De La Rue Security and Currency Print Ltd v. Commissioner of Domestic taxes

Case snapshot

Sections / provisions: Ruling

Questions before the Court / Tribunal

• Royalties paid to the UK entity were not at arms length. TAT No. 395 of 2018 Whether the price of the bank note paper purchased by the Appellant from DLRI is an arm’s length price which includes the cost associated with the know how to manufacture and design the bank note 149. Based on the above analysis, we find that there were no service or intangible assets that warranted a separate charge for a royalty. Indeed, as the Respondent has pointed out that all security features relating to the banknotes were already incorporated on the paper purchased by the Appellant from DLRI to be used to print the banknotes under the contract that the Appellant had with CBK. Further the features to be included in the banknotes was held by CBK. Thus, it is unclear what which IP the Appellant received from DLRI. 150. It was also noted that any management assistance provided such as secondment of…
• Which factual, statutory and procedural conditions controlled the requested relief?
• How did the forum apply the governing provisions to the evidence and procedural history recorded in this case?

Material facts and procedural background

REPUBLIC OF KENYA IN THE TAX APPEALS TRIBUNAL APPEAL NO. 395 OF 2018 DE LA RUE CURRENCY & SECURITY PRINT LIMITED……….…..…APPELLANT -VERSUSCOMMISSIONER OF DOMESTIC TAXES…..……………..……….RESPONDENT

JUDGEMENT BACKGROUND 1. The Appellant, De La Rue Currency and Security Print Limited (“DLRKe”) is a limited liability company incorporated in Kenya and is part of the De La Rue Plc Group whose headquarters is in Basingstoke, the United Kingdom. The Appellant is also a duly licenced Export Processing zone (EPZ) enterprise under the Export Processing Zone Act, 1990 and engages in the business of manufacturing bank notes and security printing. 2. The Respondent is a principal officer of the Kenya Revenue Authority, a public body, duly established under the Kenya Revenue Authority Act (Chapter 469 of the Laws of Kenya), whose primary duty is the collection and accounting for government Revenue. 3. The Respondent carried out an audit of the Appellant’s tax affairs for the period 2012 to 2017 for Corporation Tax, Withholding Tax, Pay As You Earn (PAYE) and Value Added Tax (VAT). 4. The Respondent issued its preliminary findings vide its letter dated 16 th November 2017 in which it also sought clarification on various matters that had arisen during the audit. The Appellan t comprehensively responded to these issues through its letter dated 18th December 2017.

5. Following various meetings and exchange of correspondence, the parties resolved all the issues raised during the audit, save for Corporation Tax on royalty recharge and interest income arising from the Appellant’s loan to its group companies. 6. On 24 th August 2018, the Respondent issued a tax assessment of Ksh s 1,106,043,698.00 (being principal Corporation Tax, penalties and interest). On 21st September 2018, the Appellant objected to the Assessment. 7. Following review of the objection letter and in consideration of all facts at issue and documents availed, the Respondent issued an Objection Decision on 2 nd November 2018 in which he confirmed the assessment. Bei ng dissatisfied with the Respondent’s decision, the Appellant lodged this Appeal through a Memorandum of Appeal dated 13 th December, 2018 filed on 1 4th December, 2018.

THE APPEAL 8. The Appeal was premised on the following grounds: i. The Respondent erred in law and fact by characterizing and assessing DLRKe as a fully -fledged entrepreneur responsible for all activities in the supply chain of the contract for the manufacture of banknotes with the Central Bank of Kenya ( CBK) whilst the Appellant is a lice nsed contract manufacturer with limited risk. ii The Respondent erred in law and fact in its assert ion that DLRKe performs all the economically significant activities and takes on the significant risks. iii The Respondent erred in law and fact by failing to ackno wledge the Appellant’s functional, asset and risk profile under the contract manufacturing arrangement with De La Rue International Limited (DLRI)

