[2023] KETAT 150 (KLR)

East Africa Re-Insurance Co Ltd v Commissioner of Domestic Taxes (Appeal 529 of 2021) [2023] KETAT 150 (KLR) (Civ) (10 March 2023) (Judgment)

Neutral citation: [2023] KETAT 150 (KLR)

Republic of Kenya

In the Tax Appeal Tribunal

Civil

Appeal 529 of 2021

E.N Wafula, Chair, RM Mutuma, RO Oluoch & EK Cheluget, Members

March 10, 2023

Between

East Africa Re-Insurance Co Ltd

Appellant

and

Commissioner Of Domestic Taxes

Respondent

Judgment

Background 1. The Appellant is a private limited liability company and is in the business of carrying on the business of reinsurance in Kenya and in the East, Central, West and Southern Africa.

2. The Respondent is a principal officer appointed under Section 13 of the Kenya Revenue Authority Act, Cap 469 of the Laws of Kenya. Kenya Revenue Authority is an agency of the Government for the collection and receipting of all tax revenue. The Authority is further mandated to administer and enforce all provisions of the written laws as set out in the Part 1 & 2 of the First Schedule to the Act for the purposes of assessing, collecting and accounting for all revenues in accordance with those laws.

3. The issue in dispute herein arose when the Respondent conducted a Corporation tax audit against the Appellant for the periods running from 2014 to 2019 whereupon a tax demand of Kshs 151,141,071. 00 vide a letter dated February 17, 2021 was issued against the Appellant for omissions and tax underpayments.

4. Aggrieved by the aforesaid decision the Appellant applied to the Respondent to review its decision vide a letter dated the March 17, 2021.

5. The Respondent considered the Appellant’s objection and issued an objection decision dated the 22nd of July 2021 wherein it confirmed the assessment of additional principal tax plus penalties and interest amounting to Kshs 222,151,624. 00 for the years March 2016 to October 2020.

6. The Appellant being aggrieved by the objection decision proceeded to file an appeal to the Tribunal on the 3rd of September 2021.

The Appeal 7. The Appellant’s Memorandum of Appeal sets out the following grounds ofAppeal:-a.That the Respondent erred in fact and in law in determining that deferred tax and Corporation tax paid by the Appellant are amounts of the actuarial surplus as determined by the Insurance Act and recommended by the actuary to be transferred from the life fund for the benefit of the shareholders and therefore taxable under Section 19 (5) of the Income Tax.b.That the Respondent erred in law and in fact in determining that deferred tax and Corporation tax paid by the Appellant are any other amounts transferred from the life fund for the benefit of the shareholders and therefore taxable under Section 19 (5) (b) of the Income Tax Act.c.That the Respondent erred in law and in fact in failing to recognize that Corporation tax and deferred tax are necessary adjustments to the life fund surplus under Section 46 (5) and 46 (6) of the Insurance Act prior to declaring or paying a dividend to the shareholders therefore not taxable under Section 19(5) of the Income Tax Act.d.That the Respondent erred in law and in fact in failing to recognize that the deferred tax and corporation tax paid by the Appellant are liabilities of the life fund that has to be deducted/adjusted to determine the value of the life fund as per Section 46(1) (a) (i) and 57(2) (b) Insurance Act.e.That the Respondent erred in law and in fact in failing to recognize that the Appellant is required under the Insurance Act, International Financial Reporting Standards and the Kenyan accepted standards developed by the Institute of Certified Public Accountants (ICPAK) to recognize and adjust for a deferred income tax liability on the whole actuarial surplus carried forward not recommended for transfer for the benefit of shareholders.f.That the Respondent erred in fact and in law in failing to recognize that the obligation to account and pay for corporation tax under Section 19 (5) of the Income Tax is an obligation of the Appellant and not the shareholders. Therefore, corporation tax paid by the Appellant cannot be held to have been transferred from the life fund for the benefit of the shareholders as purported by the Respondent.g.That the Respondent erred in law and in fact in imposing taxes on actual corporation taxes paid by the Appellant as this amounts to double taxation which will result in unjust enrichment of the Respondent and is contrary to the principles of a good tax regime such as certainty.h.That the Respondent erred in law and in fact in failing to hold that the Appellant had taken all reasonable steps to collect its debts and had proved that its bad debts have become uncollectable and the Appellant’s bad debts are therefore allowable under Section 15 (2) (a) of the Income Tax as read together with Legal Notice 37- Guidelines on allowability of bad debts.

The Appelant’s Case 8. The Appellant’s case is based on its Statements of Facts filed on the 3rd of September 2021, the witness statement by Ms. Purity Mumbe dated January 13, 2022 and filed on the 14th of January 2022 that was admitted in evidence on oath on the September 28, 2022 and the Written submissions filed on 18th of October, 2022.

