opportunity to undertake any further interviews after the interview with Bryce. The Appellant further points out that the facts set out in the minutes of the meeting in relation to the Appellant’s functions have not been reflected accurately in the objection decision, as it was clarified that key roles such as sourcing, investment decisions, fund raising, and exit are all undertaken by ECP Manager and not by the Appellant. Furthermore, with only one interview completed, the Appellant is relying on job descriptions, which are generic in nature and used across ECP Manager and its subsidiaries, rather than factual determination of what the roles and responsibilities of each individual employees of the Appellant on a day-to-day basis.
36. That in relation to the Respondent’s reliance on generic job descriptions, the Organisation for Economic Co-operation and Development Transfer Pricing Guidelines 2017 (OECD TP Guidelines) in Paragraph 1. 46 states that where conduct is not fully consistent with economically significant contractual terms, further analysis is required to identify the actual transaction. It further states:“Where there are material differences between contractual terms and the conduct of the associated enterprises in their relations with one another, the functions they actually perform, the assets they actually use, and the risks they actually assume, considered in the context of the contractual terms, should ultimately determine the factual substance and accurately delineate the actual transaction.”
37. That the OECD TP Guidelines provides under Paragraph 1. 35, that:“The accurate delineation of the actual transaction or transactions between the associated enterprises requires analysis of the economically relevant characteristics of the transaction. These economically relevant characteristics consist of the conditions of the transaction and the economically relevant circumstances in which the transaction takes place. The application of the arm’s length principle depends on determining the conditions that independent parties would have agreed in comparable transactions in comparable circumstances. Before making comparisons with uncontrolled transactions, it is therefore vital to identify the economically relevant characteristics of the commercial or financial relations as expressed in the controlled transaction.”
38. That as guided by the OECD TP Guidelines, the actual transaction between the parties is established from written contracts, as well as the conduct of the parties and other economically relevant characteristics of the transaction. In the case of inconsistencies, the transaction should be delineated in accordance with the characteristics of the transaction reflected in the conduct of the parties.
39. That the OECD TP Guidelines at paragraph 1. 36 provides that the following analysis must be performed to accurately delineate the related party transaction:40. 1the contractual terms of the transaction must be determined;40. 2the functions performed by each of the parties to the transaction taking into account assets used and risks assumed, including how those functions relate to the wider generated value by the multinational group to which the parties belong, the circumstances surrounding the transaction, and the industry practices;40. 3the characteristics of property transferred or services provided must be determined;40. 4the economic circumstances of the parties and of the market in which the parties operate must be understood; and40. 5the business strategies pursued by the parties must be understood.
40. That the Respondent has erred in its FAR analysis by failing to take into account the guidance stated above. For this reason, the Respondent reached an erroneous conclusion on the functions performed, assets utilized, and risks borne by the parties to the controlled transaction.
41. That based on the above, although the general template job descriptions of the Managing Director, Vice President, and the Associate, have roles that could be interpreted to relate to sourcing, evaluation, selection, and negotiation of investment opportunities, there was in fact a material difference with what was actually being performed by the relevant employees of the Appellant, as explained during Bryce’s interview.
42. That the OECD TP Guidelines provides under Paragraph 6. 133 that:-“The functional analysis should identify all factors that contribute to value creation, which may include risks borne, specific market characteristics, location, business strategies, and MNE group synergies among others. The transfer pricing method selected, and any adjustments incorporated in that method based on the comparability analysis, should take into account all of the relevant factors materially contributing to the creation of value, not only intangibles and routine functions.”
43. That the Respondent in its finding has failed to demonstrate and to identify which functional activities are exercising control or contributing relatively more value in the transaction between ECP Manager and the Appellant. The Appellant reiterates that, at no point does it hold investment funds on behalf of the Fund.
44. That regarding the advisory personnel, the Appellant asserts that the services provided by the employees are autonomous in nature, in that, the services can be performed by an independent consultant, such as consulting and advisory firms operating in Kenya. In addition, the Appellant has not capitalised any intangible assets in its books. The personnel in question do not create unique and intangible value to the transaction at hand. The Appellant maintains the position presented in its TP Policy that, it, does not hold unique assets and has the simpler risk profile.
45. That further the OECD TP Guidelines provides under paragraph 1. 60 for a Six-Step Approach to performing a detailed risk analysis:i.Identify economically significant risks with specificity.ii.Determine how specific economically significant risks are contractually assumed by the associated enterprises under the terms of the transaction.iii.Determine through a functional analysis how the associated enterprises that are parties to the transaction operate in relation to assumption and management of the specific, economically significant risks, and in particular which enterprise or enterprises perform control functions and risk mitigation functions, which enterprise or enterprises encounter upside or downside consequences of risk outcomes, and which enterprise or enterprises have the financial capacity to assume the risk.iv.Steps 2-3 will have identified information relating to the assumption and management of risks in the controlled transaction. The next step is to interpret the information and determine whether the contractual assumption of risk is consistent with the conduct of the associated enterprises and other facts of the case by analysing (i) whether the associated enterprises follow the contractual terms under the principles of Section D.1. 1; and (ii) whether the party assuming risk, as analysed under (i), exercises control over the risk and has the financial capacity to assume the risk.v.The actual transaction as accurately delineated by considering the evidence of all the economically relevant characteristics of the transaction as set out in the guidance in Section D.1, should then be priced taking into account the financial and other consequences of risk assumption, as appropriately allocated, and appropriately compensating risk management functions”.
46. That the risk analysis undertaken by the Respondent is factually incorrect and erroneous as it did not follow the six-step approach recommended by the OECD TP Guidelines. The Respondent specifically failed to take into consideration the guidance by the OECD TP Guidelines on whether the contractual assumption of risk is consistent with the conduct of the associated enterprises. The Appellant does not commit any capital or assume risks or own any significant tangible and intangible assets as evidenced by the financial statements and TP Policy provided to the Respondent, which is consistent with the administrative support services provided by Appellant.
47. That the Respondent ought to have considered the factual evidence provided to it in determining the Appellant’s functions to reach a correct conclusion in its FAR analysis. Unfortunately, the Respondent is misrepresenting the facts stated in the minutes of the functional analysis interview and no further factual evidence of what the Appellant’s employees do is presented.
48. That the Appellant provides support services to its related party, ECP Manager. That the Appellant does not commit any capital or assume risks or own any significant tangible and intangible assets as evidenced by the financial statements and TP Policy provided to the Respondent. The risk incurred by the Appellant are purely operational risks as evidenced in the TP Policy.
49. That it is therefore the Appellant’s assertion that the Respondent’s allegation that the Appellant’s functions are of significant value to ECP Manager, is erroneous and factually incorrect. The Appellant reiterates that its key function is the provision of administration support services to ECP Manager, which is in line with the functions stated in the TP Policy and is reflected in the minutes of the Interview with Bryce.
50. That based on the above facts, the Appellant avers that the Respondent carried out an erroneous FAR analysis and analysis in respect of the Appellant’s provision of services to ECP Manager and arrived at an erroneous conclusion that the Appellant carries out significant value adding services to ECP Manager. The Respondent’s assessment based on the TPSM is therefore erroneous and has no basis in law.
iii.The Respondent erred in law and fact by applying an inappropriate transfer pricing method (the Transactional Profit Split Method) as the basis for computing the remuneration of the functions performed by the Appellant to ECP Manager 51. That the Appellant asserts that its function is the provision of administration support to ECP Manager and as demonstrated above, the Respondent’s FAR analysis, assumptions and conclusion are demonstrably incorrect. As a result, the Respondent therefore erred in applying the TPSM in relation to the remuneration for the functions performed by the Appellant.
52. That the Appellant prepared its TP policy in line with the ITA, the TP Rules and the OECD TP Guidelines and has consistently applied the TP Policy in all its dealings with ECP Manager. The OECD Convention has often been applied in Kenya for transactions where the domestic law provisions are silent. This position was laid out in the case of Unilever Kenya Limited vs. Commissioner of Income tax [2005] eKLR. The case related to transfer pricing adjustment as provided under Section 18 (3) of the ITA. However, at the time, the TP Rules had not yet been introduced and therefore the Appellant relied of the OECD Guidelines for Multinational Enterprises to determine the appropriate method for determining the arm’s length price. In determining the case, the court held that where the ITA is silent on certain matters the provisions of the OECD will apply. In particular, the court held that;“… and especially because of the absence of any such guidelines in Kenya, we must look elsewhere. We must be prepared to innovate, and to apply creative solutions based on lessons and best practices available to us. That is indeed how our law will develop and our jurisprudence will be enhanced. And that is also how we shall encourage business to thrive in our country.”.
