[2023] KETAT 955 (KLR)

Torrent East Africa Limited v Commissioner of Domestic Taxes (Tax Appeal 501 of 2022) [2023] KETAT 955 (KLR) (10 November 2023) (Judgment)

Neutral citation: [2023] KETAT 955 (KLR)

Republic of Kenya

In the Tax Appeal Tribunal

Tax Appeal 501 of 2022

E.N Wafula, Chair, Cynthia B. Mayaka, RO Oluoch, E Ng'ang'a, AK Kiprotich & B Gitari, Members

November 10, 2023

Between

Torrent East Africa Limited

Appellant

and

Commissioner of Domestic Taxes

Respondent

Judgment

Background 1. The Appellant is a wholly owned subsidiary of Torrent Closures SL and is in the business of manufacturing and sale of plastic closures of alcoholic beverages.

2. The Respondent is a principal officer appointed under Section 13 of the Kenya Revenue Authority Act, Cap 469 of the laws of Kenya. The Authority is an agency established for the purposes of assessing, collecting and accounting for tax revenues.

3. The Respondent carried out compliance check on the Appellant for the period 2017 to 2019 and issued its investigations findings vide a letter dated 27th August, 2020.

4. The Respondent issued a notice of assessment vide a letter dated 6th December, 2021 requiring the Appellant to pay VAT principal tax of Kshs 47,096,054. 00, Withholding tax principal of Kshs 20,233,092. 00 and total interest for both of Kshs 20,988,580. 00.

5. The Appellant lodged a notice of objection to the assessment on 11th January, 2022 and further vide an email dated 31st January, 2022 provided to the Respondent supporting documents.

6. The Respondent issued its Objection decision vide a letter dated 31st March, 2022 confirming the assessment of total tax of Kshs. 88,317,727. 00

7. Being aggrieved by the Respondent’s objection decision, the Appellant filed this Appeal on 16th May, 2022.

The Appeal 8. The Appellant in its Memorandum of Appeal cited the following grounds of Appeal;i.The Respondent erred in fact by incorrectly computing the Appellant's expected sales by failing to include reconciling items not relating to the Appellant's sales.ii.The Respondent erred in law and in fact by wrongly interpreting Section 2 of the Income Tax Act by charging deemed interest on loans advanced to the Appellant that were not interest free loans and in fact the Appellant dutifully ensured it remitted withholding tax on the interest amounts.iii.The Respondent erred in law and fact by failing to correctly compute the restricted interest amount thereby inflating the tax assessment by disallowing interest based on incorrect computations.iv.The Respondent erred in law and in fact by averring that the Appellant has overstated its input VAT despite being presented with supporting documentation that illustrates that Appellant has correctly claimed its input VAT.

Appellant’s Case 9. The Appellant’s case is premised on the hereunder filed documents;i.The Appellant’s Statement of Facts dated 13th May, 2022 and filed on 16th May, 2022 together with the documents attached thereto.ii.The Appellant’s written submissions dated 23rd January 2023 and filed on 24th January, 202.

10. It was the Appellant’s submission that to facilitate its operations, it received loans from Torrent Closures and Compania de Tapones Irrellenables SA ("CTISA"). That the funds received were used as working capital to construct the Appellant's factory, ensure financing of the Appellant's operating costs for running the office are met and facilitating the importation of raw materials for manufacturing.

11. That the Respondent when conducting its audit disregarded all the supporting documentation provided that illustrates that the Appellant was compliant in how it claimed input VAT on importation of goods and furthermore, the Respondent failed to compute its assessment correctly by relying on wrong calculations when computing expected sales, restricted interest and further unfairly interpreted the law thereby inflating the said assessment.

12. The Appellant stated that the Respondent sought to verify and confirm the turn-over declared by the Appellant in the financial years 2017, 2018 and 2019. However, in doing so, the Respondent failed to include reconciling items not relating to sales such as loans, all inter-account transfers and reversals.

