[2024] KETAT 1275 (KLR)

Pwani Oil Products v Commissioner of Legal Services and Board Co-ordination (Tax Appeal E214 of 2023) [2024] KETAT 1275 (KLR) (Civ) (9 August 2024) (Judgment)

Neutral citation: [2024] KETAT 1275 (KLR)

Republic of Kenya

In the Tax Appeal Tribunal

Civil

Tax Appeal E214 of 2023

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

August 9, 2024

Between

Pwani Oil Products

Appellant

and

Commissioner of Legal Services and Board Co-Ordination

Respondent

Judgment

1. The Appellant is a limited liability company incorporated in Kenya and is involved in the production of edible oils and fats as well as the manufacture of skincare, laundry and antibacterial products.

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 assessments relating to VAT for the year 2017 on 19th January, 2023 and Income tax for 2018 and 2019 on 25th January, 2023

4. The Appellant objected to the assessments on 15th and 22nd February, 2023.

5. The Respondent issued an objection decision on 31st March, 2023.

6. The Appellant being dissatisfied with the objection decision, filed the Notice of Appeal dated 11th May, 2023.

The Appeal 7. The Appeal is premised on the following grounds as stated in the Memorandum of Appeal dated and filed on 25th May, 2023:a.That the Respondent erred and misdirected itself in allowing an assessment of Kshs. 97,399,333. 76 in Corporation tax and VAT inclusive of interest and penalties.b.That the Respondent erred in law and in fact in misapprehending the Appellant's production process, thereby arriving at an erroneous decision.c.That the Respondent erred in law and in fact in disregarding the Appellant's stock adjustments which are an integral part of its accounting practices and in line with international accounting standards.d.That the Respondent erred in law and in fact in upholding an assessment that is based on estimated/expected sales rather than actual sales thereby subjecting the Appellant to taxes on revenue over and above what was actually earned contrary to Section 3(1)and 3(2) of the Income Tax Act.e.That the Respondent erred in law and in fact in purporting to use provisional values rather than actual values which is not permissible in the computation of tax.f.That the Respondent erred in law and in fact in applying estimates of stocks used in production of finished goods, the ultimate effect of which would be the deduction of expenditure not wholly and exclusively incurred in production of income contrary to the clear provisions of Section 15(1) of the Income Tax Act.g.That the Respondent erred in disallowing the decrease in provision of impaired receivables in respect of a debt that is deductible within the provisions of Section 15(2)(a) of the Income Tax Act as read with Legal Notice No. 37 of 2011.

Appellant’s Case 8. The Appellant’s case is premised on the following documents:a.The Appellant’s Statement of Facts dated and filed on 25th May, 2023 together with the documents attached thereto.b.The Appellant’s witness statement of Maryam Salim dated 13th February, 2024 and filed on 15th February, 2024 that was admitted in evidence under oath on 26th March, 2024. c.The Appellant’s written submissions dated 9th April, 2024 and filed on 10th April, 2024 together with the authorities attached thereto.

9. That by a letter dated 23rd June, 2021, the Appellant addressed each of the issues raised by the Respondent in its audit findings and provided supporting documentation.

10. That on 25th June, 2021, KRA held a meeting with the Appellant for purposes of reviewing the tax audit findings and allowing the Appellant's representatives to explain the Appellant's position.

11. That subsequently, by a letter dated 26th July, 2022, KRA communicated the outcome of its audit findings, reducing the outstanding issues to the following:a.Production analysis - KRA indicated that it had applied an input-output methodology to ascertain the correctness of sales declared, which involved a comparison between the quantity of crude palm oil used in production, the total production in weight and the acceptable yield rates. KRA's conclusion based on this analysis was that for the period 2016 to 2019, there were under-declared sales as there was a variance between expected sales and declared sales.b.Sales and VAT reconciliation - KRA found that there were variances between accounts sales and VAT sales for the years 2018 and 2019 and brought the variances to charge.c.Disallowed expenses - KRA disallowed stock variances amounting to Kshs. 18,995,606. 00 for the year 2018 stating that the variances were not adequately supported and decrease in provision for impaired receivables from Nakumatt supplies amounting to Kshs. 60,211,397. 00 on the basis that it did not meet the threshold set in Legal Notice No. 37 of 2011. d.Overclaimed staff costs - KRA indicated that a reconciliation between the salaries and wages declared in PAYE returns and those in the Appellant's accounts showed an overclaim of expenses, which was disallowed and subjected to tax.

12. That based on its analysis, KRA concluded that Corporation tax of Kshs. 129,704,554. 00 and VAT of Kshs. 34,431,730. 00 inclusive of interest and penalties was due from the Appellant.

13. That by a letter dated 19th August, 2022, the Appellant responded to the outstanding issues communicated by KRA, explaining that:a.KRA erroneously applied acceptable yields, in this case standard yield rates, without appreciating the fact that yields could not be constant due to the nature of the raw material and the Appellant's manufacturing process. The Appellant outlined the reasons for variances in production yields and explained that the variances noted by KRA were purely normal production process losses and not underdeclared sales. Further, the Appellant provided a summary of its input-output analysis for the period 2016 to 2019 which demonstrated that the raw material was fully accounted for during the period under review and that there were no underdeclared sales.b.A reconciliation of sales as per financial statements and as per VAT returns showed that there were no variances contrary to KRA's allegation.c.The stock variances in the Appellant's accounts related to soap stock-take done at the end of 2018 and posted in the provisions account since the inventory ledgers had been closed. Subsequently, the provision was reversed in 2019 and adjustments done in the inventory ledger.d.The decrease in provision for impaired receivables related to Kshs. 60,211,397. 00 due from Nakumatt Holdings Ltd, which amount was provided for in 2017 and disallowed. Nakumatt was then placed under administration in 2018 and the Appellant allowed the amount back in its tax computation as per Section 15(a) of the Income Tax Act ("ITA") as read with paragraph 2(d) of Legal Notice No.37 of 2011. e.A summary of the fully reconciled wages and salaries as per the Appellant's financial statements and PAYE returns showed that there were no variances.

