[2024] KETAT 345 (KLR)

Acorp Gifts Kenya Limited v Commissioner of Domestic Taxes (Tax Appeal 235 of 2022) [2024] KETAT 345 (KLR) (8 March 2024) (Judgment)

Neutral citation: [2024] KETAT 345 (KLR)

Republic of Kenya

In the Tax Appeal Tribunal

Tax Appeal 235 of 2022

E.N Wafula, Chair, D.K Ngala, CA Muga, GA Kashindi, AM Diriye & SS Ololchike, Members

March 8, 2024

Between

Acorp Gifts Kenya Limited

Appellant

and

Commissioner of Domestic Taxes

Respondent

Judgment

Background 1. The Appellant is a company incorporated in Kenya carrying on the business of selling branded merchandise to corporate and individual clientele.

2. The Respondent is a principal officer appointed under Section 13 of the Kenya Revenue Authority Act Cap 469 laws of Kenya. Under Section 5(1) of the Act, the Respondent is an agency of the Government for the collection and receipt of all tax revenue. Further under Section 5(2) of the Act with respect to the performance of its functions under subsection (1), the Respondent is mandated to administer and enforce all the provisions of the written laws as set out in Parts 1 & 2 of the First Schedule to the Act for the purposes of assessing, collecting and accounting for all revenue in accordance with those laws.

3. The Respondent instituted an in-depth audit of the Appellant’s tax affairs for the years of income 2017 – 2019 and issued a notice of additional assessment on 25th August 2021 for an outstanding amount of KShs. 56,329,670. 00 for Income tax and Kshs. 33,364,496. 00 for Value Added Tax (VAT).

4. The Appellant’s tax agent filed a notice of objection to the assessment dated 23rd September 2021.

5. The Respondent thereafter issued an objection decision dated 20th January 2022.

6. The Appellant, being dissatisfied with the objection decision, filed a Notice of Appeal dated and filed on 18th February 2022.

The Appeal 7. The Appeal was premised on the following grounds contained in the Appellant’s Memorandum of Appeal dated and filed on 4th March 2022:

8. In computing the Appellant's tax liability, the Respondent brought to charge the following:Corporate income taxi.The variance between sales as per the sales ledger as adjusted for credit notes traced by the KRA to the VAT 3 returns and the sales as reported in the income tax returns amounting to KShs. 24,954,729. 00ii.The variance between the "expected sales" (as determined using the formula net receipts add withheld amounts, add debtors at year end less debtors at the start of the year) and the sales declared in the income tax returns amounting to KShs. 22,085,358. 00iii.The variance between the imports as recorded in the purchases ledger and the imports data as per the KRA's data amounting to KShs. 153,344,929. 00iv.The variance between the wage costs as declared in the PAYE returns and the wage costs as declared in the income tax returns amounting to KShs. 11,890,315. 00Value Added Taxv.The variance between sales per the sales ledger as adjusted for credit notes allowed by the KRA and the sales per the VAT 3 returns amounting to KShs. 110,210,547. 00. This variance is attributable to credit notes disallowed by the KRA.vi.The variance between the "expected sales" (as determined using the formula net receipts add withheld amounts, add debtors at year end less debtors at the start of the year) and the sales as declared in the VAT returns amounting to KShs. 107,341,176. 00vii.The variance between imports as reported in the VAT returns and imports as reported in the KRA customs data amounting to KShs. 28,967,061. 00.

9. The total principal tax demanded for income tax amounts to KShs. 44,067,598. 00. The total principal tax demanded under VAT amounts to KShs. 23,415,024. 00.

Appellant’s Case 10. The Appellant’s case is set out in its Statement of Facts dated and filed on 4th March 2022 and the witness statement of Michael Botha dated 9th June, 2023 and filed on 12th June, 2023 that was admitted in evidence under oath on the 6th September, 2023.

