[2023] KETAT 501 (KLR)

Izwe Loans Kenya Limited v Commissioner of Domestic Taxes (Tax Appeal 81 of 2022) [2023] KETAT 501 (KLR) (18 August 2023) (Judgment)

Neutral citation: [2023] KETAT 501 (KLR)

Republic of Kenya

In the Tax Appeal Tribunal

Tax Appeal 81 of 2022

RM Mutuma, Chair, RO Oluoch, EN Njeru & D.K Ngala, Members

August 18, 2023

Between

Izwe Loans Kenya Limited

Appellant

and

Commissioner Of Domestic Taxes

Respondent

Judgment

Background 1. The Appellant is a limited liability company duly incorporated under the Companies Act of the laws of Kenya, and whose principal activity is the carrying out of non-deposit taking microfinance services.

2. The Respondent is the principal officer appointed under Section 13 of the Kenya Revenue Authority Act, and is mandated with the responsibility for the assessment, collection, receipting and accounting for all tax revenue as an agent of the Government of Kenya. The Respondent is also mandated with the responsibility for the administration and enforcement of the statutes set out in the schedule to the Act.

3. The Respondent undertook an audit of the Appellant‘s operations and by a letter dated 5th October 2020, communicated its preliminary audit findings to the Appellant, which the Appellant responded to.

4. The Respondent by a letter dated 17th February 2021 issued an assessment of Kshs 368,306,006. 00 in Corporation tax against the Appellant.

5. The Appellant, aggrieved by the said assessment, lodged its notice of Objection on 19th March 2021, wherein it disputed the assessment in its entirety and requested the Respondent to have the same set aside.

6. The objection was referred to the Respondent‘s Independent Review of Objections (IRO) Department whereon several decisions were held with the view of certain clarifications and explanations being provided. The Respondent consequently requested for further documentation/information from the Appellant pursuant to Section 56 of the Income Tax Act, and the Appellant availed the requested information to the Respondent vide letters dated 23rd September 2021 and 22nd November 2021, respectively.

7. The Appellant in addition availed additional information to the Respondent by way of email, and provided links for accessing the online data rooms to enable the Respondent interrogate and review all necessary information requested for proper determination of the objection.

8. The Respondent issued its Objection decision on 17th December 2021 wherein it confirmed its assessment in its entirety save for Kshs 19,840,976. 00 which it dropped on account of lease liability which the Respondent had erroneously calculated.

9. The Appellant aggrieved by the Respondent‘s objection decision, lodged its Notice of Appeal at the Tribunal on 14th January 2022.

The Appeal 10. The Appellant filed its Memorandum of Appeal on 28th January 2022 and raised the following grounds of appeal;i.That it was not in law open for the Respondent to invoke the provisions of Section 18 of the Tax Procedures Act 2015, which is concerned with enforcement in relation to liability for current or future taxes payable by a company as the basis for confirming assessment for Corporation tax on the Appellant pursuant to the provisions of Section 16(2)(j) of the Income Tax Act which is concerned with interest restriction as a disallowable deduction.ii.That it was not in law open for the Respondent to invoke the restricted definition of ―controlling member" as provided for under Section 18(4) of the TPA and imposing Corporation tax on the Appellant when the said provision imposes liability, upon either a Director, General Manager, Company Secretary, such other senior official or a controlling member of a company who enter into an arrangement that will prevent the company from settling current future taxes. Accordingly, the provisions of Section 18 (4) of the TPA could not apply to the Appellant being the company subject of the impugned assessment as no arrangement had been entered to render the Appellant unable to settle current or future taxes.iii.That it was not permissible in law for the Respondent to disregard Section 16(2) (j) of ITA read together with Paragraph 32 of the Second Schedule (now repealed) of the ITA which provided for an elaborate and adequate definition of ―control", within the context of disallowable deductions and in place thereof invoked the restricted definition of ―controlling member" under Section 18(4) of the TPA contrary to the provisions of Section 2(2) of the TPA and purport to charge Corporation Tax under ITA.iv.That the Respondent erred in law in misapplying the provisions of Section 18(4) of the TPA and failed to prove that there was an arrangement with the intention or effect of rendering the Appellant unable to satisfy a current or future tax liability under tax law.v.That it was not in law permissible for the Respondent to shift goal posts by relying, in its objection decision, on the definition of ―controlling member" as provided for under Section 18(4) of the TPA and abandoning the definition of control under Section 16(2) (j) as read together with paragraph 32 (1) of the Second Schedule (now repealed) of the ITA which it had relied upon in its assessment dated 17th December 2021 as well as in the preliminary findings dated 5th October 2020. By so doing the Respondent deprived the Appellant its right to fair administrative action to respond to the assertions in connection with the provisions of Section 18 (4) of the TPA contrary to the constitutional dictates of Article 47. vi.Without prejudice to paragraphs (i) to (v) above, the Respondent erred in law and in fact in finding that the Appellant was controlled by Izwe Holdings (Mauritius), when it was evident that the Appellant had 100% local shareholding and as such, was not controlled by a non-resident entity. Accordingly, the Respondent could not restrict and disallow the Appellant‘s interest expense by relying either on the provisions of Section 16(2) (j) and paragraph 32 (1) (now repealed) of the Second Schedule of the ITA or under Section 18 (4) of the TPA.vii.That the Respondent failed to cite in its assessments the purported provisions of the law that the Appellant allegedly contravened in its assertion that Izwe Kenya Holdings Limited was incorporated to circumvent the law and meant to avoid tax and therefore cannot make a finding to this effect.viii.Without prejudice to the foregoing ground, the Respondent misapplied the provisions of Section 23 of ITA in finding that the incorporation of IKHL was undertaken with the sole intention of avoiding taxes on the strength of board minutes of 1st July 2015 Minute ‗7 01/07/2015‘, without any sufficient proof in support of this allegation and in total disregard of the Appellant‘s representations in its regard. The Respondent therefore failed to discharge its burden of proof in demonstrating its assertion that IKHL had been incorporated in an arrangement designed as a scheme to avoid taxes.ix.That it was not in law open to the Respondent to find in its objection decision that the Appellant was being controlled by Izwe Africa Holdings (Mauritius), contrary to its initial position as expressed in its assessment wherein the Respondent had erroneously found that the Appellant was controlled by Africa Micro Finance Equities (AMFE).x.That it was not in law open for the Respondent to disallow the Appellant‘s foreign exchange losses of Kshs 51,248,434. 00 in its assessment when the Appellant had by its own tax computations for the year of income 2015 and 2017, disallowed the sum of Kshs 53,152,547. 95 as being unrealized gains/losses.xi.Without prejudice to ground no. (ix) above, the Respondent failed to consider the evidence that the Appellant adduced in its notice of objection as well as in its letters of 23rd September 2021, 22nd November 2021 providing additional information requested by the Respondent, confirming that indeed – the Appellant had incurred the foreign exchange losses that it had claimed. It was therefore not permissible to disallow the same contrary to the provisions of Section 15 of ITA.xii.That in addition to ground (xi) above, the Respondent erred in law and fact in invoking the provisions of Section 4 A of ITA as the basis of disallowing the foreign exchange losses in the sum of Kshs 51,248,434. 00 when it was apparent that the Appellant had not received any loan from Izwe Africa Holdings, who the Respondent erroneously found in its objection decision to be in control of the Appellant. It was therefore inaccurate for the Respondent to selectively consider the thin capitalization requirement in exclusion of the need to ascertain whether there was a loan received by the Appellant from the alleged controlling entity to warrant the deferral of the foreign exchange losses in accordance with the provisions the ITA of Section 4 A (ii) (a).xiii.That the Respondent erred in law in disallowing hedging costs for the sum of Kshs 44,465,804. 00 merely on the basis that there was failure to account for the same under foreign exchange, when by a letter dated 23rd September 2021, the Respondent was furnished with hedging instruments Forward Exchange Contracts (FEC) in support of the expense. In any event, hedging costs is not a foreign exchange loss and as such, the Respondent could not invoke the provisions of Section 4 A of the ITA as the same was inapplicable in the circumstances.xiv.That it was not open in law for the Respondent to disallow the sum of Kshs 7,755,316. 00 being the finance costs (interest rate swaps) on the face of the Appellant‘s elaborate explanations both in the Notice of Objection as well as in the letter of 23rd September 2021, demonstrating that not only was this cost incurred but also that a corresponding accounting credit entry was entered in the AMFH‗s books of accounting reflecting the same gain. In any event, and without prejudice to the foregoing, even if this expense was a foreign exchange loss, the Respondent was not permitted in law to apply Section 4 A of the ITA as there was no loan issued to the Appellant in this regard.xv.That the Respondent erred in law and fact by disregarding the detailed documentary evidence placed before it by the Appellant in connection with the management fees for management services offered to the Appellant by Lethu and AMFH such as human resources, IT infrastructure management services, collection services, monitoring, administration and processing of collection batches, journals and authorization of refunds and in place thereof, disallowing these legitimate expenses on the basis of the assertion that the Appellant was self -sufficient contrary to the evidence presented before it.

11. By reason of the aforesaid grounds, the Appellant prayed that the Honorable Tribunal sets aside the Respondent‘s Objection decision dated 17th December 2021, and the corresponding assessment of Kshs 348,465,030. 00 dated 17th February 2021, and allow its Appeal herein with costs.