iv The Respondent erred in law and fact in failing to adopt a consistent and rational approach to the Appellant’ s licensed contract manufacturing operations for both local indent and export banknote manufacturing which are practically identical activities. v The Respondent erred in law and fact in failing to recognize DLRI’s involvement in the manufacturing contract f rom negotiations to research and development, production scheduling, sourcing and purchasing raw materials, procurement and vendor qualification, design decisions, use of know-how, logistics and invoicing. vi The Respondent erred in law and fact in alleging t hat the Appellant’s total production of banknotes for CBK is not purchased whilst in fact, the Appellant’s total production of banknotes for CBK is purchased by CBK. vii The Respondent erred in fact by alleging that DLRI was not involved in negotiations of the contract between DLRKe and CBK. viii The Respondent erred in fact in failing to acknowledge the historical basis and development of the contracts between DLRI and CBK and how these informed the contracting surrounding the current assessment and dispute. ix The Respondent erred in law and fact by alleging that DLRKe had legal and technical capacity to negotiate the contract, sign and fulfil the contract with CBK. x The Respondent erred in law and fact in assessing that DLRKe had created marketing intangibles due to its customer relationship with CBK. xi The Respondent erred in law and fact in disregarding the historical relationship between DLRI and CBK and DLRI’s ro le in the maintenance of this relationship.

Appellant / petitioner / assessee submissions

ii. Whether DLRI owned essential intangible assets and provided essential knowhow and technical assistance to the Appellant to perform the functions under its contract with CBK 145. The Appellant has argued that DLRI owns valuable assets that were necessary for the fulfilment of the contract between the Appellant and CBK. In particular, that DLRI carried out research and development and therefore owned the product and process IP. It further listed various support services that it provided such as sales, training, equipment procurement, systems and security audits etc. 146. The Appellant further ar gued that DLRI held the customer relationship with CBK since it has been significantly involved in the contract for the manufacture of banknotes for CBK from the onset and subsequent negotiations leading up to the signing of the contract between the Appellant and CBK. It further argued that payments under the contract were paid directly to DLRI rather than the Appellant. 147. On review of these facts the Tribunal was not satisfied as to the nature of technical assistance that was provided under the Know -how Lice nce and Technical Assistance Agreement relied on by the Appellant or that indeed the existence of the customer relationship between DLRI and CBK would warrant the payment of the royalties determined under that contract.

148. The Tribunal is not convinced of the Appellant’s contention that the Appellant does not have any capacity to manage the legal details or indeed all of the services that it lists as being provided by DLRI. The Appellant’s organogram submitted in its own documents shows that it has departments and personnel who carry out roles such as production planning and logistics, security and risk audits, engineers and quality assurance managers, operations managers and human resources. No evidence has been submitted to show the exact technical services that were carried out by DLRI, above and beyond the normal operations of the Appellant.

Revenue / respondent submissions

The judgment does not separately label the respondent’s submissions in an independently extractable passage. No contention is inferred; read the full record.

Court / Tribunal analysis and reasoning

xviii The Respondent erred in law and fact by failing to recognize the letter from the National Treasury which is in fact the competent authority in Kenya on transactions with international parties to the shareholder of the Appellant, Thomas De La Rue AG, approving the terms of the Know How Agreement xix The Respondent erred in law and fact by disregarding the importance of the letter which in essence validated the royalty payments to DLRI as being adequate compensation. xx The Respondent erred in law in breaching the Appellant’s legitimate expectation based on the conclusive position and decision expressed and communicated to Thomas De La Rue AG by the Cabinet Secretary for the National Treasury in a letter dated 13 October 2017. xxi The Respondent erred in law by wrongfully and irregularly imposing a tax shortfall penalty under Section 84 of the TPA which only applies where taxpayers knowingly provide misleading information. xxii The Responden t erred in law and fact by assessing the Appellant under Section 16(1) of the Income Tax Act (ITA) on the basis that the royalty was not incurred in production of income by the Appellant while the matter in question is a transfer pricing matter and should therefore have been properly considered under Section 18(3) of the ITA. xxiii The Respondent erred in law and fact in failing to acknowledge that without the Appellant paying the disputed royalty, the Appellant could not carry on its business of licensed contrac t manufacturer of banknotes for the CBK contract.

