[2024] KETAT 430 (KLR)

Prabakhi Developers Limited v Commissioner Legal Service & Board Cordination (Tax Appeal 273 of 2023) [2024] KETAT 430 (KLR) (22 March 2024) (Judgment)

Neutral citation: [2024] KETAT 430 (KLR)

Republic of Kenya

In the Tax Appeal Tribunal

Tax Appeal 273 of 2023

E.N Wafula, Chair, RO Oluoch, AK Kiprotich, Cynthia B. Mayaka & T Vikiru, Members

March 22, 2024

Between

Prabakhi Developers Limited

Appellant

and

Commissioner Legal Service & Board Cordination

Respondent

Judgment

Background 1. The Appellant is a private limited liability company incorporated under the Companies Act laws of Kenya. Its business is that of constructing and selling industrial warehousing units.

2. The Respondent is a principal officer appointed under Section 13 of the Kenya Revenue Authority Act, Cap 460 laws of Kenya (KRA Act). Under Section 51. of the Act, KRA is an agency of the Government for the collection and receipt of all revenue. Under Section 5(2) of the Act with respect to the performance of its function under subsection (1), the Authority is mandated to administer and enforce all provisions of the written laws as set out in Parts I and II of the First Schedule to the Act for the purposes of assessing, collecting and accounting for all revenues in accordance with those laws.

3. The Respondent carried out an audit on the Appellant’s tax affairs for the periods 2017 to 2020 and issued it with a notice of assessment dated 21st November 2022 for taxes amounting to Kshs. 208,354,243. 00

4. The assessment was premised on disallowed finance costs, underdeclared sales, overstated cost of sales and Capital gains tax which were charged to both VAT and Corporation tax as well as capital gains tax where applicable.

5. The Appellant objected to the above assessments through a notice of objection on the 23rd of December 2022.

6. On the 17th of February 2023 the Respondent issued an objection decision partially allowing the Appellant’s objection, it confirmed tax amounting to Kshs. 123,099,679. 00 as due and payable.

7. Dissatisfied by the Respondent’s decision the Appellant filed this Appeal through a Notice of Appeal dated and filed on 17th March 2023.

The Appeal 8. The Appeal is premised on the Memorandum of Appeal dated 30th March 2023 and filed on 31st March 2023 which raised the following grounds: -i.That the assessment arose from the inability of the Respondent to verify the Appellant's finance costs analysis/reconciliations, sales analysis and cost of sales reconciliation.ii.That the Respondent in its analysis of finance cost for the periods 2017 to 2021 failed to consider that all figures claimed in the financial statements are compliant with the provisions of Section 15 (1) of the Income tax Act, Cap 470. iii.That the finance costs relating to unrealized foreign exchange losses had already been disallowed for tax purposes in their respective years of income and hence disallowing the same amounts to double taxation.iii.That the Appellant disagrees with the Commissioner's act of migrating year 2021 finance cost variance of Kshs. 7,192,165 to year 2020. iii.The Respondent’s assessment of an additional amount of Kshs. 311,501,355. 00 from the transactions was made without due regard to the fact that both contracts were valid and that there is no legal requirement for the contracts to contain the same terms or selling price as each is separate and distinct from the other.iii.That in addition to the above, the Respondent failed to consider the contracts' negotiation timelines and the terms therein. That these and the fact that pricing in contracts is subject to the parties' bargaining power are a main contributor to the difference in selling price.iii.That further, the Respondent did not take notice of the fact that tax is applied on gains or profits as provided for by Section 3(2)(a)(i) of the Income Tax Act, Cap 470. iii.That the Respondent did not carry out a third party confirmation exercise to verify whether there was actual under declaration of sales.iii.That the Respondent erred in their assessment of Kshs. 434,233,440. 00 as being overstated cost of sales despite the Appellant having made all purchase declarations as mandated by law, and these being fully substantiated.x.That the Appellant reiterated that it can only streamline its own statutory declarations and has no authority over the declarations of its suppliers therefore it cannot ensure that their supplier declares all their sales.x.The Appellant averred that the disallowed amount as overstated cost of sales has been equally apportioned (Kshs. 108,558,360. 00) in the years 2017, 2018, 2019, and 2020 despite the whole amount having been accrued in the year 2018. That this amount ought to be recognized in the proper year of accrual, and that the amount be allowed as it relates to legitimate purchases.

