[2024] KETAT 23 (KLR)

Napro Industries Limited v Commissioner, Legal Services and Coordination Board (Tax Appeal 1395 of 2022) [2024] KETAT 23 (KLR) (26 January 2024) (Judgment)

Neutral citation: [2024] KETAT 23 (KLR)

Republic of Kenya

In the Tax Appeal Tribunal

Tax Appeal 1395 of 2022

RM Mutuma, Chair, W Ongeti, EN Njeru, M Makau & BK Terer, Members

January 26, 2024

Between

Napro Industries Limited

Appellant

and

Commissioner, Legal Services And Coordination Board

Respondent

Judgment

Background 1. The appellant is a company incorporated under the Companies Act, 2015 that deals with the manufacturing of Ngarisha steel wool and scouring pads.

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

3. The respondent selected the appellant for audit on allegation of under-declared income based on variances between incomes declared in the VAT returns against the income in the income tax returns.

4. The respondent issued an objection decision dated May 11, 2022.

5. Being aggrieved by the said objection decision, the appellant file an appeal on September 19, 2021.

The Appeal 6. The appeal is premised on the grounds as set out in memorandum of appeal dated and filed on November 18, 2022 as follows;a.The respondent has made an assessment of Kshs. 55,302,502. 00 and Kshs. 57,362,302. 00 excluding penalty and interest - in relation to Corporation tax and VAT, respectively. This is as a result of them conducting a verification audit of the appellant's tax affairs.b.The assessment arose from the inability of the respondent to verify the appellant's production analysis reconciliations relating to stock and wastage.c.The appellant, in its production process relies on three core imported raw materials: wire rod (6. 55MM), small coils/drawn wire (2. 65 MM), and steel wool rolls. Production begins with wiredrawing where the wire rods are put into the wire drawing machine which reduce the thickness of the rods into small coils. These coils, together with the imported small coils are thereafter taken through the shaving process where they become steel wool in different sizes as required. The final step is the cutting and packaging of the manufactured steel wool, and the imported steel wool into 15g, 75g, 250g, 500g, and 750g for sale. The cutting is done manually, and by machine. The Respondent failed to appreciate the fact that during all the stages of the production process:i.There are varying amounts of wastage. These being evidenced by the sampled production reports. The entire production reports are available for perusal at the Appellant's premises. The types of wastage are as follows:a.Dust. This is produced at three production stages: In wire drawing, dust is produced at every die section when the wire is going through a series of drawing die(s) and inlet and outlet where scales come out.

At the shaving stage, dust is produced as a result of friction between knives and the wire (material) because the wire is in motion.

At packing stage, dust is produced when the rolls are being cut using man force (winders), when the rolls pass through the spring roll machine to be cut in desired shapes and during wrapping into plastics at the BOPP machine.b.In material being residual wire that is produced but cannot produce steel wool further.c.Loose wires being previously used to tie the small coils at the first step of production- which cannot be reused.d.Wire feeding. These are damaged wire cuts which cannot be utilised;e.Rough wool produced when the machine knives are blunt or not properly tightened in the production process. The result of this is very rough wire that cannot be sold.ii.The percentage of wastage varies according to the quality of the wire rods.iii.All wastage is disposed of as they cannot be utilised.iv.The effect of dromus on the product output. Dromus is a mixture of water and cutting oil made and utilised to reduce friction in the machines. It adds to the weight of the products.d.The Respondent erred by not including the imported steel wool rolls in their analysis. These imports form a substantial amount of output from the Appellant's production of goods and charging them to tax is punitive.e.The Respondent, in its analysis was unable to capture the correct opening stock values. These have however been availed and all relevant supporting documentation are available for review.f.The Respondent has erred in fact and in law by completely disregarding all the Appellant's reconciliations, and concentrating on one reconciliation to bring to charge variances as being under declared sales under the Corporation and VAT tax heads.g.The onus of proving the error in any tax decision is on the Appellant. However, the Appellant highlights that the increase of sales amounts by the Respondent was solely based on the faulty reconciliation without coinciding evidentiary bases. There are also no input tax entries by the Appellant's customers to reinforce the assessment.h.Despite being the source of the faulty reconciliation, the Appellant avers that there was no under declaration of sales and their returns were made in accordance to the relevant tax laws and that the appropriate reconciliation had indeed been shared with the Respondent but this was disregarded.i.The taxation of an entity ought to be based on its gains from its business, and not on misunderstood variances. The Respondent's assessment lacks merit in law and should be vacated in its entirety. The Appellant relies on the attached formal reconciliation for the years under review to substantiate the source of the variances that are the basis for the assessment.j.The Respondent erred by not completely addressing the Appellant's assertions regarding the amount of Kshs. 7,895,740. 00 claimed under investment deduction on plant and machinery (roofing) for the period 2019. The Appellant, in agreeing with the Respondent's findings sought to have the amount allowed as an expense for the year 2019. The Respondent's omission of not giving a decision on whether the amount ought to be allowed as an expense in the year 2019 leaves the Appellant at a tax disadvantage. The Appellant reiterates that the amount ought to be allowed as an expense as it is supported by invoices and proofs of payment.