The Respondent therefore erred in failing to recognize the critical importance of the royalty paid by the Appellant to DLRI. xxiv The Respondent erred in law and fact by disregarding the existing transfer pricing documentation and support provided by the Appellant to justify the

Further, DLRI has held and continues to hold the customer relationship since 1991. ii) The witness for the Respondent, Mr. Philip Munyao, acknowledged during cross-examination that the Appellant does not have a research and development team, neither did it have a legal team involved in contract negotiations unlike DLRI that has such teams. The A ppellant’s expert witness outlined that under paragraph 6.65 of the OECD Guidelines, DLRI bears the research and development risk. The Appellant therefore submits that it is clear that it does not undertake any resea rch and development in respect of the banknotes that it manufactures. It does not design the banknotes, nor does it manufacture the plates used in manufacturing the banknotes, nor does it maintain any client relationships and does not make any decisions re lating to the contractual process including the contents of the contract between DLRI and its customers.

Therefore, it is not a fully-fledged manufacturer.

19. Further, in his witness statement, the expert witness Mr. Mukora affirmed the position that DLRI is a significant company with substance, and which earned royalties from the use of its intangibles. Mr. Mukora notes further that having established that the intangibles are owned by DLRI and reviewed the transfer pricing reports, the Respondent neither challenged the method that the Appellant used nor the comparable used by the Appellant in its benchmarks. 20. The Appellant therefore asserts that the royalty payment for DLRI’s Know How and Technical Assistance Agreement is commercially supported and absolutely necessary for the Appellant’s execution of its contract. Further, the payment of these intangibles is properly supported and benchmarked, and that the Respondent has not disputed the transfer price or benchmarks.

27. Based on the foregoing, the Appellant submits that it is undoubtedly a limited risk manufacturer especially as it has no Research and Development or any registered IP or patents in Kenya as was confirmed by Mr. Francis Gakuru, witness for the Appellant and by Mr. Munyao, on cross -examination by the Appellant’s counsel. The Appellant therefore submits that the Respondent therefore has no basis or justification for its characterization of the Appellant as an independent manufacturer and not a licensed contract manufacturer for DLRI. c) The Respondent failed to recognize and consider the product and process knowhow and technical assistance provided to the Appellant by DLRI 28. The Appellant submits that it and DLRI entered into a Know How License and Technical Assistance Agreement (the Agreement) that came into force on 1 April 2010.

Operative decision and relief

38. It is the Appellant’s contention that the above cases cited demonstrate its rationale for the royalty payment to DLRI and why such royalty payments are fully allowable in determining its tax li ability. It is therefore the Appellant’s submission that the royalty payments by the Appellant to DLRI were properly incurred in furtherance of its business and are therefore allowable. The Respondent’s act of disallowing these royalty expenses is without legal basis and ought to be set aside in totality. 39. Despite the Appellant demonstrating DLRI’s involvement in the Appellant’s banknote manufacturing process and its use of DLRI’s intangibles and presenting both the group transfer pricing policy and DLRKe’s transfer pricing policy, the Respondent did not question the selected transfer pricing method or resultant benchmarks forming the basis of the Appellant’s remuneration.

Appellant’s prayers 64. The Appellant therefore prays: a) That the assessment of Kshs 1,106,043,698.00 and the resulting penalties and interest be vacated together with all attendant penalties and interest b) That the Appeal be allowed with costs to the Appellant. c) Any other remedies that the Tribunal deems just and reasonable in the circumstances.

The Respondent’s Prayers 138. The Respondent therefore prays that: a) The Appellant’s Appeal be dismissed for lack of merit. b) The Respondent’s confirmed Assessment be upheld. c) The Respondent be awarded the costs of the Appeal

FINAL DECISION 167. Based on the findings above, the Appeal is partially allowed, and the Tribunal makes the following Orders:- (a) The principal tax, penalties and interest demanded in respect of the Objection Decision dated 2nd November 2018 are due and payable. (b) The Respondent shall amend the taxes demand to cater for the lower rate applicable in the year 2014. (c) Each party shall bear its own costs. 168. It is so ordered.

Ratio and legal principle

The narrow proposition associated with De La Rue Security and Currency Print Ltd v. Commissioner of Domestic taxes concerns royalties paid to the uk entity were not at arms length. tat no. 395 of 2018 whether the price of the bank note paper purchased by the appellant from dlri is an arm’s length price which includes the cost associated with the know how to manufacture and design the bank note 149. based on the above analysis, we find that there were no service or intangible assets that warranted a separate charge for a royalty. indeed, as the respondent has pointed out that all security features relating to the banknotes were already incorporated on the paper purchased by the appellant from dlri to be used to print the banknotes under the contract that the appellant had with cbk. further the features to be included in the banknotes was held by cbk. thus, it is unclear what which ip the appellant received from dlri. 150. it was also noted that any management assistance provided such as secondment of… The proposition cannot be separated from the judgment’s facts, the governing statutory version, the forum’s jurisdiction, and the exact relief recorded in APPEAL NO. 395 OF 2018.

