The High Court has delivered its judgment in Commissioner of Domestic Taxes v. Bank of Africa Limited (Civil Appeal E127 of 2020), determining that interchange fees earned by Bank of Africa Kenya Limited (BoA) as an issuing bank from acquiring banks on card transactions are exempt from VAT.

An issuing bank is a bank that issues credit and debit cards to its customers. These cards bear various marks such as Visa, Mastercard or American Express. On the other hand, an acquiring bank is a bank that concludes agreements with merchants to facilitate credit or debit card transactions as a mode of payment to the merchants for goods or services. This is through provision of point-of-sale swipe machines/terminals to such merchants.

In a typical card transaction, a customer of the issuing bank hands a card to the merchant who swipes the card in a swiping machine at the merchant’s premises. The issuing bank verifies the authenticity of the cardholder, his eligibility to use the card and the availability of sufficient funds to cover the purchase amount due to the merchant. Upon verification, a charge slip is then generated from the swiping machine which the cardholder signs and takes a copy. The merchant retains a copy which is later submitted to the acquiring bank for payment. The acquiring bank deducts an amount from the money due to the merchant for the transaction known as a Merchant Discount Rate (MDR). The acquiring bank pays the balance to the merchant and then apportions the MDR between the card companies and the issuing bank. The money paid to the issuing bank is the interchange fee.

The Kenya Revenue Authority (KRA) sought to charge VAT on interchange fees earned by BoA in its capacity as an issuing bank, leading to an appeal by KRA to the High Court.

In its appeal, KRA argued that interchange fees were subject to VAT. BoA maintained that the card transactions giving rise to interchange fees were financial services that are VAT-exempt under paragraph 1(a)(b) part II of the First Schedule to the VAT Act, 2013.

The High Court considered the issues raised by both parties and determined that interchange fees were exempt from VAT. In its decision, the High
Court made the following findings:

• Although there is a service provided by the issuing bank which gives rise to interchange fees, the service is provided to the cardholders who are customers of the issuing bank. Any service by the issuing bank to the acquiring bank is secondary to the service rendered by the issuing bank to its customers (the cardholders).
• BoA had rendered a financial service to cardholders and not to the merchant’s bank when verifying the authenticity and eligibility of its customers to use cards when purchasing goods or services.
• Subjecting interchange fees to VAT and demanding the same from an issuing bank would amount to double taxation, since the acquiring bank collects and accounts for VAT on the entire MDR amount.

The High Court also held that KRA was wrong in issuing a new assessment in an objection decision.

What does this decision mean for you?

This decision gives clarity to all banks engaged in card transactions that interchange fees earned by issuing banks are VAT-exempt. It is worth noting that the High Court distinguished this case from the Court of Appeal’s decision in Commissioner of Domestic Taxes (Large Tax Payer Office) v. Barclays Bank of Kenya Ltd [2020] eKLR, finding that the latter related to income tax and not VAT. Furthermore, the decision also emphasises that courts will not overlook procedural impropriety by KRA in issuing assessments.

KRA may yet appeal this decision, as they often do.

For more information on this decision or any other tax matters, kindly get in touch with the team listed under Key Contacts.