Commercial & Tax Division v Dac Aviation (ea) Limited

(2)The Tribunal erred in law and fact by finding that the unsupported journal entries were balance sheet transactions which were not subject to Income Tax. (3)The Tribunal erred in both law and fact when it failed to consider relevant material evidence placed before it by the Appellant in arriving at its determination. ITA E036 of 2023 5. The appeal is based on the following grounds: (1)The Tribunal erred in law by failing to comply with the statutory timelines set out for the delivery of a judgement in any matter before it. (2)That the Respondent erred in law and in fact by concluding that DAC International created a Permanent Establishment (PE) in Kenya. (3)That the Respondent erred in law and in fact by presuming two journal vouchers (inter-company promissory note and related party payables to equity) for the year 2015 to be income to the Appellant from DAC International. (4)That the Respondent erred in law and in fact by disallowing a deduction of bad debts written off on the basis that the Appellant had not provided sufficient evidence of efforts for debt recovery. (5)That the Respondent erred in law and in fact in assessing tax on reserves for maintenance of aircrafts including the repair and overhaul of engines on basis that there was no evidence that the expenses incurred by the Appellant relating to maintenance and repair of aircrafts leased by the Appellant were paid out of those reserves. (6)That the Respondent erred in law and in fact by disallowing input incurred in making exported services that are zero rated. 2

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(7)The Tribunal erred in law and fact in not examining all the material and evidence presented before it. Response 6. In opposition to the appeal, the appellant filed its statement of facts dated 12.3.2024. It urged the court to uphold the assessments for Kshs. 16,097,298, Kshs. 26,811,429 and Kshs. 375,724,800 in respect of VAT, bad debts, expenses of maintenance of aircraft. 7. The appellant also urged the court to allow the assessments of Kshs. 160,594,866 on unsupported journal vouchers contrary to the Tribunal’s judgment. It further urged the court to find that the appellant’s appeal failed to conform to the requirements of section 52(2) of the Tax Procedures Act. Background 8. The respondent is a private limited liability company incorporated in Kenya. It provides contract air services, including aircraft maintenance, sale of aircraft parts, flight personnel and related aviation support systems and is located at Wilson Airport along Langata road. 9. The appellant audited the respondent’s tax affairs for 2013 to 2015. 10. The appellant raised an assessment on 25.6.2020 demanding the taxes (income tax and value added tax (VAT) of Kshs. 2,923,461,962.00. The respondent objected to the whole assessment on 30.7.2020. The appellant issued an objection decision on 28.6.2021 confirming part of the tax assessment of Kshs.2,584,047,080.00 3

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11. Aggrieved, the respondent appealed to the Tribunal. The Tribunal delivered the judgment of 17.3.2023, precipitating the two appeals herein. Directions of the court 12. The appeal was canvassed through written submissions. The appellant filed written submissions dated 9.6.2025 and 10.2025. 13. The official receiver did not file any written submissions on behalf of the respondent despite being given the opportunity. Appellant’s submissions 14. The appellant submitted that its assessments on the two journal entries for inter-company promissory notes and related party payables to equity were lawful since the respondent failed to provide transactional documents to demonstrate that the transactions occurred. That the board resolution dated 30.12.2015 was not conclusive proof to demonstrate that the transaction occurred. 15. The appellant submitted that vide its objection letter, the respondent stated that in 2014 it owed Trident Holdings Kshs.548,973,000. That in 2015, the respondent forfeited its dues from DAC International in the form of USD 2.3 million promissory note and Kshs. 300 million worth of shares to Trident Holdings to settle the debt. According to the respondent, the amount does not relate to income due hence not taxable. 16. However, the appellant asserted that the entries relate to payments due from DAC International; that the journals were done for 2015 and that there is no evidence that the income had been reported by the 4