53. That the OECD TP Guidelines provide guidance on the typical process to be followed when preparing a transfer pricing policy and determining the arm’s length price of a related party transaction in paragraph 3. 4 as follows:“Step 1: Determination of years to be covered.Step 2: Broad-based analysis of the taxpayer’s circumstances.Step 3: Understanding the controlled transaction(s) under examination, based in particular on a functional analysis, in order to choose the tested party (where needed), the most appropriate transfer pricing method to the circumstances of the case, the financial indicator that will be tested (in the case of a transactional profit method), and to identify the significant comparability factors that should be taken into account.Step 4: Review of existing internal comparables, if any.Step 5: Determination of available sources of information on external comparables where such external comparables are needed taking into account their relative reliability.Step 6: Selection of the most appropriate transfer pricing method and, depending on the method, determination of the relevant financial indicator (e.g. determination of the relevant net profit indicator in case of a transactional net margin method).Step 7: Identification of potential comparables: determining the key characteristics to be met by any uncontrolled transaction in order to be regarded as potentially comparable, based on the relevant factors identified in Step 3 and in accordance with the comparability factors set forth at Section D.1 of Chapter I.Step 8: Determination of and making comparability adjustments where appropriate.Step 9: Interpretation and use of data collected, determination of the arm’s length remuneration”
54. That the Appellant asserts that it followed the above nine-step approach in preparing its TP Policy and arriving at the arm’s length rate applied in the remuneration for the provision of services to ECP Manager. Accordingly, based on the functions, assets and risk analysis set out in the Appellant’s TP policy, the most appropriate method was chosen i.e. the Transactional Net Margin Method with the Full Cost Mark-up as the Profit Level Indicator and the correct arm’s length compensation for the Appellant applied.
55. That the Appellant asserts that based on the transfer pricing analysis it undertook, the rationale for selecting TNMM as the transfer pricing method was explained in the TP Policy and it was also explained why TPSM would not be a suitable transfer pricing method for the routine administrative support services provided by the Appellant.
56. That the Appellant further avers that the Revised Guidance on the Application of the Transaction Profit Split Method Inclusive Framework on BEPS: Action 10th July 2018 (the TPSM Guidance) states that the TPSM is most appropriate where there are:a.unique and valuable contributions by each of the parties to the transaction; andb.highly integrated business operations.c.The TPSM Guidance further explains as follows:“Contributions (for instance functions performed, or assets used or contributed) will be ‘unique and valuable’ in cases where:i.they are not comparable to contributions made by uncontrolled parties in comparable circumstances; andii.they represent a key source of actual or potential economic benefit in the business operations. The two factors are often linked: comparables for such contributions are seldom found because they are key source of economic advantage.”
57. That the Appellant asserts that the TPSM Guidance is clear on the circumstances in which TPSM can be applied and the conditions which would need to be fulfilled. The Respondent has not demonstrated how any of these conditions have been met, to warrant application of TPSM.
58. That in addition, in the case of Aztec Software and Technology vs. ACIT 2007 107 ITD 141 Bang, the Tribunal considered both India transfer pricing legislation and the OECD TP Guidelines and gave guidance on when each of the transfer pricing methods could be applied to a transaction. The Tribunal stated the following in relation to the transactional profit split method:“This method may be applicable in cases where transactions involve transfer of unique, intangible or any multiple interrelated international transactions, which cannot be evaluated separately for determining the ALP (Arm’s Length Price) of any one transaction.The profit split method first identifies the profit to be split for the associated enterprise from the controlled transactions in which the associated enterprises are engaged. It then splits those profits between the associated enterprises on an economically valid basis that approximates the division of profits that would have been anticipated and reflected in an agreement made at arm's length. The combined profit may be the total profit from the transactions, or a residual profit intended to represent the profit that cannot readily be assigned to one of the parties, such as the profit arising from high value, sometimes unique, intangibles.The contribution of each enterprise is based upon a functional analysis and valued to the extent possible by any available reliable external market data.The functional analysis is an analysis of the functions performed (taking into account assets used and risks assumed) by each enterprise. The external market criteria may include, for example, profit split percentages or returns observed among independent enterprises with comparable functions.”
59. That the Appellant asserts that based on the TPSM Guidance and caselaw set out above, the functions performed by the Appellant, being administrative support services, are not unique and valuable contributions, noting that there are independent comparables as set out under Section 8. 5.1 of the Appellant’s TP Policy, and in addition, the administration support function is not a key source of economic benefit as demonstrated above.
60. That the Respondent further erred by alleging that the Appellant and ECP Manager functions are highly integrated. The Guidance states as follows in relation to integration of functions:“Although most multinational groups are integrated to some extent, a particularly high degree of integration in certain business operations is an indicator for the consideration of the transactional profit split method.”
61. That the TPSM Guidance further explains a high degree of integration as follows:“A high degree of integration means that the way in which one party to the transaction performs functions, uses assets and assumes risks is interlinked with, and cannot reliably be evaluated in isolation from, the way in which another party to the transaction performs functions, uses assets and assumes risks. In contrast, many instances of integration within a multinational result in situations in which the contribution of at least one party to the transaction can in fact be reliably evaluated by reference to comparable uncontrolled transactions.”
62. That the Appellant asserts that based on the definitions above, the Appellant’s function of administrative support services would not be regarded as highly integrated, since ECP Manager’s functions, assets and risks are well defined and independent comparables for the functions provided by the Appellant are readily available and this is evidenced in Section 8. 5.1 of the Appellant’s TP Policy.
63. That the Appellant further asserts that based on the above, the Respondent erred in applying the TPSM in the renumeration of the Appellant’s functions. The Appellant reiterates that it followed the required approach provided in the OECD TP Guidelines in preparing its TP policy and arriving at the correct arm’s length rate applied in its remuneration for provision of support services to ECP Manager. Accordingly, based on the FAR analysis undertaken in respect of the Appellant’s policy, the most appropriate method applicable and which was chosen, is the TNMM as discussed above.
d.Without prejudice to the above, the Respondent erred in law in applying the Transactional Profit Split Method by using the number of employees as the basis of allocating ‘’profit’’ 64. It is the Appellant’s assertion that as demonstrated above the correct delineation of the transactions and the correct functional analysis, the functions performed by the Appellant are administrative support services and the most appropriate method in accordance with the steps stated in the OECD guidelines paragraph 3. 4 is the TNMM with a full cost mark up as the profit level indicator.
65. That however, in the alternative and without prejudice to the grounds of appeal set out above, the Respondent erred in its application of the TPSM by using the number of employees of the Appellant as an allocation key and alleging that the most important element in the investment advisory industry is the personnel who ultimately determine whether the investors will realize a profit. It should be noted that based on OECD Guidance, which the Respondent has in fact relied on in paragraph 26 of its objection decision, the primary allocation keys that should be used in a profit split method are based on assets/capital (operating assets, fixed assets, intangible assets or capital employed) or costs (relative spending and/or investment in key areas such as research and development, engineering or marketing). Headcount would only be considered as an alternative allocation key when the primary allocations keys are not appropriate. The Respondent has not demonstrated why the primary allocation keys were not applied and why it went ahead to cherry pick an allocation key based on headcount.
66. That further, the use of headcount as an allocation key would also be appropriate where there would be no difference in the cost that would be incurred for the various levels of personnel. That for example, headcount would be the most appropriate allocation key for shared services relating to human resource functions and information technology support among other similar support services. In applying the headcount as an allocation key, the Respondent has assumed that the costs incurred, and the contribution made by each of the Appellant’s employees are equal.
67. That the TPSM Guidance states that in the transactional profit split method, the relevant profits are to be split between the parties to the transaction on an economically valid basis that approximates the division of profits that would have been anticipated and reflected in an agreement made at arm’s length. The Guidance further states that;“In general, the determination of the relevant profits to be split and of the profit splitting factors should:a.Be consistent with the functional analysis of the controlled transaction under review, and in particular reflect the assumption of the economically significant risks by the parties, andb.Be capable of being measured in a reliable manner.”
68. That the Respondent erred in its application of the TPSM for the reason that its application is not consistent with the Appellant’s functional analysis. That as demonstrated above a correct delineation of the transaction and functional analysis demonstrates that the Appellant’s function is administrative support. That as stated in paragraph 41 above the TPSM is applicable where there are unique and valuable contributions by each party and the activities are highly integrated, and as demonstrated above, TPSM is not the appropriate method to test the provision of administrative support by the Appellant.