On Corporation Tax 9. The Appellant laid a basis for its appeal by asserting that:a.Under Section 45(1) of the Insurance Act, an insurer carrying on long term business such as life assurance, annuities, pensions (personal pension or deposit administration), group life, group credit, and or permanent health or investment (unit link and linked investments or non-linked investments) is required to establish a statutory fund in respect of the long-term insurance carried by the insurer.b.Section 45(4) and (6) of the Insurance Act dictate that all amounts received by the insurer in respect of the class of the respective long-term insurance business and the income arising from the investment of the assets of that statutory fund.c.Section 45(7) require the insurer to keep the assets of each statutory fund distinct and separate from all other assets of the insurer.d.Section 46(5) of the Insurance Act allows the insurer to declare a dividend to its shareholders of the surplus declared in the valuation report on condition that the amount allocated to the shareholders does not exceed 30% of the surplus disclosed after making the necessary adjustments to the surplus.e.Section 46 (5) of the Insurance Act provide that:“Notwithstanding subsection (1), an insurer may, for the purposes of declaring or paying a dividend to shareholders or a bonus to policy-holders, utilize the surplus disclosed in the valuation balance sheet of a statutory fund set out in the actuary’s abstract relating to an investigation made in pursuance of Section 57 of the IA and accepted by the Commissioner, subject to the condition that the amount allocated or paid to the shareholders out of a statutory fund shall not exceed thirty per cent of the surplus disclosed therein after making the necessary adjustments to the surplus.”f.Section 45 (6) of the Insurance Act provide that“The adjustments referred to in subsection (5) are –a.the actual amount of income tax deducted at source during the period following the date on which the last preceding investigation was made and preceding the date on which the investigation in question is made may be added to the surplus after deducting an estimated amount of income tax on the surplus, the addition and deduction being shown in the abstract prepared by the actuary;b.the surplus may be increased by contributions out of a reserve fund subject to the condition and only to the extent that the reserve fund has been made up solely of transfers from similar surpluses disclosed by investigations in respect of which the returns have been accepted by the Commissioner.”g.The taxation of long term-insurance of a resident insurance business is governed by Section 19 (5) of the ITA which provides that:“The gains or profits for a year of income from the long-term insurance business of a resident insurance company, whether mutual or proprietary, shall be the sum of the following-a.the amount of actuarial surplus, as determined under the Insurance Act and recommended by the actuary to be transferred from the life fund for the benefit of shareholders; andb.any other amounts transferred from the life fund for the benefit of shareholders; andc.thirty per centum of management expenses and commissions that are in excess of the maximum amounts allowed by the Insurance Act.”

10. The Appellant was of the further view that:a.Section 19 (5) of the Income Tax Act merely provides the method for the determination of taxable income and tax payable but the Appellant is bound by the provisions of the Insurance Act on the adjustments, valuation, and statutory reporting of the Life fund.b.Deferred tax and corporation tax are necessary adjustments that the Appellant is required to make to the surplus prior to declaring a dividend to its shareholders under Section 46 (5) and 46 (6) of the Insurance Act.c.The deferred tax liability/ asset is recognized on the actuarial surplus carried forward which is not recommended for transfer for the benefit of the shareholders.d.The deferred tax liability represents an estimate of the future taxes payable to the Respondent with respect to the surplus identified by the actuarial valuation, and which has to be deducted from the surplus prior to determination of the amounts to be transferred to shareholder account for distribution as dividends as prescribed by Section 46 (5) of the Insurance Act.

11. The Appellant argued that:a.The Corporation tax paid during the year is the actual amount of tax paid by the Appellant upon determination in accordance with Section 19(5) of the Income Tax Act and deductible from the surplus pursuant to the prescriptive Section 46(5) of the Insurance Act.b.Section 46(1) (a) (i) of the Insurance Act provide that deferred tax and corporation tax paid are liabilities to the life fund and they thus ought to be deducted from the life fund to determine the surplus/value of the life fund under Section 57 (2) of the Insurance Act.c.Section 54 of the Insurance Act require the Appellant to prepare its accounts and balance sheet in accordance with international Financial Reporting Standards including the International Accounting Standards and the Kenyan accepted standards developed by the Institute of Certified Public Accountants of Kenya (“ICPAK’). And that the guidance through ICPAK recognizes that taxation or deduction for tax purposes may be delayed to a later period as is provided under Section of the Insurance Act 12 which recognizes current tax consequences and future tax consequences of an assets carrying amount.

12. It was the Appellant’s contention that it operates a life fund and carried out actuarial valuations and correctly accounted for and paid tax for the years 2015 to 2019 in accordance with the Insurance Act and Section 19 (5) of the income Tax Act as shown in the table below.Year Amount of actuarial surplus recommended to be transferred from the life fund for the benefit of shareholders. Add 30% of management expenses in excess of the allowable limit of 10% of the total netpremiums Tax atCorporation tax rate of 30%

2014 39,690,221 19,498,491 17,756,613

2015 48,848,962 31,374,053 24,066,905

2016 69,557,786 42,905,391 33,738,953

2017 85,586,195 51,947,088 41,259,985

2018 177,490,471 55,172,166 69,798,791

2019 236,937,825 83,686,241 96,172,332

12. The Appellant affirmed that:a.It correctly accounted for tax charging corporation tax to the total amount of the actuarial surplus recommended to be transferred from the life fund for the benefit of shareholders and 30% of management expense in excess of the limit allowed by the Insurance Act.b.It made all the necessary adjustments to the life fund to cater for deferred tax and corporation taxes paid in accordance with the Insurance Act, International Accounting standards and the ICPAK’s Technical Guidance TG04/2014 prior to determining the sums recommended for transfer for the benefit of shareholders.c.Prior year adjustments of the life fund claimed by the Respondent constitute deferred taxes and actual taxes paid by the Appellant and adjusted from the life fund in accordance with the Insurance Act, International Accounting Standards and ICPAK’s Technical Guidance TG04/2014 as shown below.d.It should not be compelled to pay additional taxes on account of legally recognized adjustments for deferred tax liabilities and corporation tax.

13. The Appellant stated that the fund balance after accounting for deferred tax is Kshs 496 Million as at 31 December 2019 and Kshs 710 Million excluding the deferred tax and that levying tax on the fund without accounting for the deferred tax is a contravention of the Insurance Act and would not be reflective of the true value of the fund since the deferred tax liability is a future tax payable on the fund surplus.

