[2021] KEHC 8047 (KLR)

IN THE HIGH COURT OF KENYA

AT NAIROBI

MILIMANI LAW COURTS

COMMERCIAL AND TAX DIVISION

CORAM: D.S. MAJANJA J.

TAX APPEAL NO. E004 OF 2019

CONSOLIDATED WITH TAX APPEAL NO. 2 OF 2020

BETWEEN

EQUITY BANK KENYA LIMITED........................APPELLANT

AND

COMMISSIONER OF DOMESTIC TAXES........ RESPONDENT

(Being Appeal against Judgment of the Tax Appeals Tribunal dated 18th December 2019 in Tax Appeal No. 161 of 2017)

JUDGMENT

Introduction and Background

1. This decision concerns consolidated appeals filed by the Equity Bank Kenya Limited (“Equity” or “the Appellant”) and the Commissioner of Domestic Taxes from the judgment of the Tax Appeals Tribunal (“the Tribunal”) delivered on 18th December 2019 arising from the Commissioner’s tax assessment dated 21st June 2017.

2. Equity is a bank duly licenced under the Banking Act (Chapter 488 of the Laws of Kenya) and regulated by the Central Bank of Kenya (“CBK”). It was incorporated in 2014 following amendments to the Banking Act in January 2013 to recognize non-operating holding companies. As part of the reorganization, Equity Bank Limited (“EBL”) now Equity Group Holdings PLC (“EGHP”) hived down its banking business, assets and liabilities to the Appellant (“Equity”).

3. The Commissioner carried out a tax compliance audit of Equity’s records with regard to Corporation Tax for the year of income 2015, Excise Duty for the period August 2013 to December 2015 and Pay As You Earn (“PAYE”) taxes for the year of income 2016. It issued a tax assessment on 21st June 2017 for KES. 1,738,969,276 inclusive of penalties and interest being KES 346,147,520. 00 on account of Corporation Tax in respect to bad debts written off by the Appellant, KES 1,158,683,449. 00 on account of Excise Duty on interest and PAYE on the employees share ownership plan amounting to KES 234,138,308. 00.

4. Equity objected to the assessment by an objection notice dated 21st July 2017. The Commissioner considered the objection and issued its decision dated 19th September 2017 (“Objection decision”) in which it confirmed the assessment. Aggrieved by the Objection decision, Equity lodged its appeal to the Tribunal. The Tribunal considered the matter and by the Judgment dated 18th December 2019 set aside the Commissioner’s Tax Assessment in respect to Corporation Tax in the sum of KES. 346,147,520. 00, upheld the Commissioner’s Tax Assessment in respect to PAYE in the sum of KES. 234,138,308. 00 and held the decision in respect of Excise Duty in abeyance pending the outcome of HC COMM No. E175 of 2019.

5. Equity filed ITA No. E004 of 2019 and by its Memorandum of Appeal, dated and filed on 20th December 2019 and amended on 14th February 2020, challenged the Tribunal’s judgment on the PAYE assessment on the Employee Share Option Plan (“ESOP”) and on one of the bad debts written off. The Commissioner filed ITA No. E002 of 2020 as it was dissatisfied with the Tribunal’s decision setting aside the Corporation Tax assessment with regard to 12 of the 13 bad debts written off. The appeals were consolidated as they arise from the same judgment.

Issues for determination

6. Both parties filed their respective submissions which their advocates highlighted orally. Although the parties framed four issues for determination, this appeal may be resolved by consideration of the following questions:

a. Whether the ESOP conferred a taxable benefit on Equity’s employees and if so, the whether Equity is liable to deduct and remit PAYE.

b. Whether bad debts written off by Equity were tax deductible expenses pursuant to section 15(2)(a) of the ITA as read with Guidelines on Allowability of Bad Debts in Legal Notice No. 37 of 2011 (“the Guidelines”).

PAYE taxes on Employee Share Ownership Plan (ESOP)

7. The Tribunal considered whether Equity was liable for PAYE on the ESOP benefit accruing to its employees. The Tribunal held that the ESOP was established by Equity in 2005 for the purpose of encouraging and facilitating its employees and those of its subsidiaries to acquire shares. The Tribunal noted, inter alia, that Africa Microfinance Fund (AMF), one of Equity’s shareholders in 2005 elected to dispose of its shares. It found that the establishment of ESOP or funding of the AMF shares by ESOP did not confer a taxable benefit to the eligible employees under section 5(5)(a) of the ITA. It however found that ESOP units were granted to and subsequently vested in, eligible employees at discounted prices and that in such a case, a tax benefit arises upon vesting under section 5(5) of the ITA. It held that the value of the benefit is the difference between the market price per share and the offer price per share at the date an option is granted and that the ESOP trustees were therefore required to account for the PAYE on the staff benefit. The Tribunal concluded that Equity, as the employer, should deduct and remit to the Commissioner tax on staff benefits under section 37 of the ITA. It therefore made the finding that Equity Bank is liable for PAYE on the ESOP benefit to its employees.

8. Before I deal with this issue it is important to set out the relevant legal provisions governing taxation of employment benefits contained in sections 3(2)(a)(ii), 5(2)(b), 5(5)(a) of the ITA as follows:

Section 3(2)(a)(ii) provides:

3. (1) 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 will accrue in or derived from Kenya.

(2) Subject to this Act, income upon which tax is chargeable under this Act is income in respect of—

(a) gains or profits from—

(i) …………………………..

(ii) any employment or services rendered;

(iii) ………………….

