[2024] KETAT 1136 (KLR)

Heritage Insurance Company Kenya Limited v Commissioner of Legal Services and Board Coordination (Tax Appeal E386 of 2023) [2024] KETAT 1136 (KLR) (1 August 2024) (Judgment)

Neutral citation: [2024] KETAT 1136 (KLR)

Republic of Kenya

In the Tax Appeal Tribunal

Tax Appeal E386 of 2023

RM Mutuma, Chair, EN Njeru, M Makau, AM Diriye & B Gitari, Members

August 1, 2024

Between

The Heritage Insurance Company Kenya Limited

Appellant

and

Commissioner of Legal Services and Board Coordination

Respondent

Judgment

Background 1. The Appellant is a private limited company whose principal activity is general insurance, medical insurance and investment activities as defined by the Insurance Act.

2. The Respondent is a principal officer appointed under and in accordance with Section 13 of the Kenya Revenue Authority Act, the Authority is charged with the responsibility of among others, assessment, collection, accounting, and the general administration of tax revenue on behalf of the Government of Kenya.

3. The Respondent conducted a comprehensive audit of the Appellant income and tax returns for the years 2017 to 2019 and issued a notice of assessment dated 28th February 2023. The Appellant objected to the assessment vide Notice of Objection dated 5th April 2023.

4. The Respondent having considered the Notice of Objection, issued its Objection Decision dated 31st May 2023.

5. The Appellant being aggrieved with the decision therefore, appealed to this Tribunal vide a Notice of Appeal dated and filed on 30th day of June 2023.

The Appeal 6. The Appellant lodged Memorandum of Appeal dated and filed on 14th day of July 2023 raising the following three grounds:a.That the Respondent erred in law and fact by disallowing legally accrued and allowable expenses incurred by the Appellant in the generation of income;b.That the Respondent erred in law and fact by deeming dividend income received by the Appellant from its non-resident subsidiary to be business profits and subjecting the same to corporation income tax; and,c.That the Respondent erred in law and in fact by disallowing expenses relating to decrease in a provision necessitated by changes in the financial reporting standards applicable in Kenya.

The Appellant’s Case 7. The Appellant’s case is premised upon its;a.Statement of Facts dated and filed on 14th July 2023 together with the documents attached thereto; and,b.Written submissions dated and filed on 7th February 2024.

8. The Appellant’s case is that the Respondent conducted an audit of the books, records, and accounts of the Appellant for the period January 2017 to December 2021. The audit covered corporation and withholding tax leading to issuance of tax assessment through a letter dated 28th February 2023 wherein the Respondent demanded additional CIT of Kshs 168,657,889 in respect of dividend income, disallowed bad debt provision expense and other revenue disallowed revenue expenses. The Appellant objected to the assessments leading to issuance of the impugned decision.

A. Erroneous disallowance of revenue expenses. 9. According to the Appellant, it underwrites non-life insurance risks as defined under the Insurance Act except for micro insurance. Example of insurance products they offer to the market include motor insurance, medical insurance, employer’s liability cover, fire and perils cover, industrial risks cover, professional indemnity cover and domestic packages.

10. The Appellant introduced a new product under its motor vehicle insurance package, the DriverProfile technology, which is used to monitor the driver behaviour of insured persons during the insured period and reward diligent drivers by lowering premium in subsequent renewals. Under this arrangement, when a client purchases a motor vehicle insurance from the Appellant, the client is given the option of having the technology installed in their motor vehicle. This is in the form of telematic gadget, which contains a software that uses mobile data to record the driver activity. At the end of the insurance period, the Appellant reviews the vehicle activity information and uses the same to determine the premiums payable by the insured person in the next insurance period.

11. According the Appellant, the telematics gadgets are purchased by the Appellant at cost approximately Kshs. 2,000. 00. Once purchased, they are issued to the policy holders, and the cost thereof is included as part of the premium payments. The gadgets are usually not returned to the Appellant by the policy holders and the Appellant does not enforce recovery as the cost of recovery outweighs the cost of the gadget. This is in addition to the fact that the gadgets become obsolete within a short timeframe and hence cannot be used.

12. The Appellant’s case is that the implementation of this Technology is through a partnership agreement with DriverProfiler Limited, a company incorporated in Ireland which owns the intellectual property of the DriverProfiler Technology and supply the telematic gadgets. The Appellant averred that this business relationship is governed by a Usage Based Insurance (UBI) Agreement with DriverProfiler Limited for the grant of rights to use the DriverProfiler Technology and the associated products to monitor and collect data on the driving pattern of policy holders and the supply of the gadgets.

13. The Appellant averred that the technology provided comprises of both software (‘embedded software and related technology’) and hardware (‘telematic gadgets’), where neither would function without the other. The embedded software cannot not work without the telematic gadgets and the telematic gadgets are obsolete and of no commercial value without the software.

14. It is the Appellant’s case is that under the Agreement, the Appellant received a non-exclusive and non-transferable right to use the DriverProfiler Technology that is, solely for the intended purposes, for a specific term and subject to payment of a license fee. It argued that there was no transfer or assignment of rights in the agreement and therefore, the Appellant was not granted ownership of the intellectual property rights and that Appellant could not transfer the IP to third parties or alter the technology in anyway not permitted under the agreement.

