Checkpoint Technologies Kenya Limited V Commissioner Of Domestic Taxes (tax Appeal 1181 Of 2022)

 Transfer pricing is not an exact science and precision can be challenging due to the varied methodologies. Sometimes, different methods yield a range of figures, all equally reliable. Article 3:62 of the OECD Transfer Pricing Guidelines for Multinational Enterprises acknowledges this and suggests that within such a range, any point can satisfy the arm's length principle.  

The Tax Appeals Tribunal supported this assertion in the case of Checkpoint Technologies Kenya Limited v Commissioner of Domestic Taxes (Tax Appeal 1181 of 2022), opting for the interquartile range (IQR) over the tax authority's preference for median adjustments. This aligns with the OECD's guidelines on arm's length principles, emphasizing flexibility in transfer pricing assessments. 

Background 

Checkpoint Technologies Kenya Limited (CPT-KL), a subsidiary of Checkpoint Software Technologies International Limited (CPT-IL), operates as a limited liability company incorporated in Kenya. Specializing in ICT, information technology, and software development, CPT-KL also offers pre-sale and marketing support services to its parent company, CPT-IL. To ensure compliance with arm's length standards in intercompany transactions, CPT-KL employs the Transactional Net Margin Method (TNMM) with a net cost-plus basis as the chosen profit indicator. 

The genesis of the dispute arose from the scrutiny of transfer pricing documents submitted by CPT-KL to the Kenya Revenue Authority (KRA). Upon examination, the KRA noted a deviation in the margin rates applied compared to the recommended rate of 5.5%, as outlined in CPT-KL's transfer pricing policy document. These discrepancies in the margin rates were identified across the fiscal years 2017, 2018, 2019, and 2020. 

The observed variations in margin rates across the specified fiscal years prompted the KRA to question the alignment of CPT-KL's intercompany transactions with the arm's length principle. Despite CPT-KL's adoption of the TNMM with a net cost-plus basis, the discrepancy between the applied rates and the recommended rate raised concerns regarding the accuracy and consistency of the company's transfer pricing practices. 

CPT-KL’s submissions  

CPT-KL contended that their transfer pricing policy established an arm's length range (interquartile range) for transactions conducted by the company, spanning from 4.9% to 7.3%, with a median of 5.5%. They emphasized that according to the OECD Guidelines, taxpayers possess the discretion to select any position within this range. Additionally, CPT-KL highlighted that the agreement signed between CPT-KL and CPT-IL explicitly set the markup rate for related party transactions at 5%. 

Moreover, CPT-KL argued that the KRA's imposition of a median range of 5.4% for the years 2017-2019 and 5.5% for 2020 contradicted the OECD Guidelines, which permit taxpayers to adopt any rate within the arm's length range for related party transactions. They asserted that the Transfer Pricing Rules under Kenyan Income Tax adhere to the methods stipulated in the OECD Guidelines, without mandating the adoption of a median position. Thus, taxpayers retain the freedom to select any position within the interquartile range. 

Furthermore, CPT-KL maintained that the markup rate of 5% outlined in the signed agreement between the Kenyan subsidiary and its parent company consistently fell within the arm's length range, as documented in their transfer pricing documentation. They referenced EU cases, particularly Spain v. Ikea, SAN 1072/2019, where it was ruled that no transfer pricing adjustment is warranted when transactions fall within the arm's length range. The court in the matter emphasized that adjustments to median, mean, or weighted mean are only necessary in cases of comparability defects to minimize the risk of error in assessments. 

CPT-KL therefore submitted that that the position adopted within EU cases relied upon reaches the following ratio decidendi:- 

1. That the median measure need only be adopted where there are doubts as to the reliability and comparability of the arm's length range as selected from the comparable data set or such other similar defects;  
2. That the tax authorities are required to document any defects observed in the comparable data set; and 
3. That where a taxpayer's adopted transfer price is within the accepted arm's length range, the measure adopted will not be adjusted unless there are verifiable defects in comparability.  

KRA’s submissions  

The KRA contended that CPT-KL was obligated to adopt the median position within the interquartile range, as determined and documented in the Transfer Pricing Policy. According to the KRA, benchmarking conducted by CPT-KL established the arm's length range to be between 4.9% and 7.3%, with a median of 5.5%. Therefore, KRA asserted that CPT-KL should have utilized the 5.5% rate, as indicated by their transfer pricing documentation. 

Issue for determination  

Whether the KRA was justified in making the adjustment  

Tribunal’s analysis and Determination  

The Tribunal noted that the Respondent's challenge was solely directed towards the margin rates applied by CPT-KL, not the validity of their Transfer Pricing Policy. 

 In evaluating the case, the Tribunal referred to Article 3.6 of the OECD guidelines, which prohibits adjustments when the transfer price or margin conforms to OECD regulations and falls within the arm's length range. This article mandates that if a controlled transaction's condition deviates from the arm's length range asserted by the tax administration, the taxpayer should be given the opportunity to argue for compliance with the arm's length principle and demonstrate that the result falls within an alternative arm's length range. 

The Tribunal highlighted that the markup rate stipulated in the signed agreement between CPT-KL and CPT-IL for related party dealings was consistently 5%, aligning with the arm's length range documented by CPT-KL's transfer pricing documentation. 

Based on this analysis, the Tribunal concluded that imposing the median measure as the arm's length range contradicted the OECD Guidelines, which permit taxpayers to adopt any rate within the arm's length range for related party transactions. This finding was supported by Article 3.63 of the OECD Guidelines, which suggests that any point within a range of relatively equal and high reliability satisfies the arm's length principle.  

Consequently, the Tribunal determined that the revenue reported by CPT-KL fell within the arm's length range and thus, there was no justification for the KRA to adjust the reported income. 

Conclusion/ finding 

In essence, the Tribunal concurred with the CPT-KL's arguments, affirming that the reported income from related party transactions adhered to the Company's Transfer Pricing Policy and met the requirements of the OECD Guidelines. The Tribunal concluded by stating that the KRA's decision to assess CPT-KL's Corporation tax using an unrecognized method lacked justification under the law. 

How we can help          

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