Section 5(2)(b) provides:

5 (2) For the purpose of Section 3(2)(a)(ii), “gains or profits” includes -

(a) ……………………………

(b) save as otherwise expressly provided in this section, the value of a benefit, advantage, or facility of whatsoever nature the aggregate value whereof is not less than thirty-six thousand shillings granted in respect of employment or services rendered;

Section 5(5)(a) states:

5(5) Notwithstanding any other provision of this Act, the value of the benefit excluding the value of premises as determined under subsection (3) and the value of benefit determined under subsection (2B) for the purposes of this section, shall be the higher of the cost to the employer or the fair market value of the benefit:

Provided that—

a. in the case of an employee share ownership plan, the value of the benefit shall be the difference between the market value, per share, and the offer price, per share, at the date the option is granted by the employer;

9. Equity’s case is that in 2005, AMF which was one of the major shareholders of EBL elected to dispose of its shares. EBL established an ESOP in order to encourage its employees to acquire shares. Once established, the ESOP purchased all the shares from AMF through eligible employees and from a loan obtained from British American Insurance Company (“BRITAK”). Equity therefore assails the Tribunal for failing to understand the manner in which the ESOP was established and its relationship with its employees. It submits that the entire funding for the shares, including procuring the loan from BRITAK was obtained without financial assistance or input from Equity or EBL which was not in existence at the time.

10. Equity contends that neither it nor EBL offered its shares or put down any investment in the ESOP and that its role was limited to setting up the trust by payment of KES 1,000. 00 for logistical reasons. It further states that EBL shares were not conferred on the trust as a benefit to its employees, and that the only EBL shares transferred to the trust are the shares previously owned by AMF and purchased using funds from BRITAK and the employees in an arm’s length transaction. It adds that the trust is a separate legal entity from EBL and Equity, with its own accounts and trustees and as an independent entity, it reports its financial statements separately from either Equity or EGHL and that it is the Trust that undertook the roles of inviting subscriptions for units to be allotted, receive subscriptions from employees, allotment of shares and refunds of investments before vesting and after vesting, payment of value of shares sold and other administrative activities.

11. Equity submits that the ESOP established by its employees differs from conventional ESOPS established by listed companies under the Capital Markets Authority (Collective Investments Scheme) Regulations, 2001 (“CMA CIS Regulations”) to enable their employees own shares subject to the approval of and registration by the Capital Markets Authority (“CMA”). In such ESOP’s, the company prescribes the share price, the number of shares each employee gets and which employee will get them. Unlike the ESOPs contemplated under the CMA CIS Regulations, Equity submits that neither it nor EBL set up the trust, registered it with CMA, set aside shares for acquisition by select employees or offered interest free loans for acquisition of shares. In the circumstances, Equity submits that the Tribunal erred in finding that the trust was an ESOP contemplated under the CMA CIS Regulations.

12. Equity also attacks the Tribunal for finding that Equity established an ESOP for employees contrary to the evidence on record. It points out that the Settlement Deed which clearly defines the term “ESOP” to mean the “Equity Bank Employees Share Ownership Plan” demonstrates that it was a result of the employees concerted effort to acquire shares in AMF. It points out the Tribunal failed to consider that the assessment demand was issued erroneously as Equity was not in existence until 2014 hence it could not have set up the ESOP in question even if the court was to construe the trust as an ESOP within the contemplation of the CMA CIS Regulations. It points out that EBL was not a listed company and as such the CMA CIS Regulations were not applicable to the Trust.

13. Equity also impugns the Tribunal’s finding that the tax benefit is the difference between the market price share and the offer price per share at the date the option is granted. It points out that in this case, the purchase of shares was by the trust set up and financed by the employees’ independent initiative, involving an arm’s length purchase transaction of shares by a departing shareholder at market price, and not at discounted prices to enable employees purchase, as would happen in a conventional ESOP. Further that EBL did not have an ESOP as contemplated under the CMA CIS Regulations, or at all, and thus did not and could not incur any cost to confer benefit enjoyed by employees, therefore it would be unfair and unconscionable to demand tax from the employer where it did not utilize its taxable income to meet the cost of providing the benefit.

14. Equity submits that the mischief that sections 5 and 3 (2) (a) (ii) of the ITA seeks to address is to ensure that tax is chargeable on any benefit, gain or advantage given to an employee from his employer. In this instant case, both Equity and EBL did not incur the cost of providing the shares to the employees as it was the employees joint and independent initiative to acquire the shares at market price. EBL and the Appellant cannot therefore be said to have given the employees a benefit and the Tribunal therefore erred in upholding the Commissioner’s PAYE assessment on the ESOP.

15. Equity further submits that the ITA supports the position that for a benefit to be granted there must be cost implication to the employer as section 5(5)(a) of the ITA which provides that the value of a benefit…shall be the higher of the cost to the employer or the fair market value of the benefitwhen it contemplates the taxation of conventional ESOPS. Based on the foregoing, Equity concludes that the Tribunal’s finding that it granted a benefit to its employees was misconceived and contrary to section 5(5)(a) of the ITA.

16. The Commissioner supports the Tribunal’s decision. It submits that Equity operates an ESOP whereby the employees are given an opportunity to acquire the bank’s shares at discounted prices. It submits that eligible employees are invited to take up the offers when they are opened and that the shares allotted and taken up are held for a period of five years after which the same are vested in eligible staff. That at the vesting stage, the employee makes a decision as to whether to exercise the option granted or not. The Commissioner contends that according to the ITA if the employee opts to exercise the option, this creates a benefit, similar to any other employment benefit. This is because access to the option is only granted as a result of one’s employment and it is thus not possible to classify this as anything other than a benefit of employment.

