[2024] KETAT 747 (KLR)

Prime Capital and Credit Limited v Commissioner for Legal Services and Board Coordination (Tax Appeal E101 of 2023) [2024] KETAT 747 (KLR) (24 May 2024) (Judgment)

Neutral citation: [2024] KETAT 747 (KLR)

Republic of Kenya

In the Tax Appeal Tribunal

Tax Appeal E101 of 2023

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

May 24, 2024

Between

Prime Capital And Credit Limited

Appellant

and

Commissioner for Legal Services And Board Coordination

Respondent

Judgment

Background 1. The Appellant is a limited liability company incorporated in Kenya under the Companies Act, 2015, and is domiciled in Kenya. The Appellant's principal business activity involves lending money and investing in shares listed in the Nairobi Stock Exchange, Government bonds, dividends from related parties and foreign bonds.

2. The Respondent is a principal officer appointed under and in accordance with Section 13 of the Kenya Revenue Authority Act, and the Kenya Revenue 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 issued an assessment to the Appellant dated 17th November, 2022. In the said assessment, the Commissioner disallowed portions of expenses claimed by the Appellant, recomputed the Appellant's annual tax computations and assessed a tax loss reduction of Kshs. 274,970,145. 00 for the period January 2017 to December 2021.

4. The Appellant objected on 8th December, 2022,

5. The Respondent partially amended the assessment by allowing some expenditure and issued an objection decision confirming a loss reduction of Kshs. 271,940,415. 00 vide a letter dated 10th February, 2023.

6. Dissatisfied with the Respondent’s decision, the Appellant lodged a Notice of Appeal dated 9th March, 2023.

The Appeal 7. The Appeal is premised on the following ground as stated in the Appellant’s Memorandum of Appeal dated 23rd March, 2023 and filed on the same date:-a.That the Respondent erred in law and in fact by disallowing expenditure used in the generation of taxable income, which are allowable for tax purposes.

Appellant’s Case 8. The Appellant’s case is premised on the following documents:i.Its Statement of Facts dated and filed on 23rd March, 2023 together with the documents attached thereto.ii.Its written submissions dated and filed on 29th September, 2023

9. The Appellant presented its case based on various headings as outlined below.a.Apportionment of expenses relating to the generation of taxable income

10. The Appellant confirmed that in the course of its business it generates both taxable and exempt income. The Appellant's main business activity relates to the lending of cash within Kenya and the interest earned thereof is declared as taxable income.

11. That the Appellant earns dividends from Prime Bank Limited and Northend Estates Ltd in which it owns 14. 39% and 25% of the share capital, respectively. The dividend earned is exempt from tax as provided for under Section 7(2) of the Income Tax Act (ITA).

12. That the Appellant has invested in infrastructure bonds which have a maturity period of more than 3 years and which are managed by Prime Bank Custodial Services. That the Appellant instructs the custodian on the bond purchase after which there is minimal involvement. That the Appellant receives annual interest income, which is exempt from tax under Section 51 of Part 1 of the First Schedule to the ITA.

13. The Appellant also asserted that it received a loan from a foreign bank to purchase foreign bonds from which the company earns income. That the foreign bonds relate to income not accrued in Kenya as provided for under Section 3(1) of the ITA and thus deducted while arriving at the taxable income. That the bank charges and interest relating to the foreign income was disallowed while arriving at the taxable income during the year.

14. That Section 15(1) of the ITA provides that;“…for the purpose of ascertainment of total income of a person for a year of income, there shall, subject to Section 16, be deducted all expenditure incurred in that year of income which is expenditure wholly and exclusively incurred by him in the production of that income.”

15. That in light of this, the Appellant submitted that in matching the corresponding expenses to the incomes earned from the various sources, the expenses attributable to the generation of exempt income included expenses in relation to foreign bonds such as bank charges, interest on the loan and foreign exchange gains/losses. The Appellant noted that these expenses were disallowed in arriving at the taxable income for the years under review in compliance with the provisions of Section 16(1)(a) of the ITA.

16. The Appellant averred that the exempt incomes stated above are passive in nature given that after making the initial investment, the company's management is not involved in the follow up of the investments and does not incur any additional expenses in relation to the same.

17. The Appellant submitted that the Respondent erred in fact and in law by deeming allowable expenditure incurred by the Appellant as common expenses incurred in relation to both taxable and exempt income and further disallowing the apportioned expenses in relation to the exempt income for corporation tax purposes.

