[2023] KETAT 106 (KLR)

Firtree Limited v Commissioner of Domestic Taxes (Tribunal Appeal 37 of 2022) [2023] KETAT 106 (KLR) (10 February 2023) (Judgment)

Neutral citation: [2023] KETAT 106 (KLR)

Republic of Kenya

In the Tax Appeal Tribunal

Tribunal Appeal 37 of 2022

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

February 10, 2023

Between

Firtree Limited

Appellant

and

Commissioner of Domestic Taxes

Respondent

Judgment

Background 1. The appellant is a limited liability company incorporated under the Companies Act of the laws of Kenya, with its registered offices in Nakuru and involved in the business of letting of commercial property.

2. The respondent is a principal officer appointed under section 13 of the Kenya Revenue Authority Act and Kenya Revenue Authority is a Government agency mandated with the responsibility of assessment, receipt and accounting for all Government tax revenue, and the administration and enforcement of all the laws set out in the Schedule to the Act.

3. The appellant owns a building in Nairobi, Bunyala Road, off Uhuru Highway situated on LR No. 37/132 comprising of commercial rental units with various tenants chargeable to rent. The appellant on boards tenants who pay a refundable deposit of either two or three months as a security deposit. The appellant is obligated to refund the rent deposit to each tenant on termination or expiry of the tenancy.

4. The respondent through its South Rift Valley Reginal Audit Centre conducted an audit on the appellant. Vide a letter dated September 20, 2021, the respondent issued audit findings assessing additional Corporation income tax of Kes 14,041,200. 28.

5. The appellant objected to the respondent’s audit findings via an objection notice dated October 1, 2021 and the respondent issued their objection decision on the November 15, 2021 whereon the corporation tax assessment was reviewed to Kes 10,6712,938. 00.

6. The appellant being dissatisfied with the objection decision commenced the Appeal process herein.

The Appeal 7. The appellant in its memorandum of appeal dated December 29, 2021 set out the following grounds of appeal;i.That the respondent erred in law by subjecting VAT and Corporation tax on pro forma invoices contrary to the provisions of the VAT Act 2013 and the Income Tax Act.ii.The respondent has erred in fact by forming an opinion that the appellant underdeclared and understated its rental income.iii.The respondent erred in fact and law by disallowing loan interest claim of Kes 10,723,213. 00iv.The respondent erred in law by recognizing rent deposits and proforma invoices as revenue.

8. The appellant by reason of the grounds aforesaid has prayed that the Appeal herein be allowed and the respondent’s objection decision dated November 15, 2021 be set aside.

The appellant’s Case 9. The appellant set out its case in the Statement of Facts dated 29th December 2021 and the written submissions filed on 16th August 2022.

10. The appellant stated that the respondent analyzed the appellant’s sales invoices, pro forma invoices, credit and debit notes, bank statements and tenancy agreements and that despite the fact that the appellant availed the aforementioned documents to the respondent, they erroneously concluded that the appellant’s debtor amounts were understated as the deemed rent amounts as per the aforementioned analysis were less than the amounts as per the sales invoice analysis.

11. The appellant also stated that the respondent in their assessment, erroneously assessed tax on rent deposits amounting to Kes4,689. 00 in the period under review. They stated that the Finance Act of 2008 amended the VAT Act by including renting, leasing, hiring, or letting of non-residential buildings in the list of taxable services and that the respondent thereafter publicized guidelines thereto known as “ Guidelines on Taxation of Non -Residential Buildings.” which concisely states ; “ Refundable rent deposit will not be taxable. However, when such deposit is applied to meet rent charges, tax must be accounted for.”

12. The appellant submitted that rent deposits are not taxable income and are only to be taxed once the landlord is not obligated to return the same to the tenant.

13. The appellant stated that the respondent improperly considered rental deposits amounting to Kes 2,473,735. 00 collected by the appellant from Trident Insurance Company Ltd as revenue and resulted to irregularly computed VAT amounting to Kes 395,797. 00 and Corporation tax amounting to Kes 742,120. 00.

14. The appellant submitted that the security rent deposit in question was not to be considered as income nor subjected to tax.

15. In totality the appellant submitted that the respondent also improperly assessed VAT and Corporation Tax amounting to Kes 1,137, 918.

16. The appellant further stated that the respondent charged tax against pro forma invoices raised by the appellant to three of its tenants, namely;a.Trident Insurance company Ltdb.Kevin International Group Africa Ltdc.Tushiya Ministries.