69. That the Appellant therefore asserts that not only did the Respondent err in the application of the TPSM, but it also erroneously applied the number of employees as the profit allocation key and also further erred on the number of ECP Manager employees who were utilized in arriving at the assessment. That these personnel do not reflect the assumption of the economically significant risks that each party (between ECP Manager and the Appellant) undertakes in the investment decisions, and consequently, the allocation key chosen by the Respondent is erroneous as it cannot be measured in a reliable manner in relation to the risks undertaken by each of the personnel.
70. That further, the TPSM Guidance states that the headcount as an allocation key can be used as a profit splitting factor in circumstances where the employee group has similar skills and responsibilities and there is a strong and relatively consistent correlation between this, and the creation of value represented by the relevant profits.
71. That the Respondent erred in using the headcount of the Appellant’s personnel as an allocation key because the personnel that the Respondent has referred to (the Managing Director, Vice President and three Associates) are not of similar skills neither do they have similar responsibilities in the roles they perform for the Appellant. Further, that the Respondent failed to demonstrate the correlation between the contribution of the mentioned employees and the relevant profits to be split.
72. That based on the above, the Appellant asserts that the Respondent erred in law and fact in attributing the income allegedly earned by ECP Manager to the Appellant, on the basis of the number of employees.
e.Without prejudice to the above, the Respondent erred in law and in fact in applying the Transactional Profit Split Method by assessing tax based on the entire gross revenue earned by the ECP group instead of the relevant profit attributable to the Appellant from ECP Manager 73. That the Respondent erred in its application of the TPSM by using the entire gross revenue allegedly earned by ECP Manager, ECP Manager III LP and ECP Mena Management LP (together the US ECP Entities), instead of applying a profit split on the relevant profit earned by ECP Manager, as required by the TPSM Guidance. That it is important to note that the Appellant only provides administrative support services to ECP Manager as evidenced by the Appellant’s TP Policy and does not provide any services to ECP Manager III LP and ECP Mena Management LP. That without prejudice to the above, it is therefore erroneous for the Respondent to attribute the income of ECP Manager III LP and ECP Mena Management LP to the Appellant.
74. That the Respondent has erroneously asserted that the Investment Advisory business does not have any expenses and therefore the gross profit is equivalent to the gross income for purposes of applying TPSM. That the Respondent has failed to consider the Guidance on determining the profits to be split under the TPSM method. That Paragraph 2. 154 of the Guidance provides that;“In determining the relevant profits, it is therefore essential to first identify and accurately delineate the transactions to be covered by the transactional profit split method, and from this identify the relevant income and expense amounts for each party in relation to those transactions.”
75. That the Guidance further provides under paragraph 2. 162 that the relevant profits to be split under the TPSM are operating profits. Applying the TPSM in this manner ensures that both income and expenses of the relevant entities are attributed to the relevant associated enterprise on a consistent basis. However, depending on the accurate delineation of the transaction, it may be appropriate to split a different measure of profits such as gross profits, and then deduct the expenses incurred by or attributable to each relevant enterprise (excluding expenses already taken into account). In such cases, care must be taken to ensure that the expenses incurred by or attributable to each enterprise are consistent with the accurate delineation of the transaction, particularly the activities and risks undertaken by each party, and that the allocation of profits is likewise consistent with the contributions of the parties.
76. That without prejudice to the Appellant’s argument that TPSM is not the appropriate method that should be applied to this business model, the Respondent further erred in ignoring the fact that ECP Manager incurred expenses in undertaking its advisory business.
77. That the correct position based on accounting principles is that the direct costs incurred relating to the income earned from provision of advisory services i.e., the staff costs, would be considered in determining the gross profit. That under International Accounting Standards (IAS 1), this is known as the matching concept of accounting, the most basic principle of accrual accounting, which requires expenses to be recognized in the income statement on the basis of a direct association between costs incurred and the earning of specific items of income. It would therefore be incorrect and misleading for the Respondent to allege that the investment advisory business does not have direct expenses.
78. That the Respondent did not therefore attempt to determine the profit earned by the ECP US Entities from the gross proceeds of the management fees earned /expected to be earned in respect of the various portfolios. That instead, the Respondent lumped up the entire expected revenue from all portfolio companies managed by the ECP US entities, disregarding the fact that most of the managed portfolio does not relate to investments in Kenya which the Appellant does not offer any form of support.
79. That the Respondent has therefore not only applied an inappropriate transfer pricing method, but it has also applied the transfer pricing method in an incorrect manner.
80. That without prejudice to the Appellant’s assertion that the TNMM method applied by it in accordance to its TP Policy is the correct and appropriate method to be used in the circumstances, the Appellant asserts that the Respondent did not take into consideration the basic requirements of the TPSM and accounting principles and therefore erroneously used the entire gross revenue earned by US ECP entities instead of splitting the profits earned by ECP Manager based on the specific transactional support provided by the Appellant.
Appellant’ prayers 81. That the Appellant therefore prayed that:a.The Objection decision of the Respondent contained in the letter dated 28th April 2022 demanding payment for Corporate tax amounting to Kshs. 2,521,185,943. 00 be set aside;b.The Appeal be allowed with costs to the Appellant; andc.Any other orders that the Honourable Tribunal may deem fit.
The Respondent’s Case 82. The Respondent’s case is premised on the hereunder filed documents and proceedings before the Tribunal: -i.The Respondent’s Statement of Facts dated and filed on 12th July 2022 together with the documents attached thereto.ii.The Witness statement of Timothy Nthuku dated and filed on 5th October, 2022 that was admitted in evidence on oath on 16th February, 2023. iii.The Respondent’s written submissions dated 2nd March, 2023 and filed on 7th March, 2023 together with the legal authorities filed therewith.
83. The Respondent stated that the Appellant is a branch of Baker Hughes EHO Limited, a company incorporated in Bermuda. The ultimate holding company is Baker Hughes incorporated in the United States of America.
84. That Emerging Capital Partners (ECP) is one of the largest Private Equity Fund Managers with operations that focus on Africa. ECP has over 20 years’ experience in the African Continent during which ECP has invested in over 70 companies spanning 44 countries in Africa. ECP has successfully exited 59 of the companies that it has invested in with Nairobi Java House Limited being one of those companies recently exited from.
85. The Respondent stated that ECP has offices in Washington DC (United States), Nairobi (Kenya), Abidjan (Cote d’Ivoire, Johannesburg (South Africa) and Paris (France).
86. That Emerging Capital Partners, though cited as the trading name, is not a legal entity. The legal entities that constitute Emerging Capital Partners are ECP Manager LP, ECP Manager III LP, ECP Mena Management LP, Emerging Capital Advisors LLC and ECP Manager IV LP. All these entities are registered in Delaware in the United States of America. Delaware is a known low tax jurisdiction.
87. That ECP Manager LP, ECP Manager III LP and ECP Mena Management LP are registered with the Securities and Exchange Commission in the United States of America as investment advisors.
88. The Respondent stated that it conducted an in-depth audit on the Appellant for the period 2016-2020 and issued the Appellant with an assessment on 4th February 2022.
89. That Paragraph 9 (1) of The Income Tax (Transfer Pricing) Rules, 2006 states that:“The Commissioner may, where necessary, request a person to whom these Rules apply for information, including books of accounts and other documents relating to transactions where the transfer pricing method is applied.”
90. That Paragraph 9(2) of the same Rules adds that:-“The documents referred to in paragraph (1) shall include documents relating to-i.The selection of the transfer pricing method and the reasons for selection;ii.The application of the method, including the calculations made and price adjustment factors considerediii.The global organization strategy of the enterprise;iv.The details of the transaction under considerationv.The assumptions, strategies, and policies applied in selecting the method; andvi.Such other background information as may be necessary regarding to the transaction.”
91. The Respondent stated that the above highlights what the contents of the Transfer Pricing Policy should be. That upon request by the Respondent, the Appellant provided its transfer pricing policy which highlighted the controlled transaction between the Appellant and ECP Manager. That according to Section 6. 1.2 of the Transfer Pricing Policy, the Appellant provides information based on assignments given to it by ECP Manager and also undertakes support services in support of ECP Manager’s operating activities.
