Transfleet Epz Limited v Commissioner of Domestic Taxes

Brief facts The appellant, a developer operating within the Export Processing Zone (EPZ), was subjected to a desk compliance check by the respondent which resulted in a tax assessment dated 30 January 2019 and a further assessment dated 2 May 2019. The assessments disallowed certain expenses and estimated the appellant’s income for the years 2015 to 2018, resulting in a tax demand of Kes 206,973,046 inclusive of penalties and interest. Aggrieved, the appellant lodged an objection challenging the assessment and contending that the respondent had failed to consider legitimate business expenses, including interest on credit facilities, and had improperly assessed rental income. The respondent rejected the objection on the ground that it did not comply with the statutory requirements under section 51 of the Tax Procedures Act. The appellant appealed to the Tax Appeals Tribunal (TAT), but the Tribunal dismissed the appeal on 18 June 2021, holding that the notice of objection did not meet the requirements of section 51(3)(c) and that the appellant had failed to discharge the burden of proof under section 56(1) of the Act. Dissatisfied with that decision, the appellant filed the present appeal before the High Court challenging the Tribunal’s findings on the validity of the notice of objection, the treatment of interest expenses, and the assessment of tax on rental income. Issues i. Whether a notice of objection under section 51 of the Tax Procedures Act challenging the Commissioner’s tax decision could be deemed to be valid if it did not have supporting evidence. ii. Whether the lack of an explicit provision in the Income Tax Act regarding the finality of withholding tax on rental income suggested no intention to treat it as a final tax. iii. Whether the Commissioner was justified in assessing additional tax on the appellant’s rental income, including income received from other tenants that had not been declared for tax purposes. Held 1. Section 51 of the Tax Procedures Act (TPA) set out the procedure for disputing a tax decision made by the Commissioner. It required a taxpayer, as a mandatory first step, to lodge a notice of objection before pursuing any other legal remedy. Under section 51(3), a valid notice of objection had to state precise grounds, indicate the amendments sought, confirm payment of undisputed tax or request an extension, and be supported by relevant documentation. The requirements were intended to prevent abuse of the objection process as a means of delaying payment of due taxes. 2. The appellant had failed to comply with the statutory requirements. The Tax Appeals Tribunal (TAT) had correctly observed that none of the appellant’s correspondence contained supporting evidence and that the respondent had been overly indulgent during the audit process despite the appellant’s continued failure to provide the requested documents. 3. The appellant’s failure to meet the statutory threshold rendered the notice of objection invalid. Consequently, the tax assessment by the respondent had crystallised and became payable. Nonetheless, since the TAT had addressed the appellant’s remaining grounds of appeal, the Court also proceeded to determine them for completeness. 4. Under section 56(1) of the TPA, the burden rested on the taxpayer to prove that the Commissioner’s tax decision was incorrect, consistent with the self-assessment tax regime. The appellant did not dispute that the documents were introduced late and offered no sufficient explanation. Since evidence could not be introduced through submissions and the High Court’s jurisdiction was limited to matters of law, the TAT correctly found that the appellant had not demonstrated that the assessment was incorrect. Consequently, the ground of appeal failed. 5. Under the Income Tax Act, rental income was explicitly taxable as per sections 3(2)(a)(iii) and 6A. The act of withholding tax from such income was prescribed by section 35(3)(j), but the section did not specify that the withheld amount constituted a final tax. Although paragraph 5 of the Third Schedule https://new.kenyalaw.org/akn/ke/judgment/kehc/2024/5471/eng@2024-05-13 2

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addressed final taxes for certain income types listed under items (a) to (d), it did not clarify the finality of withholding tax on rental income in paragraph 5(ja), which merely set the tax rate without indicating its finality. The lack of an explicit provision by Parliament regarding the finality of withholding tax on rental income suggests no intention to treat it as a final tax. 6. If Parliament had intended for such tax to be final, it would have clearly stated so, as it had in the preceding sections of the Act. The appellant's argument of a legitimate expectation that the withholding tax was a final tax obligation was unfounded, as such expectations must align with the clear stipulations of the law. Since the appellant's expectation contradicted statutory provisions, that ground of appeal also failed. 7. The appellant bore the burden of disproving the Commissioner’s additional assessment. The appellant failed in its duty of providing any evidence of tax paid on rental income received from its other tenants and the assessment by the respondent therefore stood. Appeal dismissed. Citations Cases Kenya 1. Commissioner of Domestic Services v Galaxy Tools Ltd Income Tax Appeal E088 of 2020; [2021] KEHC 5530 (KLR) - (Mentioned) 2. Republic v Kenya Revenue Authority; Proto Energy Limited (Exparte) Judicial Review Application E023 of 2021; [2022] KEHC 5 (KLR) - (Followed) Statutes Kenya 1. Income Tax Act (Cap 470) sections 3(2)(a)(iii); 6A; 15; 76A - (Interpreted) 2. Tax Procedures Act (Cap 469B) sections 51(3)(c); 56(1)(2) - (Interpreted) Advocates None mentioned JUDGMENT 1. The appellant, a developer in the Export Processing Zone (EPZ), challenges a tax assessment issued by the respondent following a desk compliance check. The assessment, dated January 30, 2019 and supplemented by a further assessment dated May 2, 2019, disallowed certain expenses and estimated income for 2015 to 2018, totaling Kshs. 206,973,046, including penalties and interest. 2. Aggrieved by the decision of the respondent which confirmed the tax assessment, the appellant appealed to the Tax Appeals Tribunal (the Tribunal).The Tribunal dismissed the appellant’s appeal on June 18, 2021, citing non-compliance of the appellant’s objection notices with section 51(3)(c) and section 56(1) of the Tax Procedures Act (TPA), leading to the current appeal filed on July 14, 2021. 3. The appellant contests the estimated assessment, arguing that it overlooked legitimate business expenses and deductions. The issues for determination arising from the memorandum of appeal as filed by the appellant are the validity of the notice of objection, the treatment of interest expenses on credit facilities and the assessment based on rental income. 4. The appeal is opposed by the respondent who filed a statement of facts dated January 31, 2022. The appeal was canvassed by way of oral and written submissions. https://new.kenyalaw.org/akn/ke/judgment/kehc/2024/5471/eng@2024-05-13 3