17. That the proforma invoices issued to Trident of Kes 2,728,975. 00 in 2017 , Kes 8,956,884. 00 in 2018, Kes 9,819, 165. 00 in 2019 and Kes 11,006,508. 00 in 2020 were considered by the respondent as revenue to the appellant yet the proforma invoices did not constitute invoices or receipts. The appellant averred that there was no rent received from Trident during this period.

18. The appellant cited the cases of Great Lakes Co LTD (U) Ltd v Kenya Revenue Authority [2019] eKLR 720 and Zacharia Waweru Thumbi v Samuel Njoroge Thuku (2016)eKLR where the courts held that:-“a proforma invoice is a commitment to purchase goods at a specific price. It is not a receipt in any shape or form whatsoever as such cannot be used to attest as to the existence or acquisition of goods. It is only a receipt that confirms proof of payment.”

19. The appellant also stated that the respondent in their analysis for year 2020 inaptly adjusted the appellant’s revenues to include pro forma invoices raised to Trident for the quarter December 2020 to March 2021. The appellant averred that its accounting period year end on 31st December each year. The additional revenue attributed for the year 2020 by the respondent of Kes 2,133,642. 00 is actually unearned revenue.

20. The appellant invited the Tribunal to take judicial notice that the aforementioned Trident Pro forma invoices will be allowed as bad debts and as such it will have a nil effect on the appellant’s Corporation income tax.

21. The appellant classified the aforementioned amount as a bad debt having met the threshold for bad debts as envisaged in the “ Income Tax Act Guidelines on Allowability of Bad Debts”.

22. The Appellant submitted that section 2(f) of the aforementioned bad debts guidelines provide that “efforts to collect the debts are abandoned for a reasonable cause.”

23. The appellant averred that it is justified in treating the rent due from Trident as a bad debt due to the following reasons;a.Trident vacated the appellant’s premises without the appellant’s knowledge; andb.The appellant was unable to locate Trident to their new offices due the prevailing Covid-19 restrictions on movement prevailing at the time.

24. It was also the appellant’s averment that the respondent also assessed to tax, pro forma invoices issued to Kevin Group and Tushiya for the period July 2020 to September 2020 and August 2018, respectively. The appellant contended that it was grossly inaccurate for the respondent to do so since Kevin Group was not a tenant of the appellant in the period July 2020 to September 2020.

25. The appellant asserted that it provided the respondent with the memorandum of understanding, renewal of tenancy agreement and email correspondence to prove Kevin Group’s absence from the appellant’s property.

26. The appellant also stated that the respondent assessed to tax further proforma invoices issued to Crown Motors Ltd for December 2020 amounting to Kes 11,217,558. 00. The appellant asserted that this was grossly inaccurate as the proforma invoice was issued awaiting conclusion of a dispute in the rental agreement between Crown Motors Group Ltd and the appellant, and the appellant did not issue tax invoices at the particular time.

27. The appellant also averred that the tenancy agreement for Tushiya was availed to the respondent and confirmed that the effective date of billing of rent was to commence in September 2020 , thus the respondent ‘s contention that the revenue for this tenant for the period of August 2018 was not charged to tax is completely flawed as there was no revenue from Tushiya in the period of August 2018 .The respondent therefore improperly and erroneously assessed an amount of Kes 2,266,044 that was alleged rental income for September to December 2020 from the subject tenant yet the appellant billed rent from 1st January 2021.

28. The appellant also submitted that on 15th July 2016, an affiliate of the appellant, Harleys Ltd, applied for a loan amounting to Kes 100,000,000, from M Oriental Bank Ltd on behalf of the appellant. That once the loan was granted to Harleys, it was assigned the loan vide a loan assignment agreement dated 16th August 2016 with the appellant and M Oriental Bank Ltd and the appellant took up the loan terms with the Bank as well as all the responsibilities of Harleys to the Bank.

29. That the appellant utilized the loan to facilitate the operations of its business. The respondent disallowed a sum of Kes 10,723,213. 00 as loan interest claimed by the appellant in the Financial year 2016/2017.