Appellant’s Case 9. The Appellant’s case is premised on its Statement of Facts dated 30th March 2023 and filed on 31st March 2023.

10. The Appellant averred that it had availed all the relevant and valid documentation supporting the finance cost claimed in the audited accounts which included breakdown of the interest expense, bank commitment fees, loan processing fees and loan statements confirming actual repayment of the loans for each and every bank.

11. The Appellant submitted that the finance cost deduction is backed by Section 15(1) of the Income Tax Act, Cap 470, which states that:“For the purposes of ascertaining the total income of any person for any year of income there shall, subject to Section 16 of this Act, be deducted all expenditure incurred in such year of income which is expenditure wholly and exclusively incurred by him in the production of that income.”

12. The Appellant averred that it provided loan agreements and loan statements from the lenders as proof that the costs were incurred in the production of the income in each and every year of income under review. That the contract from Forward Investments Ltd clearly stated that the loan was to be repaid in full on or before 31st December 2025.

13. The Appellant stated that security for the loans were through full directors' unconditional guarantee and the same can be confirmed from the loan agreements e.g. from Forward Investments Limited. That the reason for acquiring the loan facility was mainly to construct the 21 godowns at L.R. No. 7879/26.

14. The Appellant asserted that the sales declared for the godowns sold are the correct amounts for all the godowns sold and there was no understatement of the sales figures.

15. The Appellant explained further that it is an industry practice that customers can buy property off-plan hence taking into account the price adjustments due to inflations, the price at which a customer buys the godowns off-plan and when the go-downs are finished cannot be the same.

16. The Appellant posited that the sales agreements/contract negotiations period was not the same, the negotiation period for the sale to Westland Trading Ltd began years before the other negotiations and a reservation offer was made in the year 2016. That Westlands Trading Limited bought its godown off-plan in year 2016 while the Appellant bought its go-down as a finished unit in year 2018.

17. The Appellant averred that it adduced the relevant documents to justify the price variations, the documents included the sales agreements, reservation forms and proof of payment by the customers to prove the exact amount as per the sales agreements.

18. The Appellant contended that the cost of sales claimed in the financials of Kshs.1, 009,428,182. 00 in year 2018 being cost of construction of the godowns ought to be allowed in full since all the tax invoices and valuation certificates provided were for the period 2018.

19. The Appellant averred that the Respondent erred by disallowing part of the cost of sales amounting to Kshs. 434,233,440. 00 and spreading the same equally in years of income 2017, 2018, 2019 and 2020 whereas all the supporting documentation adduced relates to genuinely incurred costs in year 2018.

20. That while the Respondent reasoned that the lead contractor, SCIL did not declare the full amount as an income in its 2018 income tax return. The Appellant averred that it did not have legal access to the tax declarations by its suppliers and it is therefore wrong to disallow genuine costs on the basis that a supplier did not declare/disclose full income in their tax returns

21. The Appellant submitted that the Respondent erred by not verifying/querying the information/documentation relied on by the alleged purchasers. The Appellant distanced itself from the alleged sales and attached proof of the invoices being from Prabhaki Investments Limited.

22. The Appellant averred that the charge to tax of unreconciled VAT versus income tax declarations for the period 2017- 2020 by the Respondent was made in error as the differences were due to price adjustments done by the Respondent and credit notes not taken into account.

Appellant’s Prayers 23. The Appellant prayed that the Tribunal finds: -a.The Respondent be authorized to amend the Corporation tax and VAT tax additional assessments to nil for the periods under review;b.This Appeal be allowed;c.Any other remedies and reliefs deemed fit by the Tribunal.

Respondent’s Case 24. The Respondent’s case is premised on its Statement of Facts dated 30th April 2023 and filed on 3rd May 2023.

25. The Respondent submitted that it conducted an audit into the tax affairs of the Appellant for the periods of 2017 to 2020 resulting in the issuance of additional tax assessments for Income tax, VAT and Capital gains.

26. The Respondent submitted that it relied on Section 31 of the TPA which empowers the Respondent to make assessments according to the information available to it and best judgment in ensuring that the Appellant is only liable for the correct tax.