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respondent in the year earned as the ledger for 2014 was not provided for review. 17. The appellant submitted that the respondent failed to explain the movement of funds to Trident Holdings Limited in 2014. That the omissions led to the conclusion that for 2015 the respondent’s income was understated. That it therefore relied on its best judgment to raise the additional assessments for Kshs.160, 594,866 as per section 31 of the Tax Procedures Act (TPA). 18. The appellant argued that income is reported on accrual basis not on a cash basis. It contended that the respondent failed to demonstrate how the receivable had been included in the revenue account and fully taxed. 19. The appellant also submitted that the respondent did not discharge its burden of proof under section 56(1) of the TPA and Section 30 of the Tax Appeals Tribunal Act. That it was well within its mandate under Section 59 of the TPA and Section 43 of the VAT Act to ask for additional information. 20. With respect to ITA EO36 of 2023, the appellant asserted that the respondent created a permanent establishment in Kenya as per section 2 of the Income Tax Act and article V of the Kenya – Canada Double Taxation agreement. It also asserted that through the core activities performed by DAC EA on behalf of DAC International, a permanent establishment status has been created. That therefore, DAC International through DAC EA income earned through a permanent establishment in 5

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Kenya is subject to non-resident tax rate in line with sections 3 (1) and 18(3) of the Income Tax Act. 21. In this regard, the appellant highlighted that: (1) in 2013, the European Union awarded DAC International a contract known as the European Community Humanitarian Office (ECHO). (2)DAC International was to provide charter flights to the European Union. (3) it was a compulsory requirement that all bids be from (or include) an air charter operator with Kenyan Air Operating Certificate (AOC). (4) the European Commission on Humanitarian Logistics within EU Civil Protection and Humanitarian Action (2013-2017) required that all carriers must possess a valid AOC. (5) In the transfer policy, DAC Internation enters all contracts but all contracts are performed by DAC EA including ECHO. (6)DAC EA is in charge of all other operational bases in Goma, Bunia and Kinsasha in Democratic Republic of Congo (DRC). 22. The appellant further submitted that the respondent did not dispute that DAC International created a permanent establishment in Kenya in its pleadings and submissions before the Tribunal. It therefore asserted that the Tribunal’s finding in this regard was in order. 23. As regards the additional assessments for Kshs. 26,811,429.03/-, the appellant argued that the respondent did not provide sufficient evidence to demonstrate debt recovery from its debtors. That while the respondent claimed that it wrote of the bad debts merely on the basis that its demand 6

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letters were not responded to, it did not attach demands sent to debtors to demonstrate its efforts. The appellant relied on section 15 (2) (a) of the Income Tax Act and Legal Notice No. 37 of 2011. 24. The appellant argued that the respondent failed to prove that the Kshs. 375,742,800 claimed as aircraft maintenance reserve costs were incurred and allowable. That under the lease agreements, the lessee not the lessor was responsible for the maintenance costs. That there was no evidence that the maintenance costs were paid out of the reserves. It also contended the costs are general provisions which are not wholly and exclusively incurred for business and not allowable per section 16 of the ITA. 25. Regarding the claims for input VAT, the appellant submitted that the respondent misclassified VAT sales leading to a higher claim. It established that chartering of aircrafts to foreign aid agencies like UN and WFP were classified as zero-rated instead of exempt while chartering and hiring of flights to locals was classified as exempt. 26. According to the respondent, chartering of aircrafts is exempt under First Schedule, Part 2, Paragraph 18 of the VAT Act. It added that exempt services upon exportation do not become zero-rated but rather remain exempt. 27. Therefore, the appellant asserted that the Tribunal did not err in finding that the appellant cannot claim a credit for the VAT inputs in cases of exempt supplies. 28. The appellant relied on: 7

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(1)Osho Drapers Limited v Commissioner of Domestic Taxes [2022] eKLR (2)Commissioner of Domestic Taxes v Altech Stream (EA) Limited [2021] eKLR (3)Tumaini Distributors Company (K) Limited and Commissioner of Domestic Taxes [2020] eKLR (4)GTZ International Services v the Commissioner of Domestic Taxes [2020] eKLR (5)Kenya Revenue Authority v Man Diesel & Turbo Se, Kenya [2021] eKLR (6)Commissioner of Domestic Taxes v Structural International Kenya Limited [2021] eKLR Analysis and Determination Duty of court 29. Section 56 of the Tax Procedures Act sets out that: “56. (2) An appeal to the High Court or to the Court of Appeal shall be on a question of law only. (3) In an appeal by a taxpayer to the Tribunal, High Court or Court of Appeal in relation to an appealable decision, the taxpayer shall rely on the grounds stated in the objection to which the decision relates unless the Tribunal or Court allows the person to add new grounds.” 8