Appellant’s Case 7. The Appellant set down its case in its;a.Statement of facts dated and filed on November 18, 2022 together with the documents annexed thereto; andb.Written submissions dated and filed July 10, 2023.

8. The appellant in its statement of facts reproduced the entirety of the its objection and the respondent’s objection decision and made prayers for the Tribunal to amend the corporation tax and VAT additional assessments to nil, that the respondent be authorized and directed to allow the amount of Kshs. 7,895,740. 00 claimed under investment deduction on plant and machinery (roofing) for the period 2019 as an expense for income tax and at the hearing to adduce further oral and documentary evidence in support of this Appeal.

9. The Appellant submitted that it identified two issues for determination: first, whether the variances identified by the Respondent in its production analysis had been sufficiently supported by the Appellant’s reconciliation and supporting documents, and second, whether the amount of Kshs. 7,895,740. 00 claimed under investment deduction on plant and machinery (roofing) for the period 2019 ought to be allowed as an expense in the 2019 income tax return.

i. Whether the variances identified by the Respondent in their production analysis had been sufficiently supported by the Appellant’s reconciliation and supporting documents. 10. The Appellant submitted that the Respondent's assessment arose from its inability to acknowledge the Appellant's formal production analysis reconciliations relating to stock and wastage. The Respondent alleges that their inability to verify the reconciliations regarding stocks and wastage was due to the production of varying reconciliations by the Appellant. The Appellant highlights that despite being the source of the faulty reconciliation, there was no under-declaration of sales and its returns were made in accordance with the law and that the appropriate reconciliation had indeed been shared with the Respondent but this was disregarded.

11. The Appellant submitted that the Respondent erred in fact and in law by relying on unsupported variances to charge tax on the Appellant. Tax ought to be charged on gains from business and not on unsupported variances. The Appellant, in substantiating its assertion relies on its formal reconciliation for the years under review to dispute the Respondent's assessments. In addition, the Appellant highlighted that its production records are manual in nature and that the Respondent has been requested numerously to verify the information contained therein. That this request has fallen on deaf ears with the resulting effect being unsupported assessments by the Respondent. That the Appellant attached samples of these records as part of the Appeal papers and prays that these are analysed and verified in conjunction with the final reconciliations annexed.

12. The Appellant also submitted that the Respondent has erred in fact by failing to appreciate the fact that during all the stages of the Appellant’s production process there are varying amounts of waste, which vary according to the quality of the utilised wire rods. The waste cannot be utilised and is disposed of. These are categorised as:a.dust produced as a result of winders being used to cut the rods to manageable sizes and at the shaving step when there is friction between the machine's knives in the production of the steel wool, and at the packing step when cutting the steel wool into desired shapes;b.Pin material being residual wire that is produced but cannot produce steel wool;c.Loose wires being previously used to tie the small coils at the first step of production- which cannot be reused;d.Wire feeding. These are damaged wire cuts which cannot be utilised;e.Rough wool produced when the machine knives are blunt or not properly tightened in the production process. The result of this is very rough wire that cannot be sold. It is the Appellant's assertion that the figures identified as waste are indeed valid and ought to be taken into account in the reconciling the Appellant's production of steel wool.

