[2024] KETAT 276 (KLR)

M-Kopa Limited v Commissioner of Domestic Taxes (Tax Appeal 1237 of 2022) [2024] KETAT 276 (KLR) (8 March 2024) (Judgment)

Neutral citation: [2024] KETAT 276 (KLR)

Republic of Kenya

In the Tax Appeal Tribunal

Tax Appeal 1237 of 2022

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

March 8, 2024

Between

M-Kopa Limited

Appellant

and

Commissioner of Domestic Taxes

Respondent

Judgment

Background 1. The Appellant is a limited liability company incorporated under the Companies Act of the laws of Kenya and its principal business activity is that of retailing solar powered home lighting solutions, mobile phones and other related products on a pay-as you-go basis to low income households.

2. The Respondent is a principal officer appointed under Section 13 of the Kenya Revenue Authority Act and the Kenya Revenue Authority is mandated with the responsibility of assessing, collecting and accounting for all tax revenue as an agent of the Government of the Republic of Kenya. The Respondent is also mandated with the responsibility for the administration and enforcement of the tax statutes set out in the Schedule to the said Act.

3. The Appellant was issued by the Respondent with an assessment on 23rd June 2022 adjusting the Corporation tax loss position for the financial 2016 downwards to Kshs 1,789,514,499. 45.

4. The Appellant objected to the assessment on 22nd July 2022, and the Respondent on 30th August 2022 wrote to the Appellant requesting for further documents to support the Objection.

5. The Appellant on 5th September 2022 communicated to the Respondent that it was not possible to provide further documents in support of the objection, as the information was bulky, and proposed a walk through for purposes of demonstrating the data maintained in the system.

6. The Respondent issued its Objection decision on 8th September 2022 and partially disallowed the objection to the tax assessment,

7. Dissatisfied with the Respondent’s Objection decision the Appellant lodged the Appeal herein with the Tribunal on 21st October 2022.

The Appeal 8. The Appellant filed its Memorandum of Appeal on 21st October 2022 and set out the following grounds of appeal;i.That the Respondent erred in law and fact by failing to consider the explanations and documents provided by the Appellant thus disallowing genuine business expenses which were wholly and exclusively incurred in furtherance of business. The same resulted in the Corporation tax loss adjustment by Kshs 272,261,769. 00 from Kshs 2,061,776,269. 00 to Kshs 1,789,514,499. 45. ii.That the Respondent erred by disallowing bad debts written off, of Kshs. 193,736,915. 00 for the year 2016 against the provisions of Section 15 (2) (a) of the Income Tax Act and the Commissioner’s Guidelines under the Legal Notice No. 37 of 2011. iii.That the Respondent erred in law and fact by not taking consideration that the Appellant satisfied two Guidelines of Legal Notice No.37 of 2011 on allowability of bad debts.

The Appellant’s Case 9. The Appellant has set out its case on its;a.Statement of Facts dated 21st October 2022 and filed on the same date together with the documents annexed thereto;b.Supplementary Statement of Facts dated 14th July 2023 and filed on 17th July 2023 with leave of the Tribunal; andc.Written submissions dated 4th April 2023 and filed on 5th April 2023.

10. The Appellant stated that the Respondent conducted an audit on the Appellant’s operations for the year 2016 which resulted into a Corporation tax assessment communicated to the Appellant vide a letter dated 23rd June 2022. The assessment resulted into an adjusted 2016 Corporation tax loss position downwards by Kshs. 497,203,492. 00 from Kshs. 2,061,776,269. 00 to Kshs. 1,564,572,777. 00

11. The Appellant stated that the said assessment related to the Respondent’s decision to disallow bad debts of Kshs. 308,512,947. 00 on the basis that the Appellant had not demonstrated all reasonable steps that were taken into consideration to collect the debts from the customers.a.Make an income adjustment of Kshs. 47,155,779. 00 for low value services the Appellant provided to related partiesb.Disallow loan interest expense of Kshs. 110,165,690. 00 arising from the Commercial Bank of Africa syndicated loan on the basis that the Appellant had not provided supporting documents.c.Charge Corporation tax on the sales variance of Kshs. 31,369,075. 00 between the turnover declared in the Audited Financial Statements and the turnover declared in the VAT returns.