17. The Commissioner contends that the tax position of ESOPs at the point of vesting is generally governed by section 5(5) and (6) of the ITA. It submits that section 5 basically provides for the benefit whilst sub-section 6 thereof provides for valuation. It further submits that this therefore confers a clear taxable benefit to the staff who took up the offer. Any offer of shares at below the prevailing market price confers a benefit to the beneficiary or beneficiaries. It contends that Equity offered shares to its eligible employees in 2011 which were vested in 2016. That on vesting the shares, the bank did not charge PAYE appropriately as provided for by the ITA.

18. The Commissioner submits that Equity’s employees were given an opportunity to acquire the shares at discounted prices, a clear conferment of a benefit accruing from their employment. As such, Equity being the employer through which the employees derived their right to participate in the ESOP scheme, it was liable for the resultant tax liability in line with section 5(5) of the ITA which brings to charge the value of such benefits in respect of ESOPs that are registered with the Commissioner, the taxable value being the difference between the market value per share and the offer price per share at the date the option is granted by the employer.

19. The Commissioner submits that section 5(5)(a) of the ITA states that the benefit under ESOPs shall be considered to have accrued to the employee either at the time the option vests in the employee or when the option is exercised by the employee, whichever is earlier. The Commissioner points out that the employees, upon leaving employment, have to surrender the shares back to the Appellant. That this is therefore a benefit to the Equity’s employees and does not go beyond employment and therefore PAYE must attach. The Commissioner relied on the case of Samuel Gachie Kamiti v Equity Bank Limited & 6 others HC COMM No. 543 of 2010 [2018] eKLRwhere an employee sued Equity for the benefits accrued to him under the ESOP upon resignation from the company.

20. Resolution of this dispute turns on the interpretation of the provisions of sections 3(2)(a)(ii), 5(2)(b), 5(5)(a) of the ITAand in so doing, the following observations of the court in Customs and Excise Commissioner v Top Ten promotions Ltd[1969] 1 WLR 1163, 1171H are apposite: -

The task of the Court in construing statutory language such as that which is before your Lordships is to look at the mischief at which the Act is directed and then, in the light, to consider whether as a matter of common sense and every day usage the known, proved or admitted or properly inferred facts of the particular case brings the case within the ordinary meaning of the words used by Parliament.

21. The purpose to these provisions is to ensure that any benefit, gain or advantage given to an employee is taxed as income. The question then is whether membership of an ESOP confers a benefit to an employee. I do not think that the answer to this question depends on the manner the ESOP is formed but whether the subject falls within the wording of the statute. In Kenya Revenue Authority v Republic(Exparte Fintel Limited) NRB CA Civil Appeal No 311 of 2013 [2019] eKLR cited with approval the case of Inland Revenue Commissioners v Duke of Westminster [1936] A.C. 1; [1] 19 TC 490 where Lord Atkinson elucidated the rule of construing tax laws as follows;

It is well established that one is bound, in construing Revenue Acts, to give a fair and reasonable construction to their language without leaning to one side or the other, that no tax can be imposed on a subject by Act of Parliament without words in it clearly showing an intention to lay the burden upon him, that the words of a statute must be adhered to, and that so-called equitable constructions of them are not permissible.

22. On the approach to interpretation of tax statutes, more recently the Court of Appeal in Commissioner of Domestic Taxes (Large Taxpayers Officers) v Barclays Bank of Kenya Ltd NRB CA Civil Appeal No. 195 of 2017 [2020] eKLR observed as follows:

There is no doubt in our minds that the decisions in Adamson v Attorney General [1933] AC 247, Cape Brandy Syndicate v. Inland Revenue Commissioners [1920] 1 KB 64, T. M. Bell v. Commissioner of Income Tax [1960] EA 224, Republic v. Commissioner of Income Tax ex parte SDV Transami [2005]eKLR and the first judgment represent a correct statement of the law, namely strict construction of tax legislation, so that the tax demand must fall within the terms of the statute without ambiguity. If there’s any ambiguity in the legislation, it is not to be rectified by considerations of intendment, but by amending the legislation. However, determination of whether there is clarity or ambiguity in the legislation or whether a tax demand is precise and within the terms of the legislation, is not an abstract or pedantic exercise. It must be based on the evidence and the circumstances of each case. We agree with the majority of this Court in Stanbic Bank Ltd v. Kenya Revenue Authority [2009] eKLR that meaning of words should not be strained so as to find ambiguity.

23. Section 3(2)(a)(ii) of the ITA includes any, “gains or profits” from employment and services rendered as income which is chargeable with tax. Section 5(2)(b) thereof expounds on the meaning of “gains and profits” and brings the, “benefit, advantage or facility” granted in the course of employment within the meaning of gains or profits from employment as stated in section 3and sets a threshold of the value of the benefit to be brought to charge to be any benefit in excess of KES 36,000. 00.