30. That the respondent contended that the loan interest was on an M Oriental loan taken by Harleys Limited.

31. The appellant stated that the loan in question was taken during the appellant’s infancy period of operations in 2016. That the loan was intended to secure funds for the appellant’s business operations, and the Board of Directors took a Commercial decision that saw an account being opened at M Oriental bank on behalf of the appellant to receive the loan amount pending the registration process of the appellant, that would subsequently permit the appellant to open a bank account.

32. The appellant submitted that the respondent ought to have allowed the loan with the interest expense of Kes 10,671,938. 00, which they disallowed.

appellant’s Prayers 33. By reason of the aforesaid submissions the appellant prays that the Honourable Tribunal allows the Appeal herein and sets aside the respondent’s objection decision dated November 15, 2021.

34. The appellant also prayed that the additional assessment of Kes 10,671,938. 00 be expunged in totality and the disallowed loan interest expense of Kes 10,723,213. 00 be wholly allowed.

The respondent’s Case 35. The respondent has set out its response to the appellant‘s case in its Statement of Facts filed on 28th January 2922 and the written submissions filed on September 14, 2022.

36. The respondent stated that the appellant was flagged out in the “VAT Credit Filers Data’’ for December 2019, with an aim of turning around the appellant to a payment filer.

37. The respondent stated that from the returns filed on iTax, it was revealed that the appellant was a VAT credit filer (with an initial credit of Kes 81. 7 claimed in March 2017), PAYE nil filer and Income Tax non-filer as at June 2020.

38. The respondent averred that it sent the appellant the first notice of intention to review the returns for the period 2016 to 2019 on 15th June 2020 and on 22nd October 2920, the appellant provided the bank statements, the sales and purchase ledgers, the sales invoices and VAT control accounts for the period July 2016 to July 2020.

39. The respondent stated that a review was conducted and the findings were that for the period ending 2017, 2018, and 2019, undeclared income for income tax purposes was Kes 61,490,814. 00, Kes 74,482,496. 00 and Kes 56,911,964. 00 respectively while undeclared sales for VAT purposes as at 31st August 2020 amounted to Kes 146,438,906. 00.

40. The respondent stated that on I5th November 2021, after a review of further documentation provided by the appellant confirming that a total principal Corporation tax of Kes 10,819,141 for the period 2017 to 2020 was payable.

41. In response to the appellant that the respondent erroneously assessed tax on rent deposits amounting to Kes 4,689,144 in the period under review, the respondent stated that a review of the appellants ‘s records indicated that the appellant was on chargeable profit for the period 2017 to 2020, with a Corporation tax liability of Kes 30,063,329. 00.

42. With regard to rental income, the respondent states that the company‘sDTB Bank Kes Account, rent deposits were analyzed together with the accounts receivables (rent debtors) as per the appellant’s audited accounts to determine the rental income earned during the period. It was observed that the debtors’ amounts were understated as the deemed rent amounts as per this analysis were less than the amounts as per the invoices and unaccounted rent.

43. In response to the appellant ‘s contention that it erroneously disallowed its bank interest expense claim, the respondent stated that the company‘s DTB dollar account loan interest payments were analyzed together with the loan schedule to determine the allowable loan interest amounts and it was observed that for the period 2016 to 2017, the amount of loan interest claimed was overstated by a sum of Kes 10,723,213. 00 which was on an M Oriental bank loan taken by the related company, Harley’s Limited and thus should be claimed by Harley’s since related parties’ loans are interest free.

44. The respondent stated that since the loan interest claimed had been overstated, the allowable amount of loan interest claimed for the period 2016 /2017 was therefore adjusted. The overclaimed loan interest amount for the period 2016/2017 was adjusted by reducing the amount claimed by the variance of Kes 10,723,213. 00.

45. The respondent further stated that its not bound by a tax return but has the power to amend the return to ensure the taxpayer is liable for the correct amount of duty, as per section 24 of the TPA which makes provision for the submission of returns.

46. The respondent further stated that the assessments were based on Section 31 of the TPA which make provision for the amendment of the original assessment by the Commissioner.

47. The respondent asserted that the appellant did not provide any evidence contrary to the basis of the respondent’s assessment when it is clear the burden of proof entirely lies on the appellant as provided for under Section 30 of the TAT Act.

48. The respondent relied on the case of Prima Rosa Flowers Ltd v Commissioner of Domestic Taxes [2019] eKLR, where the High Court relied on Mulherin v Commissioner of Taxation [2013] FCAFA 115 in which the Federal Court of Australia held that in tax disputes , the taxpayer must satisfy the burden of proof to successfully challenge income tax assessments.