12. The Appellant further stated that the Respondent issued an objection decision by confirming the assessments vide the letter dated 8th September 2022 on the following grounds;a.That the Appellant had not demonstrated that it had exhausted all the reasonable steps to recover the debt amounting to Kshs. 193,736,915. 00. The Commissioner noted that the correct amount disallowed was Kshs. 193,736,915. 00 instead of Kshs. 308,512,947. 00 as confirmed from the Audited Financial Statement, trial balance and audit journals.b.That the services offered to the non-resident related parties at no charge had not been benchmarked and that the income from these services amounting to Kshs. 47,155,779. 55 was unreported.c.That the VAT reconciliation had not been supported by way of any documents and no amendments were initiated by the Appellant to correct the turnover position and therefore the sales variance of Kshs. 31,369,075. 00 was treated as additional income for Corporation tax purpose.

13. The Appellant set out its facts in support of its grounds of appeal under distinct heads as follows: -i.Bad debts written off:

14. The Appellant stated that it sells its products to customers on a pay-as you-go basis. The customers pay a small deposit averaging Kshs. 3,500. 00 after which they are supplied with the products. In order for them to enjoy the use of the products they make average daily payments of Kshs. 50. 00 over a period of one to two years. It stated that its products are targeted at low income households in rural areas that offer a clean and renewable energy alternative. This explains the low quantum of deposit and daily payments its customers make.

15. The Appellant further stated that unlike conventional financial institutions, it tracks delinquency based on zero credit days consecutively, thus write off happens based on this criterion as opposed to cumulative days in arrears which is the norm with financial services. The Appellant’s method of write offs is therefore much more conservative as these customers are at least 120 days in arrears cumulatively.

16. The Appellant also stated that it offers incentives for customers to cancel, return their devices and refunds them their deposit.

17. It stated that it also offers incentives for customers who maintain good repayment terms by giving them an opportunity to acquire additional products at a discounted price.

18. It also stated that despite the incentives offered, the Appellant additionally contacts customers where the conversion rate for customers post 120 consecutive days without credit less than 10% of the outstanding loan book while in the other delinquency buckets (below 120 days) conversion rate is above 70%. It stated that the cost implications far outweigh the benefits accrued as the cost is on a fixed wage as opposed to a variable which is the norm in all other delinquency buckets (below 120 days).

19. The Appellant also stated that its customers are spread across the whole country and sales are made to the customers through direct sales representatives. The primary role of the DSR being to sell the Appellant’s products and that of the field technicians being to install and troubleshoot for customers in case of malfunctions, and they are not involved in debt collection.

20. It further stated that given that it sells its products on a credit sale basis, it does not have the legal authority to re-possess its products under hire purchase or similar finance lease regime.

21. The Appellant stated that it had a bad debts provisioning policy, and took the following steps to pursue bad debts;a.The credit advanced to customers was closely monitored, and within the first 30 days into the loan, all the loanees would be called twice, being loan activation calls and education calls.b.The customer is followed up after one month of owning the product, based on zero credits.c.Between 1 to 4 days customers received payment reminder SMS that are auto generated. Customers were flagged to receive a call under the below campaign buckets;i.5 to 30 days without credit;ii.31 to 90 days with zero credit got blocked;iii.90 – 120 days – SMS every alternate day the referred to CRB;iv.Over 120 days – written off as all internal efforts not yielded any payment.The Appellant provided sample extracts of the call and SMS logs to its customers because the logs are bulky due to numerous calls.d.For struggling customers, the Appellant allowed them to return the product if it was in good working condition, and refunded full deposit for products returned with 30 days and 50% for those returned between 31 to 90 days from date of purchase. For any missing component, the Appellant deducted the replacement value from the deposit and refunded the difference.