14. That on 27th September, 2022, KRA communicated its final findings, upholding its position on two issues: the production analysis and the disallowed bad debts expense/decrease in provision for impaired receivables. That the issues relating to sales and VAT reconciliations, stock variances and overclaimed staff costs were vacated. That KRA indicated that it would issue assessments in respect of taxes amounting to Kshs. 153,016,231. 00 being Corporation tax and VAT together with penalties and interest.

15. That following KRA's communication of its findings, the Appellant held a meeting with KRA to further explain the issues of production analysis and decrease in provision for impaired receivables. That KRA however maintained its position and issued the following additional assessments: VAT for 2017 amounting to Kshs. 9,853,582. 62, Corporation tax for 2018 amounting to Kshs. 21,668,821. 03 and Corporation tax for 2019 amounting to Kshs. 27,182,606. 84.

16. That the Appellant, being dissatisfied with KRA's assessments, lodged objections dated 15th February, 2023 in respect of the assessments for the periods 2018 and 2019 and dated 22nd February 2023 for the period 2017; highlighting the following as its grounds for objection:a.The Respondent erred in disregarding stock adjustments and failing to consider the Appellant's production process. The Appellant extensively explained its production process and the factors that affect product yields at each stage of production. The Appellant elaborated on the reasons why the yield from each batch of raw materials cannot be estimated with certainty. The Respondent's conclusion that there were under-declared sales was therefore based on the application of estimated product yield rather than actual product yield.b.The Respondent failed to consider the Appellant's accounting practices and therefore disallowed the stock adjustments made by the Appellant in its financial statements, leading to the erroneous conclusion that there were under-declared sales. The Appellant explained that the stock adjustments were necessary for matching revenues and the cost of production of goods.c.The Respondent disregarded several income tax provisions by applying provisional values instead of actual values, deducting expenditure that was not wholly and fully incurred in production of income and imposing tax on expected sales instead of actual sales.d.The Respondent erred in disallowing the decrease in provision for impaired receivables for the year 2018 as it failed to consider that Nakumatt Holdings Ltd was adjudged insolvent and the debt was therefore uncollectable within the meaning of Section 15(2)(a) of the ITA as read with Legal Notice No. 37 of 2011.

17. That on 23rd February, 2023, the Respondent requested for further documents, being the Appellant's financial statements for the years under review, copies of the notices of objection and an input-output reconciliation and the Appellant provided the documents on 28th February, 2023.

18. That by a letter dated 31st March, 2023 sent to the Appellant via email on 11th April 2023, the Respondent issued an objection decision in which it stated that:a.The assessing Commissioner accounted for the factors set out in the objection when conducting the production analysis and the input-output methodology was used to test the accuracy of the taxpayer's deductions.b.The Respondent applied an allowable loss of between 5. 82% and 6. 34% to arrive at the expected RBD yield.c.The ground of objection in respect of supplies made to Nakumatt Holdings Ltd did not meet the threshold in Legal Notice No. 37 of 2011. d.The Respondent therefore upheld the assessments in the cumulative amount of Kshs. 97,399,333. 76 inclusive of penalties and interest.