24. It is not dispute that the purpose of an ESOP is to enable an employee of a company acquire shares in the company. In Samuel Gachie Kiniti v Equity Bank Limited and Others (Supra), Equity’s position on the ESOP was explained by its witnesses in that case as follows:

[28] The ESOP was established for the purpose encouraging or facilitating the holding of shares in the company for the benefit of the Bank’s employees. It was also purposed to serve as an incentive for the employees to remain with the Bank and it is for this latter reason that a minimum period of service before Vesting of the Units was agreed upon by the Staff of the Bank in the meeting at Nyeri at the time of inception of ESOP in 2005. The employee would on the other hand benefit from appreciation in the value of the investment in ESOP if they remained for 5 years and worked with others to better performance of the Bank which would in turn rise to better share performance.

25. Whereas Equity claims that it did not suffer or incur any cost in establishing the ESOP except for expending KES 1000. 00, the ESOP conferred the employees a, “benefit, advantage or facility” of acquiring the shares in the company which is chargeable with tax. It is the, “benefit, advantage or facility” conferred by the ESOP that entitles the employee to obtain shares which confers the benefit that is subject to taxation and not the cost to the employer. In an ESOP, whether registered with the CMA or not, the employee receives the benefit of getting shares in the company by virtue of his or her position as an employee. In other words, the benefit is dependent on one being an employee. Once the shares are offered and acquired, the appreciation in value is the benefit that accrues to the employee until the date of vesting which is the date the benefit is taxed. Further, it is important to note the deliberate use of "benefit, advantage or facility" broadens the meaning of the nature of the benefit. For example, an ESOP is a facility afforded to the employee by virtue of employment and it confers an advantage by giving the employee the benefit of acquiring shares as opposed to any other taxpayer.

26. The fact that section 5(5)(a) of the ITA provides for the manner of determination of the value of the benefit of an ESOP buttresses the position that an ESOP confers a benefit to an employee and therefore subject to tax. If the ESOP did not confer a benefit, then the ITA would not have specifically provided for the manner of calculation of the benefit. As I pointed out section 5(5)(a) only deals with the manner of ascertaining the value of the benefit. Thus the argument by Equity that in order to benefit there must be cost to the employer is not borne out of the statutory language.

27. Under section5(5)(a) of the ITA, the value of the benefit will be the difference between market price per share at the time of vesting and the offer price per share at the date an option is granted. In this respect, the benefit to the employee arises from the fact that value of shares, whether or not they are issued at a discount, would ordinarily appreciate at the time of vesting. The appreciation in value is the benefit to the employee that is taxed. In this respect therefore, Equity’s argument that it did not incur a cost to provide a benefit to its employees is not germane or relevant to the determination of the benefit to the employee under section 5(5)(a) of the ITA.

28. In conclusion, I find and hold that the Tribunal did not err in concluding that Equity, as an employer, should deduct and remit to the Commissioner tax on staff benefits under section 37 of the ITA. It therefore made the correct finding that Equity Bank is liable for PAYE on the ESOP benefit to its employees.

Whether bad and doubtful debts are tax deductible

29. The Tribunal determined that the bad and doubtful debts were tax deductible expenses in twelve of the thirteen cases, and that the same were improperly subjected to Corporation Tax. The controlling provision in resolving this issue is section 15 (2)(a) of the ITA which provides as follows;

15 (2) Without prejudice to sub-section (1) of this section, in computing for a year of income the gains or profits chargeable to tax under section 3(2)(a) of this Act, the following amounts shall be deducted:

a. bad debts incurred in the production of such 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 such year of income and the Commissioner may prescribe such guidelines as may be appropriate for the purposes of determining bad debts under this subparagraph;

30. The Commissioner contends that the under section 15(2)(a) of the ITA for a debt to be considered bad, it must be uncollectable, hence a doubtful debt not proven uncollectable is not bad and can only be an allowable deduction if it is bad or has become bad, incurred in the production of gains or profit and must be estimated to the satisfaction of the Commissioner to have been bad.

31. The Commissioner’s discretion is circumscribed by objective parameters issued as Guidelines pursuant to section 15(2)(a) of the ITA. The Tribunal found, and I agree, that these Guidelines mirror the Prudential Guidelines issued by the Central Bank of Kenya (CBK/PG/04 of January 2013) for the provisioning of bad and doubtful debts. The Guidelines set out the criteria for deducting bad debts in establishing income chargeable with tax. 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.” These circumstances under which such a debt is considered uncollectable are enumerated under Paragraph 2 which states as follows:

2. 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 realisable 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; or

f. efforts to collect the debt are abandoned for another reasonable cause.

32. In reaching its determination, the Tribunal concluded that customers were not related to Equity in any way and that Equity, “strove to collect its debts using reasonable available means under the circumstances of each facility, save for one customer as shown above.” The Tribunal referred to the case of Soma Properties Limited v HAYM NRB CA Civil Appeal No. 74 of 2005[2015] eKLR where the Court of Appeal held that:

The words “reasonable and reasonably….is a standard measure against the care to be exercised by a reasonably prudent person in all circumstances including the practice and usages prevailing in the community and the common understanding of what is practicable and what is to be expected. The standard of reasonableness is not one of perfection.

33. I agree with the test for what is ‘reasonable’ propounded by the Court of Appeal and applied by the Tribunal as for the reasonableness is the objective standard for review upon which the Commissioner’s discretion must be measured. I would also add that in order to benefit from a tax deduction on account of a bad debt, the taxpayer need only establish one of the grounds set out in Paragraph 2 of the Guidelines.

34. In considering this appeal, this court is guided by section 56 of the Tax Procedures Act which provides as follows:

56. (1) In any proceedings under this Part, the burden shall be on the taxpayer to prove that a tax decision is incorrect.

(2) An appeal to the High Court or to the Court of Appeal shall be on a question of law only.