92. According to the Respondent, the Appellant’s Transfer Pricing Policy further highlights the different functions that ECP Manager (herein referred to as ECP) and the Appellant carry out and is summarized as follow:ECP ECP Kenya Limited
1 Provide Investment management advisory to investment Funds Monitoring investments across Africa
2 Strategic Business Review Provide management and technical support services to investee companies
3 Business Development
4 Fund Raising and Capital Structuring
5 Financial Accountability
6 Assist in ESG and ESOPs
7 Generate and evaluate exit opportunities and search for potential purchasers
93. That additionally, the Transfer Pricing Policy highlights that the risks borne by ECP Manager and the Appellant are:Risks ECP ECP Kenya Limited
Liquidity Risk
Inflation Risk
Credit Risk
94. That based on the above analysis it was considered that the Appellant had the least complex functions between the two i.e. ECP Manager and the Appellant, and is therefore the tested party. That the transfer pricing method chosen was the Transactional Net Margin Method (TNMM) on a Full Cost Mark Up (FCMU). In carrying out a database search for a comparable, the search was based on the US SIC Code 8742 (Management and Consultancy Services), 8748 (Business Consulting) and 8720 (Accounting, Auditing and Book Keeping). The result of the benchmarking process was a FCMU of 7%.
95. That using the Transfer Pricing Policy as well as the audited financial statements, general Ledgers and other documents by the Appellant, the Respondent sought out to test the benchmarking process used by the Appellant in arriving at the FCMU of 7%.
96. That the OECD Transfer Pricing Guidelines 2010 paragraph 3. 20 states that:-“In order to select and apply the most appropriate transfer pricing method to the circumstances of the case, information is needed on the comparability factors in relation to the controlled transaction under review and in particular on the functions, assets and risks of all the parties to the controlled transaction, including the foreign associated enterprises(s).”
97. The OECD Transfer Pricing Guidelines 2017 paragraph 3. 20 is also the same as highlighted above.
98. It is the Respondent’s assertion that in order to select the most appropriate transfer pricing method, a Function, Assets and Risk Analysis must have been carried out. The Respondent avers that the Appellant did not consider any assets in selecting the Transfer Pricing Method.
99. Accordingly, the Respondent added that it carried out a FAR analysis to establish whether there would be any inconsistencies with the FAR analysis of the Appellant. In so doing, the Respondent relied on:i.Interviewsii.Documents provided by the Appellantiii.Returns filed by Emerging Capital Partners at the Securities and Exchange Commission (SEC)iv.SEC administrative proceedingsv.Linkedin profiles of Bryce Fort and Paul Maasdorpvi.ECP profiles for Bryce Fort and Paul Maasdorp
100. The Respondent submitted that ECP Manager LP, ECP Manager III LP and ECP Mena Management LP (jointly referred to as ECP) are investment advisors registered with the SEC.
101. The Respondent submitted that ECP provides investment advisory services to its Advisory Clients (Funds) on a discretionary basis. As per Item 16: Investment Discretion of the Emerging Capital Partners Brochure states that;“Typically, ECP provides investment advice to its Advisory clients on a discretionary basis; ECP is retained as the investment advisor to provide advice concerning Advisory Client Investments. Generally, this discretion is subject only to the investment guidelines outlined in the governing agreements. Such governing agreements generally expressly provide that the applicable investment manager has the authority to make all the decisions concerning the investigation, evaluation, selection, negotiation, structuring, commitment to, monitoring of, and disposition of investments."
102. The Respondent submitted that as per item 9 of Appendix C of the Glossary of Terms:“Your firm has discretionary authority or manages assets on a discretionary basis if it has the authority to decide which securities to purchase and sell for the client.”
103. This, the Respondent argued, shows that the shareholders of the Funds do not make any investment decisions with respect to the investments that the investment advisor makes. ECP has full autonomy in deciding which securities to purchase and sell.
104. The Respondent sought to explain the nexus between ECP and the Appellant. It averred that the Appellant is a fully owned subsidiary of ECP Manager LP, one of the three investment advisors referred to as ECP. According to Form ADV ECP Manager LP, the ownership of ECP Manager LP is as follows:Legal Name Type of Entity Title Ownership
Hurley Herman Doddy Individual CO-CEO 10%<=25%
Carolyn Margaret Campbell Individual CLO 10%<=25%
Vincent Le Guennou Individual CO-CEO 10%<=25%
Bryce Louise Fort Individual MD 10%<=25%
Emerging Capital Partners LLC Domestic Entity LLC 10%<=25%
105. The Respondent averred that that Bryce is an owner of ECP Manager LP as from September 2005. Bryce Fort is also the Managing Director of the Appellant and is an employee of the Appellant. The Appellant, for the period under review, files PAYE returns with Bryce Fort’s name, corresponding remuneration and deducted PAYE. For the period under review, Bryce Fort has been tax resident in Kenya.
106. That the owners of Emerging Capital Partners LLC are listed as follows:Legal Name Type of Entity Status
Carolyn Margaret Campbell Individual Partner
Hurley Herman Doddy Individual Partner
Vincent Le Guennou Individual Partner
Bryce Louise Fort Individual Partner
107. Further, the ownership of ECP Manager III LP is outlined as below:Legal Name Type of Entity Title Ownership
Carolyn Margaret Campbell Individual CLO 10%<=25%
Hurley Herman Doddy Individual CO-CEO 10%<=25%
Vincent Le Guennou Individual CO-CEO 10%<=25%
Emerging Capital Partners III LLC Domestic Entity LLC 10%<=25%
108. However, that Emerging Capital Partners III LLC is owned by:Legal Name Type of Entity Status
Carolyn Margaret Campbell Individual Partner
Hurley Hearman Doddy Individual Partner
Vincent Le Guennou Individual Partner
Bryce Louise Fort Individual Partner
109. The Respondent stated that therefore, Bryce Fort is also an owner in ECP Manager III LP.
110. That also, the ownership of ECP Mena Management LP is as highlighted below:Legal Name Type of Entity Title Ownership
Carolyn Margaret Campbell Individual CLO 5%<=10%
Vincent Le Guennou Individual Limited Partner 10%<=25%
Bryce Louise Fort Individual Limited Partner <5%
Hurley Herman Doddy Individual Limited Partner 10%<=25%
ECP Mena LLC Domestic Entity General Partner 50%<=75%
111. That Bryce is also an owner of ECP Mena Management LP.
112. It was the Respondent’s submission that SEC states that control is exhibited when one has the power to directly or indirectly, direct the management or policies of a person, whether through ownership of securities, by contract or otherwise. It adds that a partner is presumed to control a firm (ECP). The SEC further outlines that a management person is defined by the SEC (Glossary of Terms Appendix C for Form ADV) as:“Anyone with the power to exercise, directly or indirectly, a controlling influence over your firm’s management or policies, or to determine the general investment advice given to the clients of your firm. Generally, all the following are management persons: Your firm’s principal executive officers, such as your chief executive officer, chief financial officer, chief operations officer, chief legal officer, and chief compliance officer, your directors, general partners, or trustees…”
113. The Respondent averred that Bryce Fort is a control person in ECP (ECP Manager LP, ECP Manager III LP and ECP Mena Management LP) and has controlling influence over ECP’s management and investment advisory.
114. That additionally, in Section 1. F Other Offices of Form ADV filed by ECP Manager III LP on 1st April 2020, 7 employees perform investment advisory functions from the office at 9 West Building, 9th Floor, Ring Road parklands. This is the physical location of the Appellant in Kenya. This information is consistent with the organogram that the Appellant provided to the Respondent during the audit. The Appellant’s organogram has 3 Managing Directors, 1 Vice President and 3 Associates. This is also corroborated by the PAYE returns filed by the Appellant.
115. The Respondent added that the 3 Managing Directors and Vice President sit on the boards of investee companies. As members of the boards of investee companies they influence strategies in investee companies with the aim of maximizing shareholder value. According to Item 8; Methods and Analysis, Investment Strategies and Risk of Loss of the Emerging Capital Partners Brochure:“ECP targets growth equity investments in companies located or has substantial operations on the continent of Africa. ECP will generally seek control positions or influential minority positions with significant contractual rights and board representation.”
116. That the 3 Managing Directors and Vice President manage risk ensuring that there is enough downside protection, that is, significantly reduce the possibility of the Funds making losses.
117. That the assets in Investment Advisory Business are the Investment Advisory Personnel and the Funds. The Appellant has 7 advisory personnel out of a possible 22. This is as per Form ADV ECP Manager III LP.