13. That the Respondent for the year 2017 provided the following banking analysis;Expected sales through bank deposits 2017

Barclays KES 290,792,745. 0

Barclays USD 100,749,191. 0

Barclays EURO 695,927,564. 0

Gross Banking 1,087,469,500. 0

Inter bank transfers- Euro to Kshs (264,488,489. 0)

Inter bank transfers- Kshs to Euro

Inter bank transfers- Euro to USD (38,875,258. 0)

Loan-Torrent Closures S.L (Euro) (321,711,904. 0)

Loan- CIA De Tapones (284,327,400. 0)

Reversals (5,355,430. 0)

Net Bankings 172,711,019. 0

Add closing debtors 80,453,840. 0

Less opening debtors -

Less Output tax (149,995,793. 0)

Expected sales 103,169,066. 0

P&L Sales 40,624,763. 0

Variance 62,544,303. 0

14. The Appellant averred that the above reconciliation did not consider that there were various entries in the bank statements that do not relate to the Appellant’s sales. That the table below illustrates the correct banking reconciliation for the financial year 2017;Expected sales through bank deposits 2017 Appellant’s Comments

Barclays KES 290,792,745

Barclays USD 100,652,201

Barclays EURO 695,179,661

Gross Banking Add closing debtors 1,086,624,606 33,100,461

Less opening debtors -

Less Output tax (6,428,418)

Expected sales 1,113,296,649

P&L Sales 40,624,763

Variance 1,072,671,886

Reconciling items not considered by KRA

Less: Inter bank transfers-Forex (374,204,131)

less: Reversals (5,388,214)

Less:Loan received (692,862,096)

Total (1,072,454,441)

Variance 217,445 Variance is due to exchange rate differences

15. That as illustrated in the above table, the loans received from CIA de Tapones Irrellenables S.A and Torent Closures SL, the inter-account transfers and reversals ought to have been factored in by the Respondent in arriving at the net banking figures. The Appellant further provided its version of 2017 VAT return which it averred reflected the correct output VAT amount and the 2017 financial statement that indicates the closing debtor figure.

16. The Appellant further contended that the Respondent failed to review the underlying documentation and unfairly rushed in providing its findings. That it should be noted that the Respondent in its banking reconciliation, stated that the Appellant's output VAT amounted to Kshs. 149 million. A figure it averred was way above the Appellant’s sales even as per its own reconciliation. That the Respondent's mandate to ensure impartiality when conducting its audit should also include ensuring that there is no overzealous rush to put a taxpayer in a payable tax position for the sake of collection of higher taxes.

17. Regarding the financial year 2018, the Appellant contended that the Respondent once again failed to correctly analyze the 2018 bank statements. The Appellant contended that the correct 2018 banking analysis was as per the table below:Expected sales through bank deposits 2018 Appellant’s Comments

Barclays KES 370,697,624 Variance explained as exchange rate difference

Barclays USD 159,331,554

Barclays EURO 145,577,753

Gross Banking 675,606,932

Add closing debtors 93,933,737

Less opening debtors (33,100,461)

Less Output tax (51,024,612)

Expected sales 685,415,596

P&L Sales 333,398,868

Variance 352,016,728

Reconciling items not considered by KRA

Less: Inter bank transfers-Forex (205,775,626)

less: Reversals (2,553,335)

Less :Loan received (143,585,271)

Total (351,914,232)

Variance 102,496

18. The Appellant averred that the Respondent failed to pick the correct figures due to the fact that there was no proper review of the underlying documentation. That furthermore, from the 2018 VAT return it should be noted that there was no variance between the VAT return filed and the sales declared as per the company return as erroneously asserted by the Respondent.

19. That for the financial year 2019 the Respondent did not correctly compute the information within the 2019 banking statements.