14. It was contended by the Appellant that:a.Taxes are imposed on the person carrying on the long-term insurance business which in this matter is the Appellant and not the shareholders because no benefit accrues to the shareholder on account of obligations relating to the Appellant. It was its further view that shareholders are taxed in their own right through the withholding tax mechanism upon distribution of dividends and in their own capacity on dividend income received.b.The Respondent had recognized corporation tax on the thirty percent of management expenses and commissions in excess of the maximum allowed under Section 19(5) of the Income tax Act as an adjustment to the life fund. And that its failure or refusal to recognize the actual corporation tax paid under Section 19(5) (a) of the Income tax Act as a valid adjustment to the life fund by taxing the Appellant on the actual corporation tax would lead to double taxation and an absurdity.c.It is only a transfer of money from the life fund for the benefit of shareholders that is subject to taxation under Section 19 (5) (b) of the Income tax Act as held by the High Court in Kenindia Assurance Company LimitedvCommissioner of Domestic Taxes (2020) eKLR.d.Deferred tax and actual corporation tax are not transfers of money from the life fund for the benefit of shareholders and is therefore not taxable under Section 19 (5) of the Income Tax Act.

On Bad debts 15. The Appellant argued that bad debts expenses by the Appellant are in relation to the following:a.Instances where the debtors are no longer in business or do not have operating licenses therefore rendering the Appellant’s debt uncollectable.b.Instances where the economic conditions in jurisdictions such as Sudan, Mozambique and Ethiopia have rendered the clients unable to pay. An example of this is the forex devaluation issues in these countries.c.Instances where the clients were unresponsive to the company’s multiple reminders even after efforts had been applied such as holding meetings with the clients and agreeing on payment plans which were not honoured.

16. That after a careful review of its long outstanding debts through its Credit Control Department it allowed bad debts only after thorough review from the Appellant’s Credit Control Department that the debt is uncollectible.

17. It was its further argument that:a.Some of its bad debt balances are not significant and attempting to recover them would require engaging third parties and thereby visiting an unjustifiable expense on it.b.The amounts deducted as bad debts by the Appellant represented less than 10% of the turnover reported and that this showed that the Appellant has a practice of only writing off debts where it has no chance of recovery.c.It cannot and has not instituted legal proceedings due to the unnecessary costs it would incur in recovering these bad debts.d.It has complied with Legal Notice 37 and Section 15 (2) (a) of the Income Tax Act by taking all reasonable steps to recover the debts and these steps have not yielded results.

Testimony of the Appellant’s Witness 18. Ms. Purity Mumbe, the Appellant’s Chief Finance Officer, affirmed as follows in her testimony on oath:-a.That surplus is determined through valuation of assets and liabilities.b.The fund is a mix of income, expenses and liabilities.c.The Appellant should pay tax on what was transferred for the benefit of the shareholders to the shareholders under Section 19(5) of the ITA.d.Shareholders only pay tax when they receive dividend.e.Several reminders had been made to the debtors but they did not respond.f.Tanzania Interior Insurance Authority had advised the Appellant to file a civil suit to recover some of its debts and this was never done.g.Companies in Sudan and Zimbabwe cannot pay debts because they are not allowed to send dollars out of the country.

19. The Appellant’s witness concluded by affirming that:a.Liability of shareholder’s is limited to the value of their shares and the shareholders cannot be compelled to pay company liabilities pursuant to the well settled principle in the English case salomon vs salomon.b.Tax obligation of the Appellant is not a shareholder’s obligation.c.Section 46(1)(i) and 57(2) of the IA allow for the deduction of the deferred tax liability to be deducted from the life fund.

Appellant’s Prayer 20. By reasons of the foregoing grounds the Appellant prayed that the Tribunal orders that:a.The Respondent’s Corporation tax finding dated August 21, 2020, Corporation tax assessment dated February 17, 2021 and objection decision dated 22nd July 2021 demanding Kshs 222,151,624. 00 be struck out in entirety.b.The Respondent, it’s employees, agents, or other person purporting to act on its behalf be barred and/ or stopped from demanding or taking any further steps towards enforcement or recovery of principal tax, penalties and interest on the Respondent’s demand stipulated above.c.The Honourable Tribunal grants the Appellant costs of this Appeal and any other remedies that the Honourable Tribunal deems just and reasonable.

Respondent’s Case 21. The Respondent’s case is grounded on its Statement of Facts dated September 30, 2021 and filed on the 1st of October 2021, the witness statement of Bernard Kiagu dated September 19, 2022 and filed on 20th September, 2022 and the written submissions dated and filed on 18th of October 2022.

22. The Respondent raised 3 issues for determination and proceeded to address the as follows:

a. What Is the Business Model of The Long-Term Insurance Business? 23. The Respondent explained that:-a.The fund of the insurance of the company belong to the shareholders who undertake investments on behalf of the shareholders. The policyholder’s funds are ringfenced and protected from any inappropriate use. This position was emphasized in Kenindia Assurance Company Limited v Commissioner of Domestic Taxes(2020) eKLR Justice Majanja concurred with the Respondent that the purpose of such a statutory fund as stipulated in Section 45(1) of the Insurance Act is to protect policy holders by ring fencing the policy holders’ funds from the vicissitudes of ordinary business.b.It is required to establish and maintain a statutory fund under an appropriate name. For a given year, the life fund consists all amounts received by the Appellant in respect of that class including income arising from various assets of the class, less outgoings. The income includes net premiums received from the policyholders, investments made therefrom etc. whereas outgoing include total claims paid to policy holders during the year, tax provisions, management expenses etc. These are clearly spelt out under Appendix D of the Actuarial validation report prepared by the Actuary. The life fund is essentially the policyholders’ fund.c.Like any other operating business, the long-life insurance company’s intention is to make profit/gain from its business. The said profit/gain is determined in accordance to the provisions of the Insurance Act and that the taxation of these profits is guided by Section 19(5) of the Income Tax Act.