19. That the Respondent's objection decision is erroneous for the following reasons:Failure to consider the Appellant's production processa.The Appellant's production process involves first refining of crude palm oil (CPO) to produce refined, bleached and deodorized oil (RBD), with Palm Fatty Acid Distillate (PFAD) and Biox as by-products. The RBD then undergoes fractionation to produce olein and stearin, which are the finished products. Thatbowing to the continuous production process, the Appellant estimates the RBD yield that would be produced from a specific amount of CPO and the finished goods that would be expected from a specific quantity of RBD. That the Appellant then does quarterly stock takes to establish the actual amounts of finished goods, RBD and CPO and accounts for the process losses by making stock adjustments in its accounts.b.That the Respondent disregarded the process losses that are inherent in the Appellant's production process despite several explanations by the Appellant, and instead applied the estimated production yields for each year of production to arrive at expected sales. That the expected sales do not take into account the process losses and the actual quantities of finished products which were duly accounted for and declared by the Appellant.c.That the Appellant specifically explained that the RBD yield from a specific quantity of CPO is not constant and varies based on:i.The quality of CPO used, which fluctuates from season to season and from one batch to another - a lower quality batch produces a lower amount of RBD.ii.The moisture level in the CPO - a higher amount of moisture leads to a lower yield of RBD and PFAD.iii.The quantity of Free Fatty Acids (FFAs) in the CPO - where FFAs are higher, the RBD yield will be lower.iv.Tank temperatures - where the temperatures in the CPO tanks are high, the amount of FFAs will increase, leading to a low RBD yield.v.Deodorizer temperatures - higher deodorizer temperatures lead to a lower RBD yield.vi.Scrubbing temperatures - scrubbing utilizes steam drawn from the top of the deodorizer. The scrubbing temperatures therefore influence the recovery of vapors and if condensation is not effective, it leads to higher losses of PFAD and any neutral oil that is trapped in the FFA steam, thus negatively affecting the RBD yield.vii.System vacuum - inadequate vacuum leads to higher FFA and a lower RBD yield.viii.Interruption of runs - where there are power cuts or equipment breakdown, the stability of the system is affected, leading to unstable RBD yields.ix.Plant age and capacity utilization - the refinery plant used in the period under review was old having been in use for around 16 years. To meet product demand, the plant was upgraded several times in 2010 and 2016, which impacted its efficiency since it was pushed beyond its normal production levels, leading to high process losses. By contrast, following the installation of a new refinery plant in December 2020, efficiency has increased and yields have significantly improved.d.Similarly, the quantity of finished goods produced from a specific amount of RBD varies due to process losses that result from:i.Accuracy of filling line weight determination.ii.Variances caused by the filling nozzles.iii.High temperatures during fractionation.e.As such, simply applying predetermined expected product yields is not an accurate measure of the production quantities and therefore cannot be a true account of sales volumes or a basis for concluding that there were undeclared sales.f.Additionally, the Respondent's indication in its objection decision that it applied an allowable loss of 5. 82% and 6. 34% to the CPO available for production is false. The 5. 82% and 6. 34% include PFAD, Biox and process loss. This means that process losses, which are accounted for by the Appellant, were less than 1% during the period under review. That this is clear from the Appellant's input-output reconciliation that it attached to its pleadings.Failure to consider the Appellant's accounting practicesg.The Respondent, in its findings dated 27th September, 2022, omitted the Appellant's stock adjustments.h.That the effect of the Respondent's omission of the Appellant's stock adjustments is that the process losses explained above were not taken into account.i.That due to the continuous nature of the Appellant's production process, it has adopted the use of a pre-determined standard production yield for day-to-day accounting of production quantities which are usually estimates. That it then conducts periodic stock takes to determine the actual production yields.j.That in 2017, the standard/estimated RBD yields expected from processing of CPO were 94. 71% for half one and 94. 03% for half two bringing the weighted average for the year to 94. 18%. That the Appellant therefore used the pre-determined standard production yield (Bill of Materials) to record all production during the year 2017 in its ERP system. That the manufacturing process was recorded as follows:i.CPO tanks to refinery - CPO that is piped to the refinery is measured using flowmeters or tank dips and the CPO quantity used to estimate the RBD, Palm Fatty Acid Distillate (PFAD) and Biox produced as well as process losses.ii.Fractionation - The RBD piped to the fractionation plant is measured using flowmeters or tank dips and used to estimate the olein and stearin produced.k.That in 2018, the standard RBD yields were 93. 14% for half one and 93. 77% for half two, bringing the weighted average for the year to 93. 46%. That in 2019 the standard RBD yields were 93. 77% for half one and 93. 13% for half two, bringing the weighted average to 93. 40%. That for both 2018 and 2019, the Appellant also used the pre-determined standard production yield (Bill of Materials) to record all production in its ERP System. That the manufacturing process for 2018 and 2019 was recorded as follows:i.Refinery - RBD produced from the refinery was measured using flowmeters and used to estimate the CPO used, Biox and PFAD produced and the process loss.ii.Fractionation - Olein quantity produced was measured using flowmeters or tank dips and used to estimate the RBD utilized.l.That it is therefore clear that for the years under review, the production quantities recorded in the manufacturer's ERP system constituted various estimates based on pre-determined standard production yields. That this necessitated the use of stock adjustments to reconcile the actual stock quantities.m.That the Appellant conducts stock takes at least once quarterly, at which point all production processes are halted and actual measurements taken. That in view of the variances that are inevitable in the production process due to process losses, the actual stock quantities are usually different from the estimates. That this necessitates a reconciliation of stocks, which is done by way of stock adjustment entries. That the purpose of the stock adjustments is to ensure that the recorded stock (based on estimates) tallies with the actual stocks as counted and determined during the stock takes.n.That the use of stock adjustments in financial statements is in line with International Accounting Standard (IAS) 1. 27 which requires entities to prepare their financial statements using the accrual basis of accounting. That the adjustments are made for the purpose of matching revenues and the cost of production of the goods. That further, the stock adjustments are in compliance with IAS 8. 36 and 8. 37 which provide the following:“The effect of a change in an accounting estimate shall be recognised prospectively by including it in profit or loss in: [IAS 8. 36]·the period of the change, if the change affects that period only, or· the period of the change and future periods, if the change affects both.However, to the extent that a change in an accounting estimate gives rise to changes in assets and liabilities, or relates to an item of equity, it is recognised by adjusting the carrying amount of the related asset, liability, or equity item in the period of the change. [IAS 8. 37]”o.That the Respondent's application of the input-output methodology ought to take into account the fact that whereas there are predetermined product yields, there are still process losses that have to be considered and necessary stock adjustments made to reconcile the estimates of quantities with the actual quantities recorded during stock takes.p.That it is important to note that the Respondent's reference to "acceptable yield rates" and “allowable losses" was not based on any industrially accepted standards but was drawn from the Appellant's projected yield rates (indicated as average standard yields).q.That the Appellant demonstrated that the process losses for the years under review were minimal and below industry standard process loss as shown below:Net Stocks Adjustment(CPO/RBD/Olein)-KGSStocks handled(KGS) 142,409,122 140,694,830 180,047,714