118. According to the Respondent, the Appellant is tasked with the following:i.Identifying new business opportunities for the Funds to invest in.ii.Carrying out due diligence on prospective investee companies. The due diligence involves analysing investment opportunities in terms of business, industry, financials and valuations. Additionally, it requires working with financial advisors, investment banks, consultants, industry experts, financial institutions, and lawyers. Due diligence is a very critical function since it highlights whether indeed a company should be invested in. Any misstep at this level could lead to a wrong decision being made, that is, the Fund invests in a company that will eventually lead to the Fund making a loss.iii.Structuring and negotiating transactions require the preparation of all documents to complete the transaction. This is a significant and highly specialized value-adding function in investment advisory.iv.Developing and executing exit strategies. The timing to exit an investment has to be properly planned for and executed. There exists a real possibility of making a loss if an exit from an investment is not executed at the optimal time.v.Structuring and negotiating financing in connection with investee companies. This is a value-adding function as it ensures that the credit terms negotiated are the most favourable they can be for the investee companies. This includes but is not limited to the interest cost and terms of payment.vi.Monitor investee companies. This entails making financial models that are used to determine the performance of the investee companies with regard to Key Performance Indicators (KPIs). Continuous monitoring ensures that corrective action is taken early to keep the performance of investee companies optimal.vii.Developing and supporting portfolio company strategy.
119. It was the Respondent’s submission that in the letter sent by the Appellant to the Respondent dated 12th February 2020, it was explained that multi-office teams source, execute and monitor investments. ECP has offices in Washington (US), Johannesburg (South Africa), Abidjan (Cote de Ivoire), Paris (France) and Nairobi (Kenya). The Nairobi office is the Appellant’s office and is part of these teams. These deal teams, comprising of individuals from multiple offices, undertake technical analysis of opportunities, meet with management teams of prospective investee companies, model projections, evaluate risk factors and understand the market opportunity for growth.
120. That the Appellant through its correspondence with the Respondent stated that ECP employees visit global institutional investors to convince them to allocate capital to ECP Funds, that is fundraising.
121. It is the Respondent’s assertion that the risks associated with ECP’s Investment Advisory Business are, as per Item 8; Methods of Analysis, Investment Strategies and Risk of Loss of the Emerging Capital Partners Brochure, highlighted below:i.Risks relating to the African Continenti.Political risk.ii.Legal risks.iii.Crime and Corruption.iv.Environmental risks.v.Restrictions on Trade.ii.Financial Risksi.Uncertain registration, settlement, clearing and custodial systems.ii.Foreign Currency, exchange rate and market risks.iii.Restrictions on repatriation of profits.iv.Accounting standards, limited availability of information and due diligence. Accounting standards in Africa do not correspond to those in Western countries. This makes it difficult when the Appellant is carrying out due diligence.v.Tax risks. Rapidly changing tax laws can result in the Advisory Client losing money by way of tax disputes.vi.Long Term investments and illiquid securities.iii.Risks directly related to the Advisory Client (Fund) and other risksi.Speculative nature of investments.ii.A limited number of investments.iii.Project Financings.iv.Restrictions on Transfer and Withdrawal.v.Risks arising from provision of managerial assistance. ECP employees serve as members of the board of directors for portfolio companies. Since these employees are not indemnified from their activities as board members, the Advisory Client may have to bear the costs of claims made against the ECP employees acting as board members. ECP Kenya Limited has employees that serve as directors in portfolio companies.vi.Liabilities upon disposition.vii.Competition.viii.Dependence on Key Personnel. The Advisory Client's success depends in a large part on the performance of ECP advisory personnel. Any loss of key personnel could have a material adverse effect on the Advisory client. When ECP loses advisory personnel, be it in the Appellant or other registered entities, the performance of the Funds can be in jeopardy.
122. That the FAR analysis carried out by the Respondent is summarized below:Description ECP ECP Kenya Limited
Functions
Sourcing for investors
Sourcing investment opportunities
Evaluating Investment opportunities
Selection of Investment opportunities
Negotiation of Investment opportunities
Committing to Investments
Monitoring Investments
Disposing of Investments
Participate as Board Members of Invested Companies
Develop and Support portfolio company strategies
Provide periodic reports for portfolio companies
Assets
Advisory Personnel
Investment Funds
Risks
Political Risk
Legal Risk
Environmental Risks
Market Risks
Long Term Investments and Illiquid securities
Competition
123. Thus, the Respondent argues, the Appellant is not a low value adding service provider and does not offer management and business consulting services, accounting, auditing and bookkeeping services. Instead, the Respondent insists, the Appellant offers Investment Advisory services. According to the Respondent, the Appellant did not benchmark for Investment Advisory Services.
124. That as explained above, the Appellant and ECP (ECP Manager LP, ECP Manager III LP and ECP Mena Management LP) both make unique and valuable contributions in ensuring that Fund shareholders maximize their profit.
125. It is the Respondent’s assertion that the functions of the Appellant and ECP are both highly integrated since, as explained in the letter dated 12th February 2020, multi-office teams source, execute and monitor investments. Also as revealed in the job descriptions, the Appellant is involved in formulating and executing the exit strategy from investee companies.
126. That as per Item 5E of Form ADV filed by ECP Manager III LP and ECP Manager, ECP (ECP Manager LP, ECP Manager III LP and ECP Mena Management LP) is compensated on fixed fees and performance-based fees basis. According to Item 5: Fees and Compensation of the Emerging Capital Partners Brochure, the annual management fee for the Advisory Client is between 1% and 2%. Further, according to the Summary (1) of the Securities and Exchange Commission Administrative Proceeding File No. 3-19535, ECP Manager LP charged a management fee equal to 2% per annum of the total invested capital contributions. This confirmed to the Respondent that indeed the management fees are 2% of the capital contributions.
127. The Respondent averred that it only considered those Funds that ECP and Appellant have discretionary authority over. These amounts can be sourced from the Form ADV of ECP Manager LP, ECP Manager III LP and ECP Mena Management LP and varied for the period under review.Entity 2016 (USD) 2017 (USD) 2018 (USD) 2019(USD) 2020 (USD)
ECP Manager LP 1,363,000,000 1,506,591,422 1,956,977,664 1,852,485,495 1,804,397,396
ECP Manager III LP 621,407,843 669,361,547 682,990,525 603,249,085 568,332,961
ECP Mena Management LP 12,503,321 3,967,628 3,611,678 3,400,000 331,085
Total 1,996,911,164 2,179,920,597 2,643,579,867 2,459,134,580 2,373,061,442
128. To the above, the Respondent argued, is the income of ECP as a group. ECP and the Appellant are highly integrated making unique and valuable contributions and therefore the most appropriate Transfer Pricing Method is the Transactional Profit Split Method (TPSM). According to paragraph 2. 114 Chapter II of the OECD Transfer Pricing Guidelines:“The transactional profit split method seeks to eliminate the effect on profits of special conditions made or imposed in a controlled transaction … by determining the division of profits that independent enterprises would have expected to realize from engaging in the transaction or transactions. The transactional profit split method first identifies the profits to be split for the associated enterprises from the controlled transactions in which the associated enterprises are engaged (the combined profits).”
129. That paragraph 2. 115 of the same Guidelines adds that:-“The main strength of the transactional profit split method is that it can offer a solution for highly integrated operations for which a one-sided method would not be appropriate… A transactional profit split method may also be found to be the most appropriate method in cases where both parties to a transaction make unique and valuable contributions (e.g. Contribute unique intangibles) to the transaction because in such a case, independent parties might wish to share the profits of the transaction in proportion to their respective contributions and a two-sided method might be more appropriate in these circumstances than a one-sided method. In addition, in the presence of unique and valuable contributions, reliable comparables information might be insufficient to apply another method.”
130. The Respondent averred that the contribution analysis method was used to attribute income to the Appellant. Paragraph 2. 137 of the OECD Transfer Pricing Guidelines highlights:“Generally, the combined profits to be split in a transactional profit split method are operating profits…However, occasionally, it may be appropriate to carry out a split of gross profits and then deduct the expenses incurred in or attributable to each relevant enterprise (and excluding expenses taken into account in computing gross profits.”
131. That investment Advisory has gross income but does not have any expenses incurred at the gross level (cost of goods sold). This is as highlighted in the financial statements of the Appellant in Kenya.
