Commissioner of Domestic Taxes v Trical and Hard Limited (Tax Appeal E146 of 2020) [2022] KEHC 9927 (KLR) (Commercial and Tax) (8 July 2022) (Judgment)
Neutral citation:
[2022] KEHC 9927 (KLR)
Republic of Kenya
Tax Appeal E146 of 2020
DAS Majanja, J
July 8, 2022
Between
Commissioner of Domestic Taxes
Appellant
and
Trical and Hard Limited
Respondent
(Being an appeal against the Judgment of the Tax Appeals Tribunal at Nairobi dated 18th September 2020 in Tax Appeal No. 320 of 2018)
Judgment
Introduction and Background
1.The Respondent is a limited liability company involved in general trading of goods. Sometime in 2018, the Appellant (“the Commissioner”) profiled the Respondent as a beneficiary of the ‘missing traders’ invoice scheme whereby several businesses were registered with the sole aim of fictitious invoicing with no actual sale being made. The Commissioner conducted investigations into the tax affairs of the Respondent with a view of ensuring due tax compliance with the tax provisions for the period 2013-2018.
2.On 31st May 2018, the Commissioner issued additional assessments on VAT for the months February – March 2017, June 2016 and November 2016 being KES 867,943.00 and further additional assessments on 12th June 2018 in respect of Corporation Tax for the period 1st April 2016 to 31st March 2017 being KES 1,644,267.00. The Commissioner states that it examined invoices from five companies implicated in the missing traders scheme and noted that no deliveries were made to the Respondent and that the said invoices were unsupported by actual delivery and payment of the goods to prove the purchase. The Commissioner accused the Respondent of claiming input VAT on supplies that were never made to it and only held tax invoices and/or ETR receipts, which were never accompanied by actual supplies and were only fictitious to allow the Respondent claim input VAT to reduce its tax liability.
3.The Respondent objected to the additional assessments through its letter dated 27th June 2018 on the grounds that they contravened section 15(1) of Income Tax Act (Chapter 470 of the Laws of Kenya) (“the ITA’’) on allowable business costs and section 17(1) of the VAT Act, 2013. That the said suppliers issued VAT receipts generated by the Electronic Tax Registers and filed with the Commissioner and that they filed and claimed input VAT on a monthly basis as confirmed by the Commissioner. The Respondent admitted that it did business with the said suppliers and that it had all the relevant documentation as required by law to support the said transactions and that the Respondent had complied with all statutory obligations and had paid taxes where due. The Respondent further impugned the assessments for being based on preliminary findings without any factual basis and were thus erroneous and without legal basis. The Respondent also stated that said suppliers were duly registered with the Commissioner and that this could be confirmed online using the PIN checker.
4.The Respondent attached invoices from various suppliers including the ones flagged by the Commissioner. It stated that from the attached invoices, the Respondent did not have capacity to know which supplier was not complying with its tax obligations. Further, that the attached invoices demonstrated that these were cost of sales to generate income as reflected in the respective Income Tax and VAT Returns which are allowable deductions under section 15(1) of the ITA. The Respondent relied on section 17(1) and (3) of the VAT Act, 2013 to aver that it is registered for VAT and did make taxable supplies charging VAT thereof and that it claimed input VAT from its suppliers within the stipulated time by law. Further, that the Respondent was in possession of original tax invoices issued for the suppliers and it was therefore entitled to claim the input VAT as it did.
5.To further support its position, the Respondent furnished the Commissioner with further documents including copies of invoices issued for each purchase, copies of delivery notes for each purchase and copies of payment records and client statements.
6.In a letter dated 18th September 2018, the Commissioner rendered its Objection Decision (“the Objection Decision”). The Commissioner held that notwithstanding the Respondent’s assertion that it had maintained full records for the purchases disallowed, the Commissioner maintained that it had established that there was no supply of taxable goods made by the suppliers highlighted in its earlier letter. As such, the Commissioner confirmed the assessments of KES 876,943.57 in respect of VAT and Corporation tax of KES 1,644,267.00 together with the resultant penalty and interest.