22. The Appellant contended that based on the foregoing all the reasonable steps were taken to collect the debt and recover the devices from defaulting customers.

23. The Appellant also contended that unless its customers returned the devices, it would be difficult to repossess the devices due to the following challenges;a.The bad debts written off relate to 47,625 customers and the average debts written off per customer is Kshs. 6,630. 00 which translated to 3 % of the total customers.b.The DSR’s and field technicians do not know the exact location of the customers who have defaulted.c.The devices are fitted with Safaricom SIM cards which can help locate the customers. However, they only give rough estimates of the location between 10 to 30 KMS as the customer devices do not have full GPS. As a result, the Appellant would have to employ more resources (time, travel allowances, airtime allowances) to locate the customer.d.It is also important to take note that defaulting customers are highly uncooperative, and they usually do not respond to phone calls from customer care agents trying to collect the debt from them, neither would they provide their location.

24. The Appellant asserted that based on the foregoing, the debts written off are uncollectable since no form of security or collateral is realizable whether partially or in full.

25. It stated that the cost of pursuing the debts using third parties would exceed the cost of recovering the debt given that only 3% of the customers default and the debt written off. In addition, the Appellant stated that it reported the customers who defaulted to CRB, a measure taken to ensure that customers make payments. It is however noteworthy that from 2016, the customers were in CRB listing up to 2017 and beyond demonstrating that the Appellant put effort to exhaust all available means to recover the bad debts to no avail. The sample extracts of the CRB listing for 2016/2017 was provided by the Appellant.

26. The Appellant further stated that in addition, the bad debts written off under consideration by the Appellant are specific debts and not general in nature, as per the detailed list of the bad debts written off for the 47,625 customers. It stated that the specific nature of the bad debts and the fact that there is no form of security or collateral realizable, and the costs of recovering the debt exceed the value of the debt, are the reasons the Appellant rightfully allowed their write off in the 2016 year of income.

27. The Appellant further contended that the fact that there exists a listing provided to CRB and there are call logs and SMS logs showing the follow up efforts, further demonstrates that a detailed listing of all the defaulting customers, and follow up efforts made exist.

28. The Appellant stated that the Respondent alluded to the fact that the Appellant’s devices are fitted with Safaricom SIM cards that have GSM communication module that would allow the Appellant to trace the location of the defaulting customers. It stated this has shortcomings however as quoted here below;“a.The solar devices have a modem with a Safaricom SIM in them that communicates with the Appellant’s servers via 2G network, the primary reason for the communication being to pick information about payments, which is translated into a number of days of usage that the solar devices should “power on”.b.The modem has some intelligence that will cause a periodic check-in once every 24 hours. The devices battery requires sufficient charge, and to be in a reliable Safaricom network for the check-in to work. When the modem checks-in, the SIM will be active for a short time generally less than two minutes. The SIM is otherwise inactive, for devices the customer that the customer is not paying for, as the customer will not be using it, this will cause the battery to go flat and hence the SIM will not check in.c.In addition, if the customer presses the ‘M-Kopa credit’ on the device-modem, the device will wake up and check-in too. In this instance the SIM is only active for a short period, less than two minutes to receive the credit.d.The modem is not equipped with any location information.e.The time that the SIM is active is not sufficient for Safaricom to be able to triangulate the position. Even if the SIM was active to allow triangulation, it would only give a rough location of the customer devices between 10 to 30 kilometers radius from the Safaricom tower location because they do not have full GPS. This is because the SIM are primarily used for connectivity and to deliver customer payments, translated into a number of usage days.”

29. The Appellant also stated that its customer contracts have a refund of the down payment clause which is intended to provide a credit management solution to customers who might not be in a position to keep up with repayments that are aligned to the bad debts provisioning policy. It stated the foregoing is in line with its employment of corrective measures and preventative strategies to avoid accumulation of bad debts.