Pwani Total Process Loss 0. 62% 0. 79% 0. 77%

Usual Industry Standard 1. 0% 1. 0% 1. 0%

Process Lossr.That it is clear from the foregoing that the Appellant maintained an accurate record of the quantities of actual finished goods produced as well as the volume of sales that took place within each year of review.s.That the expected sales quantities which the Respondent used are an estimate or projection based on the standard yields and does not reflect the actual sales based on the actual production yields. That the Respondent therefore based its conclusion and assessment on expected sales, which are estimates, rather than actual sales recorded and declared by the Appellant. That the point of focus when determining the Appellant's income should be the actual sales made by the Appellant, which it duly declared.t.That notably, as part of the audit process, the Respondent conducted a systems audit, which would have revealed undeclared sales if there were any. That the Respondent did not find any discrepancies and as such, its conclusions are unjustified.Disallowing decrease in provision for impaired receivablesu.That the Appellant clearly explained that in 2017, it had provided for the amount of Kshs. 60,211,397. 00 which arose from one account receivable, that is Nakumatt Holdings Ltd, but the same had been disallowed in that year. That subsequently, when Nakumatt Holdings was placed under administration, the Appellant allowed the amount back as per Section 15(2)(a) of the Income Tax Act as read with Legal Notice No. 37 of 2011. That the Respondent therefore erred in disallowing the amount, which was justified and is uncollectable.1. That the Appellant’s witness explained that the stock adjustments made usually net off to a negligible amount, as the figures are adjusted downwards at one stage of the production process, and subsequently upwards at another stage, and vice versa.2. That the Appellant’s computation ought to be considered holistically, just as the production process is a holistic, integrated and seamless process. That the process losses reflected in the Appellant’s computation are less than 1% of the stocks handled, as reflected in the production process loss analysis provided in the Appellant’s bundle of documents.3. That it is important to note that the process losses reflected in the stock adjustments made by the Appellant amounted to 0. 32%, 0. 49% and 0. 35% of the stocks handled by the Appellant for the respective years of income. That adding these to the process losses estimated at refining stage brings the total percentages to 0. 62%, 0. 79% and 0. 77%, which are a very small fraction of the stocks handled and within the acceptable industry standard process losses of 1%. That as explained by the Appellant’s witness, the process losses clearly net off to a negligible percentage, which is close to zero.4. That notably, an almost similar result is reflected in the Respondent’s computation, when the Appellant’s alleged undeclared sales are compared to the declared sales of finished products with variances of 0. 41, 0. 59 and 0. 42 for the years of income 2017, 2018 and 2019 respectively.5. That even going further, to demonstrate this fact, the revenues realized by the Appellant, as reported in its financial statements, were Kshs. 18,274,670,596. 00 in 2017, Kshs. 17,254,034,653. 00 in 2018 and Kshs. 19,254,040,980. 00 in 2019. That the Appellant declared these sales and duly paid VAT and Corporation taxes arising from the sales. That when compared to the alleged under-declared sales, the result still demonstrates that these were computed figures that almost tally with the process losses that the Respondent has purported to exclude from its computation.6. That it is clear from the foregoing that the stock adjustments made by the Appellant were within acceptable levels, noting the Appellant’s huge production volumes, as the net effect was an adjustment of less than 1%.7. That the Respondent’s witness testified that the basis of the assessment was that, for instance, in 2019, there was a downward stock adjustment at CPO level. That what the Respondent omitted to note was that in that year of income, positive RBD, Olein and Stearin adjustments were made, which therefore netted off the total stock adjustments to 0. 35%. That the Respondent clearly did not review the Appellant’s computations from a holistic standpoint, which is necessary as its production process is continuous and very much integrated.8. That notably, one of the issues raised was stock adjustments recorded in its books, which was raised as a separate issue from production analysis. That the Appellant was called upon to explain the adjustments, which it did, and this issue was omitted from the subsequent findings. That this goes to show that the Appellant satisfactorily explained the need for stock adjustments, and the Respondent was satisfied with the Appellant’s position and found that this was no longer an issue to further consider. That it is therefore absurd that the Respondent, on the one hand, accepted the use of stock adjustments by the Appellant, and on the other hand omitted them from its computations on the production analysis.9. That whereas the Appellant uses estimates during the production process, the finished goods, and consequently the sales declared are actual volumes and not estimates. That this was confirmed by the Appellant’s witness, who explained that in terms of the finished goods, the actual volumes are reported, and actual sales declared. That in this regard, the Appellant’s declared sales are a true reflection of what was actually sold to consumers, which is reflected in its financial statements and in its tax returns. That it follows that there was no under-declaration of sales at any point whatsoever, as the actual goods sold were duly reported and declared.10. That the imposition of tax under Section 3(1) and 3(2)(a) is based on actual gains or profits and not estimates/projected income. That taxation on expected sales is unfair, unreasonable and unjust as it subjects the Appellant to taxes on revenue over and above what was actually earned.11. That the Respondent is purporting to use provisional instead of actual values, which is not acceptable in the computation of tax. That as such, the issuance of an assessment based on expected sales rather than actual sales is erroneous and should not be allowed.12. The Appellant submitted that it clearly explained that it applied estimates of stock used in production, which then necessitated adjustments following stock takes. That the ultimate effect of the Respondent disregarding stock adjustments and applying estimates of stock used in production of finished goods is that estimated, rather than actual expenditure, that is not wholly and exclusively incurred for the production of income, would be deducted, contrary to Section 15(1) and 16(1)(a)of the ITA.13. That with regard to the decrease in provision for impaired receivables, Section 15(2)(a) provides that in the computation of gains and profits for a year of income, debts which have become bad or doubtful shall be deducted. That Legal Notice No. 37 of 2011 provides guidelines on bad debts as follows:“1. A debt shall be considered to have become bad if it is proved to the satisfaction of the Commissioner to have become uncollectable after all reasonable steps have been taken to collect it.2. A debt shall be deemed to have become uncollectable under paragraph (1) where(a)the creditor loses the contractual right that comprises the debt through a court order;(b)no form of security or collateral is realisable 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; or(f)efforts to collect the debt are abandoned for another reasonable cause.3. A bad debt shall be a deductible expense only if it is wholly and exclusively incurred in the normal course of business.4. F or the purposes of these guidelines, a bad debt which is of a capital nature shall not be an allowable expense.”

33. That the debt due from Nakumatt Holdings Limited fits squarely within the definition of a bad debt as:a.The debt became uncollectable as Nakumatt was unable to pay its debts and insolvency proceedings were commenced against it. This was ruled in Insolvency Cause No. 10 of 2017 in which Nakumatt was then adjudged insolvent. In a ruling delivered on 22nd January, 2018, the Court, at paragraph 88, acknowledged that Nakumatt was insolvent and that the administration order issued was under the heading “Administration of Insolvent Companies” under the Insolvency Act.b.The Appellant duly lodged its claim with Nakumatt's administrator on 2nd February, 2018 following the issuance of the ruling but was unable to recover the debt.c.The Appellant did not hold any form of realizable security or collateral in respect of the debt. That the debt was incurred from the supply of finished products by the Appellant which ordinarily do not require the deposit of security to secure payment. That the Appellant was therefore an unsecured creditor.d.That the debt was incurred wholly and exclusively in the normal course of business, that is, supply of the Appellant's products to Nakumatt for resale.e.That the debt was not of a capital nature.

34. That the Respondent's conclusion that the debt did not meet the requirements under Legal Notice No. 37 of 2011 was therefore without basis and should not be allowed to stand.