24. The Respondent contended that:-a.The profit/gain of the company originates directly from a surplus which is determined by actuary at the end of every financial rear. It may also be based on any amount that is removed from the fund (owned by the policyholders) for shareholder’s benefit.b.From the actuarial valuation report, a surplus is obtained by deducting from the life fund, the actuarial liability at the year-end of making the report.c.In coming up with the actuarial surplus, an actuarial valuation is done while factoring in the assets and liabilities and by adjusting on taxes paid in advance and tax provisions.d.Its foregoing assertion is correct because in the year 2016, the Actuarial valuation report prepared by the Actuary showed that all the provisions as spelt out in Appendix D were considered while arriving at the surplus.

25. It was the Respondent’s submission that taxation of long-term insurance is stipulated in Section 19(5) of the Income Tax Act, which dictates as follows:“The gains or profits for a year of income from the long-term insurance business of a resident insurance company, whether mutual or proprietary, shall be the sum of the following-a.The amount of actuarial surplus, as determined under the Insurance Act and recommended by the actuary to be transferred from the life fund for the benefit of shareholders;b.Any other amounts transferred from the life fund for the benefit of shareholders; andc.Thirty per centum of management expenses and commissions that are in excess of the maximum amounts allowed by the Insurance.”

26. The Respondent posited that the general charging provision in Section 3 of the Income Tax Act (ITA) also applies to the gains/profit of insurance business. The said Section 3 of ITA provides as thus:“Subject to, and in accordance with, this Act, a tax to be known as income tax shall be charged for each year of income upon all the income of a person, whether resident or non-resident, which accrued in or was derived from Kenya.”

27. The Respondent affirmed that Section 46(5) of the Insurance Act provides that only a maximum of 30% of the surplus can be transferred for the benefit of shareholders in the form of dividends. The remaining amounts are directly ploughed back into the life fund. The said Section 46(5) of the Insurance Act provides as thus:“Notwithstanding subsection (1), an insurer may, for the purposes of declaring or paying a dividend to shareholders or a bonus to policy-holders, utilize the surplus disclosed in the valuation balance sheet of a statutory fund set out in the actuary’s abstract relating to an investigation made in pursuance of Section 57 and accepted by the Commissioner, subject to the condition that the amount allocated or paid to the shareholders out of a statutory fund shall not exceed thirty per cent of the surplus disclosed therein after making the necessary adjustments to the surplus.”

28. The Respondent concluded that based on the above, an actuarial valuation is arrived at by factoring the assets and liabilities of the company and the adjustments made including the tax paid in advance and tax provisions. That this was confirmed by the Appellant’s return for the year 2016 which was attached to its documents as exhibit D.

b. Taxation of Long-Term Insurances and Whether the Respondent’s Assessment of the Appellant is Merited. 29. Under this issue, the Respondent argued that:a.Taxation of long-term insurance insurances is stipulated in Section 19(5) and 3 of the Income tax Act and Section 46(5) of the Insurance Act. It was its conclusion that income of the lifelong insurance business is deemed to be summation of:i.The amount surplus recommended to be transferred from the life fund as determined by the actuary, for the benefit of shareholders in the form of dividends.ii.Any amount transferred from the life fund for the benefit of shareholders; etc.b.Taxation under Section 3 of the ITA, is based on the amounts that have been transferred from the life fund either in form of the surplus recommended or any other transfer from the life fund.c.Tax liability of a long-life insurance company is the sole responsibility of the shareholders and not policyholders. This is chargeable on the amount that has been recommended to be transferred for the shareholder’s benefit in form of dividends or any other from.d.Tax liability of the company cannot be deducted from what is available from the life fund (which is essentially the policyholder’s fund) because Section 46(1) of the Insurance Act provides life fund cannot be used to settle the taxes of the company which is the responsibility of the shareholders.

30. Section 46(1) of the Insurance Act provides that:“Subject to this Act, no part of the assets of a statutory fund shall, so long as the insurer carries on the class or classes of long- term insurance business in respect of which the fund was established—a.Be available to meet any liabilities or expenses of the insurer other than:i.Liabilities or expenses referable to that class of long-term insurance business; andii.Liabilities charged on those assets or any of them immediately prior to the appointed date, or be otherwise directly or indirectly applied for any purpose other than the purpose of that class of long-term insurance business;b.Be-i.Paid, applied or allocated as dividends or otherwise as profits to shareholders; orii.Transferred to another fund.”

31. Its reading of this Section of the law was that statutory fund can only meet liabilities and not any other liabilities or dividends for the profit of shareholders from the statutory fund so as to protect the policy holders’ interests. It supported its position with the Appellant’s actuarial valuation report for the year 2016.