49. That the onus is on the taxpayer in proving that the assessment was excessive by adducing positive evidence, which demonstrates the taxable income on which it ought to have been levied.

50. The respondent further relied on the case of Ushindi Exporters Ltd v Commissioner of Investigations and Enforcement TAT No. 7 of 2015, in which the Tribunal held that,“The burden of proving that the tax assessment is excessive or should have been made differently never shifts to the respondent and placed squarely on the appellant as section 30 (a) and (b) of the Tax Appeals Tribunal Act states…”.

51. The respondent also cited the case of Commissioner of Domestic Taxes v Metoxide Limited [2021].

52. The respondent stated that on the decision to confirm the appellant’s Corporation tax of Kes 10,819,141. 00 it relied on section 3(1) and (2) of the Income Tax Act, which makes provision for the charging to tax of gains or profits from among others, any right granted to any other person for use or occupation of property.

53. The respondent stated that in the subject matter, the appellant was deriving gains or profits from the letting of commercial property, which gain the appellant had to declare the correct tax position.

54. The respondent submitted that section 16(1) of the Income Tax Act provides for exceptions of the deductions which include expenditure or loss which is not wholly and exclusively incurred in the production of that income. In determining whether the loan interest was wholly allowable, the respondent invited the Tribunal to appreciate the case of Hancock v General Reversionary and Investment Company M-(1919) 1KB25 where Lush , J. said that;“… the proper test to apply is this; was the expenditure incurred in order to meet a continuing business demand, in which case it should be treated as an ordinary business expense and an admissible deduction , or was it an expenditure incurred once and for all in which case it should be treated as capital outlay…”

55. The respondent submitted that in the appellant‘s case, their DTB Dollar account loan interest payments were analyzed together with the loan schedule to determine the allowable loan interest amounts and they observed that for the period 2016/2017 the amount of loan interest claimed was overstated by Kes 10,723,213. 00 which was on an M- Oriental bank loan taken by a related company Harley’s Limited and ought to have been claimed by Harleys since related parties’ loans are interest free.

56. The respondent further submitted that since the loan interest claimed had been overstated, the allowable amount of loan interest claimed for the period 2016 to 2020 was adjusted. The overclaimed interest amount for the period 2016 to 2017 was adjusted by reducing the amount claimed by the variance of Kes 10,723,213. 00.

57. It was the respondent’s submission that the decision was arrived at after the assessment of the documents provided by the appellant.

58. The respondent submitted that during the assessment, they observed that the appellant’s debtors’ amounts were understated as the deemed rent amounts as per the respondent’s analysis were less than the amounts as per the sales invoice’s analysis.

59. The respondent submitted that their decision to confirm the appellant‘s Corporation tax of Kes 10,819,141. 00 and their objection decision dated 15th November 2021 is proper in law, as the appellant has failed to discharge their burden of proof pursuant to the provisions of Section 56(1) of the TPA.

Respondent’s Prayers 60. The respondent therefore, in view of their foregoing submissions prayed to the Honourable Tribunal to uphold the objection decision dated 15th November 2021 confirming the Corporation tax assessment for the tax period 2016/2017 in the sum of Kes 10,189,141. 00 and to dismiss the appellant’s Appeal.

Issues For Determination 61. The Tribunal having considered the pleadings and the written submissions made by the parties is of the considered view that the Appeal herein distils into one issue for determination being;

Whether the respondent’s assessment and objection decision were proper in law and justified. 62. The appeal is grounded on three specific objections to the respondent’s assessments, namely;a.That the respondent subjected the VAT and Corporation tax on pro forma invoices contrary to the provisions of the VAT Actand Income Tax Act and thereby erred in making the assessment,b.That the respondent recognized rent deposits as revenue and also arrived at the wrong opinion that the appellant understated and underdeclared the rent revenue and thereby erred in making the assessment,c.That the respondent unjustifiably disallowed the loan interest claim of Kes 10,723,213. 00 thereby arriving at an erroneous assessment.

63. The appellant has submitted that the proforma invoices it had issued to the tenants did not constitute revenue but was rather a notification of amounts expected to be paid. However, the respondent in their response stated that the appellant did not issue the respondent with evidence indicating that the documents were not receipts or unearned revenue and that the amounts thereon remained unpaid.