11. The Appellant stated that it is a subsidiary of 1477 Street PTY Limited, a company resident in South Africa. The Appellant appointed Amarex Group as its clearing agent for both export clearance in South Africa and import clearance in Kenya.

12. That in order to finance its business operations in Kenya, the Appellant obtained a loan from its parent company of KShs. 6,999,670. 00, for setting up in Kenya and as working capital.

13. The Appellant averred that it routinely experiences banking issues, including instances where payments made by clients are rejected by the bank and subsequently reversed. Like all other businesses, the Appellant is not immune to errors in preparation of financial statements and statutory declarations.

14. That in preparation of its financial statements, the Appellant is guided by the International Financial Reporting Standards (IFRS) and applied IFRS 15 when recognizing income, including recognition and reporting of deferred revenue.

15. That the Appellant filed self-assessment returns for the financial years 2017, 2018 and 2019 wherein the Appellant declared a tax loss of KShs. 8,662,535. 00, KShs. 16,132,664. 00 and KShs. 25,669,075. 00 for 2017, 2018 and 2019 respectively. The Appellant was unable to file its self-assessment income tax return for FY 2020 and 2021 because of an additional assessment registered on the Appellant’s i-Tax ledger for years 2017, 2018 and 2019.

16. The Appellant stated that the additional assessment relates to the current Appeal and it inhibited the filing of income tax returns for tax period after 2019. The Appellant filed nil VAT returns for the periods April 2017 and May 2017. For the periods June 2017 and July 2017, the Appellant in its VAT returns declared no sales and claimed input VAT.

17. That the Appellant also declared no sales and no purchases in its VAT returns for the tax periods of August 2017, November 2017, December 2017, January 2018, February 2018, March 2018, April 2018, June 2018 and September 2018.

18. The Appellant stated that it claimed input VAT on purchases and declared output VAT on sales for various months within the tax periods of 2018 and 2019. The Respondent issued a notice of assessment on 25th August 2021 demanding Corporation income tax and VAT arising from the variance noted amounting to KShs. 56,329,670. 00 and KShs. 33,364,496. 00 inclusive of penalties and interest, respectively.

19. That the Appellant objected to the assessment on 23rd September 2021 and an objection decision was issued on 21st January 2022 by the Respondent.

20. The Appellant averred that in relation to Corporate income tax, the Appellant provided the Respondent with copies of all credit notes for the periods in dispute. At the time of the in-depth tax audit by the Respondent, the Appellant had not yet completed the audit of its financial statements and the information relied upon by the Respondent was only interim, as the Appellant’s statutory auditor had not audited the same.

21. That the Appellant inadvertently omitted inclusion of some credit notes in the VAT returns, and even so, this omission favoured the Respondent since the VAT payable had not been adjusted with the credit notes.

22. That it was unfair to require the Appellant to pay income tax on sales invoices that have been reversed by issuance of credit notes, since this income was never earned, this amounted to deprivation of property.

23. The Appellant argued that the declaration of credit notes in the VAT returns is not a condition precedent for the adjustment of the income in the income tax returns since Sections 15 and 16 of the Income Tax Act, CAP 470 of the laws of Kenya (hereinafter ‘ITA’) outline the adjustments that are required to be made in ascertaining a taxpayer’s taxable income.

24. That ITA does not allow the adjustments of credit notes on the grounds that the credit notes have not been declared in the VAT returns. The Appellant conceded that it is now unable to amend its VAT returns to include the credit notes on account of Section 16 of the VAT Act, No. 35 of 2013 (hereinafter ‘VAT Act’) which prohibits the adjustment of VAT returns with credit notes beyond 6 months of the issuance of the invoice.

25. That the Appellant is therefore unable to rectify its VAT returns to include the credit notes inadvertently omitted.

26. The Appellant averred that it was inaccurate to assume that all receipts in the Appellant’s bank statements amounted to income at the hands of the Appellant as some receipts such as those on loans received by a taxpayer did not constitute taxable income.