20. The Appellant stated that the Respondent’s reconciliation was flawed and provided its own banking analysis for 2019 as summarized in the table below:Expected sales through bank deposits 2019 Appellant’s Comments

Barclays KES 413,701,395

Barclays USD 106,530,487

Barclays EURO 138,241,044

Gross Banking 658,472,926

Add closing debtors 124,991,268

Less opening debtors (93,933,737)

Less Output tax (60,890,449)

Expected sales 628,640,008

P&L Sales 434,574,173

Variance 194,065,835

Reconciling items not considered by KRA

Less: Inter bank transfers-Forex (170,829,187)

Less: Loan received (22,837,919)

Total (193,667,107)

Variance 398,729 Variance explained as exchange rate difference

21. That to support the adjusting items as demonstrated in the above table, the Appellant averred that the 2019 financial statements and the VAT return it provided had no variance between the VAT return filed and the sales declared as per the company return as erroneously asserted by the Respondent.

22. The Appellant averred that for the years 2017 to 2019, it adequately clarified and adequately illustrated to the Respondent that the only variances arising were negligible and mainly relate to exchange rate differences. It therefore contended that the banking assessment was done in bad faith and pleaded that the Tribunal quashes the matter.

23. Regarding deeming interest on interest free loan, the Appellant stated that Torrent Closures made available a loan to the Appellant of 3 million Euros to facilitate factory construction and working capital to finance its operations.

24. That the interest was to be paid at 3% for a loan period of 72 months as per the loan agreement. It averred that due to financial constraints faced by the Appellant in the year 2019, there was an addendum to the loan agreement reducing the interest to be paid to 1. 3% effective 1st January, 2019.

25. That on the 14th July 2017 it entered into another agreement with CTISA for the amount of 2. 5 Million Euros at an interest rate of 1. 3%. as per the loan agreement.

26. The Appellant submitted that it accrued the interest payments quarterly and remitted withholding tax amounting to Kshs 7,583,086. 84

27. That the Respondent failed to take note that in 2018 the amounts accrued were paid in 2019 and the withholding tax certificates provided to support the remittances. The Appellant further contended that the interest general ledger it presented demonstrate when each accrual was made and that the WHT was correctly remitted.

28. It was the Appellant's belief that the Respondent in its assessment incorrectly stated that deemed interest applies at 8% and 6% to the loans which was not as per the definition under Section 2 of the ITA.

29. That the provisions of the law surrounding deemed interest are clear and bearing loans cannot be subject to deemed interest. It was the Appellant’s contention that where tax laws are clear they should be interpreted with certainty.

30. That this was affirmed in the case of Cape Brandy Syndicate vs. Inland Revenue Commissioner [1921]1 KB 64. That Justice GV Odunga further affirmed the position above in Republic vs. Kenya Revenue Authority & another Ex-parte Fontana Limited [2014].

31. The Appellant further contended that the fact that the interest rate charged on the loans was below the quarterly Treasury bill rate is immaterial. That the interest charged by the Appellant had been benchmarked and supported by its transfer pricing policy.

32. The Appellant submitted that it was on this basis that deemed interest does not apply to interest bearing loans. That the Respondent cannot pick and choose how to interpret the law based on what will generate higher tax collection.

33. That furthermore, the Respondent failed to note that there was no WHT due and that in actuality there was a slight overpayment of WHT due to exchange timing differences when remitting payments.

34. Regarding the computation of the interest restricted amounts and disallowed interest, the Appellant stated that in its audit, the Respondent failed to correctly analyze.

35. The Appellant contended that interest in all the years had been correctly restricted and added back in the income tax computations. That the Respondent hence erred in its computation of thin capitalization. The Appellant illustrated with a table and recomputed what it averred was the correct amount for restricted interest in all the years and to demonstrate that this was correctly added back in the tax computations 2017-2019.

36. That the immaterial variance in the financial year 2019 was due to the fact that the Appellant's auditors did not include overdraft interest in its workings for interest restriction.

37. The Appellant therefore contended that with the above and the tax computations provided as support, the restricted interest was added back without errors and that it stands by the correctness of its computation.

38. Regarding the Respondent’s averment that it overstated its input VAT, the Appellant averred that the Respondent in its assessment incorrectly stated that the Appellant had overstated its input VAT using fictitious import entries.