13. The Appellant while appreciating the burden of proof with regard to tax decisions and tax appeals highlighted that the Respondent, in increasing its sales values solely relied on the faulty reconciliation without coinciding evidence. There are also no input tax entries by the Appellant's customers to reinforce the assessment. The Appellant averred that there was no under-declaration of sales as evidenced by the appropriate reconciliation had indeed been shared with the Respondent but this was disregarded.

ii. Whether the amount of Kshs. 7,895,740. 00 claimed under Investment Deduction on Plant and Machinery (roofing) for the period 2019 ought to be allowed as an expense in the 2019 return 14. That the Respondent erred by not fully addressing the Appellant’s assertion that the amount of Kshs. 7,895,740. 00 claimed under investment deduction on plant and machinery (roofing) for the period 2019 ought to be allowed as an expense in the year. That the Respondent, in substantiating that the cost incurred was supported, did not give a decision on the Appellant’s request to have the amount allowed as an expense leaving the Appellant at a tax disadvantage. The Appellant therefore sought a declaration on the treatment of this amount.

The Appellant’s Prayer 15. The Appellant prayed for the Honourable Tribunal to find that:i.The objection decision of May 11, 2022, with regard to the production analysis be set aside in its entirety;ii.The Respondent be authorized and directed to allow the amount of Kshs. 7,895,740. 00 claimed under investment deduction on plant and machinery (roofing) for the period 2019, as an expense in the income tax return for the year 2019. iii.This Appeal be allowed;iv.All other remedies that this Honourable Tribunal deems just and reasonable.

The Respondent’s Case 16. The Respondent’s case is premised on its statement of facts dated and filed December 15, 2022.

17. The Respondent was late in filing submissions and the same were expunged by this Tribunal on September 28, 2023 with directions that hearing to proceed based on pleadings only.

18. The respondent stated that to establish the correct production (the goods produced and available for sale) a production analysis was conducted which established variances totalling to 305,583 Kgs, 909,877 Kgs, Negative145,923 Kgs and 698,982 Kgs for 2016, 2017, 2018 and 2019, respectively.

19. According to the respondent, the appellant was unable to provide a reconciliation for the variances. Considering the fact that the Appellant was also unable to provide a bank reconciliation, the aforementioned unexplained stock variances were treated as stocks sold and therefore under-declared sales which were brought to charge.

20. The respondent agreed that while the appellant provided several reconciliations to explain the variances the same were reviewed vis-a-vis purchases based on customs data, compared against the appellant’s documents.

21. The Respondent noted that in its reconciliations, the Appellant made amendments to the stock values stated in the financial statements to arrive at negative variances. The Appellant then stated in its explanations that the question of average unit selling price should not arise as per its revised production reconciliation. This, according to the Appellant, was because the average unit-selling price can only be used when the differences in production weight are positive and not negative. In their revised reconciliation, all differences are negative hence there was no need to use average unit selling price in ascertaining the amount chargeable to tax.

22. The Respondent contended that the Appellant further provided contradicting reconciliations to support wastages, stocks and purchases but the reconciliations were not fully supported.

23. The Respondent’s review, it was imperative to establish the selling price kilogram unit of product, which was done by examining records obtained from the Appellant and employing the Respondent's best judgement as the Appellant was unable to support its reconciliations with relevant documentation.

24. Due to the difficulty in verifying the production analysis, the Respondent used the ascertainable selling price provided by examining the Appellant’s records.

25. The Respondent contended that the Appellant had failed to reconcile material banking variances, which was also confirmed by its inability to reconcile the production analysis. Thus, the production analysis adjusted was based on the documents provided by the Appellant as well as the Respondent’s best judgement.

26. The production analysis variances would remain taxable as explained under Corporation tax.

27. The Commissioner contended that the building was already in operation from 1st April 2018 and Kshs. 7,895,740. 00 does not qualify for investment deduction claim that is granted in the year of first use. That the Appellant failed to provide supporting documents, e.g., invoices and proof of payment for the construction of the roof.

28. The Respondent contended that while the Appellant provided documents to support the costs incurred relating to the roof renovations, the cost related to the roofing was not an extension of the building and thus not entitled to claim investment deduction.

29. In view of the foregoing, the Respondent urged this Tribunal to confirm the default assessment and find that the assessed taxes are due and payable by the Appellant.

The Respondent’s Prayers 30. The Respondent, therefore, prayed that the Appeal be dismissed with cost.

Issues For Determination 31. The Tribunal having considered the Memorandum of Appeal, the parties’ Statements of Facts, and Appellant’s submissions, puts forth the following issues for determination:a.Whether the variances identified by the Respondent in their production analysis had been sufficiently supported by the Appellant’s reconciliation and supporting documents; andb.Whether the amount of Kshs. 7,895,740 claimed under Investment Deduction on Plant and Machinery (roofing) for the period 2019 ought to be allowed as an expense in the 2019 Income Tax return.