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30. Although the court’s interaction with factual issues is limited, it may examine the issues of fact to ascertain that the findings by the court were based on the evidence and the law. Oceanfreight (E.A) Limited v Commissioner of Domestic Taxes [2018] eKLR Statutory timelines for judgment delivery 31. The respondent contended that the Tribunal erred by failing to comply with statutory timelines for judgment delivery. 32. Section 13 (7) of the Tax Appeals Tribunal Act provides that; the Tribunal shall hear and determine an appeal within ninety days from the date the appeal is filed with the Tribunal. Provided that in case the panel is not able to conclude hearing an appeal within ninety days, the panel may through a resolution made by not less than half of its Members, extend the time for hearing and determination of the appeal by not more than thirty days. 33. The appeal before the Tribunal was initiated through a notice of appeal dated 28.7.2021 and a memorandum of appeal dated 10.8.2021. 34. The impugned judgment is dated 17.3.2023. It was delivered beyond the 90-day statutory timeline. 35. In my considered view, the provision is meant to encourage timely delivery of judgments not to invalidate them for being outside the statutory timeline. Hence, the proviso on extended period. Statutory provisions should be interpreted in a manner that promotes justice rather than causing an injustice. Crown Beverages Limited v MFI Document 9

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Solutions Limited (Civil Appeal No.E0833 of 2021) [2023] LEHC 58 (KLR) (Civ)(17 January 2023) (Judgment) Section 52 (2) of the TPA 36. The appellant urged the court to find that the appellant’s appeal failed to conform to the requirements of section 52(2) of the TPA. 37. Section 52 (2) of the TPA states that: “A notice of appeal to the Tribunal relating to an assessment shall be valid if the taxpayer has paid the tax not in dispute or entered into an arrangement with the Commissioner to pay the tax not in dispute under the assessment at the time of lodging the notice.” 38. The Tribunal found that the respondent had appealed against the entire assessment and that the appellant’s claim that the respondent had not appealed the entire assessment was unfounded. 39. From the record, there is no document by the respondent that shows that it conceded any part of the appellant’s assessment. 40. Therefore, I concur with the Tribunal’s finding in this regard. The appellant’s assertion therefore fails. Permanent establishment 41. The Tribunal found that the respondent did not dispute that it was a permanent establishment of DAC International. 42. Yet, the respondent’s appeal is premised on the ground that the appellant respondent erred in law and in fact by concluding that DAC International created a Permanent Establishment (PE) in Kenya. 10

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43. Upon counterchecking the respondent’s memorandum of appeal dated 10.8.2021 filed before the Tribunal, I note that the question of permanent establishment had been raised in ground 1. 44. Therefore, I find that the Tribunal erred by finding that there was no dispute by the respondent that it was a permanent establishment of DAC International. 45. Given that the issue was not substantively considered in the first appeal, the appropriate remedy is to set aside that part of the decision and remit the permanent establishment issue to the Tribunal for determination. Two journal vouchers; Kshs. 160,594,866 46. The appellant asserted that the Tribunal erred by invalidating its assessment for Kshs. 160,594,866 for the two journal entries. 47. The appellant contended that the Tribunal erred by finding that the unsupported journal entries were balance sheet transactions which were not subject to Income Tax. 48. The Tribunal found that: “46. The Appellant’s action of forfeiting its dues and assigning them to Trident Holdings is a balance sheet transaction that does not attract tax liability unless it can be confirmed that the relationship of the parties was intended to be used in a tax evasion exercise. This is not the case here and the Respondent has not averred and or raised the issue that the relationship of the parties could have imputed a tax evasion endeavor in this Appeal. The same cannot therefore be inferred. 47. Having held that the deed of transfer dated the 30 th of December, 2015 is uncontested and valid, and that subject of 11

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that deed is a balance sheet transaction that is not taxable, it thus follows that the Respondent’s tax assessment of Kshs. 160,594,866.00 in regard to unsupported journals is hereby set aside for invalidity.” 49. Through its objection, the respondent stated that in 2014 it owed Trident Holdings Kshs. 548,973,000. That in 2015, the respondent forfeited its dues from DAC International in the form of USD 2.3 million promissory note and Kshs. 300 million worth of shares to Trident Holdings to settle the debt. According to the respondent, the amount does not relate to income due hence not taxable. 50. The appellant submitted that its assessments on the two journal entries for inter-company promissory notes and related party payables to equity were lawful since the respondent failed to provide transactional documents to demonstrate that the transactions occurred. 51. The Tribunal’s failure to consider the issue of permanent establishment means that the findings on the journal entries were not properly founded. 52. Additionally, the appellant raised several contentions that the that the journals were passed in 2015 and were not supported by contemporaneous 2014 ledgers, which was relevant to the ascertainment of the year of accrual and taxability of the income. 53. Therefore, I find that the Tribunal erred in law by finding the impugned journal entries were balance sheet transactions not subject to income tax without considering the material evidence. 12