The Appellant‘s Case 12. The Appellant‘s case is set out on its Statement of Facts filed on the 28th January 2023 and the volumes 1 to 20 of annexures filed thereto, the Appellant‘s witness statement of Jeff Ngeta (the Appellant‘s CEO) filed on 14th September 2022 and the Written Submissions filed on 14th February 2023.

13. The Appellant stated that it was initially incorporated in May 2012 as Mifugo Credit Ltd, whose principal activity was the provision of credit. In October 2013, Africa Microfinance Equities (AMFE) acquired 90% shareholding in Mifugo Credit Ltd. Thereafter the name of Mifugo Credit Ltd changed to Izwe Loans Kenya Ltd (ILKL), the Appellant herein.

14. The Appellant stated that the Respondent undertook an audit of the Appellant‘s operations and by a letter dated 5th October 2020, communicated its preliminary audit findings to the Appellant in connection with the same, which laiter was duly responded to by the Appellant.

15. The Appellant stated that by a letter dated 17th February 2021, the Respondent issued an assessment of Kshs 368,306,006. 00 being corporation tax assessment.

16. The Appellant lodged its notice of objection thereto on 19th March 2021 and disputed the assessment in its entirety. The Objection was referred to the Internal Dispute Resolution Unit of the Respondent, who requested for additional documentation, which the Appellant submitted.

17. The Appellant also stated that in addition to the above documentation, it also availed additional information to the Respondent by way of email, providing links for accessing the online data rooms to enable the Respondent to interrogate and review all necessary information requested for proper determination of the objection.

18. The Appellant was issued with the Respondent‘s Objection decision on 17th December 2021, wherein it confirmed its assessment in its entirety save for Kshs 19,840,976 which it dropped on account of lease liability which the Respondent had erroneously calculated.

19. The Appellant aggrieved by the Objection decision, appealed the decision, and has set out the relevant facts appurtenant to the appeal under several heads of issues, as follows;i.Thin capitalization and control;ii.Tax avoidance;iii.Lifting the corporate veil and hierarchy of laws;iv.Errors in tax computation;v.Foreign exchange losses;vi.Hedging costs;vii.Finance costs;viii.Management fees;The Appellant stated in its Statement of Facts and the submissions regarding the foregoing issues as follows:

i. Thin capitalization and control 20. The Appellant, in its notice of objection and additional information provided to the Respondent, availed the Appellant‘s official search document (CR 12) which indicated that 90 % of the Appellant‘s shares were held by Izwe Kenya Holdings limited, a limited liability company incorporated in Kenya, and the following Kenyan resident individuals;a.Hon. Kamama Asman – 4% -(Board Chairman);b.David Kibet Arusei - 2 %;c.Enock Rotich Ripko - 2%;d.Hezron Krop Ripko - 2 %.

21. The Appellant stated that the Respondent in its assessment disallowed the Appellant‘s interest expenses on the basis that it was thinly capitalized as a result of loans from Africa Microfinance Holdings (AMFH) a related entity, and that there were common directorships between the Appellant, Izwe Africa Holdings (IAH), and other operating entities in Ghana, and Zambia. Further that the loan documents between the Appellant and that AMFH were executed by two common directors together with the Treasurer and therefore AMFH, the lender, had common control.

22. That the Respondent, therefore in its assessment, based its findings on the provisions of Section 16 (2) (j) of the ITA which provided for restriction on interest expenses on loans from non-resident persons in control of the Appellant.

23. The Appellant stated that based on the definition under Section 16(2)(j), the Respondent in its assessment claimed that the Appellant‘s activities and decisions were determined by AMFE who hold shares in Izwe Kenya Holdings Limited (IKHL) and had direct control of the Appellant. In essence, the Respondent claimed that the Appellant was indirectly controlled by AMFE by virtue of the disbursed loan.

24. The Appellant further stated that in its notice of objection, it clarified to the Respondent that the definition of ―control" during the period in review was expressly restricted under Paragraph 32 of the Second Schedule (now repealed) to ITA to the following;i.Direct shareholding;ii.Voting power;iii.By virtue of powers held through the articles of association requiring the Appellant to act in accordance with the wishes of the non-resident lender;

25. It was the Appellant‘s position that AMFH has at no time met any of the above requirements and therefore never had control over the Appellant as alleged.26. The Appellant also averred that it adduced to the Respondent its Group Structure, which represented that AMFH, the entity that had loaned the Appellant, neither held any shares in the Appellant nor had any control over the Appellant as envisaged by Section 16(2) (j) of the ITA, contrary to the Respondent‘s findings in its assessment. 27. It was the Appellant‘s averment that its Shareholders‘ Agreement at clause 7. 2 expressly provides that control of the Appellant is exercised by its four individual shareholders and Izwe Kenya Holdings Ltd (IKHL), a Kenyan entity, through Directors that they were to appoint and who would expressly derive voting powers from the shareholders as per its CR 12.

28. The Appellant stated that it had sufficiently demonstrated to the Respondent, that the entities that lent it monies never had any control over the Appellant, within the statutory meaning during the period under review, and further stated that there was no requirement in the Kenyan tax law for de jure and de facto control (indirect control arguments) as purported by the Respondent in its assessment.

29. The Appellant added that, indeed it was only in July 2021 when the National Assembly passed the Finance Act which amended Section 2 of the ITA, to provide a new and broader definition of ―control" that would encompass indirect control.

30. The Appellant cited the case of Intex Construction -vs- Commissioner of Domestic Taxes TAT Appeal No. 235 of 2016, Where the Tribunal held that the interest expense restriction under Section 16(2) (j) did not apply to locally controlled entities, sentiments that were also upheld in the case of East African Growers Ltd -vs- Commissioner of Domestic Taxes TAT Appeal No. 26 of 2016.

31. The Appellant further stated that the restricted interest was attributable to loans from three entities; AMFH, IKHL, and Sanlam Africa Credit. Further it stated that IKHL is a resident entity duly incorporated in Kenya and was in control of the Appellant therefore Section 16(2) (j) of ITA could not lawfully be relied on as the basis to limit the interest expenses related to such loans.

32. It was therefore the Appellant‘s submission that it was erroneous for the Respondent to allege that the Appellant continued to receive loans from AMFH, whereas it was receiving loans from IKHL since 2017 as follows:-―The interest attributed to each year is as follows;a)As of 2017 – Kshs 16,087,280. b)As of 2018 - Kshs 13,787,552. c)As of 2019 – Kshs 5,781,598. ―

33. The Appellant contended that the Respondent‘s assessment was erroneous as the same purported to restrict interest even when it was apparent that the loans were from IKHL, a local entity and AMFH, which in the event was not controlling the Appellant.

34. It was also a submission of the Appellant that despite the Appellant providing the aforesaid evidence to the Respondent, and the extensive reference to Section 16 (2) (j) of the ITA and Paragraph 32 of the Second Schedule (now repealed) which relates to disallowable deductions, the Respondent purported to shift the goal posts in its objection decision and, while abandoning the provisions of ITA that it had hitherto relied upon, introduced the restricted definition of ― controlling member ― as per Section 18 (4) of the Tax Procedures Act, which relates to arrangements entered into by any director, general manager, company secretary, or any other senior officer or controlling member of the company, as a basis of finding that the Appellant was controlled by Izwe Africa Holdings (IAH).

35. The Appellant also submitted that the Respondent erred in its objection decision, in considering the definition of ―Control" under Section 18(4) of TPA out of context and in exclusion of the other clauses under the said Section of the TPA. The Appellant contended that the Respondent failed to consider that Section 18 of the TPA deals with liability for tax payable by a company where it concerns only with arrangements by directors, general manager, company secretary, such other senior official or a controlling member of the company entered into an arrangement that rendered the Appellant incapable of satisfying a specific current or future tax liability, having alleged that the group company structure was intended as a tax avoidance scheme.

36. The Appellant referred to the following cases Republic -vs Kenya Revenue Authority ex parte New Frarims Wholesalers Ltd & 3 others (2017) eKLR, Republic -vs- Kenya Revenue Authority & another Ex-parte Kenya Nut Company Ltd (2014) eKLR.

37. It was further the Appellant‘s contention that the Respondent while relying on Section 18 (4) of the TPA to arrive at its decision bypassed the provisions of Section 2 (2) of the TPA, which provides;―2(2) Unless a specific tax law specifies a procedure that is unique to the administration of a tax thereunder, the procedures provided for under this Act shall apply."

38. The Appellant therefore contended that he Respondent cannot invoke the restrictive definition of a ―controlling member" under Section 16 (2) (j) as read together with Paragraph 32 (now repealed) of the Second Schedule of the ITA.

39. By reason of the foregoing grounds the Appellant seeks to set aside the Respondent‘s assessments in respect to the interest restriction findings.

ii. Alleged Tax Avoidance Scheme. 40. The Appellant stated that in the Respondent‘s assessment at paragraph 2. 1.5, the Respondent claimed that the Appellant‘s parent company, IKHL, was established for the sole purpose of circumventing thin capitalization rules. The Respondent based its assessment on Minute 7 01/07/2015, without citing the provisions of the law relied upon.

41. The Appellant stated that in its notice of objection, clarified that IKHL, the Appellant‘s parent company and a local entity for that matter, and was incorporated for the primary objective of creating a business structure suitable for diversification into other business activities which was contained in the business strategy report and the board minutes, which were provided to the Respondent.

