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KRA, banks lock horns over taxation of loan fees

KRA Times Tower headquarters in Nairobi. PHOTO |  SALATON NJAU | NMG
KRA Times Tower headquarters in Nairobi. PHOTO | SALATON NJAU | NMG  

Kenya’s commercial banks #ticker:KCB have once again been placed in a tight spot after the taxman sent them letters demanding millions of shillings in excise tax liabilities accumulated over the past four years.

The Kenya Revenue Authority (KRA) says the lenders have accumulated the large tax liabilities through their failure to pay tax on fees charged during the processing of loans such as appraisal, and commitment levies, as required by law.

The KRA puts these income streams in the same league as other transaction-based charges such as money transfer and ATM withdrawals -- a position the lenders have opposed.

The banks say all income related to lending are interest, according to the Income Tax Act, and should therefore be excluded from the levy.

The Excise Duty Act is silent on the definition of interest and the lenders insist the description in the Income Tax law should be relied on to resolve the dispute.

“As per the provisions of Section 2 of the Income Tax Act, interest includes all charges incidental to advancing any loan or credit facilities by financial institutions to their customers,” Francis Kamau, a tax partner at Ernst and Young (EY), said.

“In effect, this would be interpreted to mean that all fees charged by banks in respect of any loan or credit facility would qualify as interest hence exempt from excise duty,” said Mr Kamau, who has four bank clients from whom the KRA has demanded excise tax amounting to Sh2 billion.

The KRA had not responded to our queries on the matter by the time of going to press.

The Business Daily has learned that most commercial banks, including Co-op Bank which has received a Sh621.5 million tax demand, have rejected the taxman’s position and are fighting the claims in court and at the Tax Appeals Tribunal.

“The management, through the tax agent, disputed the demand on factual and technical grounds and the matter was referred to the Tax Appeals Tribunal,” Co-op Bank #ticker:COOP says in its latest annual report, adding that the “subject of the dispute is industry-wide and the Kenya Bankers Association (KBA), is in consultation with the KRA over it.”

Mr Kamau says imposition of excise taxes on financial services was built on a law that previously applied the levy on goods, arguing that banks will continue to rely on the definition of interest in the Income Tax Act to fend off the taxman’s claims.

The law defines interest as “any sums payable in any manner in respect of a loan, deposit, debt, claim or other right or obligation and includes a premium or discount by way of interest and commitment or service fee paid in respect of any loan or credit.”

Some experts, however, warned that should the courts uphold the banks’ position, it could also have the unintended consequence of further cutting their income from lending because the total cost of credit will now be one and the same as interest rates currently capped at 14 per cent.

It means that the breakdown of the total cost of credit will not matter, forcing banks to reduce interest charged on loan processing services to accommodate the various charges under the maximum lending rate.

Some banks charge fees as high as 7.5 per cent to process loans and have insisted that these are separate from the controlled interest rates. This has helped to raise their annual percentage rate – which reflects the total cost of credit — significantly above the maximum 14 per cent lending rate.

It remains to be seen how the standoff will be resolved, with banks fearing that KRA’s move will raise their tax liability and make their services more expensive if they choose to pass on the extra costs to customers.

The Excise Duty Act defines fees by financial institutions that are subject to the levy as “any fees, charges or commissions charged by financial institutions relating to their licensed financial institutions, but does not include interest on loan or return on loan or an insurance premium or premium based or related commissions.”

The government introduced the tax on financial transactions in 2013 to raise more revenue for the ever-expanding public expenditure.

Banks and mobile telephony firms are among companies paying 10 per cent excise taxes on their fees.

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