27. The Respondent submitted that subject to this Section, it may amend an assessment (referred to in this section as the “original assessment") by making alterations or additions, from the available information and to the best of the Respondent's judgment, to the original assessment of an Appellant for a reporting period to ensure that—a.In the case of a deficit carried forward under the Income Tax Act (Cap. 470), the Appellant is assessed in respect of the correct amount of the deficit carried forward for the reporting period;b.In the case of an excess amount of input tax under the Value Added Tax Act, 2013 (No. 35 of 2013), the Appellant is assessed in respect of the correct amount of the excess input tax carried forward for the reporting period; orc.In any other case, the Appellant is liable for the correct amount of tax payable in respect of the reporting period to which the original assessment relates.

28. The Respondent stated that Section 59 of the TPA 2015 requires the Appellant to provide records to enable it to determine the Appellant’s tax liability. The Respondent maintained that the Appellant failed to provide sufficient supporting documents.

29. The Respondent posited that the burden is on the Appellant to demonstrate that it has discharged a tax liability as provided for under Section 56 of the TPA and Section 30 of the TAT Act. That Section 56 of the TPA provides that: -“In any proceedings under this Part, the burden shall be on the Appellant to prove that a tax decision is incorrect.”

30. The Respondent stated that it noted that the finance costs claimed comprised of foreign exchange losses which would require a tax treatment as prescribed under Section 4A of the Income Tax Act (ITA). That the foreign exchange losses are therefore not claimable under finance costs until certain conditions prescribed under Section 4A of Income Tax Act are fulfilled.

31. The Respondent relied on Section 4A of the Income Tax Act which prescribes that losses and gains are taken into account if and only if they have been realized so as to determine taxable income in a year of income.

32. It was the Respondent’s position that the finance costs included huge commitment fees charged which ought to have been capitalized under the loan liabilities.

33. The Respondent stated that the finance costs included costs relating to a loan from a private Company called Forward Investments Ltd whose loan agreement was not specific as to the reason for acquisition of the loan, settlement of the loan, security of the loan and no evidence was adduced to demonstrate that the loan was actually received in the bank accounts of Prabhaki Developers Ltd.

34. On the issue of the Respondent having used erroneous amount in year 2020 i.e., Kshs.128,423,659. 00 instead of Kshs.120,590,516. 00 as the finance costs booked in the audited financial statements, the Respondent stated that it established that the Kshs.128,423,659. 00 included year 2021 variances as had earlier been communicated to the Appellant through the pre-assessment letter.

35. The Respondent submitted that with regard to the sample Units A7 and A1 that the Respondent had picked on, it was established that proof of payment provided was only for Westlands Trading Ltd thus proof of payment for the related party i.e., Prabakhi Investments Ltd was not provided.

36. The Respondent contended that the assessment was based on the Appellant’s own self-assessment returns, and the Appellant was given an opportunity to challenge the same through provision of documentation at the objection level, which it failed to do.

37. That consequently, the Respondent proceeded to estimate the taxes due of the Appellant and issued an additional assessment based on the available information and best judgment as provided for under Section 31 of the Tax Procedures Act 2015.

Respondent’s Prayers 38. The Respondent prayed that the Tribunal finds that: -a.This Appeal be dismissed with costs to the Respondent as the same lacks merit.b.The Respondent’s Objection decision is proper and in conformity with the provisions of the law.

Issue For Determination 39. The Tribunal having considered the facts of the matter and the pleadings made by the parties, is of the view that there is a single issue falling for determination as follows:-Whether the Respondent erred in confirming the additional assessments.

Analysis And Findings 40. It was the Appellant’s assertion that it had provided sufficient documents to show that the Respondent erred in confirming the said VAT and Corporate income tax assessments.

41. The Respondent on its part countered that the Appellant did not provide sufficient supporting documents and that it had revised the initial assessment downwards based on the information that was provided at the objection stage.

42. Section 56 of the TPA is unequivocal that once the Respondent raises an assessment, the burden of proof falls on the Appellant to show that the assessment is excessive or incorrect. Section 56(1) of the TPA provides that:“In any proceedings under this part, the burden of proof shall be on the taxpayer to prove that a tax decision is incorrect.”

43. To determine whether the Appellant fully discharged its burden under the above Section, the Tribunal gleaned through the documents and explanations provided by the Appellant and wishes to analyse them under the relevant tax heads as follows:-a.Corporate Income Taxi.Finance Costs

44. It was the Respondent’s position that the Appellant did not provide sufficient documents to explain the variance between the finance costs as claimed and the total finance costs incurred.