132. That the Advisory personnel are the most critical in ensuring the success of the Funds. The advisory personnel offer their skills and relationships in the event any one of them leaves the group, it could adversely affect the success of the Fund (Advisory Client). This being the case, the Respondent selected the number of Advisory Personnel as the allocation key.Description 2016 (Kshs) 2017 (Kshs) 2018 (Kshs) 2019(Kshs) 2020 (Kshs)
Managed Funds 202,686,483,146 225,425,588,936 267,794,640,527 250,856,318,506 259,067,117,623
Management Fees @2% 4,053,729,663 4,508,511,779 5,355,892,811 5,017,126,370 5,181,342,352
Attributed to Kenya 740,585,227 1,401,684,752 1,388,564,803 1,554,894,536 1,648,608,930
Less Amount Previously declared - 50,402,084 - 120,404,410 - 103,236,551 - 106,488,033 - 106,250,224
Adjusted Amount 690,183,143 1,281,280,342 1,285,328,252 1,448,406,503 1,542,358,706
Tax @30% 207,054,943 384,384,103 385,598,476 434,521,951 462,707,612
133. That this resulted in the assessment and eventual confirmation by the Respondent as outlined below:-
134. That the total tax liability is Kshs. 2,521,185,943. 00 inclusive of interest and penalties.
135. That the Appellant has appealed the Respondent’s decision based on the following:-i.That the job descriptions provided by the Appellant are generic.ii.Only one interview was conducted in arriving at the functional analysis.iii.The transfer pricing document is accurate with respect to the Appellant’s functions, risks and transfer pricing method selected.iv.The letter written by the Appellant on 12th February 2020 is totally factual.v.The interview conducted on Bryce Fort is factually correct.vi.The Appellant does not assume any risk whatsoever.
136. That the Appellant has also only relied on the following in its objection and Appeal:i.The Transfer Pricing Policyii.The letter written by the Appellant to the Respondent on 12th January 2020iii.The interview conducted on Bryce Fort.
137. The Respondent argued that it has demonstrated that the Appellant’s assertions in the Transfer Pricing Policy are factually incorrect for the following reasons:i.The Appellant was characterized as being a routine service provider. The evidence presented has shown otherwise and the Appellant actually offers highly valuable contributions that cannot be remunerated on a Full Cost Mark Up of 7% basis.ii.The benchmarking process characterized the Appellant as providing management and consultancy services, business consulting and accounting, auditing and book keeping. The Appellant offers Investment Advisory Services on a discretionary basis.iii.No assets were ever considered in carrying out the Functions, Assets and Risks Analysis. This is a prerequisite to selecting the transfer pricing method. The Appellant insists that it followed the laid-out steps in OECD guidelines but the steps laid out have to be considered in the context of the whole chapter. That Paragraph 3. 4 of the OECD Transfer Pricing Guidelines highlights the steps which the Appellant states it followed. However, paragraph 3. 20 states that:“In order to select and apply the most appropriate transfer pricing method to the circumstances of the case, information is needed on the comparability factors in relation to the controlled transaction under review and in particular the functions, assets and risks of all the parties to the controlled transaction, including the foreign associated enterprise(s).”The whole chapter therefore needs to be considered in coming up with the transfer pricing method. No information was ever provided with regard to the foreign associated enterprise(s) either. The only information relied on are the assertions made in the transfer pricing policy. The process of coming up with the transfer pricing policy is actually procedurally inaccurate.iv.That the Appellant is highly integrated with all the ECP entities in relation to functions and risks. The Appellant states that all risk is borne by the Funds. However, it should be noted again that the Appellant (who carries out Investment Advisory services and functions) and all ECP entities have discretionary authority. They therefore manage and control all the risk associated with the Funds.
138. The Respondent averred that the Appellant, in its letter dated 12th February 2020, misrepresented several facts:Statements made in Letter Actual Facts
1 ECP Manager is a company incorporated in the United States ECP Manager does not exist. ECP Manager LP is a partnership registered in Delawere in the United States
2 ECP Manager owns ECP Kenya Limited ECP Manager LP owns ECP Kenya Limited
3 ECP Fund secures Capital Commitments ECP Fund has no employees. No functions are carried out in Mauritius
4 ECP Kenya has no direct relationship with any other ECP entities Bryce Fort is an employee of ECP Kenya Limited and an equity partner in ECP Manager LP, ECP Manager III LP and ECP Mena Management LP
5 None of the Kenyan employees are member of the Board of any of the Mauritius Funds Bryce Fort and Paul Maasdorp are members of the Board of some of the Mauritius Funds
139. The Respondent further averred that the interview conducted on Bryce Fort by the Respondent had several inconsistencies as highlighted below:Interview Statement Fact Source
1 Bryce Fort is not an equity partner of ECP Bryce Fort is an equity partner of ECP Manager LP, ECP Manager III LP and ECP Mena Management LP Form ADV returns
2 The is no ownership link between ECP Manager and ECP Fund III PCC ECP Fund III PCC is 2% beneficially owned by ECP Manager LP or related persons Form ADV returns
3 There is no ownership link between ECP Kenya Limited and ECP Fund III PCC ECP Manager LP and its related persons own 2% of ECP Fund III PCC and therefore are related to ECP Kenya Limited which is owned by ECP Manager LP Form ADV returns
4 ECP Fund III and ECP Manager LP are distinct and separate entities ECP Manager LP, ECP Manager III LP and ECP Mena Management LP have the discretionary authority over all funds Form ADV returns
5 Shareholders of the ECP Fund III PCC nominate the board of directors ECP Manager LP, ECP Manager III LP and ECP Mena Management LP have the discretionary authority over all funds Form ADV returns
6 ECP Manager is a Limited Liability Company ECP Manager is a Limited Liability Partnership, that is ECP Manager LP Form ADV returns
7 Bryce Fort only earns a salary in Kenya from employment Bryce Fort is an equity partner of ECP Manager LP, ECP Manager III LP and ECP Mena Management LP. Being a partner of these entities he has partnership income Form ADV returns
8 ECP has a head office in London and New York ECP Manager LP, ECP Manager III LP and ECP Mena Management LP do not have any offices in London or New York Form ADV returns
140. It is the Respondent’s averment that Bryce Fort’s interview cannot be relied on as fact at face value. That documentary evidence has proved that some of his assertions were factually incorrect. It should be noted that only one interview was ever granted by the Appellant despite a request to interview other employees of the Appellant.
141. According to the Respondent, it relied on job descriptions provided by the Appellant in coming up with the Appellant’s functional profile. These job descriptions were provided by the Appellant willingly and at no point did the Appellant state that they were generic and only did so in their objection and Appeal.
142. It should be noted, the Respondent argued, that to apply a Transactional Profit Split Method, it considered the following aspects:Paragraph 2. 115 of the OECD Transfer Pricing Guidelines states:“The main strength of the transactional profit split method is that it can offer a solution for highly integrated operations for which a one-sided method would not be appropriate… A transactional profit split method may also be found to be the most appropriate method in cases where both parties to a transaction make unique and valuable contributions (e.g. Contribute unique intangibles) to the transaction because in such a case, independent parties might wish to share the profits of the transaction in proportion to their respective contributions and a two-sided method might be more appropriate in these circumstances than a one-sided method. In addition, in the presence of unique and valuable contributions, reliable comparables information might be insufficient to apply another method.”
143. That as illustrated earlier the operations of the Appellant, ECP Manager LP, ECP Manager III LP and ECP Mena Management LP are all highly integrated. All these entities are critical to carrying out the Investment Advisory role. Additionally, paragraph 2. 121 adds that:“The Guidelines do not seek to provide an exhaustive catalog of ways in which the transactional profit split method may be applied. Application of the method will depend on circumstances of the case and the information available, but the overriding objective should be to approximate as closely as possible the split of profits that would have been realized had the parties been independent enterprises.”
144. The Transfer Pricing Guidelines, the Respondent added, highlight two possible methods of applying the Transactional Profit Split Method, specifically contribution and residual basis. The Respondent chose to apply the contribution method. It should also be noted that the contribution analysis is not cast in stone. Further, paragraph 2. 137 highlights:“Generally, the combined profits to be split in a transactional profit split method are operating profits…However, occasionally, it may be appropriate to carry out a split of gross profits and then deduct the expenses incurred in or attributable to each relevant enterprise (and excluding expenses taken into account in computing gross profits.”
145. According to the Respondent, it was able to determine the gross revenue of ECP that is, ECP Manager LP, ECP Manager III LP and ECP Mena Management LP. However, it was important to remunerate the Appellant for its functions in carrying out their role in Investment Advisory.
146. It was the Respondent’s submission that the Appellant’s own income tax returns have gross revenue but no corresponding direct costs. However, costs relating to the Advisory Personnel has been considered with respect to employment expenses.
147. The Respondent averred that it is undisputed that the Appellant did not produce financial statements relating to ECP (ECP Manager III LP, ECP Manager LP and ECP Mena Management LP) when requested by the Respondent stating that the Appellant does not have access to them. The Respondent therefore had to use best judgement to determine the Appellant’s income. This was derived based from the Form ADVs filed by ECP Manager LP, ECP Mena Management LP and ECP Manager III LP. At no point did the Respondent state that the revenue has no corresponding cost.