18. The Appellant noted that both Articles 47(1) of the Constitution of Kenya and Section 4(1) of the Fair Administrative Action Act state that “every person has the right to fair administrative action that is expeditious, efficient, lawful, reasonable and procedurally fair". That the Respondent has not demonstrated reasonableness by apportioning all general expenses of the company without analysing the basis on which the expenses were incurred.

19. The Appellant relied on the case of Joffe & Co Ltd v Commissioner for Inland Revenue 1946 AD 157, Watermeyer CJ held (at 163) where the court states as follows;“All expenditure, therefore, necessarily attached to the performance of the operations which constitute the carrying on of the income-earning trade, would be deductible and also all expenditure which, though not attached to the trading operations of necessity, is yet bona fide incurred for the purpose of carrying them on, provided such payments are wholly and exclusively made for that purpose"

20. That further, in a similar case, the South African Tax Court in ITC 1842 [2010] (72 SATC 118), noted as follows:“...It must further be appreciated that an apportionment of expenditure is only necessary where a need for such apportionment exists. Separately identifiable amounts incurred for different purposes do not require to be apportioned as their deductibility can be judged on their individual merits. It is only when a single indivisible expenditure stream has been laid out for more than a single purpose that the requirement for a possible. apportionment may arise...”

21. The Appellant asserted that the expenses in question deemed to be common expenses were wholly and exclusively incurred in generation of the taxable income in Kenya as supported below.

22. In regard to insurance, the company owns two cars for the day to day running of the business within Kenya. That these cars were purchased for the furtherance of the Kenyan operations thus necessitating the company to incur insurance expense as demonstrated in the sample insurance policy documents.

23. The Appellant averred that the purchase of these cars and the related insurance expenses are costs purely incurred for the day to day running operations of the lending business of the company.

24. The Appellant noted that the investment income earned is passive income and the only direct expense attributable to the income includes bank charges and interest expenses which are also passive in nature. That it is therefore not reasonable for the Respondent to conclude that the insurance expense relating to motor vehicles is incurred in the generation of a passive income.

25. In regard to salaries, employers' contributions to N.S.S.F, directors' fees and medical charges, over the period under review, the company had an average of four employees who are mainly involved in the furtherance of the lending business. That the employees were and are not involved in the decision-making processes relating to the exempt income since most of the exempt investments were made after the company surrendered back the banking license and stopped the banking business in 2007 and thereafter the income has been passive and does not require any intervention by the management. That the Appellant has provided bank statements indicating the dates when the investments were purchased.

26. The Appellant asserted that the salaries and other employment costs incurred relate to services rendered in the generation of taxable income in Kenya given that the exempt incomes are passive.

27. In regard to audit fees, the Appellant submitted that audit in Kenya is a statutory requirement for the Kenyan operations. That the audit fees are majorly incurred for the independent verification of the local lending business.

28. That for the exempt income, there are no expenses incurred and thus the confirmation of the running balances is obtained from the custodian to verify the amounts posted in the audited financial statements. That the above said audit fees incurred would be purely for compliance with the local statutory reporting.

29. That general administrative expenses include work permits expenses, postage, mobile phone charges, telephone charges, email services and legal and consultancy fees. That these expenses relate to costs incurred in the day to day running of the business. That for instance, annual subscriptions fees are incurred for use of software used for the local operations, legal costs were incurred to assisting the company settle a dispute in 2016 with one of the local investors and mobile charges are incurred in day to day running of the local operations.

30. The Appellant reiterated that the expenditure disallowed was incurred in the generation of taxable income. That the exempt income under consideration is passive in nature and there is no active intervention or additional direct expenditure incurred in its generation. The Appellant stressed that the expenses directly attributable to the generation of exempt income were disallowed in the respective tax computations. That these expenses were in relation to foreign bonds which included bank charges, interest on the loan and foreign exchange gains/losses.

31. The Appellant submitted that in 2017 and 2020 years of income, it made donations to the Social Service League of Kshs. 15 Million and to Shree Jalaram Satsang Mandal amounting Kshs. 1 Million, respectively.

32. That these organizations have valid exemption certificates pursuant to Paragraph 10 of the ITA and that based on this, the donations were treated as allowable expenditures for corporation tax purposes.