30. It further stated that any repairs or replacements of customer devices are only done at the service centers or the Appellant’s shops. In addition, it stated that its DSRs also market its products either from the service centers, M-Kopa shops or by moving around looking for customers in their different regions which therefore makes it difficult to tell where the customers are physically located.

31. The Appellant further stated that in the instances where the customers return the devices, it only uses these returned devices to provide parts to be used only for refurbishment purposes, and there is no significant recovery of debts from the repossession of devices.

32. The Appellant cited the case of Equity Bank Kenya Ltd vs. Commissioner of Domestic Taxes (2021) eKLR, where the High Court that,“In order to benefit from tax deduction on account of bad debts the taxpayer need only establish one of the grounds set out in paragraph 2 of the guidelines.”

33. The Appellant emphasized that it has satisfied two grounds in arriving at the decision to write off its bad debts.

ii. Appellant’s demonstration that the cost of recovering the bad debts written off is greater than the value of the debts written off: 34. The Appellant averred that as set out in its Supplementary Statement of Facts, the cost of pursuing the debts using third party agents would exceed the cost of recovering the debts given that only 3% of the customers default and the debt is subsequently written off since these customers are spread across the Country making it difficult to trace them.

35. The Appellant further averred that the bulk of the cost components that would be incurred in pursuing the bad debts relate to out of court settlement or litigation processes, and whose costs in any case have always been in place through the Advocates Remuneration Order, and this would be in addition to actual travel, logistical and accommodation costs that would be incurred in following up on the 47,625 customers that are spread across the country, it stated.

36. The Appellant further averred that the following was considered in determining how much it would cost in pursuing a customer’s debt, which on average was Kshs. 6,630. 00, with a maximum of Kshs. 37,000. 00: -“Customer tracing costs - the expected cost of contracting third party investigators to trace each customer would be Kshs 20,000. 00 per customer, which would include such costs as investigator’s fee, travel and accommodation expenses.”

37. Should the aforementioned recovery efforts be unsuccessful, the Appellant would engage an Advocate to undertake recovery action through the litigation proceedings. This will entail legal fees and court fees, and would on average cost a minimum of Kshs. 109,640. 00 for recover through litigation, and Kshs. 37,260. 00 through out of court settlement.

38. The Appellant stated that it has demonstrated in a detailed quantification of the costs of recovering the bad debts that would be incurred in recovering the bad debts written off by the Appellant in the 2016 year of income.

39. The Appellant submitted that there are significant data privacy concerns at play as personal data should not be re-purposed without getting explicit customer consent or pursuant to another lawful basis and provided further that additional training would be required prior to any such individuals handling customer personal data, which would also increase the Appellant’s costs.

40. The Appellant submitted that it does not have the legal mandate to re-possess its products under the hire purchase or similar financing or leasing regimes, since it sells its products on credit sales basis hence lacks an enforcement mechanism.

41. The Appellant contended that in view of the foregoing, it was evident that the costs of recovering the bad debts outweighed the value of the debts per customer and subsequently it made a decision to write off the bad debts in the 2016 year of income.

Appellant’s Prayers 42. The Appellant by reason of the foregoing prayed, that: -a.The Respondent’s Objection decision dated 8th September 2022 be set aside andb.The Appeal be allowed with costs.

The Respondent’s Case 43. The Respondent has set out its case on, its;a.Statement of Facts dated 21st November 2022 and filed on 22nd November 2022;b.Supplementary Statement of Facts dated 7th August 2023 and filed on 10th August 2023; andc.Written submissions dated 17th April 2023 and filed on 20th April 2023;

44. The Respondent stated that on the 23rd June 2022 it issued the Appellant with an assessment adjusting the Corporation tax position for the financial year 2016 downwards to Kshs. 1,789,514,499. 45, an assessment the Appellant was dissatisfied with.