42. It was a further averment of the Appellant that in its notice of objection, further correspondences and in the meetings with the Respondent, referred the Respondent to the Minutes wherein it was agreed by the Appellant‘s directors that it was also to ―meet the KRA requirements". The Appellant stated that it explained that a plain reading of the said phrase meant that the Appellant was desirous of ensuring compliance with tax obligations and tax planning. It also explained that there was no law against tax planning or compliance with KRA requirements.

43. The Appellant further contended that the Respondent has an obligation of proving that the Appellant‘s purported arrangement was with the sole intention of tax avoidance as envisaged under Section 23 of ITA, which onus the Respondent has not discharged.

44. The Appellant also averred that it had submitted to the Respondent in its notice of objection, that it was the Respondent‘s obligation to prove that the purported arrangement was a tax avoidance scheme.

45. To buttress its submission the Appellant relied on the cases of:-a.Ernie Campbell & Co (K) Ltd -vs – Commissioner of Domestic Taxes TAT 385 of 2018, where it was held that," where the Commissioner accuses a taxpayer of devised fraud scheme to avoid tax, the onus is on the Commissioner to prove the alleged fraud."b.In the case of Pearl Industries ltd -vs- Commissioner of Investigations and Enforcement TAT Appeal No.116 of 2018, it was established that once the taxpayer has provided evidence to refute the allegation, the burden is on the Respondent to controvert the evidence and prove the allegation it made. ―Once the Appellant discharges its burden, the onus shifted to the Respondent who was required to demolish the evidence provided."

46. The Appellant averred that despite providing the said information, the Respondent in its objection decision restated its unlawful claim that it was the Appellant‘s duty to prove that the Appellant‘s immediate parent entity was not a tax avoidance scheme, with the Respondent‘s finding; ―The onus is on Izwe Loans Kenya Limited to demonstrate and prove that the principle purpose for the adoption of the organizational arrangement was not entered into with the view of avoiding taxes. You have not discharged that burden of proving hence it is our considered view that the facts availed to the Commissioner irresistibly point to a tax avoidance scheme."

47. The Appellant restated its submission that the burden of proof squarely rests on the Respondent who alleged that the company‘s group structure was intended as a tax avoidance scheme.

iii. Lifting the corporate veil and hierarchy of laws 48. The Appellant stated that at paragraph 2. 1.5 of its assessment, in finding that the Appellant‘s immediate parent company was a tax avoidance scheme, purported to lift the corporate veil to establish the ultimate beneficial owner of the Appellant. The Appellant submitted that the Respondent however failed to provide a basis in law for lifting the veil.

49. The Appellant stated that the Respondent at paragraph 2. 1.3 of its assessment sought to rely on the Organization for Economic Co-operation and Development (OECD) definition of control despite the fact that Paragraph 32(1) of the Second Schedule to the ITA provided a conclusive definition of control. It is on this basis that the Respondent sought to erroneously lift the Appellant‘s corporate veil.

50. The Appellant also stated that the Respondent further proceeded with its misguided journey by resorting to a dictionary definition of ― control" despite the fact that Paragraph 32 (9)(1) of the Second Schedule provided a conclusive definition of ―control ――The Free Dictionary defines the term control as the power to manage, oversee, and or restrict the affairs, business or assets of a person or entity."

51. It was further the contention of the Appellant that, whilst relying on the Free Dictionary, the Respondent will fully failed to indicate that the authors of the dictionary expressly cautioned all users that the dictionary was not for use in any legal or professional settings as it was not complete. The Respondent also will fully failed to mention that the Free Dictionary uses Wikipedia as one of its sources of information, and further a disclaimer had been provided.

52. The Appellant submitted that despite the cited disclaimer, the Respondent will fully relied on a definition not provided for under any tax law and ignored the express definitions available to it in the Income Tax Act, thus resulting to the erroneous decision, the subject of the appeal herein.

53. The Appellant further stated that in essence the Respondent sought to assess taxes on disallowed interest expenses amounting to Kshs 543,894,152. 00 to the extent of interest expense attributable to the alleged excess (debt/equity ratio) loan and deferred realized foreign exchange losses and gains charged in the profit and loss amounting to Kshs 103,469,553. 00 based on a source of information that expressly discredits itself.

54. It was also a submission of the Appellant that the Respondent failed to set out the statutory requirements for lifting of the corporate veil and failed to demonstrate how the Appellant had met the statutory threshold for lifting the corporate veil.

55. The Appellant further stated that in its response to the Respondent‘s assessment, it informed the Respondent that the latters attempt to lift the corporate veil that the Appellant‘s immediate parent entity, IKHL is a going concern with a clear business strategy. The Appellant referred the Respondent to the " single economic unit argument ― set out in Adams Cape Industries PLC, 1989 WL 651250.

56. The Appellant submitted that the Respondent in its Objection decision, justified the lifting of the corporate veil by ambiguously referring to taxation principles of substance over form, without providing the source provision or document relied on.

iv. Errors in tax computation 57. The Appellant stated that without prejudice to all the other arguments presented by the Appellant, the Respondent failed to rectify the errors in its tax computation, which the Appellant provided particulars of the computation of errors in Table 2 of its notice of objection, following the provision of an appendix to the Respondent‘s assessment, wherein it provided a numerical breakdown of the assessed amount.

58. The Appellant further stated that in its notice of objection, it informed the Respondent that the latter erred in its calculation of interest restriction by misclassifying overhead costs and third party costs as management fees thereby inflating the assessment by Kshs 108,932,914.

59. The Appellant also stated that the Respondent at heading 2 of its objection decision (errors in tax computation) rectified the error relating to lease liability. The Respondent also confirmed that it erred by duplicating interest relating to lease liability thus dropped those amounts.

60. The Appellant further stated that during various meetings with the Respondent, and through email link to an online data room, the Appellant provided explanations and documentation to support its argument that the Respondent erred in its calculations, but the Respondent failed to consider the information resulting in the latter‗s confirmation of erroneous tax computations.

61. It was a further submission of the Appellant that by failing to rectify all errors, the Respondent failed to justify why it did not remove third party costs from its calculations.

v. Foreign exchange losses 62. The Appellant stated that the Respondent in its assessment deferred the Appellant‘s foreign exchange losses of Kshs 103,469,533. 90 on account of thin capitalization. The Respondent buttressed the assessment on Section 16(2) (j) of the ITA only.

63. The Appellant however averred that in its grounds of its notice of objection, and subsequent communication with the Respondent did bring to the Respondent‘s attention the fact that the Appellant had already disallowed the unrealized foreign exchange losses in its tax computation and that the Respondent could not purport to defer the sum of Kshs 51,248,434. 00, as by so doing, this amount would be taxed twice. In its notice of objection, the Appellant expressed itself in its submissions on this issue thus;―However, we noted that KRA failed to consider the company‘s foreign exchange losses of Kshs 53,152,547. 95, which had already been disallowed in the company‘s tax computations for the year 2015 and 2017 as being unrealized gains/losses. We provide herein the Izwe Loans tax computations and supporting documents under appendix 8. "

64. In addition, the Appellant availed its financial statements and tax computations for the years in question as a testimony that indeed this expense was incurred, which evidence was disregarded by the Commissioner.

65. The Appellant averred that the Respondent in the face of the overwhelming evidence, responded thus;―However, you neither offered any compelling evidence in substantiating the claim for foreign loss deduction, nor did you demonstrate how foreign exchange loss was realized."

66. The Appellant also stated that, without prejudice to the above, the Appellant in its notice of objection, did inform the Respondent that given the nature of the Appellant‘s operations (i.e. borrowing in dollars and lending in Kenya Shillings), foreign exchange losses were undoubtedly, an inevitable expense, and accordingly the same was an allowable deduction under the ITA. The Appellant further informed the Respondent that its foreign exchange losses could not be disallowed under Section 4A of ITA as the said Section is concerned with disallowance of foreign exchange losses where the company loans are from a non-resident controlling entity which was not the case herein.

vi. Hedging costs 67. The Appellant averred that the Respondent in its appendix to the assessment disallowed the Appellant‘s hedging costs on the claim that they were foreign exchange losses. The Respondent did not provide any explanation or basis in law for classifying hedging costs in the appendix to the assessment containing a numerical breakdown of the assessed amount.

68. The Appellant further averred that in its notice of objection, and in the review forums, it submitted to the Respondent thus;―The hedging costs, negotiated with the company‘s banks, shield the company from volatile exchange rates fluctuation which may lead to substantial losses if poorly managed. Given the nature of Izwe Loans‘ business, the company deals with multiple currencies in its transactions.For this reason, this cost is incurred wholly and exclusively for business purposes and should be allowable under Section 15(1) of the ITA."

69. The Appellant stated that, through further discussions with the Respondent in meetings, further informed the Respondent that the Appellant incurred hedging costs by entering into forward exchange contracts, copies of which were submitted to the Respondent.

70. The Appellant further stated that it submitted to the Respondent in its notice of objection and subsequent letters that it entered into forward exchange contracts (FEC) to reduce its exposure to foreign exchange losses arising from currency fluctuations. It averred that the FECs allow the Appellant to convert borrowed dollars to Kenya Shillings, and repay the dollar denominated loans using shillings at relatively stable conversion rates for a specific period.

71. The Appellant stated that to mitigate the significant foreign exchange risks in its business, it frequently enters into FECs with financial institutions. These FECs help the Appellant determine the confirmed margins which it will be making on the loans disbursed to its customers. The FECs also limit the Appellant‘s exchange losses when repaying its dollar denominated loans.