64. The appellant in its statement of facts attached various proforma invoices, but there is no evidence adduce to verify the alleged non-payment. The respondent stated that as the appellant did not provide any evidence, they had no other recourse other than to assess on the basis of the financial statements on the rent bankings.

65. The appellant has submitted that it is to write off the amounts of rent alleged unpaid by the subject tenants, on the basis that the tenant moved out without notice. One of the tenants and the main one for this matter being a prominent insurance firm, which cannot merely disappear into thin air. The appellant has not submitted sufficient evidence to prove the exhaustive means they did apply to follow up or trace the whereabouts of the said tenant. For instance, an insurance firm is licensed and operates under the supervision of a Regulatory Authority, did they explore pursuing through this route? No evidence is provided, an indication of lack of exhaustive follow up if any.

66. The Tribunal having carefully reviewed the evidence submitted by the appellant is satisfied that the appellant did not meet the required evidentially threshold to discharge its burden of proof, and the respondent was justified in confirming this aspect of the assessment.

67. The appellant has also contended that the respondent erred in recognizing rent deposit in the sum of Kes 4,689,144. 00 as revenue and thus arriving at the wrong assessment. The respondent submitted that the appellant‘s DTB Kes account was analyzed together with the account’s receivables (rent debtors) as per the audited accounts to determine the rental income earned during the period. The respondent further averred that the debtor’s amounts were understated as the deemed rent amounts as per the analysis and were less than the amounts as per the invoices and unaccounted rent.

68. The Tribunal has reviewed the evidence adduced by the appellant in support of the foregoing contention, and with the exception of the Lease Agreements attached in respect of the alleged defaulters, evidencing provision for deposits, there was no evidence in terms of the actual deposits paid in terms of receipts and tenants’ schedule of payments, and the respondent was therefore justified basing its analysis on the bank accounts rent receivables.

69. It is quite apparent to this Tribunal that the appellant did not provide sufficient evidence contrary to the basis of the respondent’s assessments, and it is clear the burden of proof lies on the appellant to prove the respondent‘s assessment wrong through verifiable evidence.

70. In the prevailing circumstances the Tribunal is satisfied that the respondent was justified in basing its assessment on the Bank accounts rent receivables analysis in the absence of any other evidence to the contrary.

71. The other ground forming the basis of the appellant ‘s grounds of appeal is that the respondent unjustifiably disallowed the appellant ‘s Bank loan interest expense claim in the sum of Kes 10,723,213. 00, thereby arriving at the wrong assessment.

72. The respondent submitted that for the period 2016/2017 the amount of loan interest claimed was overstated, with Kes 10,723,213. 00 which was on an M- Oriental loan taken by the related company Harley’s Limited, and therefore ought to have been claimed by Harley’s Limited since related parties’ loans are interest free.

73. The respondent submitted that since the loan interest claimed was overstated, the allowable amount of loan interest claimed for the period 2016/2017 was adjusted.The overclaimed interest amount for the period 2016/2017 was adjusted by reducing the amount claimed by the variance of Kes 10,723,213. 00.

74. The Tribunal upon review of the documents submitted by the appellant and with regard to the response and submissions made by the respondent is satisfied that the loan interest expense claim having been overstated, and being a related party loan which is otherwise interest free ought to have been claimed by the party who was advanced the loan by the Bank ie. Harleys Ltd and not the appellant.

75. The Tribunal, in the forgoing circumstances finds that the respondent was justified in arriving at the decision on the assessment regarding the bank loan interest claim of Kes 10,723,213. 00.

76. In light of the foregoing findings on all the appellant‘s grounds of appeal, the Tribunal comes to the inescapable conclusion that the appellant‘s Appeal lacks merit and the confirmed tax assessments on the part of the respondent were in the circumstances well founded.

Final Decision 77. The upshot of the foregoing analysis is that the appeal fails and the Tribunal accordingly proceeds to make the following Orders;a.The Appeal be and is hereby dismissed.b.The respondent’s objection decision dated 15th November 2021 be and is hereby upheld.c.Each party to bear its own costs.

78. It is so ordered.

DATED AND DELIVERED AT NAIROBI THIS 10TH DAY OF FEBRUARY, 2023. ERIC N. WAFULACHAIRMANROBERT M. MUTUMAMEMBERRODNEY O. OLUOCHMEMBEREDWIN K. CHELUGETMEMBER