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54. In the circumstances, it is appropriate that this part of Tribunal’s findings are also set aside and remitted to the Tribunal for determination together with the issue of permanent establishment. Bad debts; Kshs. 26,811,429.03/- 55. The respondent asserted that the appellant erred in law and in fact by disallowing a deduction of bad debts written off on the basis that it had not provided sufficient evidence of efforts for debt recovery. 56. The appellant contended that the respondent did not provide sufficient evidence to demonstrate debt recovery from its debtors. That while the respondent claimed that it wrote of the bad debts merely on the basis that its demand letters were not respondent to, it did not attach demands sent to debtors to demonstrate its efforts. 57. The Tribunals findings were that the respondent did not provide any evidence that it made sufficient effort to recover the debts that it had declared as bad debts and that the allegations that a demand letters were sent was not proved by production of those demand letters. 58. I have gone through the record. It confirms that no demand letters were produced to support sufficient efforts for recovery of the bad debts. 59. Section 30 of the Tax Appeals Tribunal Act and section 56 of the Tax Procedure Act place the burden of proof on the taxpayer to prove that an assessment is excessive or a tax decision is incorrect. 60. Therefore, I find no fault in the Tribunal’s findings in this regard. Aircraft maintenance reserves; Kshs. 375,742,800 13

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61. The respondent claimed that the appellant erred in law and in fact in assessing tax on reserves for maintenance of aircrafts including the repair and overhaul of engines on basis that there was no evidence that the expenses incurred by it relating to maintenance and repair of aircrafts leased by it were paid out of those reserves. 62. The appellant argued that the respondent failed to prove that the Kshs. 375,742,800 claimed as aircraft maintenance reserve costs were incurred and allowable. That under the lease agreements, the lessee not the lessor was responsible for the maintenance costs. That there was no evidence that the maintenance costs were paid out of the reserves. It also contended that the costs are general provisions which are not wholly and exclusively incurred for business and not allowable per section 16 of the ITA. 63. The Tribunal found that the respondent did not provide any evidence to confirm that the aircraft maintenance reserve costs were incurred. It found that the assessments in this respect were justifiable. 64. There is no evidence on record that supports the payment of the aircraft maintenance costs from the reserves. 65. Hence, the Tribunal cannot be faulted here. VAT Inputs; Kshs. 16,097,298. 66. The respondent contended that the respondent erred in law and in fact by disallowing input incurred in making exported services that are zero rated. 14

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67. The appellant submitted that the respondent misclassified VAT sales leading to a higher claim. It established that chartering of aircrafts to foreign aid agencies like UN and WFP were classified as zero-rated instead of exempt while chartering and hiring of flights to locals was classified as exempt. 68. The Tribunal found that there was no provision in the VAT Act that allows for mutation of exempt to zero rated supplies. It further found that the respondent’s claim for input VAT for exempt supplies was unlawful. It therefore upheld the appellant’s assessment for Kshs. 16,097,298. 69. Hiring, leasing and chartering of aircrafts is exempt under First Schedule, Part 2, Paragraph 18 of the VAT Act. It is not zero-rated. 70. The respondent’s contention is not founded in law leading to the conclusion that the Tribunal’s findings in this respect were in order. Disposition 71. The upshot is that: (1)The appellant’s appeal, ITA E113 of 2023, is allowed except on the two issues remitted herein below for retrial. (2)The respondent’s appeal, ITA E036 of 2023, is allowed in part. (3)The issues of establishment whether the of International DAC respondent is and a permanent whether the assessments on the two journal entries for inter-company promissory notes and related party payables to equity were lawful are remitted back to the Tribunal for determination. (4)Each party to bear its costs. 15

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Dated, signed and delivered at Nairobi through Microsoft Teams online application this 30th day of April, 2026 ------------F. Gikonyo M Judge In the presence of: Osoro for Ms. Lilian for Appellant No appearance by Respondent CA - Ivan/Aggrey 16

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