15. According to the Appellant, DriverProfiler Limited retained all IP rights and that upon termination of the agreement, all rights would revert to DriverProfiler Limited. For insurance contract which were unexpired at the time of the termination of the agreement, the Appellant stated that the agreement allowed the Appellant to use the Intellectual Property until the termination of the contracts.

16. The Appellant averred that it was a cost to collect vehicle usage information from insured during respective insurance period for the purposes of determining premiums billable and pricing. By law the Appellant recognized the entire expense as revenue expense incurred in order to use the technology. The Appellant relied on Section 15 (1) of the Income Tax Act provides that:‘‘(1) For the purpose of ascertaining the total income of any person for a year of income there shall, subject to section 16 of this Act, be deducted all expenditure incurred in such year of income which is expenditure wholly and exclusively incurred by him……’’

17. The Respondent sought to disallow the expenses incurred by the Appellant on the premise that the same were capital expenditure and that in Objection Decision, the Respondent reclassified software license expenses as capital expenditure defined under the Second Schedule of the Income Tax Act. The Appellant averred that the Respondent misrepresented the underlying transaction forming the subject of the dispute in complete disregard to the license agreement between the Appellant and Intellectual Property provider.

18. It asserted that the Respondent erred in purporting that the telematic gadgets ought to have been recognized as a capital expenditure. According to the Appellant, recognition of the costs as capital expenditure would result in a misrepresentation of the financial statements as the Appellant neither owned the telematic gadgets nor the Technology.

19. To distinguish between capital and revenue expenditures, the Appellant relied on principles that were applied in the case of Commissioner of Income Tax vs. Kencell Communications Limited (Now Airtel Kenya Limited) [2016] eKLR, which reaffirmed common law tests from various cases, including Vodafone Essar (Gujarat) vs. The Department of Income Tax and BFH vs. Comptroller of Income Tax [2013] SGHC 161, in determining whether a licence fee is a revenue or capital expenditure. The test factors derived from these cases include:i.Purpose of Expenditure: If the expenditure has been made to create a new asset, it is likely to be capital in nature.ii.Manner of Expenditure/Principle of Recurrence and Regularity: a one-time expenditure as opposed to recurrent expenditures, is likely to suggest that the expenditure is capital in nature although this factor is inconclusive.iii.Consequence or Result of Expenditure: if the taxpayer's existing core business structure, or adds to the taxpayer’s existing co business structure, it is more likely to be capital in nature. Conversely expenditure for “assets" which are themselves the stock-in-trade of the business (or which comprise the cost of earning that income itself), such expenditure is more likely to be revenue in nature.iv.Relation to Business: If the expenditure is related to the actual conduct of the business and is seen as an integral part of the profit-earning process, it can be classified as a revenue expenditure.v.Enduring Advantage: If the expenditure leads to an acquisition of an asset or a right of a permanent character, it is likely to be seen as a capital expenditure. In contrast, costs that do not confer an enduring advantage on the taxpayer are likely to be revenue in nature.vi.Exclusivity: If the expenditure confers an exclusive right or a monopoly to the taxpayer, it is more likely to be seen as a capital expenditure.

20. According to the Appellant, applying these principles to the issue at hand, it becomes evident that the expenditure on telematics gadgets, being the hardware component of the technology, by the Appellant can be more appropriately classified as a revenue expenditure due to the following reasons:a.The telematics gadgets supplied to policyholders directly contribute to the Appellant’s income generation as they enhance the value of the existing insurance services offered.b.The expenditure on telematics gadgets is recurring in nature, indicating it as revenue expenditure.c.The introduction of telematics gadgets does not create a new asset.d.The expenditure on the gadgets is directly related to the conduct of the Appellant’s business and forms a vital part of the profit-earning process.e.The telematics gadgets do not provide an enduring advantage to the Appellant. They are transferred to policyholders upon purchasing an insurance policy and do not return at the end of the one-year premium period.f.The expenditure on telematics gadgets does not offer the Appellant an exclusive tight or monopoly.

21. Consequently, the Appellant stated that the expenditure on telematics gadgets by the Appellant should be treated as a revenue expenditure.

B. Bad debts Provision disallowed in 2018. 22. According to the Appellant, the Respondent erroneously disallowed a bad debt provision (doubtful debt) expensed for the year 2018 of Kshs. 65,547,409. 00, on the basis that no sufficient documentation was provided to support the allowability of the provision. The Appellant asserted that this was in complete disregard to the explanations and supporting documents provided by the Appellant demonstrating that the amount was part of a provision, which was already disallowed in the financial year 2017.

23. According to the Appellant, on 24 July 2014 the International Accounting Standards Board issued the final IFRS 9 Financial Instruments Standard, which replaced earlier versions of IFRS 9 and completed the IASB's project to replace IAS 39 Financial Instruments: Recognition and Measurement. The Appellant asserted that this standard introduced changes in the measurement bases of the financial assets to amortized cost, fair value through other comprehensive income or fair value through profit or loss. The criteria for classification into these categories were significantly different from what was provided for in IAS 39. It argued that the standard was effective for annual periods beginning on or after 1st January 2018 with retrospective application.

24. Apart from the above, for the year 2017, prior to the effective date of the new IFRS 9, the Appellant stated that it had increased its provisions for bad debts by Kshs. 206,567,505. 00. This increase was captured as an expense in the financial statements of the entity, in accordance with the general accounting principles.

