The High Court recently delivered judgments in two cases, Commissioner of Domestic Taxes v Bank of Africa Kenya Limited. (Tax Appeal No. E004 of 2023) and Commissioner of Domestic Taxes v Standard Chartered Bank Kenya Limited. (Tax Appeal No. E123 of 2020), determining that interchange fees earned by issuing banks in card transactions are exempt from Value Added Tax (VAT).

An issuing bank is a bank that issues credit and debit cards to its customers. 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 machines/terminals to the merchants.

In a typical card transaction, a customer of the issuing bank hands a card to the merchant who swipes the card in a point-of-sale machine. 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 generated from the point-of-sale machine. The cardholder signs and maintains a copy. The merchant retains a copy that 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.

In both cases before the High Court, the Kenya Revenue Authority (KRA) sought to charge VAT on the interchange fees earned by Bank of Africa Kenya Limited and Standard Chartered Bank Kenya Limited in their capacity as issuing banks. The KRA’s argument in Standard Chartered Bank's case was that interchange fees earned in card transactions by Standard Chartered Bank as an issuing bank amounted to a royalty payment that was subject to VAT while its argument in Bank of Africa's case was that interchange fees earned in card transactions by Bank of Africa amounted to management and professional fees that were not exempt from VAT. In both cases, KRA sought to rely on the Court of Appeal's decision in Commissioner of Domestic Taxes (Large Tax Payer Office) v Barclays Bank of Kenya Ltd NRB CA Civil Appeal No. 195 of 2017 [2020] eKLR where it was held that interchange fees paid to an issuing bank amounted to management or professional fees that were subject to Withholding Tax (WHT) and that transaction fees paid to card companies by banks amounted to royalty payments that were subject to WHT.

In both cases, the High Court upheld the decisions of the Tax Appeals Tribunal which had found that services provided by issuing banks in card transactions and which gave rise to interchange fees were financial services (money transfer services) and the interchange fees earned thereon were exempt from VAT. In arriving at its decisions, the High Court made the following observations:

1. The decision of the Court of Appeal in the Barclays Bank case was distinguishable from the two appeals. While the Court of Appeal in the Barclays Bank case held that services rendered by an issuing bank to an acquiring bank were in the nature of co-ordination, managerial, professional and contractual services, the appellate court did not exclude these services from the ambit of financial services.
2. The decision of the Court of Appeal in the Barclays Bank case was also distinguishable from the two appeals because the Court of Appeal decision on interchange fees was with respect to WHT while the issue for determination in the two appeals was the VAT treatment of interchange fees. The High Court concluded that co-ordination, managerial, professional and contractual services could also fit within the category of financial services for purposes of VAT.

What does this decision mean for you?

This is a welcome decision for commercial banks as it reaffirms that interchange fees earned by issuing banks are exempt from VAT. This is a similar holding to another judgment delivered earlier this year by the High Court in Commissioner of Domestic Taxes v. Bank of Africa Limited (Civil Appeal E127 of 2020). We issued an alert for this case that can be accessed here.

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.