72. The Appellant further averred that the FECs are contracts with for-profit financial institutions such as banks, and that the cost of entering into FECs is that the dollar conversion rate will generally be slightly higher than the spot rate (i.e., dollar conversion rate under free market conditions). The higher cost being the bank‘s way of earning its profit and in lieu of the risk of future currency fluctuations. The FECs are entered into for a fixed period of time; mostly one month. The Appellant also stated that it then contracts a related entity with continent wide experience in financial analysis to fair value the FECs on a monthly basis using its treasury system.

73. The Appellant further averred that the difference between the current market rate of the security, currency or commodity (spot rate) and the forward rate agreed in the FEC (the agreed rate on the date of entering into the FEC) are considered forward points. The forward points when multiplied by the notional value of the FEC is considered the cost of entering the hedge (hedging costs) which is the cost of securing the certainty of the rate applicable in the future.

74. The Appellant further averred that the hedging costs are then amortized over the life of the FEC by journalizing these amounts out of foreign exchange movements and thus will be the cost to the Appellant and reclassified as foreign exchange gains or losses in the financial statements for presentation purposes.

75. The Appellant averred that it provided the forward exchange contracts and the details of the services provided by the related entity to the Respondent who failed to consider the same.

76. The Appellant submitted that considering the foregoing explanation, it submitted to the Respondent that hedging costs do not form part of foreign exchange losses, as these are purely costs of entering into contracts to secure any fluctuations in currency exchanges and are incurred due to the nature of the Appellant‘s business and are allowable as they are incurred towards the production of income.

77. It was a submission of the Appellant that the Respondent in its objection decision, disregarded the Appellant‘s submissions in connection with this matter of hedging costs, and proceeded to confirm its assessment of Kshs 44,465,804. 00 on hedging costs claiming that hedging costs were foreign exchange gains/losses, thus failing to consider the hedging contracts and explanations availed by the Appellant, and erroneously demanding for tax that is not due and payable.

vii. Finance costs 78. The Appellant submitted that the Respondent in its assessment disallowed the Appellant‘s finance costs amounting to Kshs 7,755,316. 00. The Respondent neither provided a basis in law or in fact as to why it classified the Appellant‘s finance costs as foreign exchange losses.

79. The Appellant in its notice of objection and letter dated 23rd September 2021, disputed the Respondent‘s treatment of interest rate swaps as the swaps were expenses relating to derivatives purchases in the ordinary course of the Appellant‘s business and were incurred wholly and exclusively in the production of income which was in accordance with Section 15(1) of the Income Tax Act.

80. The Appellant further stated that through the aforementioned letters and meetings with the Respondent, the Appellant informed the Respondent that the expenses related to interest swap agreements and not foreign exchange losses. The Appellant stated that it informed the Respondent that swaps are agreements between two parties to exchange one stream of interest payments for another, over a set period of time. Thus the interest swaps are derivative contracts and trade over the counter. In the case of the Appellant, the interest swaps were derivative contracts where the Appellant exchanged variable interest rate obligations for fixed rate obligations.

81. The Appellant averred that it demonstrated to the Respondent that the swap loss/ expense it recognized in its books was recognized by the other party to the swap, AMFH, as a gain as it demonstrated in the Appellant‘s correspondence with the Respondent.

82. It further averred that it further availed information relating to the swaps in the appendix to its notice of objection but the Respondent failed to review and consider this information.

83. It was a contention of the Appellant that the Respondent under heading 4. 0 of its objection decision confirmed its assessment of Kshs 7,755,316. 00 on the basis that the same was foreign exchange losses. The Respondent arrived at this conclusion without having reviewed the information availed by the Appellant, it added.

84. The Appellant therefore reiterated that the interest rate swaps related costs were not foreign exchange losses, and the same could not be tested against the provisions of Section 4A of ITA as a basis of disallowing a legitimate expense.

viii. Management fees. 85. The Appellant stated that the Respondent in its assessment claimed that AMFH was a shell entity with no assets or independent offices in Mauritius hence incapable of rendering any services to the Appellant, further claiming that the AMFH used a consultant‘s address as its own.

86. In response thereto, the Appellant asserted that AMFH has its independent offices in Mauritius and provided the particulars of the office. The Appellant at Appendix 11 to its notice of objection availed a copy of the AMFH‘s office rental agreement. The Appellant further clarified that AMFH‘S use of the consultant‘s office (IQ EQ) address was at the point of incorporation as AMFH needed to list a permanent address to enable the incorporation process.

87. The Appellant also stated that the management and technical services provided by AMFH were rendered by AMFH staff whose competence the Respondent never challenged. The Appellant at heading 6 and Appendix 15 of its notice of objection provide a breakdown of the services AMFH provided to the Appellant. The Respondent also stated that it emailed a spreadsheet indicating the types of tasks outsourced to AMFH and Lethu by the Appellant, a detailed narration of the cost allocation methods employed by AMFH and Lethu (another related entity) in billing and rendering services to the Appellant, and referred to the Appellant‘s transfer pricing policy.

88. The Appellant also stated that in addition thereto, AMFH provided the Respondent through the Mauritius Revenue Authority with a listing of AMFH employees, the employees‘ roles as well as the descriptions of each employees duties. It stated that the Respondent neither challenged nor sought any clarifications from the Appellant on the information received from AMFH through the Mauritius Revenue Authority.

89. The Appellant also stated that in support of the fact that AMFH is a legitimate and operational company, the Appellant availed AMFH‘s audited financial statements which expressly stated AMFH‘s place of business, noting that the financial statements were prepared by reputable firm of accountants who verified every item in the financial statements including office expenses and staff costs.

90. On whether services were delivered and authenticity of costs – The Appellant stated that the Respondent in its assessment claimed that AMFH and Lethu did not provide any services and that there was no documentation to support costs incurred by AMFH in the provision of management and technical services.

91. The Appellant averred that it provided proof of management service which included staff timesheets and proof of staff travel at Appendix 5 of its notice of objection. The Appellant further averred that it availed proof of AMFH staff travel at Appendix 9 to the letter dated 23rd September 2021, and proof of work done at Appendix 14 to the same letter. Further the Appellant availed video evidence of the management meetings as annexure ILKL 13.

92. To buttress its submission, the Appellant relied on the case of Kenya Fluorspar ltd -vs- Commissioner of Domestic Taxes (2020) eKLR, where it was stated that;-―In my view, though indeed there is no evidence that any formal written requests for such consultancy management services was produced by KFC, there was evidence of interactions and meetings held. Such interactions and meetings between KFC and KCMC in my view were adequate proof of consultancy services provided."

93. On whether there was economic benefit from AMFH and Lethu‘s administration services - The Appellant stated that the Respondent in its assessment claimed that the Appellant had not demonstrated the need for AMFH‘s and Lethu‘s services, the resultant economic benefit and whether or not an independent third party would procure the services.

94. The Appellant in its response informed the Respondent that it procured these services from AMFH, and Lethu as the Appellant did not have the capacity to offer itself these services. These services included access to intellectual property and technical support to the Appellant‘s software systems.

95. The Appellant informed the Respondent that it obtained significant economic benefit from the services offered by AMFH and Lethu (Annexure 4 page 65 to 72).

96. The Appellant further demonstrated the economic benefit accruing from AMFH and Lethu‘s services by informing the Respondent that AMFH and Lethu gave the Appellant access to technical and software support in relation to the loan management platform. In essence, AMFH and Lethu also granted the Appellant access to industry and market information, which related to Kenyan market, other countries and trends cutting across the various countries. This information greatly assisted the Appellant in remaining competitive in a lending market that has 42 banks, numerous SACCOS, 14 deposit taking micro-finance institutions, numerous non-deposit taking micro-finance institutions, and prevalent table banking activity.

97. The Appellant further stated that it informed the Respondent that it was cheaper to procure these services from AMFH and Lethu than hiring all the relevant specialists on a full-time basis. Therefore, these services had commercial value and an independent third party would have procured such services.

98. It was a submission of the Appellant that in its objection decision, the Respondent disallowed management and technical costs claiming that the Appellant had the capacity to offer itself these services. However, it stated that in arriving at this conclusion the Respondent cherry picked a few services rather than address the list of services provided, thereby failing to consider the information provided on the particulars of the services provided.

99. On whether the Appellant‘s business is self-sufficient - The Appellant stated that the Respondent claimed that ―the Appellant has an automated loans platform that is used to process loans locally." In arriving at this conclusion, the Respondent failed to consider the Appellant‘s information that the loans platform is a proprietary software from AMFH and that AMFH offers technical support for the platform.

100. The Appellant further stated that the other contention raised by the Respondent was that" loans appraisal is provided by local companies and institutions such as local credit reference bureaus, NTSA, local banks, employers such as TSC etc." and ―all loans related to administrative work such as vetting, credit control, marketing and customer care is done by the Izwe loans local staff." The appellant averred that in arriving at this conclusion, the Respondent exhibited a humble understanding of the Appellant‘s operations and that the Respondent failed to consider information availed to it by the Appellant. The Appellant further averred that the aforementioned entities provided raw data/ information, which AMFH and Lethu risk analysts used to calculate lending risks, and provided analysis reports to the Appellant, stating that such a service could not have been offered by the Appellant‘s officers. Further the Appellant averred that it would have been more expensive for it to employ a specialist capable of undertaking this work, than procuring the service from AMFH and Lethu.

