- March 10, 2026
- Posted by: admin
- Category: Business
Case Study: Premier Credit Limited v Commissioner of Domestic Taxes (Tax Appeal E1149 of 2024) [2026] KETAT 23 (KLR) (23 February 2026) (Judgment)
Case Overview
In a judgment delivered on 23 February 2026, the Tax Appeal Tribunal delivered a significant ruling concerning the tax treatment of bad debts for financial institutions. The case pitted Premier Credit Limited, a credit-only microfinance company licensed by the Central Bank of Kenya, against the Commissioner of Domestic Taxes (KRA). At the heart of the dispute was whether the principal amount of loans that had gone bad could be claimed as a deductible expense for income tax purposes.
Background of the Dispute
The matter arose from an audit conducted by KRA on Premier Credit for the 2018 accounting period. Following the audit, KRA issued an assessment on 7th June 2024 demanding additional taxes totaling Kshs. 138,438,726.00. Premier Credit objected to this assessment, and the parties subsequently entered into the Alternative Dispute Resolution (ADR) mechanism.
The ADR process yielded a partial settlement dated 7th June 2025, with the parties agreeing that Kshs. 35,641,262.10 in principal taxes were undisputed. However, the remaining disputed principal taxes of Kshs. 30,132,515.10, which related specifically to the treatment of bad debts from Premier Loans and Premier Private Lending, were referred back to the Tribunal for determination.
The Core Legal Issues
The Tribunal identified three main issues for determination.
First, whether paragraph 4 of Legal Notice 37 of 2011 (the Guidelines on Allowability of Bad Debts) is ultra vires and contrary to Section 15(2)(a) of the Income Tax Act (ITA).
Second, whether KRA erred in finding that the principal loan amount of a bad debt is capital in nature.
Third, whether KRA erred in disallowing the bad debts claimed by Premier Credit.
The Arguments
Premier Credit advanced several arguments in support of its position. The company contended that the bad debts written off were incurred in the production of its income and should therefore be deductible under Section 15(2)(a) of the ITA. It maintained that its internal write-off process, which involved extensive efforts to recover the debts through various means including engagement with debt collectors and restructuring options, satisfied the conditions set out in Legal Notice 37 of 2011. Premier Credit also challenged the validity of paragraph 4 of the Legal Notice, arguing that it was ultra vires because it contradicts the primary legislation by disallowing bad debts of a capital nature. Furthermore, the company argued that for a microfinance institution like itself, the principal element of a loan does not constitute a bad debt of a capital nature.
KRA took a fundamentally different position. The tax authority argued that deductions under Section 15 must be read subject to Section 16 of the ITA, which explicitly disallows deductions for expenditure of a capital nature. According to KRA, for a financial institution, the principal amount advanced as a loan is a capital asset. It represents the “stock” used by the institution to generate income, namely interest. Consequently, when that principal becomes irrecoverable, the loss is a capital loss, not a revenue expense, and is therefore not deductible. KRA relied heavily on paragraph 4 of Legal Notice 37 of 2011, which provides that a bad debt of a capital nature shall not be an allowable expense. The tax authority also pointed out that Premier Credit had failed to differentiate between the irrecoverable principal (which is capital) and the irrecoverable interest (which is revenue) in its claim, lumping them together as a single bad debt expense.
The Tribunal’s Analysis and Findings
On the Validity of the Legal Notice
The Tribunal declined to rule on whether paragraph 4 of Legal Notice 37 of 2011 is ultra vires, finding that it lacked jurisdiction to determine such a question. Drawing from the Supreme Court case of Samwel Kamau & Another vs. Kenya Commercial Bank & Others, the Tribunal emphasized that its mandate under Section 3 of the Tax Appeals Tribunal Act is limited to hearing appeals against tax decisions made by the Commissioner. It is not empowered to rule on the validity of laws or regulations. Consequently, the Tribunal “downed its tools” on this issue.
On the Nature of Principal Loan Amounts
Turning to the substantive question of whether the principal element of loans constitutes capital, the Tribunal conducted a thorough analysis of Premier Credit’s business and financial statements. It observed that Premier Credit, like other financial institutions, complies with International Financial Reporting Standards (IFRS) 9 in its accounting treatment of loans. Under this standard, the principal amount of a loan is recorded as a Financial Asset on the balance sheet, while interest is recognized as revenue or income on the profit and loss statement.
The Tribunal drew upon established case law to distinguish between capital and revenue expenditure. It cited the High Court decision in Commissioner of Income Tax v Kencell Communications Limited, which approved various tests for determining the nature of expenditure, including whether the expenditure created a new asset or strengthened an existing one. The Tribunal also referred to its own decision in Grain Bulk Handlers Ltd v Commissioner of Investigations & Enforcement, which defined capital expenditure as that expended on acquisition or upgrade of fixed assets expected to be productive for a long period.
Applying these principles, the Tribunal reached a decisive conclusion: the principal element of a loan is capital in nature. It reasoned that in a lending transaction, cash is exchanged for a legal contract, and that legal contract—the loan—becomes an asset in the lending institution’s books. This asset is employed to generate interest, which is the return or revenue arising from the employment of the asset. When the loan becomes irrecoverable, the loss suffered is the loss of that capital asset itself, not a revenue expenditure incurred in the generation of income.
The Tribunal further noted that Premier Credit’s own financial statements for the 2018 year of income correctly reflected this treatment, with the principal amount recognized as a financial asset and interest recognized as revenue. The company had therefore, in its financial reporting, acknowledged the capital nature of the principal, yet sought to claim a deduction for its loss as if it were revenue expenditure.
On the Disallowance of Bad Debts
Having found that the principal element of loans is capital in nature, the Tribunal concluded that paragraph 4 of Legal Notice 37 of 2011 applies squarely to the situation. A bad debt arising from the principal portion of a loan is not an allowable deduction for tax purposes. The Tribunal noted that the guidelines under the Legal Notice envisage that only bad debts that are not capital in nature would be deductible, and that Premier Credit’s claim fell on the wrong side of this distinction.
The Tribunal also observed that Premier Credit had claimed the entire loan amount—both principal and interest—as a bad debt expense without distinguishing between the two components. While the interest element might potentially be allowable under paragraph 2 of the Legal Notice if the relevant conditions were met, the company’s failure to separate the principal from the interest rendered the entire claim problematic. KRA was therefore correct to disallow the claim relating to the principal portion, and the question of whether the interest portion met the conditions for deductibility was rendered moot by the manner in which the claim was presented.
Conclusion
The legal principle emerging from this judgment is clear and significant for the financial services sector. For a financial institution, the principal amount advanced as a loan constitutes a capital asset. A loss arising from the non-recovery of this principal is a loss of capital and does not constitute a revenue expenditure incurred in the production of income. Consequently, such a loss is not deductible for tax purposes under Section 16 of the Income Tax Act and paragraph 4 of Legal Notice 37 of 2011.