- April 30, 2024
- Posted by: admin
- Category: Uncategorized
Deemed Interest only applies to loans that are provided free of interest
Case Study: Commissioner_of_Domestic_
On 11/09/2017 KRA wrote a letter to SEL to demand Withholding Tax for ‘’Deemed Interest’’ worth KES 11.1m.
SEL objected on 06/10/2017 on the grounds that the said due loan was ‘’just transactional supplier running balances from net payable invoices’’
SEL and KRA held a meeting on 13/11/2017 to deliberate on the said matter
KRA finally issued objection decision on 17/11/2017 by confirming the assessed amounts.
SEL appealed to the Tax Appeal Tribunal on 28/12/2017
SEL submitted that KES 134.1m due to Socabelec South Africa and KES 32.2m due to a local related entity were not subject to deemed interest
KRA responded that the SEL reported in their audited accounts for 2014 and 2015 that the said balances were interest free loans
KRA relied on Section 16(3) of Income Tax Act:
(3) For the purposes of subsection (2), the expressions— “all loans” means loans, overdrafts, ordinary trade debts, overdrawn current accounts or any other form of indebtedness for which the company is paying a financial charge, interest, discount or premium
“deemed interest” means an amount of interest equal to the average ninety-one day Treasury Bill rate, deemed to be payable by a resident person in respect of any outstanding loan provided or secured by the non-resident, where such loan is provided free of interest;
And Section 10 (1)(c) Of Income Tax Act:
(1) For the purposes of this Act, where a resident person or a person having a permanent establishment in Kenya makes a payment to any other person in:
(c) interest and deemed interest
And Section 35 (1) (e) Of the Income Tax Act
35. Deduction of tax from certain income (1) Every person shall, upon payment of any amount to any non-resident person not having a permanent establishment in Kenya in respect of—
e) interest and deemed interest;
The tribunal observed That:
KRA relied on the definition of the term ‘’loan’’ in Section 16(3), however there is no other definition of loan except ‘’all loans’’
‘’All loans’’ means loans, overdrafts, ordinary trade debts, overdrawn current accounts or any other form of indebtedness for which the company is paying a financial charge, interest, discount or premium.
This implies, for a loan to qualify for deemed interest it must be subject to financial charge, interest, discount or premium
SELs loans had no financial charge, interest, discount or premium. With a lacuna in law, the benefit should therefore be given to SEL
The appeal was therefore allowed and withholding Tax assessment set aside on 26/02/2020
KRA appealed to the High Court
In its ruling on 19/03/2024, the High Court observed that:
- Section 16 (2) and (3) of the Income Tax Act provide that:-
“(2) Notwithstanding any other provision of this Act, no deduction shall be allowed in respect of –
(ja) an amount of deemed interest where the person is controlled by a non-resident person alone or together with not more than four other persons and where the company is not a bank or a financial institution licensed under the Banking Act.
or an amount of deemed interest where the company is in the control of a non-resident person alone or together with four or fewer other persons and where the company is not a bank or a financial institution licensed under the Banking Act; and for the purposes of this paragraph “control” shall have the meaning ascribed to it in paragraph 32 (1) of the Second Schedule;
Provided that this paragraph—
(i) shall apply to loans advanced to the company by a non-resident associate of the non-resident company controlling the resident company….”
“16. (3) For the purpose of subsection (2), the expression-
“all loans” means loans, overdrafts, ordinary trade debts, overdrawn current accounts or any other form of indebtedness for which the company is paying a financial charge, interest, discount or premium.”
- From the above, if there is an indebtedness to a non-resident entity, withholding tax would apply whether there was interest payable or not. The only difference is that where there was no interest, deemed interest would apply at the 91 Treasury bill rate. Therefore, the Tribunal erred in by failing to appreciate that deemed interest only applies to loans that are provided free of interest and in concluding that for any form of indebtedness to qualify as a loan, there must be a fixed charge, interest, discount or premium.
- The Tribunal erred in failing to accept that SEL’s financial statements which classified amounts owed to Socabelec SA and SA Durjau as “borrowings” as proof of indebtedness.
- According to SEL, the amounts outstanding to Socabelec SA and SA Durjau were supplier trading balances. The amount of Kshs.134,117,865/= owing to Socabelec SA had been outstanding since December 2013 and was classified under “non-current” borrowing in its balance sheet. As such SEL’s outstanding balances are subject to withholding tax in accordance with section 2, 10(c) and 35(1) (e) of the Income Tax Act. Hence, in this case, deemed interest is applicable because there is no interest payable on the supplier trading balances. For avoidance of doubt
- The deemed interest rate applicable is 10% as inscribed in the Double Taxation Agreement between Kenya and South Africa.
As Such KRA Won.
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