(3) In an appeal by a taxpayer to the Tribunal, High Court or Court of Appeal in relation to an appealable decision, the taxpayer shall rely on the grounds stated in the objection to which the decision relates unless the Tribunal or Court allows the person to add new grounds. [Emphasis mine]

35. In exercising appellate jurisdiction, the Tribunal is entitled to review the facts in order to establish whether the Commissioner’s decision is “incorrect”. The second appeal to this court is limited to matters of law. Following the Supreme Court decision in Gatirau Peter Munya v Dickson Mwenda Kithinji and 2 Others [2014] eKLR, the Court of Appeal in John Munuve Mati v Returning Officer Mwingi North Constituency & 2 others[2018] eKLR summarised what amounts to “matters of law” as follows:

[38] [T]he interpretation or construction of the Constitution, statute or regulations made thereunder or their application to the sets of facts established by the trial Court. As far as facts are concerned, our engagement with them is limited to background and context and to satisfy ourselves, when the issue is raised, whether the conclusions of the trial judge are based on the evidence on record or whether they are so perverse that no reasonable tribunal would have arrived at them. We cannot be drawn into considerations of the credibility of witnesses or which witnesses are more believable than others; by law that is the province of the trial court. [Emphasis mine]

36. It is the duty of the Tribunal as the first appellant court to evaluate the facts and reach its own conclusion whether in fact the tax decision was incorrect. It is therefore not the duty of this court to review the evidence and reach it is own conclusion but to determine whether the Tribunal’s decision was based on the evidence before or a reasonable tribunal having regard to the facts and circumstances would not have reached the decision of the Tribunal. For the record, the circumstances of each loan were as follows.

Loan 1 – Loan to Kazungu Kambi (Principal amount of Ksh. 1,850,555)

37. Equity submits that the loan to Kazungu Kambi (“Kambi”) was an overdraft on an account maintained with Equity. That since the debt was unsecured, it could only recover the loan from money held in Kambi’s account. It argues that as there was no realizable security, it satisfied the criteria set out at Para. 2(b) of the Guidelines.

38. As Kambi disputed the outstanding loan balance on the ground that the repayments made exceeded the principal loan amount, Equity entered into a One Time Settlement Agreement as Kambi had made significant payments towards the facility. In an effort to ensure as much recovery as possible, Kambi was allowed to pay a lump sum of a percentage of the debt which mainly comprised interest, in full and final settlement of the same. As there was no realisable security, Equity had no choice but to write off the loan.

39. The Commissioner contends that Equity did not demonstrate that it had exhausted all avenues to collect the outstanding debt from the debtors. That no legal recourse or any such effort was undertaken by Equity to try and recover the debt.

40. In this instance, the Tribunal observed that though it is normal business practice in the banking industry to pursue settlement by allowing payment of a lump sum like in this case, it held that, “the overdraft was unsecured, assets of the customer were not followed up for recovery and neither was the customer found and or declared bankrupt.”

Loan 2: Loan to Jetlink Express Limited (Principal Amount written off KES. 771,560,780)

41. Equity advanced a term loan facility of USD 9,400,000. 00 to Jetlink Express Limited (“JEL”) to be used primarily to complete the construction of a hangar, purchase two commercial aeroplanes; registration numbers 5Y-JLB and 5Y-JLE and to fund working capital. Subsequently and at the request of JEL, Equity agreed to restructure the facility so as to exclude the purchase of the two commercial aircraft, take over the facility with Imperial Bank and convert the overdraft with Equity Bank into a term loan and to provide working capital.

42. JEL provided the following securities to Equity to secure the above facility: a Debenture dated 23rd February 2011 creating security by way of a fixed and floating charge over all the assets of JEL to secure a maximum principal amount of up to USD 9,400,000. 00 plus interest and other sums; Assignment in favour of Equity Bank dated 23rd February, 2011 of all receivables due to JEL from IATA pursuant to the Billing and Settlement Plan System; a Charge dated 23rd February 2011 over all the issued shares in the capital of JEL created by Kiran Patel and Elkana Aluvale securing a maximum principal amount of up to USD 9,400,000. 00 plus interest and other sums; a Charge dated 23rd February 2011 over the deposits held in several accounts to be maintained by JEL with Equity securing a maximum principal amount of up to USD 9,400,000. 00 plus interest and other sums; and Corporate Guarantee and Indemnity dated 23rd February, 2011 created by Jetlink Holdings Limited (“JHL”) to secure the obligations of JEL with Equity supported by a first ranking legal charge for USD 4 Million over the aircraft hangar and office block on a 2-acre plot at Jomo Kenyatta International Airport (“JKIA”).

43. According to Equity, JEL faced major financial challenges and was unable to meet its obligations to its creditors, leading to a winding up petition being filed against it in the year 2013. Despite the existence of several winding up petitions against JEL, Equity made every effort to realise the securities to settle the outstanding loan facility. It realised a corporate guarantee by JHL which had been issued in favour of Equity and which was supported by a first ranking legal charge over the aircraft hangar and office block at JKIA. That this was the only known asset owned by JHL and Equity was able to successfully dispose of it by selling it to Aviation Management Solutions Limited (AMSL) for USD 2,000,000. 00.