148. The Respondent insisted that it attributed the income that would have otherwise accrued to the Appellant and allowed for operating expenses. That hence to state that direct costs were not considered in coming up with the taxable profit of the Appellant is factually inaccurate. Since it is the Advisory Personnel that are the most critical in ensuring that the Funds make a profit, or at the bare minimum do not make a loss, the operating expenses for Investment Advisory is the remuneration received by the Investment Advisors. Each office that participated in the generation of the Management Fees (2%) then will expense its own costs having shared the revenue attributable to each office. In one particular case the Appellant invoiced a company it had invested in for Management Fees. To support its case, the Respondent cited Form ADV Part 2 A – Emerging Capital Partners Brochure, Paragraph 3 (h) Item 8, which states that:-“The Advisory Client’s success depends in large part on the performance of ECP. The loss of any key personnel could have a material adverse effect on the Advisory Client”
149. The Respondent averred that the statement emphasizes that the advisory client (Funds) performances are largely pegged to the performance of the advisory personnel in ECP Manager LP, ECP Manager III LP and ECP Mena Management LP. The advisory personnel is the single most important aspect with respect to the performance of the Funds. The allocation key used to attribute the Gross Profit was the number of Investment Advisory Personnel.
150. It is the Respondent’s submission that its decision to charge the taxes was within the law and the Appellant has not demonstrated in the Appeal which law the Respondent has contravened.
151. The law, the Respondent added, is very clear on the burden of proof and the Appellant has not produced any evidence to support the averments contained in its Statement of Facts. Further, the law is very clear and Section 56 (1) of the Tax Procedures Act 2015 provides that:“The burden shall be on the taxpayer to prove that a tax decision is incorrect.”
152. That the Respondent concluded by asserting that the allegations of the Appellant as laid out in its Memorandum of Appeal and Statement of Facts unless where agreed by the Respondent are unfounded in law and not supported by any evidence.
Respondent’s Prayers 153. That the Respondent prayed that this Honourable Tribunal:a.Upholds the Respondent’s Objection decision as proper and in conformity with the provisions of the law.b.That this Appeal be dismissed with costs to the Respondent as the same is devoid of any merit.
Issues For Determination 154. The Tribunal having evaluated the pleadings and submissions of the parties is of the view that there are four issues that call for its determination;a.Whether the Respondent erred in its FAR analysis of the Appellant’s role?b.Which is the appropriate transfer pricing method applicable to the transactionc.Whether the Respondent erred in the use of the number of employees as the profit allocation keyd.Whether the Respondent erred in assessing tax based on the gross revenue earned by ECP group instead of the relevant profit attributable to the Appellant.
Analysis And Findings 155. The Tribunal having identified the issues falling for its determination proceeds to analyse them as hereunder.a.Whether the Respondent erred in its FAR analysis of the Appellant’s role?
156. The dispute stems from the Respondent’s assessment of the Appellant. In raising the assessment, the Respondent disagreed with the Appellant’s FAR analysis as well as its choice of Transfer Pricing Method. In this first part of the judgement, the Tribunal will focus on the FAR analysis
157. The parties are at odds with each other on the functions carried out by the Appellant. The Appellant on its part averred that it does not provide high value services, nor does it bear the risks as alleged by the Respondent. It insisted that the highlighted risks are borne by the investors and ECP and the only risk it bears is the credit risk as set out in its Transfer Pricing Policy. It added that it only provides administrative support to ECP in the form of monitoring investments and providing management and technical support to investee companies. It maintains that its transactions are set out in its Transfer Pricing Policy and not the SEC documents relied upon by the Respondent.
158. The Respondent on its part argued that it carried out its own FAR analysis based on the following:a.Interviewsb.Documents availed by the Appellantc.Returns filed by ECP at the SEC;d.SEC administrative proceedings;e.Linkedin profiles of Bryce Fort and Paul Maasdorp;f.ECP profiles of Bryce Fort and Paul Maasdorp.
159. Based on the above, the Respondent submitted that the Appellant’s role extended beyond the administrative one set out in its Transfer Pricing Policy. It asserted that the Appellant’s role is that of investment advisory.
160. The FAR analysis is one that is factual. It is one that can only be deciphered from various documentation that unravel the actual transaction taking place. The Appellant sought to rely on its Transfer Pricing Policy and the interview by Bryce Ford while the Respondent sought to rely on other information.
161. The Tribunal sought to look at the information provided to determine what the exact role played by and risk borne by the Appellant. The job descriptions provided by the Appellant indicate that the role it plays goes beyond the general administrative one it portrayed. The descriptions indicate that the employees are involved in identifying new business opportunities, overseeing the negotiation, analysis and structuring and negotiating financing, completing transactions as well as executing exit strategies. This coupled with the fact that the ECP describes itself in its filings to SEC as providing advisory services on a discretionary basis point to a much greater role being played by the Appellant than indicated in its Transfer Pricing Policy.
162. It is baffling that despite being the source of the job descriptions, the Appellant termed the same as generic templates that should not be relied upon. It also insisted that the SEC filings it made are in standard forms that should be construed within a certain context. That the filing indicating that the advisory services are provided from various offices including the Appellant’s should be interpreted within the context of the filing entities being required to set out all locations from which they operate from. The Tribunal takes note of this and is willing to give the Appellant the benefit of the doubt in regard to the mentioning of the offices. However, this does not explain the job descriptions of the Appellant’s personnel and since the job descriptions are similar to the descriptions of the services ECP sets out in the SEC filings, this indicates that the services that the Appellant provides are similar to those of ECP and does not carry out a supportive administrative role as indicated in its Transfer Pricing Policy.
163. Section 31 of the Tax Procedures Act in empowering the Commissioner to issue assessments provides that the Commissioner must use the information available to him and states as follows:-“Amendment of assessments(1)Subject to this section, the Commissioner may amend an assessment (referred to in this section as the “original assessment") by making alterations or additions, from the available information and to the best of the Commissioner's judgement, to the original assessment of a taxpayer for a reporting period to ensure that—(a)…(b)…; or(c)in any other case, the taxpayer is liable for the correct amount of tax payable in respect of the reporting period to which the original assessment relates.”
164. In this case, the information included the job descriptions provided by the Appellant as well as its own SEC filings. To ask the Commissioner to disregard these in favour of the Transfer Pricing Manual and the interview with Mr Fort would be to ask the Commissioner to go against the provisions which require him to assess using all the information available to him.
165. A FAR analysis requires an analysis not only of the function but also of the assets and the risk. The assets in this case, as rightly indicated by the Respondent is the personnel. This is the key asset in the provision of the services. As indicated in the ECP brochure, “the loss of key personnel could have a material adverse effect on the Advisory Client.” This indicates that the staff are key assets.
166. Additionally, bearing in mind the descriptions of the work to be undertaken by the key staff, the risk that the Appellant bears is far greater than indicated in its Transfer Pricing Policy.
167. Accordingly, the Tribunal finds that the Respondent did not err in its FAR analysis. The FAR carried out by the Appellant in its Transfer Pricing policy was erroneous and did not capture the functions of the Appellant, the assets it applies into the transaction as well as the risk it bears.
b) Which is the appropriate transfer pricing method applicable to the transaction 168. The Appellant insisted that its application of the TNMM is appropriate for the transaction between it and its related parties. It insisted that TPSM is only applicable in circumstances where the transaction is highly integrated and/or the parties make valuable and unique contributions. It asserted that the contributions it made in the provision of the services are not unique and are in fact low level services.
169. The Respondent on its part is of the view that the services provided by the Appellant are not low level services. It views the services as being unique and valuable and as such the appropriate method for the transaction is TPSM.
170. The choice of the applicable method is one that is based on the circumstances of each transaction. The question in this case is if the method adopted by the Respondent, TPSM, is appropriate for the transaction at hand.
171. TPSM, according to the United Nations Practical Manual on Transfer Pricing for Developing Countries 2021 (UN TP Manual), TPSM is applicable where:i.each related party to the transaction makes unique and valuable contributions; and/orii.the business operations of the related parties are so highly integrated that they cannot be reliably evaluated in isolation from each other; and/oriii.the parties share the assumption of economically significant risk or separately assume closely related risks.
172. In discussing integration as an element that warrants the use of TPSM, the UN TP Manual provides as follows:-“All MNEs have business operations which are integrated to some degree. However the PSM is likely to be the most appropriate method only in those cases where the integration is so significant that the way in which each party performs functions, uses assets, and assumes risks is interlinked with and cannot be reliably evaluated in isolation from the way in which another related party to the transaction performs functions, uses assets and assumes risks.”