For working-paper purposes, the decision should be cited only after matching the material facts and reading the passages under the judgment-grounded record above. The editorial outcome label “Partly allowed” is a navigation aid; it does not replace the operative order or explain every issue in a multi-issue case.

Why this judgment matters

This decision is relevant when a file raises the same central question identified in the source headnote: Royalties paid to the UK entity were not at arms length. TAT No. 395 of 2018 Whether the price of the bank note paper purchased by the Appellant from DLRI is an arm’s length price which includes the cost associated with the know how to manufacture and design the bank note 149. Based on the above analysis, we find that there were no service or intangible assets that warranted a separate charge for a royalty. Indeed, as the Respondent has pointed out that all security features relating to the banknotes were already incorporated on the paper purchased by the Appellant from DLRI to be used to print the banknotes under the contract that the Appellant had with CBK. Further the features to be included in the banknotes was held by CBK. Thus, it is unclear what which IP the Appellant received from DLRI. 150. It was also noted that any management assistance provided such as secondment of… Its practical value lies in the way the Tribunal connected the governing provisions—Ruling—to the procedural posture and evidence before it.

The authority level is ITAT / Tribunal. That affects persuasive or binding weight, but authority level alone is never enough. Territorial jurisdiction, statutory period, the identity of the challenged order, and later appellate treatment must all be checked before the case is used in advice, a submission, or litigation strategy.

Practitioner action points

• Begin with the complete judgment and mark the paragraphs supporting the exact proposition relied upon.
• Match the statutory version of Ruling and the decision date 2021-06-04; do not assume the current text is identical.
• Compare the notice, assessment, appeal or other procedural sequence with the chronology recorded in this case.
• Verify the stated later-history status and any review, appeal, SLP, curative or rectification proceedings before citation.
• Record why the client’s evidence is materially similar, and also record any fact capable of distinguishing the result.

Does this case match your facts?

Detailed reliance and distinction analysis

Identity check. Confirm that the cited cause title is De La Rue Security and Currency Print Ltd v. Commissioner of Domestic taxes, the proceeding is APPEAL NO. 395 OF 2018, and the decision is dated 2021-06-04. These fields are taken from the judgment record and should appear exactly in the citation note.

Bench check. The judgment identifies the coram as Eric Nyongesa Wafula, Chairman; Catherine N. Mutava, Abraham K. Kiprotich, Gabriel M. Kitenga and Elisha Njeru, Members. A later order by another bench, a larger bench, or a higher forum may alter the weight or interpretation of the proposition.

Provision check. The source associates the dispute with Ruling. The practitioner should place the historical statutory text next to the current text and identify every amendment, proviso, explanation, rule or notification that could change the analysis.

Fact check. The source issue is not a free-standing abstract rule. It arises from the concrete record summarized above. A reliable application note should list the common facts, the different facts, and whether each difference affects jurisdiction, admissibility, limitation, burden, computation or relief.

Remedy check. The recorded result is Partly allowed. Where a matter is remanded, set aside, partly allowed, or disposed with directions, the exact operative language is more important than a binary winner/loser label.

History check. The current closure state is RECTIFICATION_HIGH_COURT_APPEAL_SLP_CHECK_PENDING. If that state is pending, the page does not assert that no later case exists. It means the check remains open and must be completed at the point of professional reliance.

Section / provision impact

• Ruling — apply the exact version considered in the judgment.

Case network

• Blackstone FP Capital Partners Mauritius V Ltd. v. DCIT — ITAT Mumbai · Remanded / restored
• State of Karnataka & Anr etc v. State of Meghalaya & Anr etc — Supreme Court of India · Disposed / relief as recorded
• CIT(International Taxation-2) v. Gracemac Corporation — Delhi High Court · Quashed / set aside
• Rohan Developers Pvt. Ltd. v. ITO (IT) — Bombay High Court · Disposed / relief as recorded

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