35. That in refuting the Appellant’s computation of income, the Respondent was not exercising best judgment, contrary to the provisions of Section 31(1) of the Tax Procedures Act, which provides that:“Subject to this section, the Commissioner 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 Commissioner's judgement, to the original assessment of a taxpayer for a reporting period…”

36. That the Respondent did not apply itself to all the available information provided by the Appellant. That the Appellant provided extensive information and repeated its explanations on the production process multiple times during the audit period. That the Respondent blatantly ignored the Appellant’s explanations and went on a tangent of its own, leading to an assessment that is unreasonable and unjustified.

37. That further, the Respondent has indicated severally that the input-output methodology is a viable test for measuring the accuracy of a taxpayer’s records. That what the Respondent failed to do is to point to any enabling law or at the very least, any internationally acceptable guidelines that provide for the use of this methodology, the circumstances under which it may be used and any parameters to measure the reliability of the test.

38. That the Respondent’s witness further noted that there were no discrepancies whatsoever in the Appellant’s systems and records that pointed to an under-declaration of sales, save for the results of the input-output methodology applied by the Respondent. That indeed, there was no concrete evidence to support the Respondent’s assessment. That the Respondent applied all credibility checks to the Appellant’s records and did not find any fault whatsoever that would have supported its position that the Appellant failed to declare some of its sales.

39. The Appellant submitted that if indeed there were sales that were not declared, the same would have been manifestly clear from its audited systems and records. That nothing would have been easier than for the Respondent to point out evidence that there were some sales that the Appellant had failed to declare.

40. That the Appellant’s witness was questioned on whether management reports and laboratory reports addressing the process losses were provided. That in response, she indicated that these reports were at all times available for the Respondent’s review. That the non-conformance reports (NCRs) were in fact provided during the audit, as well as all computations relating to its production process.

41. That further, the Respondent’s witness confirmed, as indicated in the objection decision, that all the documents that the Respondent’s team requested for in the course of the audit were provided and reviewed.

42. That the Appellant fully co-operated with the Respondent’s team at all times during and after the audit, and there is no indication by the Respondent whatsoever, either in its findings or the objection decision, that there were any documents that it intended to review that were not provided.

43. That Section 59(1)(a) of the Tax Procedures Act clearly delineates the procedure to be followed in requesting for documentation from taxpayers as follows:“For the purposes of obtaining full information in respect of the tax liability of any person or class of persons, or for any other purposes relating to a tax law, the Commissioner or an authorised officer may require any person, by notice in writing, to—(a)produce for examination, at such time and place as may be specified in the notice, an documents (including in electronic format) that are in the person's custody or under the person's control relating to the tax liability of any person;”

44. That to the extent that the Respondent did not request for any further documents in the course of the audit, it cannot now cast aspersions on the Appellant, who co-operated fully with the Respondent’s team. That the Respondent’s questioning during the hearing was therefore an afterthought as all the documents requested for were provided at both the audit and objection review stage.

45. The Appellant submitted, that in any event, all the relevant documents that support its position were duly provided and are also before this Tribunal. That it is the Respondent that failed to consider them in a rational manner leading to an unfair inference.

46. That once the Appellant provided all the relevant documentation and explanations to the Respondent, it was for the Respondent to rebut the Appellant’s position, with sufficient reasons for departing from what the documents demonstrated.

47. The Appellant relied on the case of Kenya Revenue Authority v Man Diesel & Turbo Se, Kenya [2021] eKLR, where the High Court, in finding that the taxpayer had discharged its burden of proof and stated the following:“38. As I observed in ITA No 078 of 2020, “Burden of Proof” is a legal term used to assign evidentiary responsibilities to parties in litigation. 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 their burden 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. However, there are some situations where this responsibility or “onus” is reversed. The onus may also shift based on the stage of the proceedings and the actions taken by the parties.39. The Supreme Court of Canada in Johnston v Minister of National Revenue[18] decided that the onus is on the taxpayer to “demolish the basic fact on which the taxation rested.” Also, the Supreme Court of Canada provided guidance on this issue in Hickman Motors Ltd. v Canada[19] that the onus is met when a Taxpayer makes out at least a prima facie case. Prima facie is another legal term that literally means “on its face.” To prove a case “on its face” you must provide evidence that, unless rebutted, would prove your position. According to the said decision, a prima facie case is made when the taxpayer can produce unchallenged and uncontradicted evidence. Once the taxpayer has made out a prima facie case to prove the facts, the onus then shifts to the Revenue Authority to rebut the prima facie case. If the Revenue Authority cannot provide any evidence to prove their position, the taxpayer will succeed.”

48. That the Appellant, therefore, at that point, had discharged its burden of proof on a prima facie basis. That it was then imperative on the Respondent to prove that its allegations had a legal and factual basis and to support its position. That the Respondent has not done that. That it instead has insisted on the input-output methodology, which does not have any legal backing.

49. That the case of Cussens v Revenue Authority [2019] TC 07337, is instructive on the exercise of best judgment by a revenue authority. That the Court cited with approval the case of Johnson v Scott [1978] STC 48 as follows:“…But what the Crown has to do in such a situation is, on the known facts, to make reasonable inferences … the Inspector’s figures … ought to be - fair. The fact that the onus is on the taxpayer to displace the assessment is not intended to give the Crown carte blanche to make wild or extravagant claims. Where an inference, of whatever nature, falls to be made, one invariably speaks of a `fair’ inference. Where, as is the case in this matter, figures have to be inferred, what has to be made is a `fair’ inference as to what such figures may have been. The figures themselves must be fair”.

50. That the Court went further to state that when considering whether assessments have been made based on fair inferences drawn from established facts or to the best judgment, it considers, inter alia, whether the Respondent made a value judgment based on the material available and whether the assessment is wholly unreasonable.