45. The Respondent stated that the case was selected for audit and the following issues raised:a.Bad debts written off;b.Services to related parties;c.Unsupported interest expense;d.Unreported income;

46. On services to related parties, the Respondent stated that the M-Kopa Global has a global presence in Kenya, Uganda, Tanzania, Nigeria and Ghana, with the Appellant acting as the Regional Headquarters in Africa, and with most Departmental Heads and including the CEO being based in Kenya, providing support to other M-Kopa operations in other countries.

47. The Respondent averred that a review of the Appellant’s limited transfer pricing policy revealed that the company had chosen the CUP method as the most suitable transfer pricing method to test the arm’s length nature of transactions.

48. It further stated that the controlled transactions as per policy are the sale and purchase of tangible goods between the Appellant and related parties and provision of intercompany loans by M-Kopa LLC to the Appellant.

49. The Respondent stated that it therefore concluded that management support services offered by the Appellant to its related parties had not been benchmarked and income from these services was reported.

50. The Respondent also posited that the Organization for Economic Cooperation and Development Transfer Pricing Guidelines, 2017 (OECD TPG) has elaborated the arm’s length principle and provided guidelines on treatment of intra-group services. It posited that Chapter 7 of the OECD TPG, 2017 guidelines require that in order to establish whether or not payment for a service is at arm’s length, a two-step approach is adopted.

51. The Respondent averred that it therefore noted that from the review of services that the Appellant provides to its related parties is that these entities derive economic and commercial benefit and therefore applied a mark-up on costs of 5%.

52. On unsupported interest expense, the Respondent stated that the Appellant claimed the interest expense of Kshs. 220,265,309. 00 but provided interest expense computation schedules for loans from M-Kopa LLC and M-Kopa funding with a total interest amount of Kshs. 110,099,618. 00.

53. It stated that the Appellant paid withholding tax on the supported amount above, therefore only the unsupported interest expense of Kshs. 110,165,690. 00 was allowed for tax computation.

54. On unreported income, the Respondent stated that a reconciliation of total income reported in the financial statements versus total income per VAT returns showed a variance of Kshs. 31,369,075. 00 which was unexplained and therefore brought to charge as under-declared income.

55. It stated that it refuted the Appellant’s argument that the variance between turnover as per income tax return versus the aggregate VAT returns was as a result of taxable sales declared twice in August and September 2016 VAT returns.

56. The Respondent contended that the double declaration was not supported by way of any documents and no amendments were initiated by the Appellant charged to the income tax.

57. On the issue of bad debts written off, the Respondent posited that the Appellant wrote off bad debts in the year 2016 amounting to Kshs. 308,512,947. 00, and claimed that expense based on the fact that customers are widely spread across the Country and that no form of security is realizable.

58. It stated that the Appellant did not demonstrate that all reasonable steps were taken to collect the debt, and therefore the bad debts claimed were disallowed.

59. The Respondent also stated that in its findings the customers pay a deposit of Kshs. 3,500. 00 in order to take the solar system home, and thereafter an amount of Kshs. 50. 00 is paid per day for a period of one year in order to own the solar device.

60. The Respondent further stated that the daily payments are made through M-Pesa, a mobile phone-based money system. It averred that by virtue of the payments, customers get solar power as they slowly offset the cost of the device.

61. The Respondent stated that the Appellant makes a provision for bad debts in case a customer defaults on payment after 30 consecutive days, and if the accumulated non-payment period exceeds 120 days classifies the debt as a bad debt, for write-off.

62. It averred that in addition, the Appellant makes sales through Direct Sales Representatives who are located in the customer’s areas, and have field technicians who assist in the installation of products and fixing of malfunctions.

63. The Respondent also stated that the Appellant offer incentives to its customers to cancel, and return their devices and refunds them their deposit, arguing that they track delinquency based on zero credit days consecutively and that their write-offs are definitively more than 120 days in arrears cumulatively.

64. The Respondent further stated that the Appellant has a collaboration agreement with Safaricom, to among other things provide the Appellant with location information at which base transceiver station is serving the Appellant system. It stated however that the Appellant argued that it can only get a rough estimate of the customer devices of between 10 to 30 Kms from the tower location because the customer devices do not have full GPS. It stated that the SIM cards in the customer’s devices are primarily used for connectivity and to deliver credit to devices and locating customers.

