Case Reference: Mwanzi Road Developers Ltd v Commissioner of Legal Services & Board Coordination (Appeal E374 of 2026) [2026] KETAT 336 (KLR) (4 September 2026)
Background of the Case
Mwanzi Road Developers Limited is a limited liability company incorporated in Kenya on 14th May 1993. Its principal activities include investment in subsidiary companies and the holding of rental property.
In January 2024, the Kenya Revenue Authority (“KRA”) flagged the company for a compliance audit after noting a Capital Gains Tax declaration in which the Appellant claimed a capital loss of Kshs. 10,858,312.00 against a capital gain of Kshs. 11,628,759.00.
The audit covered the years 2020 to 2024 in respect of Capital Gains Tax, Pay As You Earn, and Income Tax (Company). The Appellant furnished audited financial statements, trial balances, bank statements, ledgers, asset registers, rent ledgers, the Shareholders’ Agreement, and the resolutions on the increase and issue of share capital.
The audit disclosed no anomalies in the Appellant’s Pay As You Earn, Capital Gains Tax, and rental income declarations. The Respondent’s findings were confined entirely to the Appellant’s retained earnings and share issue.
The Disputed Transaction
By a Written Resolution of the sole member passed on 1st December 2021, the Appellant increased its nominal share capital by Kshs. 399,900,000.00, from Kshs. 100,000.00 to Kshs. 400,000,000.00, part of that increase being financed by the capitalisation of retained earnings.
By a resolution of 28th January 2022 and the Shareholders’ Joint Venture Agreement dated 31st January 2022, the Appellant issued to Premchandbhai Foundation Registered Trustees (“the Foundation”), then its sole member:
- 2,000 ordinary shares of Kshs. 1,000.00 each for a consideration of Kshs. 2,000,000.00; and
- A further 197,900 ordinary shares of Kshs. 1,000.00 each out of retained earnings and the accumulated profit and loss account as bonus shares.
A further 200,000 ordinary shares were issued to Costronal Holdings S.A.
KRA’s Assessment
The Respondent took the view that the bonus issue of 197,900 shares, being an issue free of cost, amounted to a deemed dividend distribution under Section 7(1)(b)(ii) of the Income Tax Act, the Foundation having been relieved of the obligation to pay for the shares.
The Respondent further analysed the Appellant’s declared taxable income from 1993 and concluded that, against opening retained earnings of Kshs. 197,713,977.00 in the year of the share issue, Kshs. 138,414,182.00 represented gains or profits on which no tax had been paid and was therefore chargeable on the Appellant under Section 7A of the ITA.
The Respondent additionally found the Foundation to be an incorporated irrevocable trust and not a company within Section 2 of the ITA, so that Section 7(2) did not avail it, and that although it held a valid exemption certificate issued under Paragraph 10 of the First Schedule to the ITA, the deemed dividend did not meet the conditions of that Paragraph.
Following a Notice of Preliminary Audit Findings dated 3rd September 2025 and the Appellant’s response, the Respondent issued a Notice of Assessment dated 29th October 2025 under Sections 29 and 31 of the Tax Procedures Act, assessing Withholding Tax of Kshs. 13,754,050 and Income Tax under Section 7A of Kshs. 56,472,986, totalling Kshs. 70,227,036 including penalties and interest.
The Appellant’s Case
The Appellant lodged a Notice of Objection dated 5th December 2025. Following engagements between the Parties, the Respondent issued an Objection Decision dated 28th January 2026 rejecting the objection in its entirety and confirming the assessment.
Aggrieved by that decision, the Appellant lodged a Notice of Appeal dated 11th March 2026.
The Appellant raised two principal grounds of appeal:
- That the Respondent erred in concluding that the issuance of ordinary shares out of retained earnings to its shareholder constituted a deemed dividend distribution under Section 7(1)(b)(ii) of the ITA, and in consequently assessing withholding tax on the alleged deemed dividend distribution.
- That the Respondent erred in assessing income tax under Section 7A of the ITA on the basis that the alleged deemed dividend distribution was a distribution out of untaxed gains.
The Appellant argued that the issuance of ordinary shares out of retained earnings does not amount to the shareholder being discharged from an obligation measurable in money owed to the company. It characterised the transaction as a capitalisation of retained earnings, or bonus issue, which merely results in a reclassification of amounts within the equity section of the financial statements and involves neither the payment of cash nor the transfer of any economic benefit.
The Appellant further contended that the retained earnings and ordinary shares fall within the same category of shareholders’ equity, so that the issuance of the one out of the other does not equate to the discharge of an obligation measurable in money. The shareholder’s overall equity position in the company remained unchanged and it received no immediate economic benefit capable of measurement in monetary terms.
KRA’s Defence
The Commissioner for Legal Services & Board Coordination defended the objection decision on several grounds.