27. The Appellant asserted that it received a working capital loan from its parent company amounting to KShs. 6,999,670. 00 and the Respondent’s demand for income tax on account of this loan was unprecedented.

28. That in addition, the Appellant erroneously received payment of KShs. 275,622. 00 from a client into its bank account which was intended to be paid to the Appellant’s parent company, hence the Appellant had no legal right to the funds which it did not recognize as income in its books of account.

29. The Appellant stated that some payments made into the Appellant’s bank account were duly reversed by the bank. The Appellant provided the Respondent with the bank statements showing the reversals.

30. The Appellant averred that the Respondent’s tax audit was undertaken in advance of the Appellant’s statutory audit and therefore, the records reviewed by the Respondent were not final and were subject to be varied once the audit adjustments had been incorporated.

31. That the Appellant relied on its external auditor to provide assurance on the accuracy of its financial statements hence the errors in its interim financial statements. The Appellant contracted the Aramex group for logistics support services including clearing of imports from South Africa to Kenya, which inadvertently declared shipments and consignments belonging to the Appellant under Aramex’s PIN number as opposed to the Appellant’s PIN number, who was the consignee.

32. That Aramex erred procedurally in making the declarations for imports under an erroneous PIN number, however, this error did not negate or diminish the validity of imports or the legitimacy of expenses incurred by the Appellant. The Appellant adduced enough documentary evidence to demonstrate that the costs were legitimate and were incurred by the Appellant.

33. These costs were legitimate business expenses incurred exclusively in the generation of taxable income and should have been allowed in the ascertainment of taxable income.

34. The Appellant erred in filing its income tax returns by declaring administration costs as wage costs, an error that arose from transposition of cells in which wage costs and administration costs are declared. The Appellant attempted to amend its income tax returns to correct this error but was unable due to the issuance of an additional assessment on the i-Tax system that precluded the amendment of the tax return until the additional assessment has been addressed and removed from the system.

35. That in relation to variance between sales as the VAT returns and the sales as per the sales ledger, the Appellant failed to account for the impact of sales that were not subject to VAT in assessing the VAT due from the Appellant.

Appellant’s Prayers 36. The Appellant thus prayed that the Tribunal sets aside and quashes the Respondent’s assessments and further requested that the Tribunal finds that.a.The Appellant has sufficiently supported credit notes issued in reversal of sales invoices.b.The Appellant has sufficiently supported the variance between 'expected sales' and sales as reported in the income tax returns and that the reconciling items are accurate and verifiable.c.The Appellant has sufficiently supported its importation costs including import VAT.d.The salaries and wage expenses are sufficiently supported in spite of the transposing error in the income tax declaration completed by the taxpayer.

Respondent’s Case 37. In the Respondent’s Statement of Facts dated and filed on 1st April, 2022 the Respondent averred as follows:

38. The Respondent averred that the Appellant was selected for audit after analysis of its returns and declarations and was later issued with an audit notice The Appellant was later issued with an audit notice dated 5th November 2020. Prior to the issuance of the assessment dated 6th October 2021, the Appellant was engaged severally via electronic mail, a physical meeting on 17th February 2021 and a virtual meeting held on 16th March 2021 with the audit team.

39. The Respondent’s audit team engaged the Appellant and third-party representatives from Amrod South Africa and Aramex Kenya. The Appellant objected to the raised assessments on 23rd September 2021. The Respondent wrote to the Appellant on 12th October 2021, acknowledging receipt of the objection and requested various documents, namely; sales ledgers, signed financial statements, schedules of credit notes, bank reconciliations highlighting debtor’s advance payment, supplier payment rejection, payment made in error and incorrect allocation, schedule of import purchases, 2019 payroll in excel.

40. That the Respondent averred that the Appellant provided bulk documentation without schedules and workings on the adjustments. Despite requesting for workings and adjustments on 15th November 2021 and 13th January 2022, the Appellant did not avail the same.