65. The Respondent averred that Legal Notice No. 37 of 2011 provides guidelines on allowability of bad debts.

66. The Respondent averred that it was of the considered view that the Appellant did not demonstrate that it exhausted all reasonable steps to recover the debts in the following ways;a.Customers who got to more than 120 days with zero credit were only blocked and no longer received SMS communication but the devices were not repossessed, which negates that no security is realizable.b.The written off customers are not pursued further except for listing with CRBs while the guidelines require the debtor to deemed insolvent by a court of law.c.The M-Kopa solar kit is fitted with a Safaricom sim card that has GSM communication module whose ownership is retained by the company as per the contract with the customers. The GSM ought to facilitate the Appellant’s field staff locate their customers for collection of the debt or recovery of the devices.d.The Appellant did not demonstrate the additional cost that would be incurred to show that to follow up the debts further would outweigh the debt recovered.

67. The Respondent averred that based on the foregoing, the bad debts as claimed in the year 2016 return was disallowed with an adjustment being made to correct the amount disallowed as Kshs. 193,736,915. 00 instead of Kshs. 308,512,947. 00 as confirmed from the audited financial statements, trial balance and audit journals.

68. The Respondent further stated that Section 24 (2) of the TPA allows the Respondent to assess a taxpayer using any information available to them, and to this extent the Respondent averred that it has operated within the confines of the law by using the data availed.

69. The Respondent also stated that it was guided by Section 56 (1) of the TPA that provides that in any proceedings under this part, the burden shall be on the taxpayer to prove that a tax decision is incorrect.

70. The Respondent further stated that Section 15 (2) (b) of the Income Tax Act provides for the deduction of bad debts, and the allowability of bad debts is guided by Legal Notice No. 37 of 2011.

71. The Respondent submitted that the Appellant has not proven and or met any of the conditions set out in Legal Notice No. 37 of 2011 to the satisfaction of the Respondent to warrant allowance of bad debts.

72. The Respondent submitted that as the Commissioner did not have an opportunity to review the new documents, the matter ought to be referred back to the Respondent for fresh consideration.

73. The Respondent further submitted that it analyzed that Appellant’s debt provisions for year of income 2016 taking into account the legal parameters and found that they did not satisfy the requirements of the law for them to be deductible under Section 15 of the ITA and LN 37/2011.

74. The Respondent submitted that the Appellant did not take all the necessary steps in recovery of bad debts as devices were not repossessed, additional costs in tracing locations of each customer in order to collect the debt/recover the devices.

75. It further submitted that in determining whether a debt is bad for the purposes of tax deduction, the Respondent’s discretion is circumscribed by parameters set out in the Guidelines made pursuant to Section 15 (2) (a) of the ITA.

76. It cited the case of I&M Bank Ltd vs. Commissioner of Domestic Taxes TAT 72 of 2017 where the Tribunal held: -“…The Act therefore considers bad and doubtful debts to be one and the same. Thus, it is the Tribunal‘s view that the Commissioner‘s guidelines applies in so far as determining whether or not a doubtful debt can be deemed to be uncollectable …”

77. The Respondent also submitted that Section 56 (1) of the TPA places the burden on the taxpayer to prove that a tax decision is incorrect.

78. It cited the case of Ushindi Exporters Ltd vs. Commissioner of Investigations and Enforcement TAT 7 of 2015, and submitted that the Appellant did not fully discharge its burden of proof that in proving that the Respondent’s decision to adjust the Corporation tax upwards was incorrect as it did not adduce sufficient evidence.

Respondent’s Prayer 79. By reason of the foregoing the Respondent prayed that;a.The Objection decision dated 8th September 2022 be upheld; andb.The Appeal be dismissed with costs;

Issues for Determination 80. The Tribunal having carefully considered the filings and submissions made by the parties is of the considered view that the Appeal herein distils into the following single issue for determination;Whether the Respondent erred in disallowing the Appellant’s bad debts of Kshs 193,736,915. 00 for the year of income 2016.