7.The Respondent lodged an appeal with the Tax Appeals Tribunal (“the Tribunal”) on 13th October 2020. Having carefully studied the parties’ pleadings and all the documents attached to the appeal and after hearing the submissions, the Tribunal was of the view that the issues for determination were; Whether the Objection Decision with respect to the Corporation Tax Assessment was valid, whether the Commissioner erred in its decision to disallow input VAT and whether the Commissioner erred in assessing additional Corporation Tax after disallowing the input VAT Claim.
8.On the first issue, the Tribunal noted that the objection was received by the Commissioner on 29th June 2018 and the Objection Decision was to be made on 28th August 2018 instead of 18th September 2018. It observed that the parties were in communication and this is what led to the Respondent providing additional information to the Commissioner on 20th July 2018. The Tribunal therefore absolved the Commissioner of any negligence and coupled with the fact that the delay was not inordinate. Guided by Article 159(2)(d) of the Constitution, the Tribunal ultimately found that the Objection Decision valid.
9.On the second issue, the Tribunal set for itself three tests; Whether the Respondent furnished sufficient proof of purchase, whether the Respondent‘s right to claim VAT was affected by the presence of fraud in the supply chain and whether the Respondent knew or should have known that there was fraud. The Tribunal was of the view that the Commissioner’s interpretation of section 17 of the VAT Act in respect of input tax was correct that indeed, the right to claim input tax is hinged upon the underlying requirements of the transaction as outlined in the VAT Act being met. That input tax can only be claimed where it was incurred in the purchase of taxable goods meaning that for a taxpayer to deduct input tax, it must have actually made a purchase and it is not merely enough to have documentation and that the documentation must be supported by an underlying transaction and the taxpayer must furnish proof that there was an actual purchase.
10.The Tribunal underlined section 30 of the Tax Appeals Tribunal Act (“the TATA’’) which places the burden of proof on the taxpayer to submit all the necessary documentation to support its case and that once the taxpayer adduces evidence that discharges his burden, then the burden shifts to the Commissioner. However, the Tribunal held that although the current tax laws provide that the burden of proof lies with the Respondent to prove that tax was paid or that the Commissioner’s assessment was wrong, it could not have been the intention of the legislature to put the taxpayer in a position where he would be required to produce any document that the taxman may require. That in demanding the production of documents that are not prescribed by legislation, the tax authority should be guided by reasonableness, the nature and circumstances of the trader otherwise it would, as it occasionally does, demand information ad nauseum.
11.The Tribunal noted that the Respondent furnished the Commissioner with the documents detailing the transactions as provided by section 17 of the VAT Act and further provided bank records, delivery notes and payment records and that this evidence established prima facie that it indeed purchased the said goods. The Tribunal held that the Commissioner did not rebut this evidence and that even though the Commissioner insisted that its investigations established a missing trader scheme of which the Respondent was a beneficiary, the evidence of this investigations was not tabled before it and that all the Tribunal had was the Commissioner’s assertions. The Tribunal was of the view that the Commissioner ought to have furnished information to prove that the invoices submitted by the Respondent to support its claim were fictitious and that it was not enough to just allege that the documents presented were fictitious. The Tribunal therefore concluded that the Respondent had furnished sufficient proof of purchase.
12.As to whether the Respondent‘s right to claim VAT was affected by the presence of fraud in the supply chain, the Tribunal relied on the European Court of Justice cases in Optigen Ltd, Fulcrum Electronics Ltd and Bond House Systems Ltd v Commissioners of Customs & Excise [2006] EUECJ C-354/03 and Axel Kittel v Etat beige and Etat beige v Recolta Recycling SPRL [2006] ECR [-0616] to hold that the Respondent‘s right to claim VAT is not affected by the presence of fraud in the supply chain unless it had knowledge of fraudulent acts of its suppliers and that the mere fact that there is suspicion that the Respondent's suppliers were engaged in fraud does not extinguish its right to claim input VAT. That this right can only be extinguished if the Respondent knew or ought to have known that the transaction was part of a fraudulent scheme and the mere fact that the VAT charged by the Respondent's suppliers was not submitted to the Commissioner was irrelevant to its exercise of claiming input tax that it incurred. Consequently, the Tribunal found that the Respondent's right to claim VAT was not affected by the presence of fraud in the supply chain unless it had knowledge of fraudulent acts of its suppliers.
