Bank Deposits Are Not A Taxable Income

Case Study : Ndiritu v Commissioner of Investigation and Enforcement (Tax Appeal E238 of 2023) [2024] KETAT 1859 (KLR) (17 December 2024) (Judgment)

Background

KRA conducted an audit on Ndiritu for the period 2016-2020. KRA used a “banking analysis” method, treating total bank deposits as gross turnover, and issued a massive additional assessment of Kshs 209,316,234. Ndiritu argued that his actual income was the commission earned from his brokerage and transport businesses, which is the difference between the money he received from clients and the payments he remitted to vendors, not the total bank deposits.

The matter ended up at the Tax Appeal tribunal

The Tribunal’s Analysis & Findings

a) The “Best Judgment” Principle and the Banking Method:

• The Tribunal confirmed that using a banking analysis is a valid method (Bachmann v. The Queen).
• However, it must be applied using “best judgment” as defined in the landmark case Van Boeckel v C&E

b) Failure to Allow for Proved Expenses:

• The Tribunal highlighted a critical admission by KRA: Ndiritu had provided some documents (broker agreements, lease agreements, fuel records).
• The law (Section 15(1) of the Income Tax Act) allows deductions for expenses “wholly and exclusively” incurred to generate income.
• KRA’s test of “inadequate support” was alien to the law. The correct approach was to allow deductions for the expenses that were proven. By disallowing them entirely, KRA unlawfully inflated Ndiritu’s taxable income.

c) Failure to Apply a Profit Margin:

• This was a fatal flaw. The Tribunal cited its own precedent in Afya X-Ray Center Limited, stating that “every deposit in an account is not necessarily income.”
• A proper “best judgment” assessment would have involved applying an industry-standard profit margin to the estimated turnover to determine a realistic taxable profit.
• By taxing the full deposit value, KRA’s assessment was inherently excessive and punitive, seeking to collect more tax than was legally due.

d) Consequences for the VAT Assessment:

• Since the VAT assessment was directly derived from the flawed income figure (the total bank deposits), it was also invalidated. If Ndiritu’s true income was commission, it was likely below the VAT threshold, making the registration and assessment incorrect.

You Can Book Consultation with me through

https://cal.com/hisibati/consulting-session