41. That the Respondent therefore issued an invalidation decision on 30th January 2022 pursuant to Section 51(3) of the TPA. The objection application was found to be invalid due to lack of additional documentation and information as requested by the Respondent.

42. That Section 31 of the TPA allows the Respondent to amend an assessment from the available information and to the best of the Respondent’s judgment to ensure a taxpayer is liable for the correct amount of taxes payable. The Appellant is required to keep proper records as required by Section 23(1)(b) of the TPA and Section 56(1) of the TPA places the burden of proof that a tax decision is incorrect on the Appellant which the Appellant did not discharge.

Respondent’s Prayers 43. The Respondent prayed that its objection decision dated 30th January, 2022 be upheld.

Parties’ Submissions 44. The Appellant filed its submissions dated 20th September 2023 as directed by the Tribunal. However, the Respondent did not file written submissions as directed by the Tribunal.

45. The Appellant’s submissions rehashed the Appellant’s Statement of Facts and witness statement as capture in the foregoing paragraphs of this judgment. For that reason, the Tribunal will not regurgitate them but has summarised them as hereunder.

46. The Appellant emphasized that it has absolutely no production or manufacturing in Kenya and does not engage in any local production or manufacturing and that all merchandise offered for sale in Kenya is produced by the parent company in South Africa.

47. The Appellant stated that it obtained a loan of KShs. 6,999,670 from its parent company which it used to set up its business and that it still receives credit terms from its parent company which allows it to continue operating despite it not being profitable.

48. The Appellant submitted the following to be issues for determination:i.Whether it is legal and proper to require a taxpayer to pay income tax on sales invoices that have since been reversed by the issuance of credit notes?ii.Whether a loan received from a parent company constitutes taxable income where such loan has not been forgiven or waived?iii.Whether a payment received by a taxpayer on behalf of another person constitutes taxable income at the hands of the party receiving the payment?iv.Whether the Appellant is liable to pay income tax on payments made into its bank account that were duly reversed by the bank?v.Whether the Appellant is liable to pay income tax on income that was incorrectly recorded in its accounting system and which were subsequently rectified by the auditor in the audited financial statements?vi.Whether a principal (the appellant) should lose the deduction of import costs due to procedural shortcomings committed by its clearing agent?vii.Whether secondary evidence in the form of customs declarations from port of exit (South Africa), airway bills, bills of lading, manifests and commercial invoices suffice to support importation costs?viii.Whether the Appellant is liable to account for PAYE on administration expenses misclassified in its income tax returns?ix.Whether the appellant is liable to pay VAT on sales that are not subject to VAT.

49. On credit notes that were disallowed by the Respondent, the Appellant submitted that Sections 15 and 16 of the ITA do not require a declaration to be made in the VAT return as a condition precedent for the deduction of any expense or in the ascertainment of taxable income. For this proposition the Appellant relied on the case of Keroche Breweries v KRA and Others Misc Civil Application No. 743 of 2006 from which the Appellant’s submissions emphasized certainty of tax legislation.

50. The Appellant submitted that ITA did not place any time limit to claiming of expenses and therefore the taxpayer is at liberty to reverse its sales anytime by issuing a credit note.

51. It was submitted that the Appellant did not receive any benefit from the credit notes. That requiring a taxpayer to pay tax on non-existent sales transactions would be unprecedented and would amount to seizure of the capital of the business contrary to Article 40 of the Constitution of Kenya, 2010 (hereinafter ‘the Constitution’). On this issue the Appellant relied on Kitengela Bar Owner’s Association v National Assembly & Others Petition E005 of 2021 and the Ruling on appeal of the same matter being Civil Appeal E591 of 2021.

52. The Appellant submitted that the variance between the “expected sales” and the actual sales as computed by the Respondent were fully explained by the credit notes.