13.The Tribunal also relied on the United Kingdom’s VAT & Duties Tribunal’s case in Calltell Telecom Ltd v HMRC [2007] UKVAT V202666 and section 107 of the Evidence Act (Chapter 80 of the Laws of Kenya) to hold that the burden of proof was upon the Commissioner to establish that there was fraud and that the Respondent knew or ought to have known about it. The Tribunal reiterated that the Commissioner failed to adduce evidence to support its averments of fraud whereas the Respondent produced documents indicating that there was indeed a purchase. Thus, the Tribunal found that the Commissioner did not discharge its burden of proof by establishing knowledge of the fraud on the part of the Respondent and therefore, the Commissioner erred in disallowing input VAT and cost of sales claimed by the Respondent. Having found that the claim for input VAT was allowable, the Tribunal found that the Commissioner erred in assessing Corporation Tax as a result of disallowing input VAT.
14.The Tribunal therefore made dispositive orders allowing the Respondent’s appeal and setting aside the Commissioner’s Objection Decision and consequently vacating the additional assessments. It is this decision that precipitated the filing of the instant appeal by the Commissioner which is grounded on the Memorandum of Appeal dated 26th November 2020. The Respondent responded to the appeal through its Statement of Facts dated 25th January 2021. The parties have also filed written submissions which disposed of the appeal and regurgitate their respective positions summarized above.
Analysis and Determination
15.In determining this appeal, I am cognizant of the fact that this court is exercising appellate jurisdiction that is circumscribed by section 56(2) of the Tax Procedures Act (“the TPA”) which provides that “An appeal to the High Court or to the Court of Appeal shall be on a question of law only”. The Commissioner has rightly cited the decision of the Court of Appeal in John Munuve Mati v Returning Officer Mwingi North Constituency & 2 others [2018] eKLR where the court summarised what amounts to “matters of law” as follows:
16.This means that an appeal limited to matters of law does not permit the appellate court to substitute the Tribunal’s decision with its own conclusions based on its own analysis and appreciation of the facts unless the decision of the Tribunal cannot be supported by any evidence.
17.The main issues for determination in this appeal are almost similar to what the Tribunal dealt with, which is whether the Respondent was entitled to the input VAT as claimed, whether the Commissioner erred in assessing additional Corporation Tax after disallowing input VAT and lastly, whether the Tribunal rightly appreciated the provisions of sections 56 and 59 of the TPA, section 30 of the TATA and sections 17 and 43 of the VAT Act, 2013.
18.It is common ground that the issue of ‘missing trader’ is a tax fraud scheme where taxpayers deliberately and fraudulently claim tax rebates from fictitious purchases leading to the taxpayer paying less or no taxes than they should and the Government consequently losing revenue. The parties also agree and understand how the Kenyan VAT system operates. In Highlands Mineral Water Limited v Commissioner of Domestic Taxes ML HC ITA No. E026 OF 2020 [2021] eKLR, the court explained that VAT is a tax chargeable on supply of taxable goods or services made or provided in Kenya and on importation of taxable goods or services into Kenya. It works under the input and output tax system. Output tax refers to the VAT charged on the sales of taxable goods or services, while input tax refers to VAT charged on taxable purchases of goods and services for business purposes. The tax payable is the difference between the output tax and input tax.
19.It is this input tax that the law allows a taxpayer to deduct from their VAT returns that is always subject to abuse and missing trader fraudulent scheme I have highlighted above. In any case, it is common ground that a taxpayer has the right to deduct input tax from its VATable transactions. Whether such a scheme exists must be established by evidence and not mere supposition.
