Financial service providers win big in VAT exemption row

Digital money transfer app companies are exempt from paying Value Added Tax (VAT), the High Court has ruled.

In a judgment earlier this month that now puts Payment Service Providers (PSPs) into focus, Justice Rhoda Ruto said the financial services offered by the digital platforms are similar to those offered by banks and hence ought not to attract VAT.

Justice Rutto’s ruling overturned the Tax Appeals Tribunal Judgment, which had sided with Kenya Revenue Authority’s (KRA) bid to have PSPs pay VAT, in a case in which the taxman had sought Sh76.8 million from licensed PSP, Pesapal.

In June 2023, the Tax Appeals Tribunal had sided with KRA, ruling that Pesapal was merely a tech platform because it wasn’t registered under the Banking Act and thus not exempt from VAT.

The tribunal ordered the firm to pay taxes, penalties, and interest totalling over Sh233 million.

PSPs in Kenya include mobile money services providers such as M-Pesa, Airtel Money, and Telkom Money.

They also incorporate apps and web-based platforms owned by fintechs such as Sasapay, Finserve, Tanda, Loop, Jumia, Flutterwave, Virtual Pay, Jambo Pay, Moja Expressway, Pesawise, and Pesapal.

There are at least 35 approved PSPs by the Central Bank of Kenya (CBK).

According to the Judge, Pesapal enjoys the protection of the law as it is a registered and licensed online payment provider.

She noted that the National Payment System Act (NPSA) shields KRA from demanding VAT from such platforms.

She observed that the VAT Act is silent on what attracts VAT and what does not. At the same time, Justice Rutto ruled that the law does not base exemption on classification of companies, either online or physical, but rather on the services offered.

“The Appellant’s activities, facilitating merchant payments, processing client funds, storing balances, and executing payment instructions, are functionally equivalent to and mirror those of financial institutions, albeit in a digital environment. The fact that these services are delivered through digital platforms does not alter their essential nature and character of the services, which are in substance ‘dealings with money’,” ruled Justice Rutto.

“Had Parliament intended to exclude digital platforms or PSPs from VAT exemption, it would have done so explicitly, appreciating the modern dynamics increasingly driven by fintech innovations.”  

In the case, Pesapal told the court that KRA demanded Sh109 million, which was Sh76 million as principal VAT and penalties and interests totalling Sh33 million.

According to the firm, the assessment was based on commissions earned from merchants for the provision of financial services.

It stated that upon objecting to the assessment and the amount, the Tax Appeals Tribunal agreed with KRA.

Pesapal argued that the commission earned is solely for financial services rendered on behalf of third-party merchants, hence the commissions qualify for VAT exemptions under the first schedule of the Act.

The court heard that KRA insisted that Pesapal merely facilitates processes such as lending, storing, or receiving money on behalf of clients, merchants, or customers, activities it likens to those of a banking software vendor; therefore, its services are not exempt.

At the tribunal, KRA won.

The TAX found that although the online money transfer platform is registered by the Central Bank of Kenya, it is an information technology system designed to facilitate payments for its clients, and it does not amount to the provision of a financial service.

The tribunal found that its customers ought to pay VAT for the services offered.
Aggrieved, Pesapal moved to the High Court, arguing that the TAT erred by finding that it is not a financial services provider.

According to the firm, the regulation by CBK was an affirmation that it provides the same services as a bank, albeit digitally.

“The VAT Act does not require registration under the Banking Act to qualify for VAT exemption. Instead, it only specifies the type of financial services that are exempt, without regard to the identity of the person or legal status of the provider. The appellant further submitted that tax laws being penal in nature, they must be interpreted strictly, and any ambiguity should be resolved in favour of the taxpayer,” argued Pesapal.

The firm asserted that there is a difference between payment systems and payment service providers, adding that the VAT Act does not contain any provision excluding services delivered through information technology from VAT exemption.

It asserted that it provides financial services on behalf of others on a commission basis and is, therefore, exempt from VAT.

In response, KRA urged the court to dismiss the case. It argued that Pesapal’s licence is clear that it ought to offer a payment system only. It argued that the tribunal was right to find that it must pay VAT.

It asserted that the online platform merely integrates with banking IT systems, mobile money transfer services, and other electronic payment channels, thereby serving as a technological enabler rather than a financial service provider.

KRA submitted that not all payment service providers are financial service providers. In addition, it stated that holding a licence is not conclusive proof that the services offered qualify as a financial service under Part II of the First Schedule of the VAT Act 2013.

Justice Rutto observed that the key issue was whether the law restricts eligibility for exemptions based on technology.

“The appellant’s activities, facilitating merchant payments, processing client funds, storing balances, and executing payment instructions, are functionally equivalent to and mirror those of financial institutions, albeit in a digital environment. The fact that these services are delivered through digital platforms does not alter their essential nature and character of the services, which are in substance “dealings with money,” she said.