Analysis and Findings 32. It is to these issues that the Tribunal will turn within as hereunder: -

a. Whether the variances identified by the Respondent in their production analysis had been sufficiently supported by the Appellant’s reconciliation and supporting documents. 33. The Appellant’s case is that the Respondent's assessment arose from its inability to acknowledge the Appellant's formal production analysis reconciliations relating to stock and wastage.

34. On the other hand, the Respondent alleged that its inability to verify the reconciliations regarding stocks and wastage was due to the provision of varying reconciliations by the Appellant.

35. The Appellant maintained that despite being the source of the faulty reconciliation, there was no under-declaration of sales and its returns were made in accordance with the law and that the appropriate reconciliation had indeed been shared with the Respondent but this was disregarded.

36. The Appellant itself admitted that reconciliations that were availed to the Respondent were faulty. The Appellant submitted that the appropriate reconciliation had indeed been shared with the Respondent but this was disregarded, however, the Appellant has not been able to pinpoint when it shared the ‘appropriate reconciliation’ with the Respondent.

37. The Appellant, in substantiating its assertion relied on its formal reconciliation for the years under review to dispute the Respondent's assessments. In addition, the Appellant highlighted that its production records are manual in nature and that the Respondent had been requested numerously to verify the information contained therein which request had fallen on deaf ears, resulting with an unsupported assessment by the Respondent.

38. The Appellant attached samples of these records as part of the Appeal papers and prayed for the Tribunal to analyse and verify them in conjunction with the final reconciliations it had provided.

39. Section 51 (3) (c) of the Tax Procedures Act provides for a taxpayer filing a notice of objection to provide all the relevant documents relating to the objection for the notice of objection to be treated as validly lodged.

40. In the instant case, the Tribunal notes that the Appellant seems to have provided an overkill of information/documents to the Respondent some of which was wrong, and whereupon the Respondent choose the inaccurate information in arriving at its determination.

41. It is evident that the Appellant setup itself for the outcome that followed its notice of objection supported by faulty reconciliations. It behoved the Appellant to exercise due care in its matters by vigilantly supporting its objection with correct documents.

42. Further, the Tribunal observes that the documents attached in its Appeal appears not to have formed part of the documents submitted to the Respondent with the notice of objection. For example, on the first page of annexure marked ‘NIL 6’, is dated 04/11/2022, while the objection decision is dated 11th May 2022.

43. Under the circumstances, the Tribunal cannot fault the Respondent for utilising documents that were at its disposal and consequently, this Tribunal finds and holds that the Appellant failed to sufficiently support the stock variances identified by the Respondent.

b. Whether the amount of Kshs. 7,895,740. 00 claimed under Investment Deduction on Plant and Machinery (roofing) ought to be allowed as an expense in the Income Tax return. 44. With regard to this issue, the Appellant submitted that the Respondent erred by not fully addressing the Appellant’s assertion that the amount of Kshs. 7,895,740. 00 claimed under Investment Deduction on Plant and Machinery (roofing) for the period 2019 ought to be allowed as an expense in the year.

45. The Respondent on its part concurred that the amount ought not be treated as an investment deduction and acknowledged that the Appellant provided documents in support of the expenditure.

46. The Tribunal however observes that while the Respondent added back to the taxable profit the investment deduction amount, so as to charge it to tax, the same has not been deducted as an expense, notwithstanding its concurrence that the expenditure was well supported by documents.

47. Consequently, the Tribunal finds and holds that the amount of Kshs. 7,895,740. 00 claimed under Investment Deduction on Plant and Machinery (roofing) ought to be claimed as an expense.

Final Decision 48. The upshot to the foregoing is that the Tribunal finds and holds that the Appeal succeeds in part and consequently makes the following orders; -a.The Respondent’s Objection Decision confirming the assessment relating to the production material variances be and is hereby upheld.b.The Respondent’s Objection Decision confirming the assessment relating to Kshs. 7,895,740. 00 previously claimed under investment deduction be allowed as an expense for the year 2019. c.Each party to bear its own cost.

49. It is so ordered.

DATED AND DELIVERED AT NAIROBI THIS 26TH DAY OF JANUARY, 2024. ROBERT M. MUTUMA - CHAIRPERSONDR. WALTER ONGETI - MEMBERELISHAH N. NJERU - MEMBERMUTISO MAKAU - MEMBERBONIFACE K. TERER - MEMBER