101. It was the submission of the Appellant that the Respondent failed to give due regard to the fact that the listed services were performed by local staff, whereas certain services were performed by AMFH and Lethu staff who had greater experience and qualification in terms of time and practice in various countries (as specified in annexure 6).

102. The Appellant stated that the other contentions by the Respondent were that ―the Appellant being self-sufficient was managed locally and its Board decisions were undertaken in Kenya."The Appellant averred that the assertion contradicted the Respondent‘s claim that the company was managed and controlled by non-resident entities, and also failed to appreciate that a company can be locally managed and still procure specialist services from non-resident entities.

103. The Appellant further submitted that any business entity considers the best available options for its operations, and the Respondent would be overstepping its mandate under the Kenya Revenue Authority Act, if it were to be allowed to dictate to businesses on the services that they can outsource, contrary to the normal business practices.

104. It was therefore the submission of the Appellant that the Respondent failed to consider and address its mind fully to the issue on management fees, thereby arriving at an erroneous decision in connection thereto.

105. By reason of the foregoing submissions, the Appellant prayed that its Appeal be allowed, and the Respondent‘s objection decision be set aside.

The Respondent‘s Case 106. In its response to the Appellant‘s case, the Respondent has grounded its case on the Statement of Facts filed on 25th February 2022, the Respondent‘s Witness Statement by Linnet Anne Ojiambo filed on 9th September 2022 and the Written Submissions filed on 28th February 2023.

107. The Respondent stated that the Appellant was identified to have entered into multiple intra-company loan transactions to augment its operating capital reserves, being;a.An agreement between Izwe Kenya ltd and AMFH originally executed on 1st February 2014, with subsequent amendments.b.An agreement between Izwe Kenya Ltd and Izwe Kenya Holdings executed on 1st February 2018. c.An Agreement between Sanlam Africa Credit Investment Ltd (SACIL) executed on 16th May 2018.

108. The Respondent stated that all these leading entities with the exception of Sanlam Africa have mutual director-shareholders. It stated that the Directors of Izwe Loans and Izwe Kenya Holdings include David Eugene Fichardt and Lance Graham Clever, who feature in the Boards of Izwe Africa Holdings and other Izwe entities within the continent.

109. The Respondent sought to audit the Appellant‘s tax compliance for the period 2015 - 2019 and preliminary findings were communicated to the Appellant on 5th October 2020.

110. The Respondent further stated that the Appellant had entered into several loan transactions with other companies whose directorship was shared with the Appellant with the sole purpose of eroding the taxable base in Kenya to the low tax jurisdiction of Mauritius.

111. The Respondent stated that it therefore raised an assessment on 17th February 2021, and the Appellant lodged an objection on 19th March 2021, and after engagements and review of documents, issued an objection decision on 17th December 2021.

112. In its substantive response, the Respondent addressed the issues in dispute in sequential order as set out here below;

113. Whether the Respondent erred in its definition of ―controlling member" The Respondent contended that Izwe Africa Holdings (Mauritius) is the ultimate beneficial owner of the shares held by Izwe Kenya Holdings Ltd and as result can be deemed to exercise its rights as a shareholder in Izwe Loans Kenya Ltd.

114. The Respondent submitted that Section 18 (4) of the TPA defines ―controlling member" in relation to a company, means a member who beneficially holds, directly or indirectly, either alone or together with a related person or persons-a.Fifty per cent or more of the voting rights attaching to the membership interest in the company;b.Fifty per cent or more of the rights to dividends attaching to membership interests in the company;c.Fifty per cent or more of the rights to capital attaching to membership of the company.

115. The Respondent also submitted that Section 18 (1) of TPA makes provisions for liability, either current or future liability in the following terms, ― Every person who was a director or controlling member of the company when the arrangement was entered into shall be jointly and severally liable for the tax liability of the company." To this extent, the Respondent contended that Izwe Loans Kenya Ltd is liable to the same extent as the controlling member.

116. The Respondent stated that the issue of control was addressed in the Appellant‘s notice of objection, and it is not a new ground introduced by the Respondent in the objection decision.

117. It was the Respondent‘s contention that the Appellant did not provide evidence to dispute the Respondent‘s findings on this issue.

Thin Capitalization 118. The Respondent stated that the company entered into several intercompany loan agreements with its related parties for the provision of loans mainly for onward advance to its customers.

119. The Respondent stated that for the years 2014 -2019, the company expensed interest amounting to Kshs 583,261,839. 00, which arose from loans mainly obtained from AMFH, a related party based in Mauritius and SACL. The Respondent stated that during this period, Izwe Kenya was thinly capitalized, and the foregoing notwithstanding, it failed to restrict the interest expense as per the provisions of Section 16(2) (j) of the Income Tax Act.

120. The Respondent stated that the three conditions for thin capitalization to apply are;a.The highest amount of loans outstanding during a year of income exceeds three times revenue reserve and equity;b.The company is in the control of a non-resident person alone or with four or fewer other persons;c.The company is not a bank or financial institution licensed under the Banking Act.

121. The Respondent stated that the definition of control under Paragraph 32(1) of the Schedule is as follows;―32(1)in this schedule, unless the context otherwise requires ―control", in relation to a body corporate, means the; Power of a person to secure, by means of the holding of shares, or

The possession of voting power in or in relation to that or another body corporate, or

By virtue of powers conferred by the articles of association or other document regulating that or another body corporate, that the affairs of the first mentioned body corporate are conducted in accordance with the wishes of that person."

122. The Respondent submitted that from the group structure provided by the Appellant, Izwe Loans Kenya Ltd, control is exercised directly by AMFE through a Kenyan holding company, Izwe Kenya Holdings Ltd, and therefore meets the criteria and requirements of Section 16(2) (j) with regard to thin capitalization.

123. It was a further submission of the Respondent that the foregoing position is strengthened by the fact that the Directors of the Appellant and Izwe Kenya Holdings Ltd, include David Eugene Fichardt and Lance Graham Cleaver, who are also Directors of Izwe Africa Holdings Ltd. The signatories to the loan agreements between the Appellant and AMFH are these two directors abovementioned, and Eugene Du Plessis, the Group Treasurer, Izwe Africa.

124. The Respondent stated that Section 16(2) (j) of the ITA defines ―all loans ― to mean loans, overdrafts, ordinary trade debts, overdrawn current accounts or any other form of indebtedness for which a company pays a financial charge or interest. The company ought to have applied this in determining the interest costs to allow in its tax computations based on the ratio of loans to equity.

125. The Respondent stated that by reason of the foregoing, it restricted the interest expense of Kshs 546,398,354. 00 based on all loans including balances on the related party payables.

126. The Respondent further stated that the Appellant claimed interest despite the fact that the company was thinly capitalized owing to the fact that it was controlled by non-resident related parties as described hereinabove, thus interest income was brought to charge in accordance with Section 16(2)(j) of ITA.

127. It was a contention of the Respondent that irrespective of the absence of direct ownership or control, it can be rightly concluded that Izwe is foreign controlled as AMFE owns majority of the shares in Izwe Kenya- through interposing entity. The Respondent tendered the House of Lords decision in British American Tobacco Ltd -vs- IR Commissioners (1942) in support of the contention.

128. The Respondent asserted that as can be noted from the Minutes of the Group Board meeting held on 1st July 2015, the auditors Deloitte & Touché advised the group to form a holding company in Kenya and it is explicit that the main purpose was tax avoidance. Izwe Kenya Holdings was formed in 2015 way after the formation of Izwe Loans Kenya Lt in 2012, foreign control existed before the formation of the holding company, and the Appellant continued to receive loans from the same source (AMFHM) and carried on with the same business.

129. The Respondent also stated that from the Group structure, whose graphic illustration was provided, Izwe Loans Kenya Ltd is directly controlled by Izwe Kenya Holdings Ltd, which is indirectly controlled by Izwe Africa Holdings through Africa Microfinance Equities, all the companies sharing the same directorships.

130. The Respondent further stated that Kenyan shareholding stake in the Appellant pales in comparison to that held by the other competing shareholder. The stake held by the Kenyan shareholders represents 10 % of the issued shares and thus it cannot be objectively concluded that the Appellant is controlled by Kenyan domiciled shareholders, notwithstanding, Lance Graham Cleaver and David Eugene Fichardt are common directors in all the related companies.

131. The Respondent also stated that reflective of its position on Izwe Africa Holdings (Mauritius)‘s role in the Appellant by virtue of its proxy presence in the Appellant, the Tax Procedures Act considers Izwe Africa Holdings (Mauritius) as a ―controlling member" irrespective of the lack of active direct involvement in the in the Appellant‘s affairs. The Respondent cited Section 18 (4) of the ITA which defines a ―controlling member."

132. It was a further contention of the Respondent that the substance of these transactions and the totality of the circumstances surrounding the organizational structure outweighs the formalities in the company‘s shareholding, therefore Izwe Africa Holdings (Mauritius) is the ultimate beneficial owner of the shares held by the Kenyan holding company, Izwe Kenya Holding Limited (IKHL) and as a result can be deemed to exercise its appurtenant rights as a shareholder in Izwe Kenya Ltd.

133. The Respondent stated that the onus is on the Appellant to demonstrate and prove that the principal purpose for the adoption of its organizational arrangement was not entered into with a view of avoiding taxes. The Respondent stated that the Appellant had not discharged the burden of proving and hence it is its contention that the facts availed to the Respondent irresistibly point to a tax avoidance scheme.