45. The Appellant on its part averred that the Respondent had erred by not taking into consideration other relevant deductible expenses which it incurred. The Appellant provided a list of the said expenses, however the only evidence it provided to support the listed expenses were bank statements.

46. The Respondent queried why finance costs included huge bank loan commitment fees which should have been capitalized under loan liabilities, the Appellant did not traverse this issue.

47. The Respondent contended that the loan terms were not clear from the loan agreements and that the Appellant had not provided evidence to demonstrate that the loan was actually received in its bank accounts. The Appellant did not attach the loan agreement for the Tribunal’s analysis.

48. The Appellant listed foreign exchange losses as part of the expenses which ought to have been allowed, however it did not show how the said foreign exchange losses arose. The Tribunal noted that part of the foreign exchange losses were attributable to the foreign currency denominated loan from a private company, Forward Investments limited. The Appellant did not provide the loan agreement, it only attached the loan statement.

49. The Appellant’s failure to provide details of the foreign exchange losses lends credence to the Respondent’s contention that the Appellant did not address itself to the provisions of Section 4A of the Income Tax Act, Cap 470 (ITA) which requires that for foreign exchange losses to be claimable, a specific tax treatment should be preferred as prescribed therein.

50. It is the Tribunal’s considered view that the Appellant besides providing a list of the amounts making up finance costs, the Appellant should have provided further documents in support of the expenses such as loan agreements, currency exchange analysis, transaction details and any other relevant documentation to support its averment with regard to claimable finance costs.

51. The Tribunal is persuaded that the Appellant did not dislodge its burden with regard to disallowed finance costs.ii.Overstated Cost of Sales

52. The main contention was on the disallowed cost of sales amounting to Kshs. 434,233,440. 00. which the Respondent had equally apportioned to Kshs. 108,558,360 for the years 2017, 2018, 2019, and 2020.

52. The Tribunal noted that the Respondent had arrived at this figure by comparing the purchase declarations made by the Appellant and the sales declared by its main contractor for construction of godowns Structural Construction International. The Respondent stated that it disallowed the cost in line with Section 16 of the Income Tax Act Cap 470 of the laws of Kenya.

53. The Appellant averred that the Respondent erred by deciding that due to the lack of corresponding declarations by the Appellant's suppliers, the expenses were disallowable despite the Appellant having made all purchase declarations as mandated by law and substantiated the same.

54. The Tribunal’s analysis of the documents provided showed that the Appellant had indeed attached the tax invoices, valuation reports and certificates issued by the contractor in support of the cost of sales.

55. The Appellant reiterated that it could only ensure/streamline its own statutory declarations and has no authority over the declarations of its suppliers. This in turn means that the Appellant cannot ensure that their supplier declares all its sales.

56. It is the Tribunal’s position that the Appellant is only liable to provide documents to support its transactions and cannot be expected to compel the supplier to declare its own sales.

57. The Tribunal therefore finds that the Appellant supported its cost of sales and the same should be allowed in accordance with Section 15(1) of the Income Tax Act Cap 470 of the laws of Kenya which states that:“For the purpose of ascertaining the total income of any person for a year of income there shall, subject to section 16 of this Act, be deducted all expenditure incurred in such year of income which is expenditure wholly and exclusively incurred by him in the production of that income”b.VATi.Understated Selling Price

58. The Respondent questioned the difference of Kshs. 39 Million in selling price of godown A1 and A7 whereas the two were transacted within the same week. Godown A1 was sold to Prabhaki Investments at Kshs. 69 Million while go-down A7 was sold to Westlands Trading Limited at Kshs. 30Million.

59. The Respondent contended that the price for the sale to Prabhaki Investments Limited, a related party was below the market value compared with similar transactions contrary to Section 13 of the VAT Act 2013. The Respondent stated that on this basis it made an adjustment to the underdeclared value of sales and brought the same to charge under VAT.

60. The Appellant countered by stating that there was a timing difference in the negotiation period whereby negotiation for the sale to Westlands Trading Limited began years earlier with a reservation offer made in the year 2016. The Appellant averred further that the sale to Westlands Trading Limited was on an off-plan basis and that each contract of sale was on a willing buyer willing seller basis.

61. The said sale agreements were not attached to enable the Tribunal examine whether the two transactions were comparable and further ascertain whether the sales occurred in the same week. The Appellant only provided a copy of the reservation offer for the Westlands Trading Limited showing the agreed instalments however proof of payment to show actual performance was not attached. The Tribunal did not sight any document relating to the Sale to Prabhaki Investment Limited.