Analysis and Determination 81. The dispute herein arose when the Respondent issued the Appellant with an assessment on 23rd June 2023 adjusting the Corporation tax position for the financial year 2016 down wards to Kshs. 1,789,499. 45, as a consequence of the Respondent disallowing the Appellant’s bad debts of Kshs. 193,736,915. 00

82. In disallowing the Appellant’s bad debts the Respondent submitted that it wrote off bad debts in the year 2016 amounting to Kshs. 308,512,947. 00, and cited lack of traceability of customers and lack of realizable securities or collateral.

83. The Respondent submitted that the Appellant did not demonstrate that all reasonable steps were taken to collect the debts, and thereby disallowed the bad debts claimed.

84. It was also a submission of the Respondent that the Appellant did not take all the necessary steps in recovery of bad debts as the loaned devices were not repossessed, and additional costs in tracing the location of the customers to collect the debts or devices were not demonstrated. It stated that the Appellant further did not demonstrate the additional cost that would be incurred to show that further follow up of the bad debts would further outweigh the debt to be recovered.

85. The Respondent further submitted that the Appellant has not proven and or met any of the conditions set out in the Legal Notice No.37/2011 to the satisfaction of the Respondent.

86. The Respondent posited that based on the foregoing, the bad debts as claimed in the year 2016 return were disallowed with an adjustment being made to correct the amount disallowed as Kshs. 193,736,915. 00 instead of Kshs. 308,512,947. 00

87. On the other hand, the Appellant posited that it exhausted all the reasonable steps to recover the debt amounting to Kshs. 193,736,915. 00 and the bad debts written off under consideration by the Respondent are specific debts and not general in nature, and provided a listing of 47,625 defaulting customers.

88. The Appellant submitted that specific nature of the bad debts, and the fact that there is no form of security or collateral realizable, and also the fact that the cost of recovering the debts exceeded the value of the debt likely to be recovered, informed the decision to write off the 2016 year of income debts as bad debts.

89. The Appellant further posited that it sells its products in the lower market segment on credit sales, and it does not have a legal mandate to repossess the products from defaulting customers as would be the case under hire purchase or leasing contracts, and in this regard the products cannot be seized as securities as argued by the Respondent.

90. Further the Appellant demonstrated its bad debts provisioning policy and the elaborate steps it takes in following up the debtors from daily monitoring through regular calls and SMS, flagging, blocking, reference to CRB, and incentives to return gadgets for refund of deposit. It further demonstrated where practicable it undertakes tracing of the defaulting customers through the Safaricom SIM card and base stations, which option is limited by lack of GPS system.

91. The Appellant therefore submitted that it did take all the reasonable steps possible given the nature of its business, to collect the debts and recover the devices from the defaulting customers.

92. The Appellant submitted that it had demonstrated through a detailed quantification of the costs of recovering the bad debts, that it would cost on average a sum of Kshs. 109,640. 00 per customer to pursue the hardcore, 47,625 defaulters making up the written off debt, through litigation and an average of Kshs. 37,260. 00 per defaulter through out of court debt collection through third parties, in addition to Kshs. 20,000. 00 for private investigators to trace the whereabouts of each of the 47,625 defaulters.

93. The Appellant submitted that in view of the foregoing fact that the costs of recovering the bad debts per customer clearly outweighed the value of the recoverable debts per customer, informed its decision to write off the bad debts in the year of income 2016.

94. For Income tax purposes, for bad debts to be allowable, it is imperative they meet the parameters set out in the relevant law.

95. Section 15 (1) of ITA provides as follows:-“(1)For the purposes of ascertaining the total income of a person for year of income, there shall, subject to Section 16, be deducted all expenditure incurred in that year of income which expenditure wholly and exclusively incurred by him in the production of that income …”Section 15 (2) (a) provides;“bad debts incurred in the production of those gains or profits which the Commissioner considers to have become bad, and doubtful debts so incurred to the extent that they are estimated to the satisfaction of the Commissioner to have become bad, during that year of income; and the Commissioner may prescribe such guidelines as may be appropriate for the purpose of determining bad debts under this paragraph.”