44. Equity contends that it was unable to recover any amounts from JEL’s accounts as these were all overdrawn by the time the loan was written off. Accordingly, no amount could be set-off from these accounts. It further contends that it was precluded from disposing JEL’s assets because of the winding up petitions filed by the various creditors and higher-ranking claims from these creditors. When Equity evaluated JEL’s assets to determine whether they would be sufficient to cover the liabilities of JEL, it identified two aged aircraft. One aircraft was grounded at the hangar at JKIA. It required a full engine overhaul before it could be sold. Further, the cost of repairing the aircraft, which model was not popular in Kenya, would have exceeded the amount that was likely to be recovered from its disposal. The other aircraft was parked at the airport terminal at the JKIA and had incurred significant parking fees payable to the Kenya Airports Authority. The two aircraft together with other assets owned by JEL were subject to claims by other creditors including the Kenya Revenue Authority which advertised the sale of the two aircraft along with other assets of JEL to recover unpaid taxes allegedly owed to it by JEL. Accordingly, it was not possible for Equity to dispose of JEL’s assets including the two aircraft to satisfy the debt owed to it.

45. Equity stated that it had agreed with JEL that it would assign all receivables due to JEL from the International Air Transport Association (“IATA”) pursuant to the Billing and Settlement Plan, such that all payments to JEL would be settled through IATA and any such funds would be paid to Equity in order to settle the loan. At the time of default, IATA did not have funds on account of JEL that could be paid to Equity Bank owing to the fact that JEL had halted its operations in November 2012, by which time there were no receivables available with IATA on account of JEL.

46. Equity submits that from the totality of circumstances, it was unable to realise the charge it had over the shares in JEL due to the financial difficulties faced by JEL, the winding up petition filed against it and the low value of its assets. Further, the value of JEL’s shares was insignificant and no proceeds would be realisable from their sale. Equity therefore submits that while it was to satisfy any one of the Guidelines, it satisfied almost all of the criteria before writing of the JEL debt and the Tribunal’s finding that the JEL debt was allowable was well-grounded in law.

47. On the other hand, the Commissioner submits that Equity did not exhaust all efforts provided in the Guidelines. It notes that Equity was still pursuing the debt with JEL using the Court process by seeking to be enjoined in the petition for winding up JEL in Winding Up Cause No. 5 of 2013 and which judgment was delivered on 26th July 2016. That this demonstrated that Equity had securities not fully realised to secure the debt, therefore the debt is deemed not to have been bad at the time it made the decision to write it off. It also notes that Equity held other securities in the form of aircrafts parked at the airport together with other assets owned by JEL but which Equity claims were subject to claims by other creditors.

48. The Commissioner contends that Equity had securities which had not been fully realized to secure the debt and therefore the debt is deemed not to have been bad at the time of making the write off. It submitted that the Guidelines states that a debt can only be considered bad; if the securities have been realized but the proceeds fail to cover the entire debt. It submits that Equity should have made efforts to demonstrate this by first disposing off the assets and whatever proceeds were realized be used to offset the debt.

49. It adds that JEL also had deposits amounting to USD 2,500,000. 00 held in Equity Bank South Sudan for which no efforts to realize this amounts have been demonstrated given that the Bank had previously granted credit to JEL against deposits held in Equity Bank South Sudan.

Loan 3: Loan to Stout Minmetals Limited (Principal Amount written off KES. 19,742,319. 57)

50. Equity advanced a loan facility to Stout Minmetals Limited (“SML”) to finance the mining of iron ore, chrome ore, copper ore and manganese ore at Chivara in Kilifi County ("the Facility"). The funds were applied towards the hiring of machinery and equipment, storage facilities for the crushed manganese ore, road freight and pre-shipment logistics. The Facility was structured against and on the basis of a standby letter of credit ("SBLC") for USD 602,373. 13 issued by Hongkong and Shanghai Banking Corporation Limited (“HSBC”) in favour of SML. Under the SBLC, upon:

a. delivery of the consignment to the port of delivery, verification to confirm its quality and fitness for purpose, the relevant consignment verification documents including inter alia certificate of inspection, certificate of quality, bill of lading ("Verification Documents") would be delivered to HSBC;

b. receipt of the Verification Documents, HSBC would then be bound to release the purchase price for the consignment to SML by transferring into a bank account held by SML with Equity Bank as set out in the SBLC;

c. receipt of the funds into the designated account in Equity, Equity was entitled to recover the amount advanced to SML under the Facility and release the balance, if any, to SML.

51. Equity submits that recovery of the facility based on the SBLC as described above is ordinarily a reliable repayment method as SBLCs must, pursuant to the International Chamber of Commerce rules, be honoured by the issuing bank, in this case HSBC, if all applicable conditions are met. That however, since SBLCs are contingent on the satisfaction of applicable conditions, there is therefore an inherent risk that recovery may fail if the relevant conditions are not met. That a lender typically relies on alignment of interests between the borrower, as exporter, based on the existence of inter alia, an authentic mining and export licence, purchase transaction and the SBLC.

52. Equity contends that in this particular case, SML carried out the mining of the manganese ore in Kenya but did not meet the minimum manganese content requirement of the buyer. That the consignee rejected the manganese ore and, accordingly, the Verification Documents were not delivered to HSBC. Consequently, the SBLC issued by HSBC lapsed and could not be honoured and as a result, no funds were remitted into the designated account leading to a default by SML.

