- February 8, 2024
- Posted by: admin
- Category: Uncategorized
CASE STUDY: Commissioner of Investigations & Enforcement v Mohamed & another (Tax Appeal E029 of 2022) [2023] KEHC 21494 (KLR) (Commercial and Tax) (28 July 2023) (Judgment)
MOHs operate a business within Garissa County. It deals in wholesale and retail sale of food commodities.
On the basis of intelligence reports ,KRA found out that MOHs had deposited huge sums of money into their business bank account at Gulf African Bank on diverse dates, KRA commenced investigations against MOHs for the period 2014 to 2019 for Income Tax and Value Added Tax (VAT) obligations. KRA sought and obtained MOHs’ bank statements and also interrogated its i-tax system to ascertain MOHs’ tax compliance status.
Having concluded its preliminary investigations, KRA communicated its preliminary findings to MOHs by the letter dated 12th May 2020 which also served as a notice to them that they were under investigations for failure to declare income for tax purposes. From its analysis of the Bank account, KRA found that there was evidence of business activities as the statements showed several payments to suppliers for purchases of trading goods and ‘credits’ received indicating deposits on sales made. KRA therefore concluded that computation of taxes payable was to be based on the income received into the Bank account and that the deposits were to be taken as business income.
KRA also stated that it appeared that MOHs dealt in both vatable and non-vatable supplies since they bought supplies from some named Wholesalers and Maize Millers, among others who deal in both vatablenon-vatable supplies. In this regard, KRA stated that the total bank deposits were to be apportioned on a ratio of 60:40 for vatable to non-vatable supplies consistent with similar taxpayers in the retail/ wholesale sector. KRA further found that MOHs were filing nil-returns and also not filing their income tax and VAT obligations.
As a result, KRA stated that no input VAT had been allowed due to the six-month restriction, and given that they had never filed VAT returns, VAT was computed at Kshs. 316,962,718.00. On income tax, KRA held that since MOHs had not filed any returns and there were no financial statements available for comparison, the income tax payable was to be estimated based on their turnover. KRA, therefore, required MOHs to provide the audited accounts for the period under review for analysis before any taxes were computed. That failure to provide the same would lead to estimation of taxes payable based on industry averages.
KRA communicated its final findings by the letter dated 17th December 2020. It reiterated its earlier findings on the income analysis based on the banking deposits and MOHs’ filing of nil returns and non-filing altogether. On the analysis it had done on the financial statements provided by MOHs and the supporting records, KRA noted that not all the purchases claimed were supported from the records provided and in its summarized tabulation, KRA stated that from the purchases of the subject period amounting to Kshs. 2,454,268,170.00, MOHs was only able to support purchases worth Kshs. 614,943,399.00, leaving unsupported purchases amounting to Kshs. 1,839,324,771.00.
KRA further noted that from the Bank statement, MOHs made several cash withdrawals which they claimed were payments for the expenses incurred by the business, however on comparison to the drawings made and the business expense claimed, variances were noted amounting to Kshs. 121,424,405.00. On the vatable and non-vatable supplies, KRA stated that from the information availed, its analysis placed the average ratio at 52:48 and that VAT payable was to be computed apportioning the sales declared in the financial statements on this ratio but that no input tax would be allowed due to the time limitations on the claim of input tax. Based on the sales declared and the ratios identified, KRA computed and tabulated the VAT payable for the said period. On income tax, it stated that the tax payable was computer based on the variances identified on unsupported purchases being disallowed, and it similarly calculated and tabulated the income tax payable for the said period The drawings from the bank account identified above were also apportioned between MOHs and subjected to Pay As You Earn(PAYE) of Kshs. 8,816,880.00.
MOHs objected to the findings and assessments by the letter dated 31st December 2020. They stated that the profit margin of their business was very meagre, and hence, deposits were mainly goods offered on credit and that what KRA treated as purchases were payment to creditors (providing goods on credit). MOH did not deny that the partners were nil income tax returns filers
MOHs averred that they had never been inducted or trained by KRA’s staff on tax issues especially income tax and VAT and this had contributed to ignorance of the law and illiteracy which was their current status of schooling.
Further to this letter, MOHs, through their representative, objected to the assessments by an email dated 16th January 2021. On VAT, they stated that they were still looking for more information to establish the correct proportions as most of the products sold were exempt from VAT. On income tax, they faulted KRA’s basis for computing the income tax payable for the period arguing that it was practically not possible to buy goods at Kshs. 614,943,399.00 and sell the same at Kshs. 2,510,595,610.00 as this amounts to gross profit rates of 76% and a markup of 308%. Thus, MOHs stated that KRA’s computation was exaggerated and beyond any economies or accounting reasoning. On PAYE, they averred that it was not correct to charge tax on profits on a sole proprietor and then charge them PAYE on the drawings because the business and the owner are one and the same. MOHs stated that they did not get details of how KRA arrived at the drawings figures as the cash withdrawals as explained were used for the purpose of business expenses.