39. The Appellant asserted that all import VAT were correctly claimed under correct import entries and that it further provided the filed VAT returns to illustrate that the input VAT was claimed within 6 months of importation and provide the corresponding C17s with the proof of payment of taxes.

40. It was the Appellant’s contention that the Respondent failed in its mandate by not meticulously reviewing all information provided to support the claims made by the Appellant in its objection.

Appellant’s Prayers 41. The Appellant prayed that the Tribunal;a.Allows this Appeal.b.Annuls the Respondent's confirmed assessment based on the grounds above as well as the information contained in the Statement of Facts.c.Awards costs of this Appeal to the Appellant.

Respondent’s Case 42. The Respondent’s case is premised on its Statement of Facts dated 5th September, 2022 and filed on the same date.

43. The Respondent stated that it received an intelligence report concerning the Appellant and consequently carried out a detailed investigation for the period January 2017 to May 2019 on the following identified tax evasion schemes;i.Under declaration of VAT Sales resulting from the differences in self-assessment turnovers.ii.Claim of input VAT using fictitious import entries.

44. That upon conclusion of the investigation, the Respondent issued the Appellant with investigation findings vide a letter dated 27th August, 2020. That the investigations noted the following issues;i.That the Appellant had one director of PIN No A008008419N, however, data at the Registrar of Companies indicated that the Appellant had three directors.ii.That the Appellant had been reporting losses for the period under review despite having an average gross profit of 35%.iii.That there were significant variances between the turnovers in IT2C and VAT for the period under review which indicated under declaration of turnovers for tax purposes.iv.That the Appellant operated three bank accounts at Barclays Bank of which it had received Kshs. 2,449,379,248. 00.

45. The Respondent submitted the following regarding the Appellant’s averments in the Memorandum of Appeal and Statement of Facts:-i.The Notice of Appeal and subsequent Appeal herein were defective.ii.The assessment was done according to the law.iii.On the issue of Respondent’s failure to include reconciling items not related to the company's sales, an analysis of the Appellants bank statement revealed that the Appellant had received Kshs. 772,000,000. 00 from CIA De Tapones and Torrents Closures. The loans were adjusted from the gross banking but there was a charge for withholding tax on deemed interest.iv.On the issue of interpretation of the law by deeming interest on interest free loans, the Appellant charged arbitrary interest rates instead of applying the deemed interest rates of 8% and 6% for the years 2018 and 2019 as guided by the public notices dated 15th October, 2018 and 25th October, 2019. v.On the issue of Respondent failing to correctly compute the interest restricted amounts and disallowed interests based on wrong calculations, the Appellant is thinly capitalized and the interest expense should have been restricted in line with Section 16(2)(j) of the Income Tax Act.vi.On the issue that the Appellant had overstated its input VAT, the Appellant had overstated its input VAT using import entries that did not belong to it. Some of the entries claimed were overstated and the corresponding input VAT did not match the VAT paid at the point of importation.

46. The Respondent stated that it relies on Section 17, VAT Act 2013, Section 16(2) (j) of the Income Tax Act, Section 51 and Section 59 of the Tax Procedures Act among other enabling provisions of the law.

Respondent’s Prayers 47. The Respondent prayed that;a.The Appeal be dismissed with costs.b.The Objection decision dated 31st March 2022 be upheld.

Issues For Determination 48. Having carefully reviewed the parties’ pleadings, submissions and all documentation provided, the Tribunal is of the respectful view that the issues for determination are as follows:i.Whether the Respondent erred its assessment of VAT.ii.Whether the Respondent erred in its assessment of WHT.

Analysis And Findings 49. Having identified the issues falling for its determination, the Tribunal wishes to analyze them as hereunder.

Whether the Respondent erred its assessment of VAT. 50. The genesis of this dispute is the Respondent’s assessment and subsequent objection decision dated 31st March, 2022 which confirmed taxes amounting to Kshs 88,317,727. 00 being VAT and Withholding taxes inclusive of interest.