Tax avoidance scheme 134. The Respondent submitted that from the Appellant‘s Board Minutes, among the reasons for incorporating Izwe Kenya Holdings Ltd, was to ―meet KRA requirements", which with facts availed to the Commissioner as set out herein, substantively pointing to an arrangement with a view to avoiding taxes.

135. The Respondent stated that Section 3 of the TPA defines ―tax avoidance" as a transaction or a scheme designed to avoid liability to pay tax under any law. It further stated that the Commissioner invokes Section 23 of the ITA, on transactions designed to avoid liability to tax.

136. The Respondent cited the provisions of the said Section 23 ITA as follows;― 1)Where the Commissioner is of the opinion that the main purpose or one of the main purposes for which a transaction was effected (whether before or after the passing of this Act) was avoidance or reduction of liability to tax for any year of income, or that the main benefit which might have been expected to accrue from the transaction in the three years immediately following the completion thereof, was the avoidance or reduction of liability to tax, he may, if he determines it to be just and reasonable, direct that such adjustments shall be made as respects liability to tax as he considers appropriate to counteract the avoidance or reduction of liability to tax which could otherwise be effected by the transaction.2)Without prejudice to the generality of the powers conferred by Subsection (1) of this Section, those powers shall extend –a.to the charging to tax of persons who, but for the adjustments, would not be charged to the same extent;b.to the charging of a greater amount of tax than would be charged but for the adjustments.3)Any direction of the Commissioner under this Section shall specify the transaction or transactions giving rise to the direction and the adjustments as respects liability to tax which the Commissioner considers appropriate."

Foreign exchange losses 137. The Respondent stated that the Appellant had expensed forex losses amounting to Kshs 103,469,554. 00 for the period under audit.

138. It further stated that Section 4 A (1) (ii) (a) provides that the forex exchange loss shall be deferred (and not taken into account) where the foreign exchange loss is realized by a company with respect to a loan from a person who alone or together with four or fewer other persons, is in control of that company, and the highest amount of all loans by that company outstanding at any time during the year of income is more than three times the sum of revenue reserves and the issued and paid up capital of all classes of shares of the company.

139. The Respondent cited Section 4A of ITA which provides that :-4(A) Aforeign exchange gain or loss realized on or after the 1st January 1989 in a business carried on in Kenya shall be taken into account as a trading receipt or deductible expenses in computing the gains and profits of that business for the year of income in which that gain or loss was realized; Provided that –i.No foreign exchange gain or loss shall be taken into account to the extent that taking that foreign exchange gain or loss into account would duplicate the amounts of gain or loss accrued in any prior year of income; andii.The foreign exchange loss shall be deferred and not taken into account)."

140. The Respondent contended that the Appellant did not offer any compelling evidence in substantiating the claim for forex losses neither did it clearly demonstrate how the foreign exchange losses were realized. In addition, the company is thinly capitalized in the Respondent‘s observation and does not qualify to claim foreign exchange loss, and therefore confirmed the forex assessment amounting to Kshs 103,469,554. 00 in line with Section 4 A of ITA as the same was not taken into account as a deductible expense.

Hedging costs 141. The Respondent stated that it disallowed hedging costs of Kshs 44,465,804. 00 for the years 2015 to 2018 as a foreign exchange loss on the basis that Izwe Loans Kenya Ltd is thinly capitalized and asserted that hedging costs being contracts cushioning the Appellant in foreign borrowing rates fall under foreign exchange loss expenses.

142. Derivatives on the other hand are interest costs which arose from loans obtained from AMFE, and the Respondent‘s contention is that there exists some amount of control on the Appellant by AMFE.

143. The Appellant had invoked Section 15(1) of the ITA on the basis that the Act allowed for the deduction of expenses incurred solely for the generation of income and in the matter at hand hedging costs attributed to foreign exchange volatility ought to have been allowed.a)The Respondent cited Section 16(2) of the ITA which provides; -―(2)notwithstanding any other provisions of this Act, no deduction shall be allowed in respect of –an amount of deemed interest where the person is controlled by a non-resident person alone or together with not more than four other persons and where the company is not a bank or a financial institution licensed under the Banking Act."

144. It therefore submitted that as the Appellant was established to be thinly capitalized, its hedging costs and derivatives being foreign exchange losses are deferred.

145. It was a contention of the Respondent that a hedging cost is a forex loss and should be accounted for under foreign exchange loss, thus confirmed the hedging cost assessment in line with Section 4A of the ITA.

Finance costs 146. The Respondent disallowed the Appellant‘s finance costs amounting to Kshs. 7,755,316. 00 for the year 2015 as an interest expense, on the basis that the Appellant is thinly capitalized. The Appellant had contended that the said cost related to movement on derivatives which AMFH incurred in the year 2015, and invoked Section 15(1) of ITA on the basis that the Act allows for the deduction of expenses incurred solely for the generation of income.

147. The Respondent submitted that loss from derivatives is a forex loss and should be accounted for under forex loss, otherwise it would result to a duplication of expenses, and thus it confirmed the assessment on hedging costs.

Management fees 148. The Respondent stated that the Appellant claimed that it had procured management and technical services from Lethu and AMFH from Mauritius. The Respondent further stated that the Appellant did not satisfactorily demonstrate that the two Mauritius companies had the ability and capacity to deliver on their service engagement with the Appellant.

149. The Respondent contended that the Appellant did not provide conclusive evidence that the two Mauritius entities indeed have the capacity and or relevant skill and expertise to provide services that would be tailored for the Kenyan consumption, proof against the notion that the two companies are shell companies and lacked substance in the overall running of the enterprise, and compelling.

150. The Respondent contended that its findings were AMFH was a company incorporated in Mauritius with no known physical assets and address or independent office, and used another company known as IQ EQ Corporate Services (Mauritius Ltd) as its registered address.

151. The Respondent contended that AMFH is a shell entity with no position to render the alleged services. It also stated that the Appellant did not indicate which services and supporting source documents to make economic sense.

152. It further averred that the Appellant‘s employee job descriptions and employment contracts provided proof that the Appellant was self-sufficient and had the capacity to offer management services without the help of the related foreign company. There was a presence of local platforms used locally, loans appraisal information provided by local institutions like NTSA, local Banks, clients employers (e.g. TSC),, all loans related to administrative work e.g. Vetting done by the Appellant‘s local staff all pointing to the fact that loan processes are managed locally. In addition, all Board decisions relating to the company are taken in Kenya.

153. The Respondent stated that therefore it decided that the proportion of management fees represented in the profit and loss be added back, and the assessment in regard to the proportion of that expense be upheld and accordingly confirmed the amount of Kshs 339,985,372. 00

154. The Respondent stated that cumulatively upon review of the Appellant‘s objection on the foregoing heads, it confirmed a total amount of the assessed tax in the sum of Kshs 368,306,007. 00 and dropped a sum of Kshs 19,840,977. 00

155. By reason of the foregoing, the Respondent prayed that the Appellant‘s Appeal be dismissed with costs, and the Respondent‘s objection decision be upheld.

Issues For Determination 156. The Tribunal having carefully considered the pleadings and submissions made by the parties is of the considered view that the Appeal distils into the following issues for determination: -a.Whether the Appellant effected a transaction to avoid tax or reduce tax liability.b.Whether the Respondent was justified in issuing its Objection Decision dated 17th December 2021.

Analysis And Determination a. Whether the Appellant effected a transaction to avoid tax. 157. The Respondent invoked Section 23 of the Income Tax Act and issued Corporation income tax assessments in 2015, 2016, 2017, 2018 and 2019, stating that the incorporation of Izwe Holdings Kenya Limited on 24th December 2015 and its subsequent 90% ownership of the Appellant was a tax avoidance scheme. To arrive at this opinion, the Respondent relied on the Appellant‘s board meeting minutes reference ‗Minute 7 01/07/2015 III Business Strategy‘, which stated: -―Mr. DF took Board Members through the concept of Thin Capitalisation where interest expenses are not fully allowable for tax purposes if the Company is thinly capitalized.Mr. DF informed the Board Members that the company had contracted a consultant firm to advice on the way forward in this regard. The Consultant recommended formation of a Holding company owned 100% by AMFE. The Holding company will be incorporated in Kenya. In turn AMFE will transfer its 90% shareholding in IZWE Loans Kenya Limited to the new Holding Company. This new structure will provide many future benefits with regards to Company expansion and cost efficiencies and will also enable to group to meet the KRA requirements."

158. In response to the Respondent‘s allegation, the Appellant stated that Izwe Holdings Kenya Limited, a company incorporated in Kenya, was incorporated for the primary objective of creating a business structure suitable for diversification into other business activities which was contained in its Business Strategy Report and Board Minutes reference Minute 22/2018 dated 31st October 2018 and reference Minute 7/2019 dated 6th March 2019.