32. The Respondent clarified that:a.The basis of its assessment emanated from the fact that the there were variances in the opening and closing stock of the surplus for the years under review. This was attributed to prior adjustments made to the actuarial reports after the close of the financial year. These adjustments, therefore distorted the opening and closing balances of the respective years because ordinarily, the closing balance of the previous year should be opening balance of the subsequent year. This was not the case in this this appeal.b.This action by the Appellant contradicted the provisions of Section 46(5) of the Insurance Act because taxes of the company should arise from the amount which is recommended for the transfer to shareholders, the Appellant in this case, went back to the fund and deducted the taxes therefrom and a further deduction of what they call ‘deferred taxes’. Essentially, the taxes accruing from the company was not deducted from the amount recommended for transfer to shareholders but from the statutory fund itself. And that this was contrary to Section 46(1) of the Insurance Act.c.The plain reading of Section 46(6) of the Insurance Act only allows for two adjustments, namely, for tax provisions and income taxes deducted from source within a specific year of assessment (withholding tax credits accrued at source and paid in advance on behalf of the company).

33. The Respondent asserted that the Appellant had erred and misapplied the law by:a.Deducting funds other than WHT from the fundb.Making provisions for current year when the deferred provision allowed by law under Section 46(6) of the Insurance Act relates to future tax liabilities which have not been recognised as adjustments to the surplus or to the life of the fud.c.Deducting adjustments and tax provisions that had already been factored in the 2015-2019 Actuarial Reports according to Section 46(6) of the Insurance Act. There was therefore, no need for the Appellant to make a double adjustment.d.Disguising funds transferred from the life funds for the years 2015-2019 for the benefit of shareholders as deferred and or paid taxes.

34. The Respondent argued that any amount transferred from the life fund for the benefit of shareholders is taxable under Section 19(5)(b) of the ITA. That the funds transferred from the life fund for the benefit of shareholders should thus be taxed, irrespective of the nomenclature that it is given.

35. It distinguished this case from the Kenindia case (supra) because in the in Kenindia, the assessment was based on transfer made from statutory reserve rather than life fund. Transfer from statutory reserve is not captured by Section 19(5) of the Income tax Act unlike the present case where the transfer was from the life fund itself.

36. The Respondent cited several authorities from where it urged the Tribunal to interpret Section 19(5) of the ITA plainly and strictly.

b. Whether the Respondent Was Right to Disallow the Appellant’s Bad Debts of Kshs 69,364,749. 00 37. The Respondent submitted that the bad debts were disallowed because the Appellant did not demonstrate to the satisfaction of the Commissioner that the debts had become bad for tax purposes.

38. It was its argument that the test for allowing bad debts is found in:a.Section 15(1) of the ITA which provides that:-“For the purpose of ascertaining the total income of a person for a year of income there shall, subject to Section 16, be deducted all expenditure incurred in that year of income which is expenditure wholly and exclusively incurred by him in the production of that income, and where under Section 27 any income of an accounting period ending on some day other than the last day of that year of income is, for the purpose of ascertaining total income for a year of income, taken to be income for a year of income, then the expenditure incurred during that period shall be treated as having been incurred during that year of income.”b.Section 15(2) of the ITA which provides that:“Without prejudice to subsection (1), in computing for a year of income the gains or profits chargeable to tax under Section 3(2)(a), the following amounts shall be deducted -1. bad debts incurred in the production of those gains or profits which the Commissioner considers to have become bad, and doubtful debts so incurred to the extent that they are estimated to the satisfaction of the Commissioner to have become bad, during that year of income and the Commissioner may prescribe such guidelines as may be appropriate for the purposes of determining bad debts under this subparagraph.”c.Legal Notice No 37 of 2011, Paragraph 1 thereof provides that a“debt shall be considered to have become bad if it is proved to the satisfaction of the Commissioner to have become uncollectable after all reasonable steps have been taken to collect it.”

39. That the circumstances under which such a debt is considered incollectable are enumerated under Paragraph 2 as follows:“A debt shall be deemed to have become uncollectable under paragraph (1) where;a.The creditor loses the contractual right that comprises the debt through a court order;b.No form of security or collateral is realizable whether partially or in fill;c.The securities or collateral have been realized but the proceeds fail to cover the entire debt;d.The debtor is adjudged insolvent or bankrupt by a court of law;e.The costs of recovering the debt exceeds the debt itself; orf.Efforts to collect the debt are abandoned for another reasonable cause.”

40. Based on the above, the Respondent submitted that the Appellant had not proved that its debts were uncollectible to the satisfaction of the Commissioner.

41. That satisfying the Commissioner that the debt in question has become bad is crucial in the determination of debts as ‘bad debts’. That this position was affirmed in the following cases:a.I & M Bank Kenya Ltd –v- Commissioner of Domestic Taxes(TAT 72 of 2017)b.Commissioner of Domestic taxesvKenya Maltins Limited [2013] eKLR it was stated as follows:c.Republic –vs.- Commissioner for Income tax & Another exParte stockman Rozen Kenya Limited eKLR (2015), where the court stated that:“…taxable income is that income that has accrued minus allowable deductions and that the said deductions from the accrued income must be those that are allowable under Sections 15(1) and (2) of the Act which includes bad debts at Section 15(2)(a). However, for these to be deductible (i) they must be bad or have become bad, (ii) must have been incurred in the production of gains or profits and (iii) must be estimated to the satisfaction of the commissioner to have been bad.”