25. The Appellant stated that by law, the Appellant disallowed the increase in the provision for bad debt in computing the taxable income for the year. Therefore, the Appellant averred that this was a restatement following the adoption of a new IFRS 9 accounting reporting standard which replaced IAS 39. This required the Appellant to write back part of the excess general provisions made in in 2017 amounting to Kshs. 206,567,505. 00.

26. The Appellant relied on the case of Waweru & 3 others (suing as officials of Kitengela Bar Owners Association) & another vs. National Assembly & 2 others; Institute of Certified Public Accountants of Kenya (ICPAK) & 2 others (Interested Parties) (Constitutional Petition E005 & E001 Consolidated) of 2021) [2021] KEHC 9748 (KLR) where the Court pronounced itself as follows;‘‘it is not only unconstitutional and unlawful to subject one to double taxation but the same is also economically punitive in nature. According to Article 201(b) (i) of the Constitution, one of the principles guiding public finance in Kenya was that the burden of taxation should be shared fairly. A system of taxation that lent itself to the possibility of double taxation could not be said to be fair. Such a system failed the test prescribed in Article 201(b) (i).”

27. The Appellant also cited the case of Keroche Industries Limited vs. Kenya Revenue Authority and 5 Others HC Misc. Civil Appl No. 743 of 2006 [2007] eKLR where it was observed that:“it is of course regarded as penal for a person to be taxed twice over in respect of the same matter.”

28. The Appellant relied on Article 47 (1) of the Constitution of Kenya and Section 4 of the Fair Administrative Action Act to argue that the Respondent’s action of disallowing allowable deductions which the Appellant is lawfully entitled to claim amounts to unfair and unlawful administrative action.

C. Taxation of Dividend Income. 29. On this subject matter, the Appellant stated that it owns 60% shareholding in Heritage Insurance Tanzania Limited, from which it receives dividend income at the end of the financial year. For the years under consideration, i.e. 2017, 2018 and 2019, the Appellant received dividends of Kshs. 82,849,668. 00, Kshs. 62,448,981. 00 and Kshs. 62,527,072. 00 respectively.

30. According to the Respondent, the Respondent misapplied Sections 7 (3) and Section 4 of the Income Tax Act in demanding Corporation tax on this dividend. The Appellant maintained that Section 7 (3) of the ITA serves to guide that the dividends received by financial institutions are taxable just like dividends received by other entities. It argued that the Respondent imagined that Section 7 (3) of the Act distinguishes dividends received by financial institutions from those received by other entities, which is wrong. Further, it argued that by applying Section 4 to demand tax, the Respondent wrongly treated dividends as ‘gains from business’, yet, ‘business’ is clearly defined in the Act and excludes investment. According to the Appellant, dividend is a return on investment. It also argued that the demand violates the settled principle set out in Tembo Co-operative Savings & Credit Limited vs. Commissioner of Domestic Taxes, Tax Appeal No, 103 of 2016.

31. Based on the foregoing, the Appellant asserted that the Respondent erred in law and fact in seeking to subject the dividend income received by the Appellant from its subsidiary to Corporation tax for the following reasons:i.The dividend income was not accrued or derived from Kenya.

32. The Appellant relied on Section 3 (1) of the ITA provides that:“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.”

33. The Appellant argued that the Income Tax Act does not define what “accrued in or derived from Kenya" means. Therefore, the Appellant relied on the case of Esso Standard East African Inc. vs. Income Tax [1971] E.A. 127 where it was held that:“the words ‘accrued in’ and ‘derived from’ are synonymous; the source of income is the place from which it is derived and this is a question of fact; and that the source of the interest was the contract made in New York, the location of that source was New York and the interest neither accrued in nor was derived from Kenya.”

34. The Appellant also cited the case of CIR vs. Hang Seng Bank Ltd (1991)1 AC 306 wherein Lord Bridge attempted to define the terms “accrued in” and “derived from” in relation to the source of income and stated that;“The broad guiding principle, attested by many authorities, is that one looks to see what the taxpayer has done to earn the profit in question.”

35. On strength of the foregoing, the Appellant stated that the dividends had been generated from a Tanzanian subsidiary thus should be determined as Tanzania, not Kenya. It argued that the contract, the business operations, and the distribution of dividends all take place in Tanzania, leading to the averment that the source of this income does not rest in Kenya.

36. Consequently, the Appellant asserted that the Respondent’s reliance upon Section 4 of the Act does not hold merit as the business in Heritage Tanzania is not conducted by the Appellant. The Appellant maintained that the entity in Tanzania is a separate legal entity from the Appellant, having been incorporated under the law of Tanzania and that the Appellant only owns shares in the company as a shareholder.

37. Further, the Appellant stated the guidelines established by the Organization for Economic Co-operation and Development (OECD) can be instrumental in determining the issue at hand. The Appellant relied on LG Electronics Africa Logistics FZE Kenya Branch vs. Commissioner of Domestic Taxes, Tax Appeal No. 359 of 2018 and Coca-Cola Central East and West Africa Limited vs. The Commissioner of Domestic Taxes; Tax Appeal No. 5 of 2018, where the Court endorsed the application of international taxation principles to inform its decisions.