159. The Tribunal considered the Appellant‘s Statement of Facts, submissions, witness statement to determine the appropriateness of Respondent‘s claim that the Appellant had entered into a tax avoidance scheme. It was key for the Tribunal to determine if the Respondent was justified in its opinion by analysing whether the Appellant effected a transaction in a manner to merit the operation of Section 23 of the Income Tax Act which provides that:―(1)Where the Commissioner is of the opinion that the main purpose or one of the main purposes for which a transaction was effected (whether before or after the passing of this Act) was the avoidance or reduction of liability to tax for any year of income, or that the main benefit which might have been expected to accrue from the transaction in the three years immediately following the completion thereof was the avoidance or reduction of liability to tax, he may, if he determines it to be just and reasonable, direct that such adjustments shall be made as respects liability to tax as he considers appropriate to counteract the avoidance or reduction of liability to tax which could otherwise be effected by the transaction.2. Without prejudice to the generality of the powers conferred by subsection (1) of this section, those powers shall extend—a.to the charging to tax of persons who, but for the adjustments, would not be charged to the same extent;b.to the charging of a greater amount of tax than would be charged but for the adjustments.3. Any direction of the Commissioner under this section shall specify the transaction or transactions giving rise to the direction and the adjustments as respects liability to tax which the Commissioner considers appropriate."

160. The Tribunal, in its review, aimed to establish if the main purpose or one of the main purposes for which the Appellant restructured its control was the avoidance or reduction of liability to tax for any year of income. The Tribunal analysed the Appellant‘s tax position prior to the restructuring and the tax position subsequent to the restructuring.

161. From October 2013 to 24th December 2015, the Appellant‘s shareholding was ninety per cent (90%) held by Africa Micro-Finance Equities (AMFE), a company registered and resident in Mauritius. AMFE was in control of the Appellant according to Paragraph 32 (1) of the Second Schedule to the ITA.

162. The Appellant, being a non-deposit-taking microfinance lender, in the period under assessment, used to obtain loans from a related party named African Micro-Finance Holdings Limited (AMFH), a company registered and resident in Mauritius. Based on the Appellant‘s data, the Tribunal confirms that the Appellant was thinly capitalised between October 2013 and 24th December 2015. Being thinly capitalised meant that according to Section 16 2(j) of the ITA, deduction of the Appellant‘s interest payments on loans advanced to it by a non-resident person or a non-resident associate of AMFE, were to be restricted in proportion to the extent that the highest amount of all loans held by the company at any time during the year of income exceeded three times the sum of the revenue reserves and the issued and paid capital of all classes of shares of the company.

163. The Tribunal scrutinised the Appellant‘s Board meeting minutes reference Minute 7 01/07/2015 III Business Strategy‘ and noted that the Appellant specifically discussed thin capitalisation and had contracted a consultant firm to advise it on the way forward in regard to thin capitalisation. The Appellant‘s director in those minutes stated that the consultant recommended formation of a Holding company owned 100% by AMFE. The Appellant did not dispute these board minutes. Evidence from the Appellant‘s board meeting minutes which articulated the Appellant‘s intention to reduce its tax liability.

164. On 24th December 2015, Izwe Kenya Holdings Limited was incorporated in Kenya, and on the same day, AMFE transferred its ninety per cent (90%) shareholding to it. Paragraph 32 of the Second Schedule of the Income Tax Act sufficiently defines ‗control‘ and provides, inter alia, that: -_… Provided that in the case of a body corporate, unless otherwise expressly provided for by the articles of association or other documents regulating it ―control" shall mean the holding of shares or voting power of twenty-five per cent or more."

165. From 24th December 2015, the Tribunal determines that Appellant was in the control of Izwe Kenya Holdings Limited, a company incorporated in and resident in Kenya. The import of this restructuring, rendered that the Appellant was in the control of a resident person and thus, the restriction of the deduction of interest payments on loans advanced to it by a non- resident person or a non-resident associate of AMFE no longer applied.

166. A review of the Appellant‘s tax position before and after the restructuring of controlling interest demonstrated that one of the main purposes of the restructuring was reduction of its tax liability.

167. Based on the foregoing the Tribunal finds that the Appellant significantly reduced its Corporation income tax liability as a result of the restructuring, because from 24th December 2015, the date of the restructuring, it was allowed to deduct the entire interest expense which would not have been the case had it not formed the resident holding company.

b. Whether the Respondent was justified in issuing its Objection Decision dated 17th December 2021. 168. The Respondent undertook an audit of the Appellant‘s operations for years of income 2015 – 2019. By a letter dated 5th October 2020 the Respondent communicated its preliminary audit findings to the Appellant issuing an assessment on 17th February 2021 for Kshs 368,306,006. 00. The Appellant objected to the assessment. The parties went through the process of objection review in which the Appellant submitted to the Respondent its volumes of supporting documentation and engaged in several one-on-one meetings.

169. The Respondent then issued to the Appellant its objection decision on 17th December 2021 in which it confirmed an assessment of Kshs 348,465,030. 00 having dropped Kshs 19,840,976. 00 on account of lease liability. The confirmation of this assessment in the said Objection decision triggered the Appeal herein.

170. The Appellant and the Respondent concretized the issues giving rise to the Corporation income tax assessment around several heads. The Tribunal finds it reasonable and convenient to base its analysis of the issue under the thematic heads below:-a.Whether the Respondent erred in restricting deduction of the Appellant‘s interest payments.b.Whether the Respondent erred in deferring and disallowing foreign exchange losses.c.Whether the Respondent erred in classifying hedging costs as foreign exchange losses and subsequently deferring and disallowing the hedging costs.d.Whether the Respondent erred in classifying finance costs on derivatives as foreign exchange losses and subsequently deferring and disallowing the finance costs on derivatives.e.Whether the Respondent erred in disallowing management fees.

a. Whether the Respondent erred in restricting deduction of the Appellant‘s interest payments. 171. The Appellant stated that the Respondent in its assessment disallowed the Appellant‘s interest expenses on the basis that it was thinly capitalized as a result of loans from Africa Microfinance Holdings (AMFH) a related entity, and that there were common directorships between the Appellant, Izwe Africa Holdings (IAH), and other operating entities. Further that the loan documents between the Appellant and that of AMFH were executed by two common directors together with the Treasurer and therefore AMFH, the lender, had common control.

172. The Respondent invoked Section 23 of the Income Tax Act stating that the incorporation of Izwe Holdings Kenya Limited on 24th December 2015 and its subsequent 90% ownership of the Appellant was a tax avoidance scheme thereby applying Section 16 (2) (j) of the ITA to restrict the Appellant‘s deduction of interest payments on the basis that the Appellant was thinly capitalized as it was in the control of a non-resident person.

173. The Tribunal having held that the Appellant had entered into a tax avoidance scheme in the restructuring of its control, proceeds to determine that the Respondent did not err in restricting the deduction of the Appellant‘s interest payments.

174. The Tribunal holds that under the circumstances of this case the Appellant would still be liable under Section 23 of the ITA whether or not the Respondent had relied on Section 18 of the Tax Procedures Act to support its case.

175. The Tribunal has examined the computation of the interest which the Respondent disallowed to counteract the reduction of liability to tax which was otherwise effected by the restructuring transaction.

176. The Tribunal takes cognizance of the fact that in 2017, 2018 and 2019 the Appellant was advanced interest-bearing loans from entities that are resident in Kenya. Accordingly, the Tribunal finds that the Respondent erred in restricting the deduction of Appellant‘s interest payments on loans advanced by resident persons.

177. The Tribunal finds that the Respondent correctly disallowed interest payments to correct the tax avoidance or reduction scheme perpetuated by the Appellant, save for the Respondent‘s failure to exclude from its ascertainment of the Appellant‘s additional taxable income interest payments on loans advanced to the Appellant by resident persons.

b. Whether the Respondent erred in deferring the Appellant‘s foreign exchange losses. 178. The Respondent in its assessment deferred the Appellant‘s foreign exchange losses of Kshs 103,469,533. 90 on account of alleged unlawful claim of realized foreign exchange losses, thin capitalization and control under Section 4A of the ITA.

179. The Appellant had averred that forex losses are a normal part of its business model because of borrowing in US Dollars, converting the US Dollar loans to Kenya Shillings, disbursement in Kenya Shillings to its customers, repayment of disbursed loans by its customers in Kenya Shillings, conversion of the Kenya Shillings to US Dollars for repayment of US Dollar loans.

180. The Appellant further averred that US Dollar loans are its trading stock and are akin to a supermarket procuring goods on credit for cash sales, and for planning purposes it borrows the funds before the local demand arises, so as to secure the funds earlier in order not to lose customers to competitors.

181. The Respondent stated in its statement of findings that the Appellant entered into inter-company loans with AMFH, Izwe Kenya Holdings Limited and Sanlam Africa Credit Investment Ltd. Based on the foregoing, the Appellant borrowed loans from a person who was in its control (Izwe Kenya Holdings Limited), and other persons who were not in its control during the tax periods under review.

182. Section 4A of the ITA provides that:(ii)the foreign exchange loss shall be deferred (and not taken into account)—

(a) where the foreign exchange loss is realized by a company with respect to a loan from a person who, alone or together with four or fewer other persons, is in control of that company and the highest amount of all loans by that company outstanding at any time during the year of income is more than three times the sum of the revenue reserves (retained earnings) and the issued and paid up capital of all classes of shares of the company;" 183. From a reading of the above provision, foreign exchange losses may only be deferred when it occurs from a loan borrowed from a person who controls a company and the company is thinly capitalized. In other words where the loan is borrowed from a person who does not control the company or the company is not thinly capitalized, there is no legal requirement to defer the foreign exchange loss.