33. That KRA raised additional assessment on unrealized exchange for 2018 and 2020 years of income amounting to Kshs. 6,710,162. 00 and Kshs. 59,160. 00, respectively. That the amounts were disallowed on the premise that this relates to unrealized exchange differences. That the amounts relate to realized exchange differences during the year and thus expenses incurred wholly and exclusively for the generation of taxable income.

34. The Appellant relied on the following cases to support its position:i.Usher’s Wiltshire Brewery Limited and Bruce [19195] A.C. 433ii.Hancock vs. General Reversionary and Investment Company (1919) 1K.B. 25iii.Joffe & Co. Ltd v Commissioner for Inland Revenue 1946 AD 157

Appellant’s Prayers 35. The Appellant prayed for orders that;a.the Respondent's Objection decision made on 10th February, 2023 that confirms a tax loss reduction assessment of Kshs. 271,940,415. 00 be vacated;b.this Appeal be allowed; andc.the costs of and incidental to this Appeal be awarded to the Appellant.

Respondent’s Case 36. The Respondent’s case is premised on the hereunder filed documents and proceedings before the Tribunal: -i.The Respondent’s Statement of Facts dated and filed on 20th April, 2023 together with the documents attached thereto.ii.The Respondent’s written submissions dated 16th October, 2023 and filed on 17th October, 2023 together with the legal authorities filed therewith.

37. The Respondent averred that the expenses were disallowed as they did not meet the criteria set out in Section 15(1) of the Income Tax Act. That the common expenses relating to the running of the company as a whole were apportioned in the ratio of the various revenue streams.

38. That from the Appellant's letter of objection, the Appellant did not provide any evidence to demonstrate that the employees (other than directors) were only involved in the lending business. That therefore, the Respondent was not able to establish the nature of the job done by the said employees.

39. That the salaries of the directors were rightly apportioned since the directors were involved in the running of the entire company and not just the taxable income. The directors were continuously making decisions on behalf of the Appellant’s company despite the exempt income being of passive nature.

40. That it was also noted that one director had been paid a bonus each year; normally a bonus would be paid when a company is mostly on a profit trajectory. That it was also noted, from the return filed for the 5 years' under review, that the Appellant’s company was in a loss position and therefore it would not be prudent to pay bonus from a loss making (taxable portion) business.

41. That secondly the directors handle all business streams of the company by making decisions on the going concern of each revenue stream. That therefore, it was right for the Respondent to apportion these costs between the revenue streams.

42. That, in relation to insurance expenses, the two cars were charged individual income tax as benefit to the directors and thus this proved that the said cars were used by the directors to enable them run the affairs of the Appellant’s company (exempt & taxable income). That since the directors dealt with the affairs of the entire Appellant company it was found to be prudent for the Respondent to apportion the cost.

43. That in relation to audit fee, the Respondent was of the view that audit in Kenya is a statutory requirement. That however, the Respondent disagrees with the Appellant who stated that audit was conducted for just the taxable income portion of the Appellant’s company. That the audited financial statements show the financial position of the Appellant on all its revenue streams. That therefore, the Respondent was right in apportioning the costs.

44. That in relation to general administration expense, the Appellant did not demonstrate to the Respondent that this expenditure was not a common expense. That the Respondent therefore treated it as a common expense and the onus was on the Appellant to demonstrate it was specific to the business of lending loans by providing documentary evidence that it was incurred exclusively for the lending taxable business.

45. The Respondent averred that the Appellant failed to demonstrate that this expenditure was incurred in furtherance of taxable business income and not the exempt income. That the Appellant ought to have provided documentary evidence to show, first that it relates to the local lending business and secondly, that the loss was realized and thus deductible for tax purposes.

46. That the Appellant provided an exemption certificate given to it by the Respondent under Paragraph 10 of the First Schedule of the Income Tax Act. That the donation was allowable as per Section 15(w) of the Income Tax Act. That however, the Respondent allowed part of the donation as deductible expenses based on the apportionment formula as the company gave a donation based on its total income and not just the taxable income. That in fact, the company was making taxable losses from the business income that was chargeable to tax.

47. That Section 54A(1) obliges businesses to keep records of all their expenditures so as to prove such and that the burden of proof lies with the taxpayer to demonstrate that a tax assessment is faulty.

48. That the Appellant failed to discharge its evidential burden of proof under Section 107 of the Evidence Act in demonstrating that the assessment by the Respondent was in any reasonable manner excessive or incorrect.