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5. Having carefully considered the pleadings, evidence, submissions and authorities cited by the parties, it is important to point out that by dint of section 56(2) of the TPA, appeals from the tribunal to this court are only on matters of law. this means that this court will not re-assess the evidence or re-evaluate factual determinations made by the Tribunal unless to the extent that they amount to a flawed interpretation or application of the law. That said, I now turn to analyze the issues raised by the appellant. Analysis and Determination The Notice of Objection 6. The respondent contends that it was justified in rejecting the notice of objection raised by the appellant for being filed beyond the statutory timelines. Additionally, the appellant failed to submit any supporting documentation despite multiple reminders. Consequently, the tax assessment was confirmed, and the assessed taxes crystalized. The respondent argues that the appeal is therefore invalid as it stems from an invalid objection. 7. The appellant challenges the respondent’s submission asserting that the rejection of its notice of objection was improper. The appellant contends that the Tribunal should have evaluated the objection's substantive merits instead of focusing solely on procedural compliance.Top of Form 8. Section 51 of the TPA outlines the process for taxpayers to dispute tax decisions made by the Commissioner. Before any legal recourse under different laws can be sought, a taxpayer must first lodge an objection (by way of a notice of objection) to the tax decision under this section. The provision is worded in mandatory terms. 9. As to what constitutes a valid notice of objection, section 51(3) provides that the objection must be made on precise grounds and should state the required amendments. It also requires that taxpayers must have paid all the tax amounts not under dispute or must have formally requested an extension for such payment. Finally, all necessary documentation related to the objection must be submitted. This mandatory threshold is meant to prevent the objection process from being used as a delay tactic against paying due taxes. 10. After perusing the record and in particular correspondence between the parties dated May 29, 2019, August 6, 2019, September 30, 2019, October 25, 2019, February 14, 2020, May 21, 2020, May 29, 2020, it is clear that the appellant did not comply with any of these requirements. I therefore align myself with the finding by the Tribunal’s finding expressed as follows: “ From the totality of evidence before us, the appellant’s objection notices have not qualified for the threshold established in section 51 (3) (c) of the TPA as none of the correspondences with the respondent during the audit process carry any evidence. On the contrary the record before us supports a case of the respondent being overly indulgent and lenient with the appellant in so far as the provisions of its documents is considered. From the inception of the audit, the appellant has demonstrated indifference in complying with the respondent’s requests in providing documents. it is in light of this that we find the appellant is being utterly dishonesty in its submissions in averring that it submitted documents to the respondent in support of the objection notices.” 11. For the appellant to have demonstrated such indolence and then expected the Tribunal to aid the same by ignoring the form of the objection purportedly so as to do justice reflects a disregard for both the established process and the law on the part of the appellant. A valid notice of objection is https://new.kenyalaw.org/akn/ke/judgment/kehc/2024/5471/eng@2024-05-13 4