20.The aforementioned position on the VAT system above is anchored under section 17 (1), (2), (3) and (5) of the VAT Act, 2013 which provides as follows:
21.Section 43 of the VAT Act, 2013 provides for the requirement that a tax payer is required to maintain records and that the Commissioner has the power to request for the production of such records as follows:
22.Section 59 (1) of the TPA also provides that a tax payer shall produce records when required to do so by the Commissioner as follows:
23.It is also not in dispute that section 30 of the TATA and section 56 of the TPA impose the burden of proof on the tax payer to prove that an assessment is excessive or a tax decision is incorrect. All these provisions must be read holistically hence I am in agreement with the dictum in Okiya Omtatah Okoiti v Attorney General & another NRB HC Petition No. 156 of 2017 [2020] eKLR where the court held that a section or sections of a law should not be read in isolation of the other provisions of that law particularly where they deal with the same subject.
24.The core of this appeal is that the Commissioner impugned the records and documentation submitted by the Respondent. It maintained that no supplies were actually made in support of those records. The question before the court that was also before the Tribunal was whether the Respondent sufficiently discharged its burden when it availed those records to the Commissioner as proof of supply.
25.I agree with the Tribunal’s holding that the burden of proof in tax matters is not stationary but is like a pendulum swinging between the taxpayer and taxman at different points but more times than not swings towards the taxpayer. The uniqueness of our tax system in placing the evidential burden of proof on the tax payer is neither a mistake nor is it unconstitutional. In Republic v Kenya Revenue Authority; Proto Energy Limited (Exparte) (Judicial Review Application E023 of 2021) [2022] KEHC 5 (KLR) (24 January 2022) (Judgment) the court stated that:
26.From the above, it is clear that the evidential burden of proof rests with the taxpayer to disprove the Commissioner and that once competent and relevant evidence is produced, then this burden now shifts to the Commissioner. I have emphasized and underlined ‘competence’ and ‘relevance’ because it is only evidence that meets these two tests that demolishes presumption of correctness and swings the burden to the Commissioner. This means that even if one avails evidence but then it is found that the same is incompetent or irrelevant, then the burden continues to remain with the tax payer.
27.In this case, the Commissioner accused the Respondent for being part of the missing trader scheme and being involved in transactions where no supplies were actually made and that all the Respondent had were tax invoices from the flagged companies meant to reduce the Respondent’s tax liability. With this assertion, the burden swung to the Respondent to prove the Commissioner wrong. In this attempt, the Respondent availed documents including copies of invoices issued for each impugned purchase, copies of delivery notes for each impugned purchase and copies of payment records and client statements. Once these documents were availed, the burden shifted to the Commissioner. When the Commissioner reviewed the said documents it maintained its position that there was no supply notwithstanding the documents availed, meaning it directly challenged the competence, relevance and veracity of the evidence produced. I find that once this was done, the burden shifted back to the Respondent to disprove the Commissioner because as I have stated, only competent and relevant evidence can demolish the presumption of the Commissioner’s correctness and shift the burden to the Commissioner.
28.In rejecting the evidence produced by the Respondent, can it be said that the Commissioner was unreasonable or that it had to accept the Respondent’s evidence regardless? I do not think so. Had it been the position that the Commissioner is obliged to accept all and any document submitted to it as evidence, one can imagine the proliferation of fake and bogus documents by tax payers in a bid to cheat the tax system. Another issue raised by the Tribunal and the Respondent was that in declining the Respondent’s evidence, the Commissioner ought to have made available its investigation report to the Respondent and the Tribunal. While this is desirable, I do not think it was obligatory. A report is a record of the investigations and not necessarily the primary evidence leading to the conclusion of fraud. The fraud alleged can be proved by any other evidence produced through witness statements and affidavits. This position was taken by the Court of Appeal in Total Kenya Limited v Kenya Revenue Authority NRB CA Civil Appeal No. 148 of 2013 [2018] eKLR which also dealt with a similar issue where the appellant therein had claimed to have paid import duty and submitted copies of Import Entries of the consignments it claimed to have paid. Investigations by the respondent therein revealed a different story in that the import documents as well as the receipt were all forgeries since they related to a different consignment as opposed to the subject of the demand. This position was not countered by the appellant and the appellate court found that indeed fraud had been proved and that it was specifically pleaded by the respondent in its replying affidavit. In this case, the Commissioner adduced evidence by one of its officers who outlined details of its investigations and how it was established that there were no deliveries that were made to the Respondent as claimed in the invoices. This evidence was not countered by either a witness statement, affidavit or such documents from the Respondent responding to the Commissioner’s allegations. It would have even sufficed for the Respondent to call the flagged companies as witnesses before the Tribunal or obtain such statements or letters from them to prove that they indeed supplied goods to the Respondent. Thus, it is not correct that there was no ‘evidence’ of fraud before the Tribunal merely because the investigation report was not tabled before it.