184. Upon review of the detailed submissions by the parties, the Tribunal is of the considered view that only foreign exchange losses from loans advanced by Izwe Holdings Kenya Limited to the Appellant may be deferred. The Respondent therefore erred in deferring the entire foreign exchange losses without taking into account the controlling interest of the lenders.

c. Whether the Respondent erred in classifying hedging costs as foreign exchange losses and subsequently deferring and disallowing the hedging costs. 185. The Respondent disallowed the Appellant‘s hedging costs in the sum of Kshs 44,465,804. 00 on the basis that it was a foreign exchange loss and should therefore have been accounted for under foreign exchange gain or loss computation. The Respondent therefore confirmed the hedging costs assessment under Section 4A of the ITA.

186. The Respondent also asserted that it disallowed hedging costs of Kshs 44,465,804 for the years 2015 to 2018 as a foreign exchange loss on the basis that Izwe Loans Kenya Ltd is thinly capitalized and asserted that hedging costs being contracts cushioning the Appellant in foreign borrowing rates fall under foreign exchange loss expenses.

187. The Appellant had averred that it incurred hedging costs by entering into forward exchange contracts to reduce its exposure to foreign exchange fluctuations. It further averred that the FECs allow it to convert borrowed dollars to Kenya Shillings, and repay the dollar denominated loans using Kenya Shillings at relatively stable conversion rates for a specific period.

188. The Appellant had also averred that the FECs help it to determine the confirmed margins it will be making on the loans disbursed to its customers, and also limit the Appellant‘s exchange losses when repaying its dollar denominated loans.

189. It was also an averment of the Appellant that the FECs are contracts with financial institutions such as banks, the main one being Absa Bank PLC, and that the cost of entering into FECs is that the dollar conversion rate will be generally be slightly higher than the spot rate (dollar conversion rate under free market economy). The Appellant therefore submitted that the hedging cost is a business expense just like insurance expense, and it is therefore an expense incurred in the production of the Appellant‘s income.

190. The Tribunal having considered the Appellant and the Respondent‘s submissions and the definition of foreign exchange loss as provided for in Section 4A(2) of ITA, is satisfied that the Appellant‘s hedging costs are an expense incurred in the production of income and not a foreign exchange loss.

191. In view of the above, the Tribunal finds that the Respondent erred in confirming additional taxable income on the basis that the hedging costs were foreign exchange losses.

d. Whether the Respondent erred in classifying finance costs on derivatives as foreign exchange losses and subsequently deferring and disallowing the finance costs on derivatives. 192. The Respondent in its assessment disallowed the Appellant‘s finance costs amounting to Kshs 7,755,316. 00, and classified the same as foreign exchange losses.

193. The Appellant averred that the said costs were on account of interest rates swaps, as the swaps were expenses relating to derivatives purchases in the ordinary course of its business and were incurred wholly and exclusively in the production of income which was in accordance with Section 15(1) of ITA. The Appellant further averred that the interest rates swaps related costs were not foreign exchange losses, and the same could not be disallowed under Section 4A of ITA (supra).

194. The Tribunal having reviewed the documentation submitted by the Appellant, is satisfied with its explanation that its interest swaps were agreements between the parties wherein they were to exchange one stream of interest for another over a set period of time and were derivative contracts traded over the counter, meaning the interest swaps were derivative contracts where the Appellant exchanged variable interest rate obligations for fixed interest rate obligations.

195. In view of the foregoing, the Tribunal finds that the Respondent erred in confirming additional taxable income of Kshs 7,755,316. 00 on the basis that the finance costs were foreign exchange losses.

e. Whether the Respondent erred in disallowing the Appellant‘s management fees costs. 196. The Respondent in its assessment disallowed the Appellant‘s management fees expenses amounting to Kshs 339,985,372. 00 on the basis that the Appellant had failed to provide conclusive evidence that Lethu Administration and African Microfinance Holdings indeed provided services that were key in the operations of Izwe Loans Kenya Ltd.

197. The Respondent further contended that its review of the Appellant‘s employee contracts and job descriptions established that the company was self-sufficient and had the capacity to offer management services without the help of the related foreign companies, and highlighted the reasons thereof as;a.the company has an automated loans platform that is used to process loans locally;b.loans appraisal information is provided by local companies and institutions such as local credit reference bureaus, NTSA, local banks, client‘s employers such TSC;c.all loans related administrative work such as vetting, credit control, marketing, and customer care is done by Izwe Loans local staff;d.The Board minutes evidence that the operations of the company are managed locally;e.from the Appellant‘s letter of 22nd November 2021 all the Board decisions relating to the company are undertaken in Kenya.

198. The Respondent also contended that the Appellant failed to prove that the management services offered;"… had a direct and positive influence on the company‘s performance, reduced any costs, favoured the improvement of production and marketing of the loan, or reduced costs previously assumed for similar services by Mifugo Ltd, or even that the provision of the new services had, even on provisional basis, increased the company‘s potential."

199. In view of the foregoing reasons, the Respondent confirmed the assessment on management fees paid to foreign related parties.

200. The Appellant contended and submitted that the Respondent‘s basis for the assessment was unreasonable for the following reasons;a.The Income Tax Act only requires that the costs be incurred wholly and exclusively in the production of taxable income, nothing more;b.The Respondent acted ultra vires by purporting to mandate the Appellant to meet certain key performance indicators upon purchase of services;c.The Respondent acted ultra vires by requiring the Appellant to prove improved performance; and,d.The Respondent acted irrationally by claiming that the procurement of services must result in improved production.

201. The Appellant had provided the particulars of the services provided by the related entities, being, business support, technical services and management services, in a detailed matrix showing the functions carried out locally versus those outsourced:a.collection support – credit support,b.finance/administration support -Tax computations,c.reconciliations,d.payroll administration support,e.operations support - ICT services,f.loan platform review service,g.treasury services support - proof of meetings,h.treasury packs.

202. The Appellant also provided a detailed schedule outlining the Lethu staff members providing the services, their qualifications, and details of the outsourced functions and a detailed listing of the benefits enjoyed by the Appellant.

203. However, from the Respondent‘s submissions, it is of the view that the Appellant‘s staff could have provided the particularized outsourced services. It did not however indicate the reasons for such an opinion or from the staff schedules given and the job descriptions, the staff members who would have performed such jobs and their reasons for holding so.

204. The Appellant, however, contended that its staff lacked the requisite technical capacity, skills, training, time and the technical resources and tools to undertake the outsourced tasks. The Appellant has by a letter dated 22nd November 2021 at schedule 5 attached a schedule demonstrating the role of the Appellant‘s past and current employees earning more than Kshs 100,000. 00 monthly, and it is noteworthy from the schedule that the staff members did not have the technical capacity to undertake certain tasks such as developing an online loan management platform, maintaining the platform, generating treasury packs, and carrying out risk assessments. The Appellant also adduced sample employment contracts as proof that its staff did not have the technical capacity to carry out the outsourced services.

205. The Appellant has submitted that the management and technical services procured from related third parties, were incurred wholly and exclusively in the production of taxable income, were necessary to the operations of the Appellant and could not be provided by the Appellant‘s staff at the quality and speed needed for the Appellant to benefit from the same.

206. In the case of Kenya Fluorspar Ltd -vs- Commissioner of Domestic Taxes (2020) eKLR, it was stated: -―In my view, though indeed there is no evidence that any formal written requests for such consultancy management services was produced by KFC, there was evidence of interactions and meetings held. Such interactions and meetings between KFC and KCMC, in my view were adequate proof of consultancy services provided."

207. The Tribunal has pored in detail over the documents submitted in the Appellant‘s bundles of documents and is satisfied that the Appellant availed proof of the outsourced management and technical staff travel details, work time-sheets, proof of work done and video evidence of the management meetings held by the said staff.

208. The Tribunal is therefore satisfied that the Appellant has adequately demonstrated proof of the need for the outsourced services, the resultant economic benefit, and also that an independent third party could have procured the services. The Appellant also adequately demonstrated that it outsourced these services as it did not have the capacity to offer itself these services, which included access to intellectual property and technical support to the Appellant‘s software systems.

209. In light of the foregoing, the Tribunal comes to the conclusion that the Respondent failed to consider and address its mind fully to the issue of management fees incurred by the Appellant in outsourcing technical and management support services for its business operations, and thereby arrived at an erroneous decision in connection thereto.

210. Consequently, the Tribunal finds and holds that the Respondent erred in disallowing the Appellant‘s management fees expense.

211. In view of the Tribunal‘s analysis of the issues for determination, the Tribunal finds and holds that the Respondent erred in part in the confirmation of its assessments in its Objection decision dated 17th December 2021.

Final Decision 212. The upshot of the foregoing is that the Appeal partially succeeds and the Tribunal accordingly issues the following Orders: -a.The Appeal be and is hereby partially allowed.b.The Respondent‘s Objection decision dated 17th December 2021 be and is hereby set aside.c.The Respondent is at liberty to revise its assessment within 60 days of the date of this Judgment as follows: -a.Restricting interest pursuant to Section 16 (2) (j) of ITA on foreign loans from AMFH.b.Deferring foreign exchange losses pursuant to Section 4A(1)(ii) of ITA on loans from Izwe Kenya Holding Limited.d.Each party to bear its own costs.

213. It is so ordered.

DATED AND DELIVERED AT NAIROBI THIS 18TH DAY OF AUGUST, 2023. ROBERT M. MUTUMA - CHAIRPERSONRODNEY O. OLUOCH - MEMBERELISHA N. NJERU - MEMBERDELILAH K. NGALA - MEMBER