KRA submitted that the bonus issue of 197,900 ordinary shares of Kshs. 1,000.00 each out of retained earnings amounted to a deemed dividend distribution under Section 7(1)(b)(ii) of the ITA. The Respondent characterised Section 7(1)(b)(ii) as a “deeming” provision, citing Prof. Peter Anyang’ Nyong’o and 10 Others v Attorney General of Kenya & 4 Others for the proposition that the word “deemed” creates a legal fiction.
The Respondent identified two conditions for the operation of the provision:
- That a dividend be distributed by a company to a shareholder; and
- That the shareholder be discharged from an obligation measurable in money owed to the company by that shareholder.
On the second condition, the Respondent invited the Tribunal to examine how the Appellant raises its share capital, directing attention to Paragraph 56 of its Articles of Association, adopted by a special resolution passed on 9th February 2021, which provides that “The Company may not issue shares unless they are fully paid.”
From that provision the Respondent reasoned that the Foundation was obligated to pay for share capital amounting to Kshs. 199,900,000.00, and pointed to the Shareholders’ Joint Venture Agreement as disclosing that the 197,900 shares were instead paid for out of the Appellant’s retained earnings and accumulated profit and loss account.
The Respondent further relied on Paragraph 74 of the Appellant’s Articles of Association, which requires dividends and other distributions to be paid by transfer to a bank account, by cheque, or by such other means of payment as the directors may agree, and argued that instead of distributing Kshs. 197,900,000.00 as dividends the Appellant elected to relieve the Foundation of the obligation imposed by Paragraph 56.
On the untaxed character of the reserves, the Respondent recounted its analysis of declared taxable income from inception in 1993 to December 2021, from which it concluded that cumulative taxed profits stood at Kshs. 59,974,680.00, leaving Kshs. 138,414,182.00 of the opening retained earnings of Kshs. 197,713,977.00 untaxed.
The Respondent invoked Section 24(2) of the TPA, under which it is not bound by a taxpayer’s self-assessment returns, together with Section 31(1)(c) of the TPA, under which it may amend an assessment from the available information and to the best of its judgement.
Finally, the Respondent urged that the Appellant had failed to discharge the burden of proof imposed by Section 56(1) of the TPA, Section 30 of the Tax Appeals Tribunal Act, and Section 107 of the Evidence Act.
The Tribunal’s Analysis
The Tribunal carefully reviewed the rival pleadings and documentation. The central question was whether the issuance of 197,900 ordinary shares out of the Appellant’s retained earnings constituted a deemed dividend distribution under Section 7(1)(b)(ii) of the Income Tax Act.
Section 7(1)(b)(ii) Requires an Existing Obligation
The Tribunal noted that Section 7(1)(b)(ii) of the ITA is engaged only where the shareholder “is discharged from any obligation measurable in money which is owed to that company by that shareholder”.
The provision therefore requires four matters to be established:
- That an obligation existed;
- That the obligation was measurable in money;
- That it was owed by the shareholder to the company; and
- That the shareholder was discharged from it.
Article 56 Did Not Create a Debt
The Respondent located the requisite obligation in Paragraph 56 of the Appellant’s Articles of Association, which provides that “The Company may not issue shares unless they are fully paid.”
The Tribunal held that this provision is a prohibition addressed to the company rather than a covenant given by the member, and it therefore neither creates nor could create a debt owed by a member to the company.
The Tribunal further observed that in the model articles, “paid” is defined to mean “paid or credited as paid.” Shares allotted credited as fully paid therefore satisfy Paragraph 56 without any payment falling due. The Parties’ own Shareholders’ Joint Venture Agreement defined “Fully Paid” as meaning that the consideration payable for the shares “has been Fully Paid or credited as paid in money or money’s worth.”
The Documentary Record Confirmed the Distinction
The recitals to the Shareholders’ Joint Venture Agreement described the 2,000 ordinary shares as “being issued for total consideration of Kenya Shillings Two Million,” whereas they described the 197,900 ordinary shares as “being issued out of Corporation’s Retained Earnings and Accumulated profit and Loss Account.”
A consideration obligation therefore attached to the former shares alone, and that obligation was discharged in cash.
The Respondent’s Figures Were Internally Inconsistent
The Respondent’s Statement of Facts asserted that the Foundation was obliged to pay Kshs. 199,900,000.00, yet the sum said to have been forgiven was Kshs. 197,900,000.00, the difference of Kshs. 2,000,000.00 being precisely the consideration that the Foundation in fact paid.
The Tribunal observed that the Respondent’s reliance upon Paragraphs 56 and 74 of the Articles in tandem was internally inconsistent. The Respondent asked the Tribunal to find simultaneously that a dividend of Kshs. 197,900,000.00 was payable to the Foundation and that the Foundation was released from a subscription debt of the same amount. Those two characterisations cannot stand together.