51. The Appellant also relied on the following cases to buttress its arguments:a.Republic v Kenya Revenue Authority Ex parte Jaffer Mujtab Mohamed [2015] eKLR on the finding that the authority must exercise its powers fairly and there ought to be a basis for the exercise of such powersb.M-Kopa LLC (C/O M-Kopa Kenya Limited v Commissioner of Domestic Taxes (Tax Appeal No. 65 of 2023) to support the listing under Section 3(2) of the ITA on income chargeable to tax.c.Republic v Kenya Revenue Authority ex-parte Bata Shoe Company (Kenya) Limited (2014) eKLR, where the Court emphasized that “...a taxpayer is notobliged to pay a single coin more than is due to the taxman.”d.Insolvency Cause No. 10 of 2017 where the High Court pronounced itself on insolvent companies and the issue of bad debts.

Appellant’s Prayers 52. The Appellant prayed that:a.The Appeal herein be allowed and the Respondent's audit findings dated 27th September, 2022, the Respondent's assessments issued on 19th January, 2023 and 25th January, 2023 and the Respondent's objection decision dated 31st March, 2023 be set aside in their entirety.b.The Respondent, its employees, agents or other persons purporting to act on its behalf be barred and/or estopped from demanding or taking any further steps towards enforcement or recovery of principal tax, penalties and interest on the assessments issued.c.The costs of this Appeal be borne by the Respondent.

Respondent’s Case 53. The Respondent’s case is premised on:a.Its Statement of Facts dated 15th August, 2023 and filed on 22nd August, 2023 together with the documents attached thereto.b.The Witness statement of Madeleine Irungu dated 27th February, 2-24 and filed on 3rd March, 2024 that was admitted in evidence under oath on the 26th March, 2024c.The Respondent’s written submissions dated 10th April. 2024 together with the authorities attached thereto.

54. That the Respondent is allowed by Section 24(2) of the Tax Procedures Act to assess a taxpayer's liability using any information available to it. That to this extent, the Respondent confirms to have operated within the confines of the law by using the data available following a return review for the period of 2017 for VAT declarations and 2018-2019 period for Income Tax.

55. The Respondent averred that it is allowed to make additional assessments based on the available information to the best of its judgment pursuant to Section 31 of the Tax Procedures Act.

56. That the Respondent conducted an analysis which involved the establishment of the quantity of crude palm oil subjected to the refinery and fractionation to produce oil, fats, and soap as a by-product.

57. The Respondent stated that the total production in weight was obtained and the acceptable yield rates were used to determine the possibilities of under-declared sales.

58. The Respondent noted that an allowable loss of between 5. 82% and 6. 34% was applied on the CPO available for production thereby arriving at a reduced RBD yield that accounted for the various elements that would affect the production yield.

59. That from the foregoing, it was evident that the Respondent accounted for the various factors alluded to in the Appellant’s objection application and thereby this objection ground did not succeed.

60. That in addition, the input-output methodology of determining expected sales is a viable test of the accuracy of the Appellant's records. That the Respondent, by applying the same and allowing some margin for waste and loss would expect to arrive at a relatively close number to the declared sales but instead established a variance.

61. That the variance observed is therefore, not a means by the Respondent to forego tax norms and rules but rather simply a means to test the accuracy of the Appellant's declarations, which in this case were found to have some variances which were subsequently brought to charge.

62. That in this respect too, the Appellant's objection grounds did not succeed. That it is based on the above observations that the Respondent rejected the Appellant's ground of objection to this particular item.

63. That on the Appellant's ground of objection that bad debts in respect of supplies made to Nakumatt Holdings had met the requirements of LN 37 of 2011, the Respondent examined and the debt was found to not have met the threshold set out therein (LN 37 of 2011), in addition to not being fully supported in the absence of the Court order or judgement clearly setting out the status of the debtor amongst other conditions.

64. That the Appellant's evidence to support its position was not sufficient to vary the Respondent's assessment. It was the Respondent's further averment that it did nor err in law or fact in confirming the VAT and Income Tax due.

65. That the Respondent is guided by Section 56(1) of the Tax Procedures Act which provides that:“in any proceedings under this Part, the burden shall be on the taxpayer to prove that a tax decision is incorrect.”

Issues For Determination 66. The Tribunal has considered the pleadings, submissions and the evidence adduced by both parties and is of the view that the issue falling for its determination is:-

Whether the Respondent’s assessment was justified Analysis And Findings 67. The Tribunal having established the issue falling for its determination, proceeds to analyse the same as hereunder.

68. The Appellant argued that the Respondent disregarded its explanations and the documents it submitted which led to an erroneous decision.

69. The Respondent on its part averred that it made its decision based on the available information to the best of its judgement pursuant to Section 31 of the Tax Procedures Act.