53. In appraising SML for purposes of the Facility, Equity obtained, inter alia, a Mining Licence issued by the Mines and Geology Department to SML which confirmed that SML was duly authorised and licensed to carry out the business to be financed. The essence of obtaining the Mining Licence was to satisfy Anti Money Laundering/Know Your Client (“AML/KYC”) requirements and, in particular, to confirm that SML was licensed and authorised to mine and export manganese. The Mining Licence was neither transferable nor assignable without specific approval from the Mines and Geology Department. Equity contends that although it is listed as a security, it did not take the Mining Licence as security but rather for AML/KYC purposes and to validate the borrowing. No value was attached to it as it was expected that the amount stated in the SBLC would be sufficient to cover the SML Facility.

54. With respect to the director’s personal guarantees, Equity conducted investigations and discovered that the individual directors had relocated from Kenya to the Democratic Republic of Congo. That despite various attempts made to recover the sums from them personally including issuing formal demand notices and instructions to debt collectors, the balance of the loan could not be recovered.

55. It was against the background aforesaid that Equity proceeded to treat the loan as a bad debt and deducted it as an expense. It stated that the Facility was written off in accordance with the Guidelines. It further urges that at the time of writing off the SML Facility, no form of security or collateral was realisable whether partially or in full and that efforts to collect the debt were abandoned for another reasonable cause as the guarantors could not be traced despite best efforts.

56. The Commissioner contends that the write off was not justified as it established that the Bank had the director’s personal guarantee and the original mining license issued by the Mines and Geology Department. It contended that Equity also did not take any legal remedies to try and recover the outstanding debt from the directors. It rejected the submission by Equity that it attempted to recover sums personally from the directors as this was not supported by any evidence and that the alleged demand notices and instructions to debt collectors remain mere allegations.

Loan 4: Loan to Nyanza Shuttles Limited (NSL) (Principal Amount written off - KES. 9,086,970. 27)

57. Equity advanced a loan to NSL to finance the purchase of two new buses from CMC Motors Limited (“CMC”). NSL contracted CMC to purchase buses manufactured in Germany but it was sold an inferior model manufactured in India. NSL only realised that it had been sold an inferior model when the buses began to break down and CMC could not repair them. At the material time, CMC was in possession of the buses as they had been delivered to its for repairs. CMC was claiming repair and maintenance costs of KES. 2,000,000. NSL instituted a suit against CMC regarding the purchase of the two buses.

58. As the buses were grounded, NSL defaulted on the loan facility. Equity contends that it hired an auctioneer to dispose of the two buses in an attempt to recover the debt. In an effort to dispose of the buses, Equity engaged market brokers to carry out market surveys and solicit bids but it was revealed that the available offer price for the two buses would be KES 400,000. 00 in aggregate. Further, it was not practically possible to auction the buses at CMC yard as CMC would only permit the buses to be removed from its premises after all repairs costs and maintenance charges were paid to it and that CMC’s claim would rank in priority over other security interests including the chattel mortgage security Equity had over the buses. It submits that due to the prior ranking legal right by CMC as bailee in possession and taking into consideration the ascertained offer price for the buses, there was no chance of recovery by Equity as the proceeds therefrom would not have been sufficient to pay CMC’s claim and retain a residue that could be claimed by Equity.

59. The Commissioner contends that Equity did not demonstrate that all reasonable steps were taken to recover the outstanding debt since by the time of making the write off, the security in the form of two buses was still not disposed of.

Loan 5: Loan to Munyeki Agricultural Marketing Unit Self Help Group (MAMU) (Principal Amount written off KES 6,373,946. 20)

60. Equity advanced a loan to MAMU, a self-help group comprising potato farmers, for on-lending to members to finance the purchase of seed and fertiliser. Under the terms of the loan, the farmers would sell their produce to Midland Company Limited (“MCL”) at a pre-agreed price. MCL would pay off the loan taken by each individual farmer to Equity in order to repay the facilities.

61. A dispute arose among the MAMU members which impeded the production and supply of potatoes to MCL leading to default by the farmers in the group. Equity contends that it made various attempts to recover the loan from members including attending a meeting with MAMU in which members were informed that auctioneers would be retained to recover the debt from the various individuals and that the matter would also be reported to the Governor’s office and to the local police. Further efforts included seeking the intervention of the Principal Secretary of the Ministry of Agriculture, Livestock and Fisheries.

62. It submits that although auctioneers were retained to recover the amounts from the individual farmers no funds were recovered. Equity’s assessment was on the erroneous basis that some of the evidence provided in support of efforts made to recover the debt were by MAMU and not Equity directly. MAMU is a self-help group that comprises over 180 members known only to the officials of MAMU. It is noteworthy that that the letters were only issued by MAMU upon receiving and as a result of a formal demand from Equity. Owing to the inability of the auctioneers to recover the funds from individual members of MAMU, Equity determined that the loan was not recoverable and wrote off the loan.

63. The Commissioner submits that Equity has not has not demonstrated that all efforts to recover the debt had been exhausted. It contends that there is no evidence of the such efforts to recover the debt from the individual farmers. That the documentation provided only supports the recovery efforts of Munyeki Agricultural unit from the individual farmers.

Loan 6 and 7: Loan to Amani Farmers Community Based Organisation (KES. 3,787,495) and to Vumilia Community Based Organisation (KES. 3,197,459)

64. Equity contends that the loans advanced were to small scale farmers organized in a group/community-based organization to farm several parcels of land known as a block. That the facility was such that a single loan was issued in respect to the whole block and guaranteed by the individual block members.