38. The Appellant averred that Kenya does not Double Taxation Agreement with Tanzania therefore, the Appellant referred this Honourable Tribunal to The OECD's commentary on Article 10 (Dividends) of the Model Convention. It states as follows:“Dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State.”ii.The Appellant owns more than 12. 5% of the total shareholding in the subsidiary.

39. The Appellant relied on Section 7 (2) of the Income Tax Act to state that the said law does not distinguish whether the dividend is received from resident company of a foreign company or whether the company is a financial institution or not. It argued that it holds 60% of the total shareholding in Heritage Insurance Tanzania therefore, the Appellant receive dividends pay outs from the distributable profit after tax of the company, having paid all the applicable corporation income taxes and withholding taxes in the Republic of Tanzania as per the tax laws of the country.

40. The Appellant relied on Mount Kenya Bottlers Ltd & 3 others vs. Attorney General & 3 Others NRB CA Civil Appeal No. 164 of 2013 [2019] eKLR to support the position that language imposing the tax must receive a strict construction.

41. The Appellant asserted that the Respondent failed to take into account that the income contemplated under the said Section 7 (3) of the Act is chargeable to tax under Section 7 of the Act, which speaks to income from dividends. The Appellant also averred that Dividend income under Section 7 is subject to withholding tax under Section 35 (3) (a) of the Income Tax Act as read with Paragraph 5 (e) Head B of the Third Schedule of the Income Tax Act, at the rate of 5% for residents. It argued that this is final tax. The Appellant also added that withholding tax is normally an obligation on the payer, who is based in Kenya.iii.The income under consideration constitutes dividend income and not gains or profits from business referenced under Section 4 of the Income Tax Act.

42. According to the Appellant, the Respondent relied on Section 4 of the Income Tax Act which imposes income tax on income from business, and where the business is conducted partly in Kenya and partly outside Kenya, the whole of the gains and profits from the business shall be deemed to have accrued or to have been derived from Kenya. The Appellant does not dispute this position. However, the Appellant urged this Honourable Tribunal to take judicial notice of the clear distinction between business income and dividend income under the Income Tax Act.

D. Applicability of penalty and interest 43. According to the Appellant. The Respondent levied penalty at 5% and interest at 1% on the Appellant without stating the statutory basis of levying the said penalty and interest. The Appellant alleged that failure to state the said legal provisions limited the Appellant's ability to respond on the same.

44. In further support of the Appeal, the Appellant relied on it written submissions in which it identified three issues for determination:a.Whether dividend income is taxable as ‘gains from business’ and whether dividend income from foreign subsidiaries is subject to further tax;b.Whether motor vehicle insurance expenditure wholly and exclusively incurred in the production of taxable income should be disallowed for tax purposes; and,c.Whether the Respondent's assessment of tax for the year 2017 to 2018 is valid, given that it exceeds the statutory time limitations for tax assessment of five (5) years.

45. The Tribunal notes that the Appellant’s submissions are identical to the contents of the statement of facts save for the third issue that the Appellant has raised in the submissions. To avoid reciting what has already been stated herein, the Tribunal highlights the third issue that the Appellant raised.

46. The Appellant submitted that the Respondent’s assessment of tax for the year 2017 and 2018 is beyond the legally prescribed five-year limitation period under Section 31 (4) of the Tax Procedures Act, rendering the assessment invalid and unenforceable. The Appellant submitted that the Assessments that extend beyond this five-year period are ultra vires.

47. The Appellant relied on a number of case laws including Katsran Limited vs. Commissioner of Domestic taxes and Gitere Kahura Investments Limited vs. Commissioner of Investigations and Enforcement Tax Appeal No. 16 of 2019 to submit that time barred assessments cannot be enforced.

Appellant’s Prayers 48. The Appellant urged the Honorable Tribunal to grant orders that:a.The assessed amount in dispute be vacated;b.Penalty and interest be vacated from the date of the assessment;c.This Appeal be allowed; andd.The costs of and incidental to this appeal be awarded to the Appellant.

The Respondent’s Case 49. The Respondent’s case is premised on its;a.Statement of Facts dated and filed on 11th August 2023 together with the documents attached thereto; and,b.Written submissions dated 7th March 2024 and filed on 8th March 2024.

50. The Respondent responded as follows:Whether the dividend earned by the Appellant was income and therefore subject to taxation.

51. According to the Respondent, the Appellant claimed allowable deductions on dividend income for the years of income 2017 to 2019. The Respondent acknowledged that the dividend received by the Appellant was from the Heritage Insurance Company Tanzania Limited (“Heritage TZ Limited”), a subsidiary of the Appellant.

52. The Respondent relied on Section 7 (1) of the Income Tax Act to argue that for a dividend to be termed as a dividend income taxable under Section 7 of the Income Tax Act, it must have been paid by a resident company.

53. According to the Respondent, Heritage TZ Limited is a non-resident company. It contended that the dividend received by the Appellant from Heritage TZ Limited does not qualify as a dividend income taxable under Section 7 of the Income Tax Act. Therefore, it contended that the dividend paid to the Appellant should therefore be treated as any other income that accrued to the Appellant. Further, the Respondent contended that having not qualified as a dividend income; the same does not qualify for the exemption provided under Section 7 (2) of the Income Tax Act.