70. The Tribunal having reviewed the parties pleadings, submissions and testimony of the witnesses proceeds to analyse the matters in contention as follows:Corporation Taxa.Production Analysis1. The contention between the parties in relation to production analysis is whether the Commissioner’s use of input-output analysis is a valid basis for determining sales chargeable to tax.2. From the pleadings, the Tribunal observes that the Appellant provided its production processes both in its pleadings as well as through the testimony of its witness. The Tribunal notes that owing to the continuous nature of the production process, the Appellant typically estimates the refined, bleached and deodorized oil (RBD) that would be produced from the refining of crude palm oil (CPO) and the expected finished products from a specific quantity of RBD.3. The Tribunal further notes that the above estimates are necessitated by various factors including the fluctuations in the quality of CPO used from season to season as a lower quality batch of CPO produces a lower amount of RBD. Further, the moisture level in the CPO, the quantity of free fatty acids in the CPO, tank temperatures in the CPO tanks, deodorizer temperatures, scrubbing temperatures, interruptions of runs and plant age and capacity utilization are all factors that affect the final RBD yield from batch to batch.4. The Tribunal further established that to get actual quantities after production and based on the above varying factors, the Appellant undertakes quarterly stock takes in which it establishes the actual amounts of finished goods produced, RBD and CPO and in this way accounts for any variances by making stock adjustments which then result in adjustments in its accounts.5. The Appellant, in its pleadings, provided the following documents:-i.An input-output reconciliation for the years 2017 to 2019 that depicted the following:a.Opening stocks, closing stocks, purchases, transfers to soap production, sale and stock adjustments of CPO.b.The available CPO for production.c.The RBD yield, opening stocks, closing stocks and stock adjustments of RBD.d.Transfers of RBD to Kikambala and RBD sold.e.Details of RBD fractionating into olein and stearin.f.Production for sale in kilograms.g.Expected sales vis a vis declared sales of finished products.h.Other yield/ production differences.i.Stock adjustments of CPO, RBD and olein.j.The production process loss adjustment that resulted in variances of 0. 32, 0. 49 and 0. 35 for 2017, 2018 and 2019 respectively.i.Sample journal entries showing the inventory adjustments for the three years in dispute.ii.The company financial statements for the years under dispute.1. The Tribunal notes from the pleadings that while the Appellant worked with initial estimates of expected production based on pre-determined standard production yields, the Appellant undertook stock adjustments and computation of actual input and output to establish the actual production and sales which it used in its declarations in its financial statements.2. The Tribunal has further established that the assessed taxes by the Respondent were based on an input-output analysis that was based on acceptable yield rates and allowable losses which the Respondent drew from the Appellant’s projected yield rates that were part of the Appellant’s input-output analysis. This was confirmed by the Respondent’s witness who testified and confirmed that the Respondent was “taxing expected sales”.3. Having reviewed the parties’ positions holistically, the Tribunal affirms that the Appellant provided detailed information supporting its position as well as the sales it declared for tax. The Tribunal has in this regard noted that the Respondent, while confirming its assessment, did not dispel the accuracy of the Appellant’s input-output analysis with its own computation on input-output to support the expected sales that it seeks to tax.4. Further, the Respondent, in its objection decision, simply stated that input-output methodology of determining expected sales is a viable test of accuracy of the Appellant’s records and that it applied the same and allowed for some margin of waste and loss and arrived at a relatively close number to the declared sales.5. In the instant case, the Tribunal has established that the Appellant provided the information required of it by the Respondent to support its actual production quantities as well as actual sales it made in support of its financial records and its tax declarations. Notably, while the Respondent stated that it applied an input-output methodology to ascertain the correctness of sales declared and applied the acceptable yield to determine under-declared sales, it did not address the input-output analysis provided by the Appellant nor specifically rebut the actual numbers provided in the said input-output analysis.6. Further, while the Appellant provided detailed journal entries of its stock adjustments, the Respondent did not address the same or rebut the position that these stock adjustments presented in relation to the final declarations.7. The Tribunal posits that it is now settled that the burden of proof in tax cases lies with the Appellant as is encapsulated in Section 30 of the TAT Act which 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.”

83. 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.

84. This position was explained in the case of Kenya Revenue Authority v Maluki Kitili Mwendwa [2021] eKLR, where Mativo J ( as he then was) adopted the doctrine in the Canadian Supreme Court case of Johnston v Minister of National Revenue {1948} S.C.R. 486 where the court stated that:“… the onus is on the taxpayer to “demolish the basic fact on which the taxation rested.” Again, the Supreme Court of Canada provided guidance on this issue in Hickman Motors Ltd. v Canada which held that the onus is met when a Taxpayer makes out at least a prima facie case. Prima facie is another legal term that literally means “on its face.” To prove a case “on its face” you must provide evidence that, unless rebutted, would prove your position. According to the said decision, a prima facie case is made when the taxpayer can produce unchallenged and uncontradicted evidence. Once the taxpayer has made out a prima facie case to prove the facts, the onus then shifts to the Revenue Authority to rebut the prima facie case. If the Revenue Authority cannot provide any evidence to prove their position, the taxpayer will succeed.”

85. From the above decision of the superior court, it is apparent that the Appellant was required to present a minimum amount of information and documents necessary to support its position. This safety valve seems to place the burden of proof on the Appellant without completely relieving the Respondent of its fair share of the burden of proof.

86. The bottom line is that once the Appellant has provided evidence that the Respondent’s assessment was wrong, then the Respondent must push back and show that its assessment was not arbitrary, capricious or imagined. The pendulum (onus of proof) would swing back to the Appellant once the Respondent has discharged its burden on a balance of convenience.

87. By tabling the documents that the Appellant did, the Appellant succeeded in making a prima facie case that its sales declarations are supported by its production processes and the related actual losses as demonstrated in its input-output analysis and the documents it supplied.

88. The onus, therefore, shifted to the Respondent to disprove these documents by making a prima facie case that its tax assessments based on expected sales as opposed to actual sales was justified.

89. The taxation of expected sales by the Respondent as confirmed by its witness is a contradiction to the well settled principle in taxation that a taxpayer should never be subjected to pay tax that is not due. This was discussed in Waweru & 3 others (suing as officials of Kitengela Bar Owners Association) & another v National Assembly & 2 others; Institute of Certified Public Accountants of Kenya (ICPAK) & 2 others (Interested Parties) (Constitutional Petition E005 & E001 (Consolidated) of 2021) [2021] KEHC 9748 (KLR) (20 September 2021) (Judgment) where Odunga J (as he then was) stated as follows:-“A taxpayer was not obliged to pay a single coin more than was due to the taxman. The taxman on the other hand was entitled to collect up to the last coin that was due from a taxpayer.”

90. Based on the above and the Respondent’s witness’ confirmation that the Respondent was taxing expected sales and not actual sales, the Tribunal finds and holds that the Respondent did not discharge its onus of rebutting the prima facie case that had been made out by the Appellant. It merely relied on acceptable yield rates and allowable losses to compute expected sales that it based its tax assessments on.

91. The Tribunal relies on the High Court decision regarding the swinging nature of the burden of proof in Kenya Revenue Authority v Man Diesel & Turbo Se, Kenya [2021] eKLR, where it was stated that:“Once the taxpayer has made out a prima facie case to prove the facts, the onus then shifts to the Revenue Authority to rebut the prima facie case. If the Revenue Authority cannot provide any evidence to prove their position, the taxpayer will succeed.”