51. It was the Respondent’s submission that the Appellant had overstated its input VAT using import entries that did not belong to it. That some of the entries claimed were overstated and the corresponding input VAT did not match the VAT paid at the point of importation.

52. The Appellant on its part stated that Respondent erred in fact by incorrectly computing the Appellant's expected sales by failing to include reconciling items not relating to the Appellant’s sales.

53. That the Respondent when conducting its audit disregarded all the supporting documentation provided that illustrates that the Appellant was compliant in how it claimed input VAT on importation of goods and furthermore, the Respondent failed to compute its assessment correctly by relying on wrong calculations when computing expected sales, restricted interest and further unfairly interpreted the law thereby inflating the said assessment.

54. The Appellant stated that the Respondent sought to verify and confirm the turn-over declared by the Appellant in the financial years 2017, 2018 and 2019. That however, in doing so, the Respondent failed to include reconciling items not relating to sales such as loans, all inter-account transfers and reversals.

55. The Tribunal perused through the pleadings of both parties and documents attached by the Appellant and noted that the Appellant had provided a detailed analysis of its expected sales through bank deposits as compared to the Respondent’s analysis indicating a variance of Kshs 217,445. 00 as opposed to the Respondent’s variance of Kshs 62,544,303. 00. The Appellant further explained that the variance was due to exchange rate differences. The Appellant attached details of its VAT returns and its financial statements for the period in question.

56. The Tribunal noted from the Respondent’s pleadings that the Respondent did not address itself to this information provided by the Appellant. Further, the Tribunal noted that although the Respondent stated that the Appellant had overstated its input VAT using import entries that did not belong to it, it did not specify the specific entries or provide anything in support. This averment was also not mentioned in the objection decision.

57. It is the Tribunal’s view that although the tax laws provide that the burden of proof lies with the Appellant to prove the Respondent’s assessment was wrong, once the taxpayer adduces evidence that discharges its burden, the burden shifts to the Commissioner who must demolish such evidence.

58. This fact that the burden of proof in tax cases is not stationary was explained in Commissioner of Domestic Taxes v Trical and Hard Limited (Tax Appeal E146 of 2020) [2022] KEHC 9927 (KLR) (Commercial and Tax) (8 July 2022) (Judgment) where Justice Majanja stated as thus:-“I agree with the Tribunal’s holding that the burden of proof in tax matters is not stationary but is like a pendulum swinging between the taxpayer and taxman at different points but more times than not swings towards the taxpayer.”

59. In the instant case, the Appellant having provided the detailed information and the accompanying documents, the Respondent ought to have addressed itself to the evidence which in this case it failed to do.

60. Additionally, while the Appellant provided a schedule of input VAT claimed and the corresponding customs entry documents in support of its import VAT claims, the Respondent was not specific on its averment that some entries did not belong to the Appellant. All that the Tribunal has is the Respondent’s assertions. The court in Janet Kaphiphe Ouma and another vs. Marie Stopes International (Kenya), HCC No. 68 of 2007 held that:“In this matter, apart from filing its statement of defence the defendant did not adduces any evidence in support of assertions made therein. The evidence of the 1st plaintiff and that of the witness remains uncontroverted and the statement in the defence therefore remains mere allegations… … Sections 107 and 108 of the Evidence Act are clear that he who asserts or pleads must support the same by way of evidence”

61. Given the foregoing case laws and the provisions of the law, the Tribunal finds that the Respondent erred in its assessment VAT on the Appellant.

Whether the Respondent erred in its assessment of WHT. 62. It was the Appellant’s contention that Torrent Closures made available a loan to the Appellant of 3 Million Euros to facilitate factory construction and working capital to finance its operations.