42. The Respondent further submitted that it had analyzed the Appellant’s debt provisions for the years 2014-2018 and it arrived at the conclusion that they did not satisfy the requirements under Section 15 of the Income tax Act and Legal Notice No 37 of 2011 because of the following reasons:a.During the hearing, the Appellant’s witnesses admitted that no legal suit was instituted to recover the said debt because it was protecting its reputation.b.Sufficient efforts were not made to recover the debt. In its view a debtor’s failure to comply with a reminder notice is not sufficient to have it declared as bad debt.c.Some of the listed debtors were capable of paying their debts. It cited the example of:a.United Insurance Company who paid a debt amounting to Kshs 9,781,260. 20 in the year 2016 and thereby reducing its debt balance to Kshs 4,516,540. 99. b.UAP Insurance Southern Sudan was able to pay a debt of Kshs 1,534,578. 84 thereby reducing debt provision of 2016 from Kshs 1,934,453. 66 to Kshs 399,874. 82 in the year 2017. It affirmed that these examples support its theory that the general economic situation in a Country does not automatically mean that debtors based in such Countries cannot pay their debts.c.NIB Insurance Company Ltd from Ethiopia who did business with Appellant in the years 2017/2018 resulting into a debt of Kshs 1,860,348. 28 in the year 2018. This company however paid all its debtsthat were due in 2018. Whereas in the previous year 2017, there was no debt owed to the Appellant.

43. The Respondent argued that despite having been advised by the Tanzania Insurance Regulatory Authority to file a suit to recover its debts from Wananchi Insurance Company, the Appellant deliberately opted not to file this suit because of the costs involved in litigation and the need to protect its corporate reputation.

44. It submitted further that the revocation of the licence for one its debtors does not automatically imply that the debt becomes bad because such licences are often reinstated once the debtor has complied with the Regulator’s request.

45. It was its view that the Appellant failed in its statutory duty under Section 56 of the ITA to provide evidence to confirm that the revocation was terminal.

Respondent’s Prayers 46. In view of the above facts, the Respondent submitted that its decision to subject the amount transferred from the life fund for the benefit of shareholders to tax and disallowing bad debts for Income tax purposes should be upheld. Its prayer was that the Tribunal:a.Dismisses the Appeal for lack of merit.b.Upholds the Respondent’s assessment dated February 17, 2021 and the Objection Decision dated July 22, 2021.

Issues for Determination 47. Having listened to the parties witnesses, gleaned through their pleadings and written submissions the Tribunal has identified the following as the issues that fall for determination in this matter:a.Whether the Respondent erred in subjecting the amount transferred from the life fund for the benefit of shareholders (life business) to tax amounting to Kshs 152,786,876. 00 inclusive of penalties and interest.b.Whether the Respondent erred in disallowing the bad debts for income tax purposes amounting to Kshs 69,364,748. 00 inclusive of penalties and interests.

Analysis and Findings 48. The Tribunal shall now proceed to sequentially analyse these two issues and render a determination thereof.

i. Whether the Respondent erred in subjecting the amount transferred from the life fund for the benefit of shareholders (life business) to tax amounting to Kshs 152,786,876. 00 inclusive of penalties and interest. 49. Section 46(1) (5) and 6 of the Insurance Act provides as follows:“(1) Subject to this Act, no part of the assets of a statutory fund shall, so long as the insurer carries on the class or classes of long-term insurance business in respect of which the fund was established—a.be available to meet any liabilities or expenses of the insurer other than—i.liabilities or expenses referable to that class of long-term insurance business; andii.liabilities charged on those assets or any of them immediately prior to the appointed date, or be otherwise directly or indirectly applied for any purpose other than the purpose of that class of long-term insurance business;b.be —(i)paid, applied or allocated as dividends or otherwise as profits to shareholders; or(ii)transferred to another statutory fund(2)….(3)……..(4)………5. Notwithstanding subsection (1), an insurer may, for the purposes of declaring or paying a dividend to shareholders or a bonus to policy-holders, utilize the surplus disclosed in the valuation balance sheet of a statutory fund set out in the actuary’s abstract relating to an investigation made in pursuance of Section 57 and accepted by the Commissioner, subject to the condition that the amount allocated or paid to the shareholders out of a statutory fund shall not exceed thirty per cent of the surplus disclosed therein after making the necessary adjustments to the surplus.6. The adjustments referred to in subsection (5) are—a.the actual amount of income tax deducted at source during the period following the date on which the last preceding investigation was made and preceding the date on which the investigation in question is made may be added to the surplus after deducting an estimated amount of income tax on the surplus, the addition and deduction being shown in the abstract prepared by the actuary;b.the surplus may be increased by contributions out of a reserve fund subject to the condition and only to the extent that the reserve fund has been made up solely of transfers from similar surpluses disclosed by investigations in respect of which the returns have been accepted by the Commissioner.”

50. It is clear from the above that:a.The assets of a statutory fund shall not meet the liabilities or expenses of a long-term insurance business.b.The surplus disclosed in the statutory fund can be utilized to pay dividends and bonus to long life policy holders provided that such payments do not exceed 30 percent of the surplus disclosed therein after making the necessary adjustments to the surplus.c.The adjustments would be worked out by the Actuary on the basis of this formula:Actual income + surplus - estimated income tax on surplus= Adjustments

51. The Appellant argues that deferred tax and Corporation tax are necessary adjustments that must be deducted from the surplus prior to the declaration of dividend so as to determine the amounts to be transferred to shareholders account for distribution.

52. It therefore asserted that the Appellant correctly accounted for tax by charging tax on the total of the amount of surplus recommended by the Actuary, plus 30% of management expenses which were in excess of allowable limit of 10% of the total net premiums.

53. It was its further view that this working was consistent with the reading of Section 46(5) (6) of the Insurance Act and Section 19(5) of the ITA which provides as thus:-“(5) The gains or profits for a year of income from the long- term insurance business of a resident insurance company, whether mutual or proprietary, shall be the sum of the following—a.the amount of actuarial surplus, as determined under the Insurance Act and recommended by the actuary to be transferred from the life fund for the benefit of shareholders;b.any other amounts transferred from the life fund for the benefit of shareholders; andc.thirty per centum of management expenses and commissions that are in excess of the maximum amounts allowed by the Insurance Act (Cap. 487).”