92. Flowing from the above analysis, the Tribunal finds and holds that the Appellant produced competent and relevant evidence to support its position. On the other hand, the Respondent failed to provide evidence to cast doubts on the Appellant’s evidence and to accordingly justify its decision.

b. Whether the Respondent was justified in disallowing the Appellant’s impaired receivables (bad debt) 93. The Respondent stated that it examined a debt owed by Nakumatt Holdings Limited and it did not meet the threshold set out in Legal Notice Number 37 of 2011.

94. It was the Appellant’s submission that it supplied its products to Nakumatt Holdings Limited (NHL) in the ordinary course of its business. That however, due to the fact that Nakumatt Holdings Limited was unable to meet its financial obligations and NHL was placed under administration the Appellant was unable to collect its debt after the pursuit of the same over the years.

95. That further, the Appellant duly lodged its claim with Nakumatt’s administrator on 2nd February, 2018 following the issuance of a ruling but was unable to recover the debt.

96. Legal Notice No. 37 of 2011 states as follows regarding provision for bad debt;“1. A debt shall be considered to have become bad if it is proved to the satisfaction of the Commissioner to have become uncollectable after all reasonable steps have been taken to collect it.2. A debt shall be deemed to have become uncollectable under paragraph (1) where(a)the creditor loses the contractual right that comprises the debt through a court order;(b)no form of security or collateral is realisable 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; or (1) efforts to collect the debt are abandoned for another reasonable cause.3. A bad debt shall be a deductible expense only if it is wholly and exclusively incurred in the normal course of business.”

97. In addition, Section 15(2)(a) of the ITA provides as follows regarding deduction of bad debt in the process of ascertainment of the total income of a person.“(2)Without prejudice to sub-section (1) of this section, in computing for a year of income the gains or profits chargeable to tax under section 3(2)(a) of this Act, the following amounts shall be deducted:(a)bad debts incurred in the production of such 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 such year of income and the Commissioner may prescribe such guidelines as may be appropriate for the purposes of determining bad debts under this subparagraph;”

98. It was not in dispute that Nakumatt Holdings Limited had been placed under an administrator by the High Court. The Respondent’s argument was that the Appellant’s debt did not meet the threshold of Legal Notice 37 of 2011.

99. The Tribunal notes that in support of its arguments to the effect that the debts owed to it by NHL were bad or doubtful, the Appellant attached a claim it lodged with the administrator demanding for payment of the outstanding amounts and the Court ruling based on which NHL was adjudged insolvent. The Appellant provided an explanation to confirm that it was an unsecured creditor.

100. Further the Tribunal takes note of the High Court Ruling in Insolvency Cause No. 10 of 2017 dated 11th March, 2021 where the Court while adopting the administrator’s report ruled as follows;“In this regard, I am satisfied that this is a fit case to disapply sub-section 1 of section 600 of the Act. Further, I disapply section 600(6) of the Act. The Administration Order is hereby extended to enable the Administrator to carry out the matters set out in his Report. The Court therefore adopts the Report of the Administrator.”

101. Section 600 of the Insolvency Act states as follows as regards cases where a company under a Court Administrator has no property to meet its obligation to creditors;“(1)On forming the belief that a company that is under administration has no property that might allow a distribution to its creditors, the administrator shall lodge with the Registrar a notice to that effect.(2)On the application of the administrator of a company, the Court may disapply subsection (1) in respect of the company.”

102. It was not in dispute that the Appellant was an unsecured creditor to Nakumatt Holdings Limited. In consideration of the above Ruling of the Court, the Tribunal was persuaded that the Appellant’s situation as a Nakumatt creditor had satisfied the condition as set out under Clause 2(b) of the Legal Notice No. 37 of 2011 namely; No form of security or collateral is realisable whether partially or in full.

103. The Tribunal further reiterates the holding in the case of Equity Bank Limited vs. Commissioner of Domestic Taxes Tax Appeal No. 161 of 2017 where the learned judge stated that;“Having considered the facts, I have outlined, the arguments by the parties and the reasons proffered by the Tribunal, I cannot say that the conclusions reached by the Tribunal are unreasonable. As I stated earlier, the Guidelines do not require that Equity exhaust all the avenues for collecting the debt. It only needs to satisfy one or more of the Guidelines in order to satisfy the Commissioner. In the circumstances, I do not find any reason to interfere with the Tribunal’s decision in each instance as the conclusions reached were within the law.” (emphasis added)

104. Going by the foregoing analysis and the position as held by the court in the case of Equity Bank Limited vs. Commissioner of Domestic Taxes [2021] eKLR, it follows that the Appellant only needed to satisfy one or more of the conditions set out in Clause 2 of the Legal Notice No. 37 of 2011.

105. Consequently, the Tribunal finds that the Respondent was not justified in its decision to disallow the Appellant’s claim for bad debts against its supplies to Nakumatt Holdings Limited and in the subsequent tax assessment.

VAT - Production analysis 106. In its earlier review, in the foregoing paragraphs, on production analysis resulting in a Corporate tax assessment, the Tribunal found that the Respondent did not dispel the Appellant’s prima facie case that its production process, stock adjustments and subsequent losses were supported.

107. The Tribunal notes that the same argument was used by the Respondent to raise VAT on expected sales as opposed to actual sales.

108. As a result of the finding that the Respondent did not rebut the Appellant’s case, neither did it provide evidence to prove and justify its decision, the Tribunal similarly holds that the VAT assessment, based on the same arguments, similarly fails as it was not justified.

Final Decision 109. The upshot of the foregoing analysis is that the Appeal is merited and consequently the Tribunal proceeds to make the following Orders: -a.The Appeal be and is hereby allowed.b.The Respondent’s Objection decision dated 31st March, 2023 be and is hereby set aside.c.Each Party to bear its own costs.

110. It is so ordered.

DATED AND DELIVERED AT NAIROBI THIS 9TH DAY OF AUGUST, 2024ERIC NYONGESA WAFULACHAIRMANCYNTHIA B. MAYAKA DR. RODNEY O. OLUOCHMEMBER MEMBERABRAHAM K. KIPROTICH DR. TIMOTHY B. VIKIRU MEMBER MEMBER