173. This is echoed in the OECD Revised Guidance on the Application of the Transactional Profit Split Method - BEPS Action 10 which provides:-“In some cases the parties may perform functions jointly, use assets jointly and/or share assumption of risks to such an extent that it is impossible to evaluate their respective contributions in isolation from those of others. As an example, the transactional profit split method can be applied to the global trading of financial instruments by associated enterprises.”
174. In the current transaction, the documentation indicates that the services provided by the Appellant are highly integrated to the services rendered by ECP to the Funds. So integrated are the services that it is difficult if not impossible to reliably split the exact services rendered by the Appellant and those rendered by ECP. In addition, it would appear that both entities (the Appellant and ECP) jointly render the services to the Funds making it difficult to evaluate each party’s exact contribution in the services rendered. The few services that both do not provide are fundraising which is carried out by ECP preparation of periodic reports and support of portfolio companies which is carried out by the Appellant. The other services are done jointly by both and delineating the role of each reliably is a difficult if not impossible task.
175. Accordingly, the Tribunal finds that since the services provided are highly integrated, the appropriate method should be TPSM.
c) Whether the Respondent erred in the use of the number of employees as the profit allocation key 176. It was the Appellant’s averment that the use of the number of employees as a profit allocation was erroneous. It argued that based on the OECD Guidance, the primary allocation keys that should be used in TPSM are based on assets or costs. Headcount, it submitted, would only be considered as an alternative allocation key when the primary allocation keys were not applied. Additionally, it adds that the use of headcount would only be applicable where there was no disparity in the cost for the various levels of personnel.
177. The Respondent argued that it applied headcount as the allocation key based on the importance of personnel in provision of the services. Since the Appellant’s personnel is critical in ensuring the success of the fund, it only makes sense to use them as the allocation key. It cited the Appellant’s brochure which states:-“The Advisory Client's success depends in a large part on the performance of ECP advisory personnel. Any loss of key personnel could have a material adverse effect on the Advisory client.”
178. Both the UN TP Manual and the OECD Guidelines offer guidance on the use of allocation keys. The two provide that various profit splitting factors can be used. The UN TP Manual provides as follows:-“Depending on the circumstances, profit splitting factors might be based on the value of (certain types of) assets or capital, where there is a strong correlation between tangible assets or intangibles, or capital employed, and the creation of value in the controlled transaction. In such cases, care should be taken to ensure reliable and consistent measures of the value of the asset(s) concerned.In other cases, cost-based factors may be found to be appropriate, e.g. costs related to the unique and valuable contributions such as R&D, engineering, design, marketing, etc., or the development of unique and valuable intangibles. Note that although cost is often a poor measure of the absolute value of unique and valuable intangibles, the relative costs incurred by each party may provide a reasonable approximation of the relative value of their respective contributions. In some instances, it may be appropriate to adjust the cost amounts, e.g. where they are incurred in different periods, to ensure they represent reliable measures of the respective contributions of each party.Other examples of profit splitting factors could include incremental sales, employee remuneration or bonus payments, time spent, headcount, etc. Such factors may be found to be appropriate where they provide a strong and sufficiently consistent correlation to the creation of value represented by the relevant (residual) profits.”
179. A reading of both documents indicates that selection of the allocation keys is dependent on the circumstances. It does not, however, set out that some keys rank higher than others as averred by the Appellant. Rather a choice must be made that suites the circumstances. Thus, the use of headcount is allowed under both the UN TP Manual and the OECD Guidelines.
180. In this case, the main asset that the Appellant uses in the performance of its services is personnel. The core business of the Appellant is reliant upon the personnel which, from the description of their roles, are highly skilled persons. Thus, it would make sense for the Respondent to use this as an allocation key.
181. The Tribunal therefore finds that the Respondent did not err in using the number of employees as a profit allocation key.
d) Whether the Respondent erred in assessing tax based on the gross revenue earned by ECP group instead of the relevant profit attributable to the Appellant. 182. It was the Appellant’s contention that the Respondent erred in applying TPSM on the entire gross revenue allegedly earned by ECP instead of applying a profit split on the relevant profit earned by ECP as required under the TPSM Guidance. It added that the Respondent erred in stating that investment advisory business does not have any expenses and therefore the gross profit is equivalent to the gross income for purposes of applying TPSM.
183. The Respondent opined that use of gross profit was correct. It insisted that in arriving at the allocated amount, it attributed the income that would have otherwise accrued to the Appellant and allowed for operating expenses. It denied the Appellant’s allegation that direct costs were not considered in coming up with the taxable profits.
184. The OECD Guidelines provide as thus:-“Most commonly, the relevant profits to be split under the transactional profit split method are operating profits. Applying the transactional profit split method in this manner ensures that both income and expenses of the MNE are attributed to the relevant associated enterprise on a consistent basis. However, depending on the accurate delineation of the transaction, it may be appropriate to split a different measure of profits such as gross profits, and then deduct the expenses incurred by or attributable to each relevant enterprise (excluding expenses already taken into account)”.
185. The above provision provides leeway for the use of gross profit where appropriate. Gross profit is defined in the UN TP Manual as:“The result of deducting from total sales the cost of sales, including all the expenses directly incurred in relation to those sales.”
186. This means that where the Respondent seeks to use gross profit account should be taken of the direct cost of sales. In this case, the Respondent seems to have deducted the expenses after allocating the amount. The correct way should be that the direct cost of sales are deducted in order to arrive at the gross profit which can then be split between the Appellant and ECP.
187. Unfortunately, despite being requested, the Appellant failed/refused to provide the financial information for the ECP group which would play a key role in calculating the gross profit prior to the profit split. The current information used by the Respondent in arriving at that profit to be split was reconstructed from the SEC forms filed by ECP.
188. Section 31 of the Tax Procedures Act requires the Commissioner to use the information available and his best judgement in determining the tax due. The question of what amounts to best judgement has been numerously dealt with by courts. In Van Boeckel v C & E QB Dec 1980, [1981] STC 290 Woolf J stated that:“the very use of the word ‘judgment’ makes it clear that the commissioners are required to exercise their powers in such a way that they make a value judgment on the material which is before them Secondly, clearly there must be some material before the commissioners on which they can base their judgment. If there is no material at all it would be impossible to form a judgment as to what tax is due…What the words ‘best of their judgment’ envisage, in my view, is that the commissioners will fairly consider all material placed before them and on that material, come to a decision which is one which is reasonable and amount of tax which is due. As long as there is some material on which the commissioners act then they are not required to carry out investigations which may or may not result in further material being placed before them.”
189. In Raghubar Mandal Harihar Mandal vs The State Of Bihar AIR 1952 Pat 235 the court held that:-“The officer is to make an assessment to the best of his judgment against a person who is in default as regards supplying information. He must not act dishonestly or vindictively or capriciously, because he must exercise judgment in the matter. He must make what he honestly believes to be a fair estimate of the proper figure of assessment, and for this purpose he must, their Lordships think, be able to take into consideration local knowledge and repute in regard to the assessee's circumstances, and his own knowledge of previous returns by & assessments of the assesses, & all other matters which he thinks will assist him in arriving at a fair and proper estimate and though there must necessarily be guess-work in the matter, it must be honest guess-work.”
190. The Tribunal is of the view that the Respondent exercised its best judgment under the circumstances. It did not have access to the required information to compute the gross profit at the global level and thus it allocated the amount and allowed the Appellant to deduct the expenses it incurred prior to taxing it. Had the Appellant provided the required information then it would have been possible for the gross profit to have been computed and the profit split.
191. Accordingly, the Tribunal finds that based on the information available to the Respondent, the Respondent exercised its best judgement and did not err in using the gross profit.
Final Decision 192. The upshot of the foregoing is that the Appeal lacks merit and the Tribunal accordingly proceeds to make the following Orders:-a.The Appeal be and is hereby dismissed.b.The Respondent’s Objection decision dated 28th April 2022 be and is hereby upheld.c.Each party to bear its own costs.
193. It is so ordered.
DATED AND DELIVERED AT NAIROBI THIS 10TH DAY OF NOVEMBER, 2023. ERIC NYONGESA WAFULA...................CHAIRMANCYNTHIA B. MAYAKA..............MEMBERGRACE MUKUHA..............MEMBERJEPHTHAH NJAGI..............MEMBERABRAHAM K. KIPROTICH..............MEMBER