62. Section 56(1) of the TPA provides as follows with regard to discharge of burden of proof in tax disputes:“In any proceedings under this part, the burden of proof shall be on the taxpayer to prove that a tax decision is incorrect.”

63. In view of the above, the Tribunal finds that the Appellant did not discharge its burden of proving that the tax assessment was excessive, inaccurate or should have been made otherwise.ii.Unreconciled VAT

64. The Respondent stated that it identified variances between the Appellant’s VAT 3 returns and the IT2C returns which it brought to charge.

65. The Appellant explained that part of the variances were due to the deposits that were paid by the customers when booking godowns and credit notes which the Respondent failed to take into account.

66. The Appellant averred further that the difference was also informed by the Respondent’s adjustments of the selling price of godowns upon claiming that they were understated that this meant that the sales amount declared for VAT as per the Respondent's workings were higher than the actual sales declared in the filed VAT returns.

67. The Respondent in its objection decision confirmed its VAT assessment on the basis that the Appellant’s own reconciliation had variances. The Appellant in its response to the assessment had prepared an analysis of the VAT as per VAT 3 returns and IT2C returns without adjustment for selling prices as had been done by the Respondent. The resultant reconciliation had a minor variance of Kshs. 446. 83 for the years under review. Despite the Appellant having presented the said analysis in its objection to the assessment, the Respondent confirmed the VAT assessment on the basis of its own analysis which was arrived at by use of adjusted selling prices as opposed to actual selling prices showing a variance Kshs. 368,296,931. 00

68. The Tribunal is of the view that the reasons proffered by the Appellant for the variance as well as its own analysis should have informed the Respondent to revise the assessment accordingly.

69. Further, the Tribunal holds the view that it is not in the province of the Respondent to adjust selling prices whimsically without basis.

70. Once the Appellant provided the sale agreements and bank statements as proof of having sold the godowns at the reported prices, it fell upon the Respondent to provide a basis for adjustment.

71. The Respondent has an obligation to demolish any evidence furnished by the Appellant, this was the Tribunal’s holding in Tax Appeal No. 435 Of 2022 Abyssina Iron And Steel Ltd where it held that:“This onus may however shift to the Respondent if the Appellant has made a prima facie case. In this case, the onus may then shift to the Respondent to rebut the prima facie case failure to which the taxpayer succeeds.”

72. The Tribunal is further guided by the holding of the High Court in the case of Kenya Revenue Authority v Man Diesel & Turbo Se, Kenya [2021] eKLR where it stated that:“32. The shifting of the burden of proof in tax disputes flows from the presumption of correctness which attaches to the Commissioner’s assessments or determinations of deficiency. The Commissioner’s determinations of tax deficiencies are presumptively correct. Although the presumption created by the above provisions is not evidence in itself, the presumption remains until the taxpayer produces competent and relevant evidence to support his position. If the taxpayer comes forward with such evidence, the presumption vanishes and the case must be decided upon the evidence presented, with the burden of proof on the taxpayer.”

73. In conclusion, the Tribunal finds that:a.The Appellant dislodged its burden of proof under the tax heads of Corporate tax for overstated cost of sales and unreconciled VAT.b.The Appellant failed to discharge its burden of proof under the tax heads for Corporate tax in regards to finance costs and VAT for understated selling price.

Final Decision 74. The upshot of the foregoing analysis is that the Appeal partially succeeds and the Tribunal accordingly proceeds to make the following Orders:a)The Appeal be and is hereby partially allowed.b.The Respondent’s Objection decision dated 17th February 2023 be and is hereby varied as follows:i.Taxation on tax heads regarding Corporate tax on overstated cost of sales and unreconciled VAT are hereby set aside.ii.Taxation on Corporate tax regarding finance costs and VAT for understated selling price are hereby upheld.c.Each party to bear its own costs.

75. It is so ordered.

DATED AND DELIVERED AT NAIROBI THIS 22ND DAY OF MARCH, 2024. ERIC NYONGESA WAFULA - CHAIRMANDR. RODNEY O. OLUOCH - MEMBERABRAHAM K. KIPROTICH - MEMBERCYNTHIA B. MAYAKA - MEMBERTIMOTHY B. VIKIRU - MEMBER