63. That the interest was to be paid at 3% for a loan period of 72 months as per the loan agreement. It averred that due to financial constraints faced by the Appellant in the year 2019, there was an addendum to the loan agreement reducing the interest to be paid at the interest rate of 1. 3% effective 1st January, 2019. That further, on the 14th July, 2017 the Appellant entered into another agreement with CTISA for the loan amount of 2. 5 Million Euros at an interest rate of 1. 3%.

64. The Appellant submitted that it accrued the interest payments quarterly and remitted withholding tax.

65. On the other hand, the Respondent stated that the Appellant charged arbitrary interest rates instead of applying the deemed interest rates of 8% and 6% for the years 2018 and 2019 as guided by the public notices dated 15th October, 2018 and 25th October, 2019.

66. On the issue of the interest restricted amounts and disallowed interests based on wrong calculations, the Respondent averred that the Appellant is thinly capitalized and the interest expense should have been restricted in line with Section 16(2)(j) of the Income Tax Act.

67. Section 2 of the Income Tax Act defines deemed interest as follows;““deemed interest” means an amount of interest equal to the average ninety-one day Treasury Bill rate, deemed to be payable by a resident person in respect of any outstanding loan provided or secured by the non-resident, where such loan is provided free of interest” (Emphasis added)

68. From the above definition of deemed interest under the ITA it is clear to the Tribunal that it is only applicable where the loan has been provided free of interest. In the instant case, the Tribunal noted that the Appellant had averred that it obtained the loans at an interest of 3% from Torrent Closures which was later reviewed to 1. 3%. That a similar loan was obtained by the Appellant via an agreement with CTISA at the rate of 1. 3%.

69. In support of its averments, the Appellant attached agreements, addendum to agreements and the Transfer Pricing Policy with its related companies as evidence that indeed the loans obtained were not interest free. The Appellant further attached an analysis to demonstrate the WHT accrued and remitted to the Respondent in relations to the same which the Respondent does not dispute.

70. Regarding the computation of the interest restricted amounts and disallowed interest, the Appellant stated that in its audit, the Respondent failed to correctly analyze.

71. The Appellant contended that that interest in all the years had been correctly restricted and added back in the income tax computations. That the Respondent hence erred in its computation of thin capitalization.

72. The Tribunal noted that the Appellant recomputed what it averred was the correct amount for restricted interest in all the years and to demonstrate that this was correctly added back in the tax computations 2017-2019. It was the Tribunal’s view that since the Appellant had provided the information to demonstrate what it restricted and added back in the income tax computations, the Respondent ought to have either specifically disputed the Appellant’s analysis or provided any basis of its averments on the same.

73. The Respondent’s averments that the Appellant was thinly capitalized and the interest expense should have been restricted in line with Section 16(2)(j) of the Income Tax Act were not enough to rebut the evidence adduced by the Appellant.

74. The Tribunal reiterates the finding in Trust Bank Limited V Paramount Universal Bank Limited & 2 others [2009] eKLR where the Court observed that:“It is trite that where a party fails to call evidence in support of its case, that party’s pleadings remain mere statements of fact since in so doing the party fails to substantiate its pleadings.”

75. The Tribunal has further aligned itself with the High Court regarding the swinging nature of the burden of proof in Kenya Revenue Authority v Man Diesel & Turbo Se, Kenya [2021] eKLR, where it 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

76. Accordingly, the Tribunal finds that the Respondent erred in its assessment of WHT on the Appellant.

Final Decision 77. The upshot of the foregoing is that the Appeal is merited and succeeds, and the Tribunal makes the following Orders:a.The Appeal be and is hereby allowed.b.That the Respondent’s objection decision dated 31st March, 2022 be and is hereby set aside.c.Each party to bear its own costs.

78. It is so Ordered

DATED AND DELIVERED AT NAIROBI THIS 10TH DAY OF NOVEMBER,2023ERIC NYONGESA WAFULA - CHAIRMANCYNTHIA B. MAYAKA - MEMBERDR. RODNEY OLUOCH - MEMBEREUNICE NG’ANG’A - MEMBERABRAHAM K. KIPROTICH - MEMBERBERNADETTE GITARI - MEMBER