54. The Responded cited the provisions of Section 3 (4) of the Income Tax Act which provides that,‘‘For the purposes of section 3(2) (a)(i)—where a business is carried on or exercised partly within and partly outside Kenya by a resident person, the whole of the gains or profits from such business shall be deemed to have accrued in or to have been derived from Kenya.’’We believe that it intended to rely on Section 4 (a) of the income tax Act and not Section 3 (4). Section 3 (4) does not exist under the Income Tax Act.

55. The Responded asserted that the Appellant received dividends from Heritage TZ Limited, is a subsidiary of the Appellant and that the Appellant hold 60% shares of the shares in Heritage TZ Limited. The Respondent stated that since the Appellant also carries out business in Kenya, any income that was accrued and/or derived by the Appellant such as the Income from Heritage TZ Limited is deemed to have accrued or derived from Kenya.

56. The Respondent relied on section 3 (2a) of the Income Tax Act which provides that,‘‘(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)a business, for whatever period of time carried on;(ii)employment or services rendered(iii)a right granted to another person for use or occupation of property;”

57. The Respondent stated that the aforementioned section provides for taxation of income paid to the Appellant. The Respondent contended that the Dividend accrued to the Appellant on account of their shareholding/investment in Heritage TZ Limited is deemed as income and hence chargeable to tax as per the provisions of Section 3 of the Income Tax Act.

58. Apart from the above, the Respondent contended that even if the dividend paid to the Appellant was to be treated as Dividend income, the same is taxable under Section 7 (3) of the Income Tax Act. Section 7 (3) provides that,“A dividend received by the financial institutions specified in the Fourth Schedule shall be deemed to be income chargeable to tax in accordance with this section.”

59. The Respondent maintained that the aforementioned section is very specific in that it is applicable to dividend paid to financial institutions. It stated that Forth schedule of the Income Tax Act provides for financial institutions among them an insurance company licensed under the Insurance Act. The Respondent argued that the Appellant is an insurance company licensed under the Insurance Act and therefore qualifies as a financial institution. The Respondent asserted that income of the Appellant is therefore chargeable to tax according to section 3 of the Income Tax Act.Whether the Respondent was justified in disallowing the accrued expenses incurred in generating income;

60. The Respondent’s case in relation to this issue is that the Appellant entered into an agreement ‘UBI Agreement’ with DriveProfile Limited, a company resident in Ireland for right to use Drive Profiler technology to obtain and monitor vehicle activity information in respect of insured with respect to their insurance cover.

61. The Appellant also entered into an agreement with Telematics Africa Limited, a company resident in Kenya, whose obligations included installation, deinstallation, and refurbishment of the gadgets, as well as reinstallation in other vehicles. The Appellant consequently claimed as a revenue expense at the cost of acquisition of the Drive Profiler technology (software), cost of support and ancillary services.

62. The Respondent stated that the Appellant charge a premium to the insured which is based on actuarial valuations and is determined by many factors including pooled funds, risk element, and previous experience.

63. The Respondent cited Section 15 (2b) of the Income Tax Act which provides that,(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.……………….b.Amounts to be deducted under the Second Schedule in respect of that year of income.”

64. The Respondent contended that an amount incurred as capital expenditure is to be deducted subject to provision of the second schedule to determine the amount of income to be subjected to tax. The Respondent cited Paragraph 218 of the Second Schedule of the Income Tax Act (now repealed) provides that: -“Where a person incurs capital expenditure on the purchase or acquisition of the right to the use of a computer software, there shall be deducted, in computing his gains or profits for the year of income in which the software is first used and for subsequent years of income, an amount equal to one fifth of that expenditure.”

65. According to the Respondent, the Tax Amendments Act 2020 amended the Income Tax Act by introducing investment allowance at the rate of 25% on computer and computer peripheral hardware and software, which was later amended in the Finance Act 2021 and Finance Act 2022 from reducing balance to straight line basis.

66. The Respondent cited Paragraph 1 (1) of the Second Schedule of the Income Tax Act which provides that;“Where a person incurs capital expenditure in respect of an item listed in the first column of the table, an investment allowance may be deducted in computing the gains or profits of that person at the corresponding rate specified in the second column, for each year of income— Computer and peripheral computer hardware and software, calculators, copiers and duplicating machines at 25% per year, in equal installments”

67. The Respondent contended that even though the gadgets are installed in the policy holder’s vehicle, the beneficiary is the Appellant who uses it to collect data and execute the insurance model. In addition, the Responded averred that according to the terms of the contract, the right of use the gadgets is non-transferable which means that the ownership of the gadgets is retained by the Appellant.

68. Therefore, the Respondent contended that the costs of the telematics devices are a capital expense so it was justified in disallowing the capital expenses and subjecting the amount of expenses claimed to the provisions of the Second schedule of the Income Tax Act.Whether the Respondent was justified in disallowing the accrued expenses relating to decrease in provision necessitated by changes in the financial reporting standards;

69. The Respondent’s case in relation to this issue is that Section 15 (1) and Section 15 (2a) of the Income Tax Act provides for the expenses that can be deducted to ascertain the total income chargeable to tax.

70. According to the Respondent, a review of the Appellant’s affairs revealed that the bad debt provisions relating to the adoption of IFRS 9, had indeed been disallowed in the year 2017. However, the Appellant was unable to justify movement of an additional amount of Kshs. 82,233,678. 00 in the year 2018 in bad debts provisions.