29.Further, investigation reports may contain matters of a confidential in nature, for example sources of information, method of investigation and matters not relevant to the issue at hand. The report may also involve ongoing investigations that may touch on other entities not party to the subject proceedings and thus disclosing the report to third parties may scuttle or prejudice such investigations, sources and investigation methods (see Commissioner of Domestic Services v Galaxy Tools Limited ML ITA No. E088 of 2020 [2021] eKLR)
30.I therefore disagree with the decision of the Tribunal and find that the Respondent did not discharged its burden of proof before the Commissioner and the Tribunal when the competence, relevance and veracity of its evidence was challenged meaning that the presumption of correctness of the Commissioner’s decision remained as such. I further hold that where the veracity and authenticity of the documents availed have been called into question by the Commissioner, the burden shifted back to the taxpayer, in this case the Respondent, to prove the Commissioner wrong. There is a concern that the Commissioner may request for documents ad nauseam. I hold that the Commissioner has a duty to act reasonably and where it shown that the request is unreasonable in the circumstance, the Tribunal may reject such a request. The duty to act reasonably is anchored in the right to fair administrative action in Article 47 of the Constitution. The Commissioner is not a conveyor belt for information and documents, it has a right to satisfy itself the documents presented to it by the taxpayer are capable of discharging the burden imposed on it. If the documents are questioned on bona fide and reasonable grounds, then the burden shifts back to the Respondent, as the taxpayer, to disprove the Commissioner and prove that the said documents are genuine and that actual goods were purchased from the said listed suppliers (see Commissioner Investigations and Enforcement v Sangyug Enterprises(K) Limited (Income Tax Appeal E056 of 2020) [2022] KEHC 59 (KLR) (Commercial and Tax) (4 February 2022) (Judgment) and Commissioner of Investigations and Enforcement v Pearl Industries Limited (Tax Appeal E086 of 2020) [2022] KEHC 51 (KLR) (Commercial and Tax) (31 January 2022) (Judgment)).
31.While the general rule or requirement under the sections 107 and 108 of the Evidence Act is he who asserts must prove, it must also be remembered that a person has the burden of proving facts that are peculiarly within its knowledge as provided by section 112 of the Evidence Act which states that, “In civil proceedings, when any fact is especially within the knowledge of any party to those proceedings, the burden of proving or disproving that fact is upon him.” In matters of tax law, this provision is underpinned by the duty of the taxpayer, as shown in the provisions I have outlined elsewhere, to keep specific documents and supply them to the Commissioner upon request.
Conclusion and Disposition
32.For the reasons I have set out above, it is my finding that the Commissioner’s appeal is merited. The Tribunal erred in its interpretation and application of sections 56 and 59 of the Tax Procedures Act, sections 17 and 43 of the VAT Act, 2013 and section 30 of the Tax Appeals Tribunal Act and arrived at the wrong conclusion in this matter. They misapprehended the evidence and facts on record and arrived at a decision that was perverse and warrants the intervention of this court.
33.I allow the appeal and set aside the judgment of the Tribunal dated 18th September 2020 and uphold the Commissioner’s Objection Decision dated 18th September 2018.
DATED AND DELIVERED AT NAIROBI THIS 8TH DAY OF JULY 2022.D. S. MAJANJAJUDGEMs Gitau, Advocate, instructed by Kenya Revenue Authority for the Appellant.Mr Mbaye instructed by Humphrey and Company LLP for the Respondent