The Legal Nature of a Capitalisation Issue
The Tribunal applied established legal principles:
In Bouch v Sproule (1887) 12 App Cas 385, the House of Lords held that a company may resolve to treat undivided profits as capital and to apply them in paying up shares, in which case what the member receives is capital and not income.
In Inland Revenue Commissioners v Blott [1921] 2 AC 171, the House of Lords held that bonus shares issued upon such a capitalisation are not a payment of dividend to the shareholder. Viscount Haldane stated:
“If this is done, the money so applied is capital and never becomes profits in the hands of the shareholder at all.”
The reason for that principle is that in a bonus issue nothing leaves the company. Its assets are unaltered, its net worth is unchanged, and the member’s proportionate interest is identical before and after the issue. All that occurs is a rearrangement of the internal composition of equity.
The Principle Against Implication in Taxing Statutes
The Tribunal applied the classic principle from Cape Brandy Syndicate v Inland Revenue Commissioners [1921] 1 KB 64:
“In a taxing Act one has to look merely at what is clearly said. There is no room for any intendment. There is no equity about a tax. There is no presumption as to a tax. Nothing is to be read in, nothing is to be implied.”
Had Parliament intended a capitalisation issue to be treated as a deemed dividend, it could readily have said so. Parliament did not do so, and the Tribunal cannot supply by implication a charge that the statute does not impose.
Section 7A Assessment Fails
Section 7A of the ITA charges the company distributing a dividend to tax where that dividend is distributed out of gains or profits on which no tax is paid. The charge is therefore conditional upon an anterior event—the distribution of a dividend.
Having found that no dividend was distributed, the Tribunal held that the gateway to Section 7A was never opened, and the assessment of Kshs. 56,472,986.00 could not stand.
Withholding Tax Assessment Fails
The withholding tax assessment of Kshs. 13,754,050.00 was wholly dependent upon the deemed dividend. Since that premise failed, the charge founded upon it could not survive.
The Respondent’s findings upon the Foundation’s status—specifically that an incorporated irrevocable trust is not a company for the purposes of Sections 2 and 7(2) of the ITA, and that its exemption certificate issued under Paragraph 10 of the First Schedule did not extend to the sum in question—did not repair that position. Those findings go only to whether an established dividend would have been exempt from tax or relieved from deduction at source. They cannot supply a dividend where none exists.
The Tribunal’s Decision
The Tribunal allowed the Appeal and issued the following Orders:
- The Appeal be and is hereby allowed;
- The Respondent’s Objection Decision dated 28th January 2026 be and is hereby set aside;
- Each party to bear its own costs.
Key Takeaways for Taxpayers
1. Bonus Issues Are Not Deemed Dividends—But Know the Boundaries
A capitalisation of retained earnings into bonus shares does not constitute a deemed dividend under Section 7(1)(b)(ii) of the Income Tax Act. However, this does not mean all share issues are immune from tax scrutiny. The key is whether there was an actual obligation owed to the company that was discharged.
Taxpayers should carefully structure share issues and ensure they understand the distinction between a bonus issue and a distribution of profits.
2. Understand the Distinction Between a Restriction and a Debt
A provision in a company’s articles requiring shares to be fully paid is a restriction on the company, not a debt owed by the member. For Section 7(1)(b)(ii) to apply, there must be an actual obligation measurable in money owed by the shareholder to the company.
This distinction can mean the difference between a Kshs. 70 million tax bill and no tax liability at all.
3. Document the Nature of Share Issues Meticulously
Companies should clearly document whether shares are issued for cash consideration or as bonus shares out of capitalised reserves. The recitals in the Shareholders’ Joint Venture Agreement in this case proved decisive in demonstrating that no obligation attached to the bonus shares.
Proper documentation can be the difference between winning and losing a tax appeal.
4. The Principle Against Implication in Taxing Statutes Works Both Ways
Taxing statutes must be construed strictly. If Parliament intended a particular transaction to be taxable, it will say so expressly. The Tribunal cannot supply by implication what the statute does not impose.
This principle protects taxpayers from creative interpretations that seek to expand the scope of taxation beyond the clear words of the statute.
5. Raise All Issues at the Objection Stage
The Tribunal’s mandate is limited to analysing evidence and material produced before the Commissioner. Issues not raised at the objection stage cannot be introduced for the first time on appeal.
Taxpayers should ensure all relevant arguments and documentation are presented during the objection process.
6. Consider the Tax Implications of Corporate Restructuring
When considering a bonus issue or capitalisation of retained earnings, companies should carefully assess the potential tax implications. While this case confirms that bonus issues are not deemed dividends under Section 7(1)(b)(ii), other provisions of the law may have different consequences.