71. Further, the Respondent stated that the amount claimed as Impairment for doubtful receivable for 2017 was Kshs. 206,568,000. 00. According to the Respondent, no part of this amount has been disallowed or taxed as per the tax computation. In addition, the Respondent contended that the Appellant failed to demonstrate that the movement taxed by the Respondent was accounted for in 2017. Further, the Respondent averred that an analysis of the specific bad debts revealed that all recovery efforts were not exhausted and, in some cases, efforts were still ongoing.

72. In the absence of any further supporting information with respect to the same, the bad debt provisions amounting to Kshs. 65,547,409. 00 for the year 2018 was disallowed in accordance with Section 15 (1) and 15 (2) (a) of the Income Tax Act. The Respondent also contended it revised the allowable bad debts for the year 2018. Further, the Respondent argued that the bad debts claimed as allowable deduction in the Appellant’s IT2C return in the year of income 2019 were not adequately supported.

73. Finally, the Respondent contended that the bad debts written off for year 2018 and 2019 did not met the threshold of section 15 (2) (a) as read together with the Legal Notice 37 of 2011 and the Respondent was justified in disallowing the said bad debts.

74. In further support of its case, the Respondent filed written submissions in which it identified four issues for determination:a.Whether the Dividend Income earned by the Appellant is subject to tax and if so whether they are taxable under Section 3 (2) (b);b.Whether the motor vehicle insurance expenditure was wholly and incurred in the production of income;c.Whether the tax assessments for the year 2017 and 2018 are within the statutory timelines; and,d.Whether the Respondent breached the legitimate expectation.

75. The Tribunal examined the Respondent’s submissions and noted the submissions are largely similar to the contents of its statement of facts. Therefore, the Tribunal wishes to point out matters that few aspects that were not covered in the statement of facts but are part of the written submissions.

76. In relation to the first issue, the Respondent submitted that it is not in dispute that the Appellant herein is a Financial Institution, more specifically an Insurance Company licensed under the Insurance Act. Consequently, the Respondent relied on the doctrine of lex specialis derogate generali, which is a Latin doctrine that means that the specific law prevails over general law.

77. It submitted that where there is a general law and a specific law touching on a particular issue, the specific law applies. In this case, application of Subsection 3 of Section 7 of the Income Tax Act is specific to dividend income received by a financial institution meaning that in the event, such as this one, the Appellant qualifies as a financial institution, its income from dividends will be subject to tax as provided for in the said Section.

78. To that end, the Respondent cited the case of Commercial Tax Officer, Rajasthan vs. M/S Binani Cement Ltd and Another where the Indian Supreme court held that;“It is well established that when a general law and a special law dealing with some aspect dealt with by the general law are in question, the rule adopted and applied is one of harmonious construction whereby the general law, to the extent dealt with by the special law, is impliedly repealed. This principle finds its origins in the latin maxim of generalia specialibus non derogant, i.e., general law yields to special law...’

79. Finally, on this issue, response to the Appellant’s averments at paragraph 59 of its submissions on the interpretation of Section 7 (3) of the Income Tax Act to mean that the entire Section 7 of the Act on taxation of dividends also applies to financial institutions, the Respondent submitted that the words “in accordance with this section” under Section 7 (3) of the Income Tax Act refer only to the very Section 7 (3) of the Act and not Section 7 (2) or any other Section in the Act. The Respondent further submitted that if the said Section 7 (3) of the Act was meant to apply to the entire Section 7, then nothing would have been easier than for the Legislature to have placed Section 7 (3) of the Act as alphabet (c) of Section 7 (1) of the very Act by continuation.

80. With regards to second issue, the Respondent relied on Republic vs. Commissioner for Income Tax & another Ex-Parte Stockman Rozen (K) Limited [2015] eKLR; Commercial & Industrial Credit Limited vs. Commissioner of Income Tax [1986] eKLR; and Income Tax vs. T Ltd (No 2) EA (1971) 509.

81. With regards to the third issues, the Respondent submitted that the issue of timeline was not one of the grounds of appeal. The Respondent cited Section 13 (6) of the Tax Appeals Tribunal Act provides that;“The appellant shall, unless the Tribunal orders otherwise, be limited to the grounds stated in the appeal or documents to which the decision relates.”

82. The Respondent also submitted that the assessments were within the timelines. The Respondent relied on Section 92 (2) (b) of the Income Tax Act which provides that the Corporation tax is filed and paid on or before the 30th day of June of the following year. Therefore, the Respondent submitted that Corporation tax for the years 2017 and 2018 were to be filed and paid by 30th June 2018 and 30th June 2019 respectively.

83. The Respondent further submitted that it amended an assessment within five (5) years of the self-assessment as stipulated under Section 31 (4) of the Tax Procedure Act. According to the Respondent, the Appellant filed tax for the years 2017 and 2018 in the years 2018 and 2019 respectively. Therefore, the Respondent submitted that the Respondent had until 2023 and 2024 respectively to amend the assessment.

84. With regards to the fourth issue, the Respondent submitted that legitimate expectation can only be created within the confines of the law as was held in the case of Kenya Revenue Authority & another vs. Republic (Ex parte) Kenya nut Company Limited [2020] eKLR. The Respondent also relied on The Supreme Court in the case Communications Commission of Kenya and 5 others vs. Royal Media Services Limited & 5 others [2014] eKLR to submit that it did not make any clear and uncontroverted statement of promise that the Appellant would not be subjected to tax on dividends and/or issued with assessments.