54. The Respondent argued that the reading of Section 46(1) of the Insurance Act makes it clear that statutory fund can only meet liabilities arising from expenses or liabilities arising from the long-term insurance business and nothing more.

11. It argued further that the prior adjustments made by the Appellant and which were related to transfer to shareholders and deferred tax liabilities on the remaining surplus for each year under tax review were at variance with Section 46(5) and (6) of the Insurance Act.

55. It is apparent that Section 46(1) of the Insurance Act prohibits any other deductions other than expenses and liabilities from the statutory fund. However, Section 46(5) of the Act is prefaced with the words ‘Notwithstanding subsection (1)’ This makes it a non-obstante clause.

56. Stroud’s Judicial Dictionary of Words and Phrases 6th Edition, London, Sweet and Maxwell 2000 at page 1732 have defined notwithstanding as follows:“Notwithstanding: “Anything in this Act to the contrary notwithstanding” is equivalent to saying that the Act shall not be an impediment to the measure, …”

57. On the other hand, the Blacks Law Dictionary, 9th edition, Bryan and Garner, 2009, defines the word notwithstanding to mean “despite, inspite of”.

58. A High Court bench of 3 judges (Kimondo, Mabeya & Ong’udi) held as follows in regard to an obstante clause in the case of National Super Alliance (Nasa) Kenya v Independent Electoral & Boundaries Commission & 2 others[2017] eKLR“85. In this regard, the use of the term notwithstanding in Section 44A means that inspite of what the provisions of Section 39 and 44 stipulate as to the mechanism in our electoral system, the Respondent is to put in place a mechanism to complement Sections 39 and 44 of the Act.86. We are fortified in our finding by the decision of the Supreme Court of India in Chandavakar Rao v Ashalata Guram [1986] 4SCC 447. It was held-“A clause beginning with the expression ‘notwithstanding anything contained in this Act or in some particular provision in the Act or in some particular Act or in any law for the time being in force, or in any contract’ is more often than not appended to a Section at the beginning with a view to give the enacting part of the Section in case of conflict an overriding effect over the provision of the Act or the contract mentioned in the non-obstante clause. It is equivalent to saying that inspite of the provision of the Act or any other Act mentioned in the non-obstante clause or any contract or document mentioned the enactment following it will have its full operation or that the provisions embraced in the non-obstante clause would not be an impediment for an operation of the enactment”

59. From the above analysis, it is clear that Section 46(5) and (6) of the Insurance Act do override provisions of Section 46(1) of the Insurance Act. Meaning that the limited instances in which deductions are allowed from the statutory fund under Section 46(1) of the Insurance Act are applicable only in so far as they do not contradict the provisions of Section 46(5) and (6) of the Insurance Act.

60. The Appellant is thus legally allowed to make the statutory deductions that are permitted under Section 46(5) and (6) of the Insurance Act. These include making payments out of the statutory fund for purposes of paying dividends or bonus provided that they do not exceed 30% of the surplus disclosed after making the necessary adjustments.

61. Section 46(6) of the Insurance Act makes it clear that the actual amount of tax deducted at source would be:‘… added to the surplus after deducting an estimated amount of tax on the surplus’.

62. The Tribunal holds that being an obstante clause, this provision overrides the provisions in Section 46(1) of the Insurance Act that the Respondent had relied on to dispute deductions of estimated amount of income tax. Its plain reading and interpretation have led the Tribunal to the conclusion that:a.It allows for deduction of estimated tax on the surplus notwithstanding/despite the prohibitions that are contained in Section 46(1) of the Insurance Act.b.That the term ‘an estimated amount of income tax’ means and is also synonymous to ‘ a tax provision’

63. Meaning that Section 46(6) of the Insurance Act allows for use and application of tax provisions in determining the net gain of long-term insurance funds contrary to the Respondent’s assertion.

64. Considering that Section 19(5) of the ITA which is the charging provisions has dictated that the ITA must be read and interpreted together with the relevant provisions of Insurance Act which are Sections 46(1) (5) and (6) of the Act. The Tribunal is thus compelled to conclude that the Appellant did not err when:a.It included tax provisions in its calculation which was aimed at determining the net gain of the fund because this is permitted under Section 46(5) and 6)(a) of the Insurance Act.b.It paid its shareholders out of the statutory fund but ensured that these payments did not exceed the 30 percent upper limit prescribed by law as this is allowed under Section 46(5) of the Insurance Act and Section 19(5) (c) of the ITA.c.It included the amounts transferred from the life fund for the benefit of the shareholders as part of its taxable gain (as shown in the table below) because this action is permitted under Section 19(5)(b) of the ITA.Year Amount of actuarial surplus recommended to be transferred from the life fund for benefit ofshareholders Add 30% of management expenses in excess of the allowable limit of 10% of the total netpremiums Tax atCorporation tax rate of 30%

2014 39,690,221 19,498,491 17,756,613

2015 48,848,962 31,374,053 24,066,905

2016 69,557,786 42,905,391 33,738,953

2017 85,986,195 51,947,088 41,259,985

2018 177,490,471 55,172,166 69,798,791

2019 236,937,825 236,937,825 96,172,332

65. The foregoing analysis therefore, confirms that the Appellant acted lawfully and within the remit of Sections 46 (5),(6) (a) of the Insurance Act as read with Section 19(5) of the ITA when it included tax provisions as part of its adjustments, so as to arrive at its taxable gains or profits.