MOHs averred that the additional tax demand was estimated and excessive and could not be recovered as they did not have such cash or assets. They reiterated that they are old and illiterate and that most of the necessary business records were either not maintained or have been lost or destroyed and it was only reasonable to approach the matter on this understanding as not doing so will result to the business closure.
MOHs lodged an appeal against the Objection Decision with the Tax Appeals Tribunal on 5th May 2021. The Tribunal rendered a decision on 28th January 2022.
On income tax, the Tribunal stated that the shop was operated by MOHs as a “general partnership” as construed from their supplementary list of documents and that the income of a partnership is chargeable to tax under section 3 of the ITA and as expounded under section 4 but that from KRA’s computations, the same was not based on aforementioned provisions and the graduated tax rates specified in the Third Schedule of the ITA. Thus, the Tribunal found that KRA erred in its assessment of MOHs’ income tax.
On PAYE, the Tribunal considered two questions; whether MOHs were employees of Barwaqo Shop and whether the drawings were business emoluments, and to these, it answered in the negative. The Tribunal noted that drawings from a partnership were an appropriation, not a charge, in the financial statements of the partnership and in essence, the withdrawals by MOHs could not be assumed to constitute emoluments as defined under the ITA. The Tribunal took note of the fact that the partners were not employees of the partnership and that PAYE therefore does not apply under the circumstances and that in effect, KRA still had the opportunity to tax the partners at a personal income level. As such, the Tribunal held that KRA erred in issuing the additional PAYE assessment.
On the VAT assessment, the Tribunal noted that the shop dealt with vatable and non-vatable supplies but that the partnership was not registered for VAT either voluntarily or by KRA during the subject period The Tribunal relied on its decision in TAT No. 441 of 2019; Miao Yi v Commissioner of Investigations & Enforcement to hold that since there was no voluntary registration or registration by KRA, then Commissioner could not bring to charge MOHs’ supplies. Thus, the Tribunal held that KRA erred in raising an additional assessment on MOHs in respect of VAT.
KRA Appealed to the High Court
In its ruling on 28/07/2023, the High Court observed that:
- The taxpayer bears the burden of proving that a tax decision is incorrect or excessive. This position is in line with section 30 of the Tax Appeals Tribunal Act, 2013, and section 56(1) of the TPA, which provide as follows:
30. Burden of proof
In a proceeding before the Tribunal, Mohs has the burden of proving—
a. where an appeal relates to an assessment, that the assessment is excessive; or
b.in any other case, that the tax decision should not have been made or should have been made differently.
56. General provisions relating to objections and appeals
(1)In any proceedings under this Part, the burden shall be on the taxpayer to prove that a tax decision is incorrect.
- The law requires the taxpayer to maintain records that may be called upon by KRA to be produced
Section 43 of the VAT Act, 2013, provides as follows:
43. Keeping of records
(1)A person shall, for the purposes of this Act, keep in the course of his business, a full and true written record, whether in electronic form or otherwise, in English or Kiswahili of every transaction he makes and the record shall be kept in Kenya for a period of five years from the date of the last entry made therein
Section 59 (1) of the TPA also provides that a tax payer shall produce records when required to do so by KRA .
Section 54A of the ITA requires a person carrying on a business to keep records adequate for the purpose of computing tax.
- Partnership or not, every taxpayer has a duty and obligation to keep records.
- MOHs, having been requested for records and documents by KRA and having failed to produce the same meant that they did not discharge the burden of proof placed on them and thus they failed to prove that KRA was wrong in its decision or that its assessments were excessive. KRA could not thus be faulted for coming to the conclusion that the deposits in MOHs’ bank accounts were income and that, together with the unsupported expenses, the same was chargeable to tax
- Whereas MOHs found it impossible as per KRA’s computation that their business could have a gross profit rate of 76% and a mark-up of 308%, it was also equally baffling that they neither had supporting documents nor maintained records for a business that was having a turnover of averagely Kshs. 300 million every year. Without supporting evidence, KRA could not be expected to presume MOHs’ expenses and lower their chargeable income. In this case, tax was payable
- It was erroneous for the Tribunal to lay blame on KRA for not registering MOHs for VAT when MOHs themselves did not register for VAT as required by law. In this case, VAT was payable.
- PAYE can only be charged on the income of individuals in gainful employment and that it is only the employer in an employer-employee relationship that has the statutory obligation to deduct and remit PAYE in accordance with the ITA. Section 8(2) of the Partnerships Act, 2012 states that, “A partnership shall not employ a partner as an employee of the firm” hence MOHs were not employees of the business and as such, PAYE could not be charged on them. Thus, any drawing made by the partners could only be considered as part of their income and not subject to PAYE
In conclusion, the High Court allowed KRA’s appeal with regards to income tax and VAT. The High Court , however rejected KRA’s appeal on PAYE. As such, KRA partially Succeeded
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