Respondent’s prayers 85. The Respondent prayed that the Appeal be dismissed with costs to the Respondent and the Objection decision dated 31st May 2023 be upheld.

Issues For Determination 86. The Tribunal having considered the Memorandum of Appeal, the parties’ Statements of Facts and submissions, puts forth the following issues for determination:i.Whether the Respondent’s assessment of tax for the year 2017 to 2018 is statute time barred;ii.Whether the Respondent erred in taxing the Appellant’s dividend income earned from its Tanzanian subsidiary;iii.Whether motor vehicle insurance expenditure was wholly and exclusively incurred in the production of taxable income, if so, whether the Respondent erred in disallowing it; and,iv.Whether the Respondent was justified in disallowing the accrued expenses relating to decrease in provision necessitated by changes in the financial reporting standards.

Analysis And Findings 87. The Tribunal shall analyse the issues as herein under.i.Whether the Respondent's assessment of tax for the year 2017 to 2018 is statute time barred

88. The Notice of assessment is dated 28th February 2023 for the period January 2017 to December 2021 which is why the Appellant argued that the 2017 to 2018 assessments are statute time barred. The Respondent relied on Section 13 (6) of the Tax Appeal Tribunal Act to argue that the Appellant did not raise this issue in its Notice of Objection. Section 13 (6) gives this Tribunal powers to consider additional grounds. Apart from that, raising the issue of time under Section 31 (4) (b) of the Tax Procedures Act is as good as raising a preliminary objection which can be raised at any point during the proceedings.

89. Whereas the Respondent relied on Section 92 (2) (b) of the Income Tax Act, the Tribunal notes that the said section relates to time within which payment is to be made yet the timelines under Section 31 (4) (b) of the Tax Procedures Act relates to the date that the self-assessment taxpayer submitted the self-assessment return to which the self-assessment relates. Clearly Section 92 has no role to play concerning this issue.

90. Section 52B (1) (b) of the income tax Act provides that;‘‘every person, other than an individual chargeable to tax under the Act, shall for any accounting period commencing on or after 1st January, 1992, furnish to the Commissioner a return of income, including a self-assessment of his tax on such income, not later than the last day of the sixth month following the end of the year of income.’’

91. In absence of any other accounting period from the Respondent or the Appellant, the Tribunal relies on Section 52 B (1) (b) to find that last date for filing tax returns under the law is 30th day of June of each year. It then follows that the Appellant must have filed returns not later than 30th June 2017 and not later than 30th June 2018.

92. Based on the above, the 2017 taxes being assessed on 28th February 2023 are time barred pursuant to Section 31 (4) (b) of the Tax Procedures Act and the same are hereby expunged.ii.Whether the Respondent erred in taxing the Appellant’s dividend income earned from its Tanzanian subsidiary;

93. From the pleadings, the parties herein agree that the Appellant is a resident in Kenya. The parties also agree that the Appellant is a majority shareholder in a Tanzanian Subsidiary, Heritage TZ Limited. The Parties are also in concurrence that the Appellant received dividends from Heritage TZ Limited. The point of departure is whether the dividends from Heritage TZ Limited are taxable in Kenya.

94. The Applicable law is Section 3 (1) of the Income Tax Act. The said section 3(1) provides as follows:‘‘3. Charge of tax1. 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.’’

95. Section 3(2) gives some of the incomes that can be taxed. The income includes dividends.

96. From Section 3 (1) ITA, income tax is charged upon resident or non-resident. Secondly, the income must accrue in or must have been derived from Kenya. Residency or non-residency is not in issue therefore the Tribunal will not delve on that.

97. Section 3 (1) is not ambiguous in any way. Under the said section, income which did not accrue in or was not derived from Kenya cannot be charged of tax.

98. The Respondent ventured into Section 7 (1) of the Income Tax Act. Under this Appeal, the Appellant did not pay dividends therefore, Section 7 (1) is not applicable to this appeal. Consequently, all narratives hinged on Section 7 (1) must fail.

99. Under the circumstances and pursuant to Section 3 (1) of the Income Tax Act, the Tribunal finds and holds that the Respondent erred in subjecting dividends from Heritage TZ Limited to tax since dividends did not accrued in or was not derived from Kenya.iii.Whether motor vehicle insurance expenditure was wholly and exclusively incurred in the production of taxable income, if so, whether the Respondent erred in disallowing it.

100. The Appellant submitted that it introduced a new product under its motor vehicle insurance package, the DriverProfile technology used to monitor the driver behaivour of insured persons during the insured period. When a client purchases a motor vehicle insurance from the Appellant, the client is given the option of having the technology installed in their motor vehicle. The Appellant submitted that this telematic gadget contains a software that uses mobile data to record the driver activity.

101. The Appellant submitted telematics gadgets are purchased by the Appellant at cost approximately Kshs. 2,000. 00 and that once purchased, they are issued to the policy holders, and the cost thereof is included as part of the premium payments. However, the Appellant did not adduce evidence to indicate that it incurred purchase costs.

