Production of records/documents to the taxman

Case Study: KRA VS Muga Developers Limited

KRA conducted a review of MDL tax affairs to ascertain its compliance status for the income period 2015 to 2017. KRA communicated its review findings in a letter dated 4th September 2018 where it stated that MDL had not filed tax returns for the subject period contrary to section 24(1) of the Tax Procedures Act (“TPA”). Further, that from the information available to KRA, MDL developed the Project in partnership with Suraya Property Group Limited (“Suraya”) which was in three phases; Phase one and two comprising 756 units of which 695 units were sold as complete houses while phase three had ongoing off-plan sales. KRA took the view that income arising from the sale of the units was not declared for tax purposes and that MDL had not filed income tax returns for the subject period thus had not declared the income and tax from the Project. KRA assessed tax for the period at KES 2,915,192,263.0

KRA urged MDL to file all the corporation tax returns within 14 days of that letter, failure to which KRA would issue MDL with a default assessment in accordance with the provisions of section 29(1) of the TPA. MDL filed original corporation tax returns on 20th and 21st September 2018, and KRA reviewed those returns together with one filed on 28th October 2015.

KRA, in a letter dated 28th September, communicated its findings on the returns in respect of the years of income 2014-2017. It maintained that MDL was a Special Purpose Vehicle incorporated by Suraya for the development of the Project and that Phases one and two of the Project which comprised of 756 units were sold as complete whereas Phase three comprised of 152 units which were sold off-plan. KRA held that from the returns, MDL had under declared its gross turnovers and fell short of complete disclosure and, as such, brought to charge the gross revenue variances.

KRA also noted that MDL had erroneously carried forward the taxable loss of KES 1,845,781,896.00 into the year of income 2017 instead of KES 1,439,780,437.00 expected from the year of income 2016. Thus, the tax computational variance of KES 406,001,459.00 in respect of the overstated taxable loss in 2017 was corrected and accordingly brought to charge.

KRA revised the tax computations for the subject income years and determined the total additional principal tax payable by MDL as KES 3,553,263,459.00 and consequently issued additional assessments

MDL wrote to KRA on 26th October 2018 stating that its returns had been filed using draft accounts which had not been completed and signed off and that they had attached the final audited accounts for KRA’s analysis and corrections as may be necessary.

MDL further explained and sought to clarify that the turnover expected on the booked units of the Project was a cumulative figure that depicted the anticipated revenue from the Project while the revenue recognized for the year were the actual sales/income for the period and that the final accounts would be clearer on this.

MDL was requested to furnish KRA with records, documents and reconciliations/ computations which should include but not limited to all the tax computations for the years of income 2014-2017, all Trial Balances (in soft copies) in respect of the Management and Final accounts for all the years of income under review, all the Gross Revenue Accounts, Debtors Accounts and Creditors Accounts Ledgers (in soft copies) for the years under review, all the Cash Books (Cash & Bank in soft copies) for the years under review, all Revenue Recognition Accounts (in soft copies) for the years under review and any other records, documents, accounts and reconciliations deemed necessary.

Upon assessment, MDL objected.

KRA issued an objection decision

In its decision, KRA stated that MDL had not produced most of the documents as requested by KRA. The documents included; Copies of sale agreements, shareholder loans agreement, All bank loan agreements and bank statements to confirm loan interest for the years 2014 to 2017, all records relating to sale of land to CFL Limited and any other records, documents, accounts and reconciliations deemed necessary in line with the review

KRA confirmed that as of the date of the Objection Decision, it had only received the tax computations for years of income 2014 to 2017 but that a review of the profit/(loss) for the years of income 2015, 2016 and 2017 as per the tax computation on the iTax return compared with the signed audited accounts provided revealed a variance between the two. It also received the breakdown of sales per customers, sale contract numbers, and sales amounts for the years 2015 to 2017, but that this was not sufficient in the absence of sales agreements and other records requested there with

As such, KRA confirmed the assessment

MDL appealed to the TAT.

In its decision, the TAT held that:

  • KRA issued the additional assessments on the basis of MDL’s draft financial statements and that the values which KRA had treated as sales revenue on the sold units were projected values at the end of the respective accounting periods and therefore, the additional assessments were issued on an incorrect basis and were excessive
  • KRA confirmed to have received sale agreements that had sale prices per unit, which the Tribunal expected KRA to calculate the estimated annual sales values in arriving at the additional assessments.
  • Alternatively, to the test of reasonableness of the additional assessments, KRA should have used industry figures from a review of the tax compliance status of the said top fifteen real estate developers which according to the Tribunal, would have been considered more appropriate.
  • On whether it was appropriate to receive bank statements from Suraya when KRA requested for bank statements from MDL, the Tribunal found no fault in this and held that it was a practice and not uncommon in the real estate industry for using an agent for cash receipts as long as the cash is accounted for correctly and that the MDL’s audited financial statements for 2014 to 2017 did not suggest an anomaly in this respect.

As such, TAT found KRA assessment erroneous

KRA appealed to the High Court

In its decision on 19/05/2022, the High Court observed that

  • Section 59(1) of the TPA empowers KRA to require a taxpayer to produce for examination at such time and place as may be specified in a notice, any documents (including in electronic format) that are in the taxpayer’s custody or under its control relating to the tax liability of that taxpayer and further require the taxpayer to furnish information relating to the tax liability of the taxpayer.
  • Under section 24(1) of the TPA, a tax payer is required to submit a tax return under a tax law in a manner approved by KRA, in this case itax, however, section 24(2) of the TPA provides that KRA shall not be bound by such a tax return or information provided by, or on behalf of, a taxpayer and KRA may assess a taxpayer’s tax liability using any information available to KRA
  • Once KRA made the additional assessments based on the returns filed by MDL, then it was incumbent on MDL to disprove KRA.
  • From the parties’ correspondence, more so the Objection Decision, it is clear MDL never furnished KRA with all the documents requested and it is on this basis that KRA reaffirmed its earlier position on the additional assessments.
  • While it is true KRA admitted that it received sale agreements for the units that had a sale price, MDL still did not provide all the documents requested by KRA and the furnishing of these sale agreements did not in any way mean that MDL was now excluded from furnishing the other listed documents or that it had sufficiently discharged the burden of proof.
  • MDL, in failing to provide its bank statements to enable KRA to verify that the bank deposits tallied with the sale agreement values failed to discharge the burden of proof. It could not then be a fault for KRA for using the documents and information available to it, including MDL’s own projected sales in its audited accounts and details of units sold to determine the gross income of MDL
  • The Tribunal misapprehended the facts and evidence on record and the applicable law to a point that they arrived at an erroneous decision

As such KRA won

However, KRA had in its submissions and, in its Memorandum of Appeal, agreed to give MDL a window to provide the documents requested in its earlier correspondences to ascertain the correctness of the additional assessments

The Court therefore granted MDL (60) days from the date of this judgment to furnish KRA with all the documentation and information requested by KRA in its letter dated 21st November 2018 failure to which the said additional assessments confirmed on 24th January 2019 would be upheld.

Production of records/documents to the taxman

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