49. The Respondent relied on the following authorities to buttress its case:i.Civil Appeal No. 10 of 2018; Commissioner of Domestic Taxes vs. Ocean Freight (East Africa) Limited [2020] eKLRii.Nairobi Tax Appeal No. E002 of 2020; Leah Njeri Njiru vs Commissioner of Investigations and Enforcement Kenya Revenue Authority and Chief manager Debt Collection and Enforcementiii.Nairobi TAT No. 25 of 2016 Family Signature Limited vs The Commissioner of Investigations ad Enforcementiv.TAT No. 28 of 2018; Joycott General Contractors Limited vs Kenya Revenue Authority

Respondent’s Prayers 50. The Respondent prayed that the Tribunal finds that this Appeal lacks merit.

ISSUES FOR DETERMINATION 51. The Tribunal upon due consideration of the pleadings and the written submissions of the parties was of the considered view that the Appeal raises the following single issue for its determination: Whether the Respondent’s confirmed assessments were justified

Analysis And Determination 52. This dispute arose from the Respondent’s apportionment of business expenses by the Appellant thereby recomputing income tax and assessing the same on the Appellant.

53. The Appellant contended that all the expenses apportioned by the Respondent were wholly and exclusively incurred in the generation of its business income.

54. The Respondent argued that it rightfully apportioned the Appellant’s expenses which resulted in an additional income tax liability. That further the Appellant did not provide any evidence to prove that the expenses in question were wholly and exclusively incurred in generating its “non-exempt’ income.

55. The Tribunal considered the pleadings of the Appellant as well as the documents attached to the pleadings and noted as follows:i.The expenses in question and apportioned by the Respondent were:i.Insurance expenses;ii.Salaries;iii.Employer’s contribution to NSSF;iv.Work permit expenses;v.Directors’ fees;vi.Postages;vii.Mobile phone charges;viii.Telephone charges;ix.E-mail service;x.Medical charges;xi.Audit fees; andxii.Legal, consultancy and accountancy fees.

56. The Tribunal further noted that in support of its grounds, the Appellant attached the following documents to its pleadings:i.Tax computations for Prime Capital Holdings Limited for the years 2021, 2020, 2018 and 2017ii.Car insurance renewal advices and motor insurance policies.iii.A confirmation of securities (shares and Government bonds) held under custody by Prime Bank vide a letter by the bank.iv.An account statement, for the period under dispute, with a confirmation of securities held and interest earned under custody by Credit Suisse AG. The statement also depicts details of a loan held with the bank.v.An investment report by Credit Suisse AG depicting a valuation of assets held in custody by the bank for the assessment period.vi.An Income tax exemption certificate for the Social Service League.vii.An Income tax exemption certificate for Shree Jalaram Satsang Mandal.

57. Section 15(1) of the Income Tax Act provides as follows:“For the purpose of ascertaining the total income of a person for a year of income there shall, subject to section 16, be deducted all expenditure incurred in that year of income which is expenditure wholly and exclusively incurred by him in the production of that income, and where under section 27 any income of an accounting period ending on some day other than the last day of that year of income is, for the purpose of ascertaining total income for a year of income, taken to be income for a year of income, then the expenditure incurred during that period shall be treated as having been incurred during that year of income.”

58. Further Section 15(2)(w) of the ITA provides as follows regarding charitable donations:“(2)Without prejudice to subsection (1), in computing for a year of income the gains or profits chargeable to tax under section 3(2)(a), the following amounts shall be deducted –…. any cash donation in that year of income to a charitable organization registered or exempt from registration under the Societies Act or the Non-Governmental Organizations Coordination Act, 1990, and whose income is exempt from tax under paragraph 10 of the First Schedule to this Act, or to any project approved by the Minister for Finance;”

59. The Tribunal while reviewing the Appellant’s pleadings noted that the company earned both taxable and exempt income during the period under dispute. The taxable income was derived from lending of money to its clients. Its exempt income was derived from investment in foreign bonds.

60. Part I of the First Schedule to the Income Tax Act provides for the following exemptions on income accrued in, derived from or received in Kenya which is exempt from tax:“51. Interest income accruing from all listed bonds, notes or other similar securities used to raise funds for infrastructure and other social services, provided that such bonds, notes or securities shall have a maturity of at least three years.