102. The Appellant also submitted that the implementation of this Technology is through a partnership agreement with DriverProfiler Limited, who own the intellectual property of the DriverProfiler Technology and supply the telematic gadgets. The Appellant also stated that this business relationship is governed by a Usage Based Insurance (UBI) Agreement with DriverProfiler Limited for the grant of rights to use the DriverProfiler Technology and the associated products to monitor and collect data on the driving pattern of policy holders and the supply of the gadgets. The Appellant further alleged that under the Agreement, the Appellant received a non-exclusive and non-transferable right to use the DriverProfiler Technology that is, solely for the intended purposes, for a specific term and subject to payment of a license fee. Curiously, the Appellant did not adduce in evidence the partnership agreement with DriverProfiler Limited. Therefore, the Tribunal had nothing to examine.

103. The Appellant relied on the case of Commissioner of Income Tax vs. Kencell Communications Limited (Now Airtel Kenya Limited) [2016] eKLR, in which the Appellant stated that several test factors and key principles were applied to distinguish between capital and revenue expenditure. For example, the Appellant cited the principle of exclusivity which the appellant defined as, ‘If the expenditure confers an exclusive right or a monopoly to the taxpayer, it is more likely to be seen as a capital expenditure.’ Perhaps the Tribunal would have been able to determine whether the expenses conferred exclusive right or not if the Appellant had adduced the agreement between itself and the software provider. Unfortunately, the Appellant failed to discharge this burden of proof.

104. Rule 5 of the Tax Appeals Tribunal (Procedure) Rules, 2015 provides as hereunder:1. Statement of fact signed by the appellant shall set out precisely all the facts on which the appeal is based and shall refer specifically to documentary evidence or other evidence which it is proposed to adduce at the hearing of the appeal.2. The documentary evidence referred to in paragraph (1) shall be annexed to the statement of fact.’’

105. The High Court in Darwine Wholesalers Limited vs. Commissioner of Investigations and Enforcement (Income Tax Appeal E051 of 2021) [2023] KEHC 23537 (KLR) held as follows:“Under section 59 of the TPA and section 43 of the VAT Act the Commissioner is expressly empowered to ask for additional information to ascertain the tax chargeable. This legal position is in consonance with section 107 and 112 of the Evidence in that the balance of proof lies with the party with the knowledge of facts. Further section 30 of the Tax Appeals Tribunal Act (TATA) and section 56 of the TPA imposes the burden of proof on the tax payer to prove that an assessment was wrong or that it was excessive.’

106. Similarly, the high Court in Tumaini Distributors Company (K) Limited vs. Commissioner of Domestic Taxes [2020] eKLR held that the taxpayer has the burden to prove that the tax decision is wrong.

107. Under the circumstances, we do not think that the Appellant complied with Rule 5 of the Tax Appeals Tribunal (Procedure) Rules, 2015 with regards to the issue under review.

108. Consequently, the Tribunal is unable to find that motor vehicle insurance expenditure was wholly and exclusively incurred in the production of taxable income. Therefore, the Tribunal is unable to fault the Respondent.iv.Whether the Respondent was justified in disallowing the accrued expenses relating to decrease in provision necessitated by changes in the financial reporting standards;

109. The Appellant argued that the Respondent erroneously disallowed a bad debt provision (doubtful debt) expensed for the year 2018 of Kshs. 65,547,409. 00, on the basis that no sufficient documentation was provided to support the allowability of the provision. However, the Appellant in its written submissions did not mention or submit on the same at all. Perhaps the Appellant abandoned it all together once the Respondent to the same.

110. On this issue, the Respondent stated that the Appellant failed to justify the movement of an additional amount of Kshs. 82,233,678. 00 in the year 2018 in the bad debt provisions. The Respondent also stated that the amount claimed as Impairment for doubtful receivable for 2017 was Kshs. 206,568,000. 00 but no part of this amount was disallowed or taxed as per the tax computation. The Respondent also contended that the Appellant failed to demonstrate that the movement taxed by the Respondent was accounted for in 2017.

111. Apart from the above, the Respondent stated that an analysis of the specific bad debts revealed that all recovery efforts were not exhausted and, in some cases, efforts were still ongoing. Finally, the Respondent asserted that the bad debts written off for year 2018 and 2019 did not meet the threshold of Section 15 (2) (a) as read together with the Legal Notice 37 of 2011 and the Respondent was justified in disallowing the said bad debts.

112. The Appellant did not challenge the Respondent’s assertions. The Appellant’s submissions did not address issues to do with bad debts. This amounts to admission of facts. The Tribunal will let this issue rest here.

Determination 113. The upshot to the foregoing is that the Tribunal finds and holds that the Appeal is partially merited and consequently makes the following orders; -a.The Appeal is hereby partly allowed;b.The Respondent’s Objection Decision issued on 31st May 2023 be and is hereby varied in the following terms;i.The Respondent’s tax assessments relating to the year of income 2017 be and are hereby set aside;ii.Respondent’s tax assessment on dividends received by the Appellant be and is hereby set aside;iii.The Respondent’s assessment on motor vehicle insurance expenditure be and is hereby upheld; and,iv.The Respondent’s assessment on provision on bad debts be and is hereby upheld.c.Each party to bear its own cost.

114. It is so ordered.

DATED AND DELIVERED AT NAIROBI THIS 1ST DAY OF AUGUST 2024ROBERT M. MUGAMBI - CHAIRPERSONELISHAH N. NJERU - MEMBERMUTISO MAKAU - MEMBERABDULLAHI DIRIYE - MEMBERBERNADETTE GITARI - MEMBER