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essential to initiate the appellate process and legitimize any subsequent appeal to the Tribunal against the Commissioner. 12. I concur with the Tribunal that the notice of objection filed by the appellant was invalid and as such, the taxes as assessed by the respondent had crystalized and were due. Be that as it may, I note that the Tribunal dealt with the other two grounds raised by the appellant and I too will nonetheless determine them for finality’s sake. Interest expenses on the credit facilities 13. The appellant takes issue with the respondent for failing to consider the interest accrued on credit facilities obtained by the appellant. These facilities, according to the appellant, were secured for the express purposes of acquiring two prime movers, augmenting the appellant's working capital, refurbishing its manufacturing plant, and procuring manufacturing equipment. 14. Consequently, it is asserted that these facilities were instrumental in generating the appellant's revenue during the tax periods in question. On this basis, the appellant argues that the interest expense incurred in the generation of this income should have been considered by the respondent as a legitimate business expense and, therefore, an allowable deduction under section 15 of the Income Tax Act. 15. The respondent vehemently opposes this claim by the appellant due to a lack of supporting evidence. It is noted by the respondent that documents provided by the appellant, appearing on pages 66 to 93 of the record of appeal to support this assertion were not submitted during the initial objection phase or the Tribunal hearing. These documents were only introduced as supplementary submissions to the Tribunal on May 24, 2021. 16. Section 56(1) of the TPA is clear that in any proceedings under this part, the burden shall be on the taxpayer to prove that a tax decision is incorrect. This principle has been consistently upheld as evidenced in the case of Commissioner of Domestic Services V Galaxy Tools Limited, [2021] eKLR. The court observed that Kenya operates under a self-assessment tax regime, which mandates taxpayers to calculate and remit taxes based on their own declarations and assessments of what they owe. Within this framework, tax laws empower the Commissioner to retrospectively review and determine the accuracy of the taxes remitted by the taxpayer. 17. Against this background the court acknowledges that the appellant does not dispute the respondent's claim that the documents intended to support the interest expense claims were not provided at the initial stages but only presented during the Tribunal submissions. The appellant has not offered any compelling reasons for this. I concur with the respondent that evidence cannot be presented by way of submissions. Reflecting on the Tribunal’s observations, it is evident that the appellant's approach did not meet the required procedural standards. 18. At paragraph 25 of the Judgment the Tribunal notes that: “ The appellant herein has not produced a shred of evidence in this appeal to demonstrate, reasonably, to the Tribunal that the respondent’s assessment was incorrect and the extent of its incorrectness….” 19. Having already stated that the jurisdiction of this court is limited to matters of law only, it follows that an appeal before the High Court cannot review new factual evidence. This ground of appeal therefore fails on that account. https://new.kenyalaw.org/akn/ke/judgment/kehc/2024/5471/eng@2024-05-13 5

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Rental income 20. The final issue that forms the basis of this appeal is premised on the submission by the appellant that the respondent had appointed the appellant’s tenant (New Wide Garments (K) EPZ Limited) as withholding tax agents in respect of rental income. The said tenantwithheld and remitted to the respondent the sum of Kshs. 5,387,707/=as amount withheld. It is the appellant’s case that the tax withheld on the rent was the final tax and more tax was not payable, contrary to section 76A of the Income Tax Act. 21. While the respondent acknowledges that it had appointed the appellant’s tenant as a withholding tax agent, but disputes the appellant's interpretation that the tax withheld is a final tax. According to the respondent, withholding tax on rental income should be considered a credit against the taxpayer’s annual returns, not a final tax. Consequently, due to the appellant's failure to file annual returns, the respondent assessed additional rental income taxes totaling Kshs 6,978,718 for the year 2018. 22. In fact, the respondent notes that this was not the only case where the appellant failed to declare rental income. Records indicate that the appellant had other tenants from whom rental income was received but not declared for tax purposes. 23. In dealing with this issue it is important to note that under the Income Tax Act, rental income is explicitly taxable as per sections 3(2)(a)(iii) and 6A. The act of withholding tax from such income is prescribed by section 35(3)(j), but this section does not specify that the withheld amount constitutes a final tax. 24. Although paragraph 5 of the Third Schedule addresses final taxes for certain income types listed under items (a) to (d), it does not clarify the finality of withholding tax on rental income in paragraph 5(ja), which merely sets the tax rate without indicating its finality. In the court’s opinion, the lack of an explicit provision by Parliament regarding the finality of withholding tax on rental income suggests no intention to treat it as a final tax. 25. If Parliament had intended for such tax to be final, it would have clearly stated so, as it has in the preceding sections of the Act. For these reasons the appellant's argument of a legitimate expectation that the withholding tax was a final tax obligation is unfounded, as such expectations must align with the clear stipulations of the law as affirmed in the case of Republic V Kenya Revenue Authority; Proto Energy Limited (Exparte) (Judicial Review Application E023 of 2021), [2022] KEHC 5 (KLR) (24 January 2022) (Judgment). Since the appellant's expectation contradicts statutory provisions, this ground of appeal also fails. 26. Regarding the undeclared rental income from additional tenants, as earlier stated, the appellant bears the burden of disproving the Commissioner’s additional assessment. Without belaboring the point, it is clear that the appellant failed in its duty of providing any evidence of tax paid on rental income received from its other tenants and the assessment by the respondent therefore stands. Disposition 27. For the reasons that I have stated, this court upholds the decision of the Tribunal dated June 18, 2021. Consequently, the appeal is found to be devoid of merit and is dismissed with no orders to costs. DATED, SIGNED AND DELIVERED IN NAIROBI THIS 13 TH DAY OF MAY 2024. F. MUGAMBI JUDGE https://new.kenyalaw.org/akn/ke/judgment/kehc/2024/5471/eng@2024-05-13 6

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