53. On the banking reconciliation the Appellant submitted that it was improper for the Respondent to assume that all receipts in the Appellant’s bank account represented income. Further, the Appellant submitted that Section 3 of the ITA lists sources of income that are subject to tax and that list does not include loans and advances. The Appellant also cited the definition of income under the IFRS. The Appellant submitted on payments received on behalf of related parties, rejected supplier payments, incorrect allocation and advance payments and stated that the Respondent failed to accord them the right treatment.

54. The Appellant sought to distinguish the case of Home Bridge v Commissioner of Domestic Taxes TAT 43 of 2019 in which the Tribunal made an exception from the general IFRS Rules and departed from guidelines on the timing and recognition of income for construction companies which have substantial work in progress and rather long turnaround times for conversion of work in progress to sales and income.

55. The Appellant also submitted on verification of purchases, wage variances; turnover and banking reconciliation; VAT3 to imports reconciliation and submitted that the Respondent had erred in treatment of the issues and the resultant assessments were therefore erroneous.

Issues for Determination 56. The Tribunal having carefully considered the parties’ pleadings, documentation and Submissions finds that a single issue, calls for its determination:

Whether the Appeal is properly before the Tribunal Analysis and Findings 57. The Tribunal notes that this Appeal arose out of the invalidation of the objection of the Appellant. The Respondent’s objection decision dated 20th January, 2022 invalidated the Appellant’s objection.

58. The Tribunal further finds that although both parties referred to the said objection decision, the same did not form part of the record of Appeal. Section 13 (2) of the Tax Appeals Tribunal Act, No. 40 of 2013 (hereinafter ‘TAT’) states as follows:“(2)The appellant shall , within fourteen days from the date of filing the notice of appeal, submit enough copies, as may be advised by the Tribunal, of—(a)a memorandum of appeal;(b)statements of facts; and(c)the tax decision.” [emphasis added]

59. In this regard, the Tribunal relies on Equity Group Holdings Limited Vs. Commissioner of Domestic Taxes, Civil Appeal No. E069 & E025 of 2020 wherein it was held as follows: -“Substantive law is a statutory law that deals with the legal relationship between people or the people and the state. Therefore, substantive law defines the rights and duties of the people, but procedural law lays down the rules with the help of which they are enforced. ……………….. Article 159(2) (d) of the Constitution in clear terms talks about procedural technicalities. A statutory edict is not procedural technicality. It was a law which had to be complied with. ……………………’ (Emphasis added)

60. It is the finding of the Tribunal that the objection decision is a critical and mandatory document that must be lodged by the Appellant in its record of appeal and without it, the Appeal is rendered incompetent. The Tribunal notes that although the Appellant has devoted enormous effort in demonstrating that the assessment is erroneous and/or excessive, it did not include the objection decision in its record of appeal.

61. In order for the Tribunal to determine whether or not the assessment was justified, erroneous or excessive, it must peruse and review the basis of the Appeal and that is the objection decision dated 30th January, 2022.

62. It is the finding of the Tribunal that the record of Appeal was filed contrary to the provisions of Section 13(2) of TAT. Failure to include the objection decision as part of the record of Appeal is fatal and renders this Appeal incompetent. The Appeal is thus improperly before the Tribunal. The Tribunal hastens to add that the objection decision was the most material documents that forms the substrum of the Appeal and absence of the tax decision denies the Tribunal the critical opportunity to appropriately review the decision under appeal.

Final Decision 63. The upshot of the foregoing is that the Appeal is incompetent and the Tribunal accordingly proceeds to make the following Orders:a.The Appeal be and is hereby struck out.b.Each party to bear its own costs.

64. It is so ordered.

DATED AND DELIVERED AT NAIROBI THIS 8TH DAY OF MARCH, 2024. ERIC NYONGESA WAFULA - CHAIRMANDELILAH K. NGALA - MEMBERCHRISTINE A. MUGA - MEMBERGEORGE KASHINDI - MEMBERMOHAMED A. DIRIYE - MEMBERSPENCER S. OLOLCHIKE - MEMBER