TL owns and manages a Shopping Mall in Nairobi. In the year 2018, it received a term loan from a private equity fund, Vantage Mezzanine III Pan African Sub Fund Partnership. According to the Principal Loan Agreement, the loan ought to have been paid in full, including interest, within 7 years of the date of signing the loan Agreement. Interest was chargeable at the rate of Libor (London Inter Bank Offer Rate) – which fluctuates monthly and is a global benchmark used to make adjustments to variable-rate loans) plus 11.5%.

The Principal Loan Agreement was amended on 20th October 2020 by both parties by an Addendum to the effect that interest payment, as well as accrual of the expense and interest, would be deferred, with effect from 1st January 2019. This was due to the financial constraints faced by the Respondent. The loan term expires in 2025, the initial amount of USD 8,000,000 having been disbursed on or about 25th April 2018.

Following a VAT refund application for the sum of Kshs. 1,925,666/- by TL, KRA undertook a tax verification for January 2017 to December 2021. On 24th May 2022, KRA issued a tax assessment demanding the sum of Kshs. 18,011,425/- from TL in respect of withholding taxes on deemed interest for the years of income 2019 and 2020. KRA alleged that the Addendum to the Principal Loan Agreement altered the loan terms to an interest-free loan and, as a consequence, withholding tax on deemed income was applicable on the loan under section 2 of the Income Tax Act.

KRA also issued an assessment on the iTax web portal demanding the slightly higher additional tax amount of Kshs. 18,689,679/- consisting of Kshs. 18,296,550/- in additional withholding tax and Kshs. 393,129/- in additional corporate income tax.

In response:

TL filed a Notice of Objection dated 23rd June 2022 against the entire assessment. KRA issued the objection decision dated 22nd August 2022 confirming the initial withholding tax assessment of Kshs.18,296,541/- and revised the corporate income tax assessment downwards to Kshs.8,477/-.

TL appealed to the TAT

TAT made its ruling  in  the year 2023

Being dissatisfied with TAT ruling , KRA appealed to the High Court on the following grounds:

• That the Tribunal erred in law and fact by setting aside the Withholding tax Assessment amounting to Kshs. 18,296,541.00/-.
• That the Tribunal erred in law and fact in finding that the funds borrowed by TLAs per the Mezzanine Facility Agreement do not constitute an interest free loan and therefore do not attract Withholding tax pursuant to Section 2 of the Income Tax Act.
• That the Tribunal erred in law and fact in finding that the loan facility obtained by KRA should not be subjected to deemed interest provisions as per Section 2 of the Income Tax Act.
• That the Tribunal erred in law in its interpretation of the word “paid” in Section 2 of The Income Tax Act as read with Section 35 of the Income Tax Act hence arriving at an erroneous Decision.

its assessment of WHT was premised on the 2019 addendums to the loan agreements which it argued changed the terms of the loan to an interest-free loan. KRA pointed out that TL adopted the accrual system of accounting for both its income and expenses and that from 2019 onwards, TL had not accrued or credited this interest in favour of the lender in its profit and loss account.

KRA also highlighted that TL did not reduce the amount of profit chargeable to tax and in effect had not enjoyed the interest expense as a benefit while tabulating its taxable position. It therefore argued that withholding tax assessed is due and payable because TL has neither been paying interest on the loan, nor accruing the interest in its books of account, the loan is an interest-free loan as per section 2 of the ITA.

On the other hand, TL submitted that the Addendum did not change the nature of the loan to be interest-free as it did not alter the terms of the principal loan agreement. It also submitted that the Addendum only deferred interest payment to a future date before the expiry of the term of the loan in 2025. It again contended that deemed interest cannot arise when the loan is not interest free.

In its judgment on 19/12/2024 , the High Court observed that:

• the loan facility is not interest-free and is therefore not subject to deemed interest.
• In the impugned judgment, the Tribunal noted that the Mezzanine Facility Agreement executed on 21st March 2018 provided that the agreed interest rate was the LIBOR rate plus the margin, accruing and compounding quarterly in arrears. It also noted that in the Third Addendum to the Mezzanine Facility Agreement, the parties agreed to further amend the facility agreement to increase the capital amount and deferral of the accrual of interest and payment thereof.
• Section 35(3) of the ITA, withholding tax is deducted upon payment of the interest which is chargeable to tax or accrued (recorded as a liability). Since  the interest wasn’t  accrued nor paid the withholding tax was not due yet .

As Such TL won

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