ii. Whether the Respondent erred in subjecting the amount transferred from the life fund for the benefit of shareholders(life business) to tax amounting to Kshs 152,786,876 inclusive of penalties and interest. 66. Section 15 (2) of the ITA provides as follows:“Without prejudice to subsection (1), in computing for a year of income the gains or profits chargeable to tax under Section 3(2)(a), the following amounts shall be deducted -(a)bad debts incurred in the production of those gains or profits which the Commissioner considers to have become bad, and doubtful debts so incurred to the extent that they are estimated to the satisfaction of the Commissioner to have become bad, during that year of income and the Commissioner may prescribe such guidelines as may be appropriate for the purposes of determining bad debts under this subparagraph;”

67. Legal Notice No 37 of 2011 provides as follows under paragraph 1 and 2 respectively:“1. A debt shall be considered to have become bad if it is proved to the satisfaction of the Commissioner to have become uncollectable after all reasonable steps have been taken to collect it.2. A debt shall be deemed to have become uncollectable under paragraph (1) wherea.the creditor loses the contractual right that comprises the debt through a court order;b.no form of security or collateral is realizable whether partially or in full;c.the securities or collateral have been realized but the proceeds fail to cover the entire debt;d.the debtor is adjudged insolvent or bankrupt by a court of law;e.the costs of recovering the debt exceeds the debt itself; orf.efforts to collect the debt are abandoned for another reasonable cause.”

68. The Tribunal is obliged to read Section 15(2) of the ITA alongside Legal Notice No 37 of 2011 in determining whether debts in this dispute have indeed become bad. The Tribunal’s analysis of the law against the facts and evidence presented by the Appellant has resulted in the following outcome:a.The Commissioner has confirmed that he is not satisfied that the debts in this Appeal have become bad.b.The Appellant did not plead or provide evidence that it had lost contractual right over the debts in question through a court order.c.The Appellant did not plead or provide any evidence that any security that it held in regard to these debts had become unrealizable.d.The Appellant did not plead or prove that the securities it held were not sufficient to cover the entire debt.e.The Appellant did not provide evidence that any of its debtors had been adjudged bankrupt or insolvent by a court of law. The Appellant only pleaded that the licence for one of its debtors had been withdrawn. Withdrawal of a licence is a common regulatory sanction. It does not amount nor can it equate to insolvency or bankruptcy of a company.f.The Appellant pleaded that the costs of recovering the debts would be in excess of the debts owed. No evidence was however provided to verify this data. It is not enough just to allege that the costs of recovery exceed the value of the debt owed. The Appellant is under duty under Section 30 of the Tax Appeals Tribunal Act to provide evidence of such an assertion. None was provided in regard to this ground and the said allegation therefore remains unproved.g.The Tribunal holds the view that the Appellant did not provide any other reasonable cause that was capable of persuading the Tribunal that it had made sufficient efforts to recover the debts owed and these efforts did not bear any fruit. The writing of a demand letter and doing business with an entity that is situated in a Country that is experiencing harsh economic situation does not automatically mean that the companies situated in such countries would not be able to pay their debts. This position was affirmed by the fact that UAP Insurance that is based in Southern Sudan paid its debt in 2016 and the Appellant has also continued to do business in Ethiopia, South Sudan and Sudan while on the other hand alleging that transactions involving entities in these Countries qualify for bad debt provisions.

69. The foregoing analysis brings to fore the reality that the Appellant’s decision to make provisions for bad debts amounting to Kshs 69,364,748. 00 inclusive of penalties and interests has not passed the minimum threshold prescribed under Section 15(2) of the ITA as read with Paragraphs 1 and 2 of the Legal Notice No 37 of 2011. It cannot therefore, be allowed to stand.

70. This position was affirmed in Nrb TAT No 72 of 2017 I & M Bank Kenya Ltd v Commissioner of Domestic Taxeswhere this Tribunal stated that:“Thus, it is the Tribunal’s view that the Commissioner’s Guidelines applies on so far as determining whether or not a doubtful debt can be deemed to be uncollectible.On the basis of the foregoing, the Tribunal has taken into account the Commissioner’s Guidelines in determining whether the various provisions made by the Appellant are allowable for deduction or not.”

71. The Tribunal is emphatic that this position still holds true. The analysis of the Appellant’s action by the Tribunal shows that it has failed to bring its debt recovery actions within Section 15(2) of the Insurance Act and Paragraphs 1 and 2 of the Legal Notice No 37 of 2011. Consequently, the Tribunal finds and holds that the Respondent did not err when in its objection decision when it disallowed the Appellant’s bad debts provisions for failure to meet threshold of Section 15(2)(a) of ITA and the Paragraphs 1 and 2 of the Legal Notice No 37 of 2011.

Final Decision 72. The upshot of the foregoing analysis is that the Appeal is partially merited and the Tribunal accordingly proceeds to make the following Orders :-a.The Appeal be and is hereby allowed partially.b.The Respondent’s confirmation decision for a demand for Corporation tax amounting to Kshs 152,786,876. 00, inclusive of penalties and interest be and is hereby set aside.c.The Respondent’s decision to disallow the appellant’s provision for bad debts of Kshs 69,364,784. 00 and its tax demand against the Appellant for income tax inclusive of penalties and interests in respect of the disallowed provisions for bad debts be and is hereby upheld.d.Each party to bear its own costs.

73. It is so ordered .

DATED AND DELIVERED AT NAIROBI THIS 10TH DAY OF MARCH, 2022……………………………ERIC N. WAFULACHAIRMAN……………………………RODNEY O. OLUOCHMEMBER……………………………EDWIN K. CHELUGETMEMBER