65. In the case of Amani farmers, the purpose of the loan was to fund seed maize multiplication to supply Bura Farmers Management (“BFM”) which was contracted directly by Kenya Seed Company Ltd (“KSC”) as the main grower for the whole scheme. Amani Farmers delivered their seed to KSC on behalf of BFM. That unknown to the farmers, BFM had accrued debts due to KSC from previous seasons. KSC proceeded to recover the debts owed by BFM. As a result, AmaniFarmers were not paid for their produce and the members defaulted on the loan.

66. In the case of Vumilia, members were engaged in maize farming in Bura Irrigation Scheme and would also sell to KSC under BFM’s contract. They borrowed funds from Equity for land preparation, purchase of fertilizer, operation and maintenance, de-tassling, and post-harvest handling. As with the case of Amani Farmers, Vumilia were also not paid on account of KSC recovering outstanding debts from BFM.

67. Equity contends that it did not have any contractual agreement with BFM or KSC and could not enforce collection of the loan against either of these entities. The only legal avenue Equity had for recovery is by following each individual farmer under the two schemes. While the aggregate amount written off attributable to these self-help groups is KES. 6,984,954. 00 individually members owed small amounts. It contends that on this basis, it was clear that there were no securities available which could be sold to recover the amount owed, and in any event, the cost of recovery against specific members would clearly outweigh the amount in default and therefore be uneconomical.

68. The Commissioner on the other hand submits that Equity has not demonstrated that all efforts for recovery of the debt had been exhausted. That there is no evidence that the Bank made any efforts to recover the debt from the individual farmers. The documentation provided only supports the recovery efforts made by the two organizations unit from the individual farmers.

Loan 8: Loan to Stanley Kimani Gichia (Principal Amount written off KES. 2,304,824)

69. Equity issued a loan to one Stanley Kimani for purposes of developing his business. When the borrower was unable to settle the loan, Equity disposed of a prime mover and a trailer which had been provided as the securities for the loan. The money recovered was used to offset the loan and the balance remaining was written off as the securities has been realized but the proceeds failed to cover the entire debt.

70. The Commissioner submits that Equity has not demonstrated any other effort to try and recover the outstanding debt before writing off the amount.

Loan 9: Loan to Harmo Engineering and Building Contractor (Principal Amount written off-KES. 1,731,352)

71. Equity advanced a loan to one Alison Zaphania Mogere trading as Harmo Engineeringto fund working capital requirements and acquisition of a motor vehicle. The borrower defaulted in servicing the loan facilities after it lost major contracts. Equity sold the borrower’s motor vehicle and Safaricom shares that the borrower had acquired. That the borrower did not have any other known assets that could be recovered and sold to offset the loan.

72. The Commissioners submits that Equity has not demonstrated any other effort to try and recover the outstanding debt before writing off.

Loan 10, 11 and 12: Loan to Clarion Merchandise (KES 5,419,093. 26), Collmark Trading Agencies (KES 2,650,220. 98) and Capitrade Merchants Limited (KES 3,211,830)

73. Equity Bank submits that it granted temporary accommodations on cheques to the above borrowers to accommodate cash flow. In each of the cases, the businesses experienced financial difficulties and defaulted in paying the loans. Equity Bank made formal demands for the settlement of the loans and made various attempts to recover the debts including hiring auctioneers and having them listed with Credit Reference Bureaus (CRB). It submits that it made sufficient efforts to recover the debt hence it was entitled to write off the debts in line with Paragraph 2(b), (e)and(f) of the Guidelines.

74. The Commissioner contended that Equity did not produce any evidence of correspondence between it and the loanees to support any efforts to collect the debt. Further, that Equity did not take any legal measures taken towards recovery of the loan. The Commissioner contends that the ascensions that Equity was guided by the provision of Paragraph 2(b), (e)and(f) of the Guidelines is not justifiable since there was no legal recourse or any such effort undertaken by Equity to try and recover the debt.

Loan 13: Loan to Telia Communications Limited (Principal Amount written off-KES. 5,188,276. 75)

75. Equity provided a business loan to Telia Communications Limited (TCL) against the security of a motor vehicle. When TCL defaulted on the loan, Equity disposed of the motor vehicle but was only able to recover a part of the loan. It contends that TCL did not have any other known assets that could be recovered and sold to recover the balance of the loan and its sole director has been suffering from a prolonged illness. Equity Bank was therefore unable to make any further recovery on the loan apart from the disposal of the security provided. It is on this basis that Equity Bank made the decision to write off the net balance of the loan after realisation of the security.

76. The Commissioner countered by submitting that Equity did not demonstrate that it had exhausted all avenues to collect the outstanding debt.

77. Having considered the facts, I have outlined, the arguments by the parties and the reasons proffered by the Tribunal, I cannot say that the conclusions reached by the Tribunal are unreasonable. As I stated earlier, theGuidelines do not require that Equity exhaust all the avenues for collecting the debt. It only needs to satisfy one or more of the Guidelines in order to satisfy the Commissioner. In the circumstances, I do not find any reason to interfere with the Tribunal’s decision in each instance as the conclusions reached were within the law.

Disposition

78. For the reason I have expounded above, the Tribunal came to the correct decision on both issues framed for determination in this appeal. As both appeals have not succeeded, they are accordingly dismissed. As a result, each party shall bear its own costs.

DATED AND DELIVERED AT NAIROBI THIS 31ST DAY MARCH 2021.

D. S. MAJANJA

JUDGE

Mr Nyaburi instructed by Iseme Kamau and Maema Advocates for the Appellant.

Ms Chelangat, Advocate instructed by Kenya Revenue Authority for the Commissioner of Domestic Taxes.