96. The Guidelines which set out the criteria for writing off bad debts, and the deductibility of such bad debts have been provided for under the Legal Notice No.37 of 2011. Paragraph 1 thereof provides that:-“a debt shall be considered to have become bad if it is proved to the satisfaction of the Commissioner to have become irrecoverable after all reasonable steps have been taken to collect it.”

97. Paragraph 2 enumerates the circumstances under which the debt is considered uncollectable and capable of being written off as follows;“a.the creditor loses the contractual right that comprises the debt through a court order;b.no form of security or collateral is realizable whether partially or in full;c.the securities or collateral have been realized but the proceeds fail to cover the entire debt;d.the debtor is adjudged insolvent or bankrupt by a court of law;e.the costs of recovering the debt exceeds the debt itself;f.efforts to collect the debt are abandoned for another reasonable cause.”

98. The import of legal Notice No.37 of 2011 is that it ought to be demonstrated to the Commissioner that all efforts have been made to collect a debt as cited in Commissioner of Domestic Taxes vs. Kenya Maltings Ltd (2013) eKLR.

99. It is noteworthy that Section 15 (2) (a), the proof that the debt has been rendered uncollectable and therefore a bad debt or doubtful debt ought to be a reasonable estimation on the basis of the facts and information provided by a taxpayer. In this regard therefore, it is incumbent on the Commissioner to consider all the circumstances of a taxpayer’s business model and operations so as to arrive at a fair determination.

100. The Appellant has demonstrated the business model it uses to provide on credit terms solar systems and mobile phone gadgets solutions to the lower market segment through mobile application-based system spread to various corners of the country.

101. The Appellant has also demonstrated how it has put in place a robust mobile application credit control system as well a debt provisioning policy to monitor and action various recovery measures on its defaulting customers.

102. The Appellant has also submitted evidence of the additional cost of pursuing any further debt recovery measures on the bad and doubtful debts on the 47,625 defaulting customers subject of the written of debt, and confirmed that the cost of undertaking such a measure will far outweigh the amount of doubtful debt likely to be recovered from the defaulters, and exceed the actual debt.

103. In view of the aforesaid, the Tribunal is satisfied that the Appellant reasonably demonstrated that the all reasonable steps were taken to collect the debts during the subject year of income 2016, and confirmed the same uncollectable. Further it demonstrated and proved that the cost of further pursuing the said debts through other means including third party agents, would far outweigh and exceed the amount of doubtful debts likely to be collected through such an additional venture.

104. The Tribunal is guided by the case of Equity Bank Kenya Ltd vs. Commissioner of Domestic Taxes (2021) eKLR, where the High Court held that,“In order to benefit from tax deduction on account of bad debts the taxpayer need only establish one of the grounds set out in paragraph 2 of the guidelines.”

105. In view of the foregoing Tribunal is satisfied that the Appellant satisfied the conditions set out under the Legal Notice No, 37 of 2011 and was justified in treating its unrecoverable debts as bad and doubtful and consequently writing them off.

106. The upshot of the foregoing is that the Appeal is found meritorious and hereby succeeds.

Final Decision 107. The Appeal having succeeded the Tribunal makes the following Orders;a.The Appeal be and is hereby allowed.b.The Respondent’s Objection decision dated 8th September 2022 be and is hereby set asidec.Each party to bear its own costs.

108. It is so ordered.

DATED AND DELIVERED AT NAIROBI THIS 8TH DAY OF MARCH, 2024ROBERT M. MUTUMA - CHAIRPERSONELISHAH N. NJERU - MEMBERMUTISO MAKAU - MEMBERMOHAMED A. DIRIYE - MEMBERBERNADETTE M. GITARI - MEMBER