60. Interest income accruing from all listed bonds, notes or other similar securities used to raise funds for infrastructure projects and assets defined under Green Bonds Standards and Guidelines, and other social services:

Provided that such bonds, notes or securities shall have a maturity of at least three years.”

61. The Tribunal notes that from the attachments by the Appellant, it earns dividends from Prime Bank Limited and Northend Estates Ltd. Further, the Appellant has invested in infrastructure bonds managed by Prime Bank Custodial Services whose maturity is above 3 years based on information that the Tribunal reviewed on the specific infrastructure bonds listed in the Confirmation of Assets letter. Notably, the detailed information relating to the infrastructure bonds is available on the Central Bank of Kenya website.

62. In relation to the investments by the Appellant therefore, the Tribunal confirmed that this income is exempt and passive in nature and does not require intervention by persons other than the institutions with custody thereof to manage the same.

63. Due to the foregoing, and pursuant to the provisions of Section 15(1), 15(2)(w) and Part I of the First Schedule, the Tribunal concludes as follows:i.The general expenses that the company incurred which are: insurance expenses, salaries, employer’s contribution to NSSF, work permit expenses, directors’ fees, postages, mobile phone charges, telephone charges, E-mail service, medical charges, audit fees and legal, consultancy and accountancy fees were not incurred in the generation of the Appellant’s exempt income and therefore were utilised in its taxable business and should therefore not be apportioned.ii.The donations by the Appellant to the Social Service League and Shree Jalaram Satsang Mandal were backed by valid tax exemption certificates in compliance with Section 15(2)(w) of the ITA and Paragraph 10 of the First Schedule to the ITA.iii.On unrealised exchange loss and overstated unrealized exchange gain, the Appellant did not produce any documentation to support its averments. The only reference made to this item is on the tax computations with a reference to a note in its financial statements which were not adduced as evidence to support its averments.

64. In addition to the conclusion by the Tribunal on unrealised exchange loss and overstated unrealized exchange gain, the Tribunal states that Section 30 of the Tax Appeals Tribunal Act places the burden of proving that a tax decision is erroneous on the Appellant. It states as follows:“In a proceeding before the Tribunal, the appellant has the burden of proving—(a)where an appeal relates to an assessment, that the assessment is excessive; or(b)in any other case, that the tax decision should not have been made or should have been made differently.”

65. The Tribunal relied on the case of Kenya Revenue Authority v Man Diesel Turbo Se, Kenya [2021] eKLR which addressed the issue of burden of proof as follows:“38 The party that carries the burden of proof must produce evidence to meet a threshold or “standard” in order to prove their claim. If a party fails to meet theirburden of proof, their claim will fail. “Burden of Proof” at the Tax Court is somewhat unique. At the Tax Court, a taxpayer is required to disprove an assessment by the Commissioner. In other words, a Tax payer challenging a tax assessment will need to collect and present evidence in order to disprove the Commissioner’s position. This is the basic principle”

66. As a result of the foregoing the Tribunal finds that the Respondent was neither justified in apportioning the Appellant’s general expenses nor disallowing the donations made by the Appellant.

Final Decision 67. In view of the foregoing analysis the Tribunal finds the Appeal to be partially merited and accordingly proceeds to make the following Orders: -a.The Appeal be and is hereby partially allowed.b.The Respondent’s objection decision dated 10th February, 2023 be and is hereby varied in the following terms:i.The confirmed assessment arrived at by the apportionment of general expenses incurred by the business be and is hereby set aside.ii.The confirmed assessment arrived at by the disallowance of donations to the Social Service League and Shree Jalaram Satsang Mandal be and is hereby set aside.iii.The confirmed assessment relating to unrealised exchange loss and overstated unrealized exchange gain be and is hereby upheld.iv.The Respondent is hereby directed to recompute the tax assessment based on the Tribunal’s findings under (i), (ii) and (iii) above within Thirty (30) days of the date of delivery of this judgment.c.Each Party to bear its own costs.

68. It is so ordered.

DATED AND DELIVERED AT NAIROBI THIS 24TH DAY OF MAY, 2024ERIC NYONGESA WAFULA - CHAIRMANCYNTHIA B. MAYAKA - MEMBERTIMOTHY B. VIKIRU - MEMBERDR. RODNEY O. OLUOCH - MEMBERABRAHAM K. KIPROTICH - MEMBER