Instalaciones Inabensa, S.A v Commissioner of Domestic Taxes (Tax Appeal 571 of 2022) [2023] KETAT 1014 (KLR) (Commercial and Tax) (8 September 2023) (Judgment)
Neutral citation:
[2023] KETAT 1014 (KLR)
Republic of Kenya
Tax Appeal 571 of 2022
E.N Wafula, Chair, Cynthia B. Mayaka, Grace Mukuha, Jephthah Njagi & AK Kiprotich, Members
September 8, 2023
Between
Instalaciones Inabensa, S.A
Appellant
and
Commissioner of Domestic Taxes
Respondent
Judgment
Background
1.The Appellant is a Spanish company duly incorporated under the laws of Spain and registered in Kenya under a Certificate of Compliance in 2013. The company deals in engineering and clean technology.
2.The Respondent is appointed under and in accordance with Section 13 of the Kenya Revenue Authority Act and the Kenya Revenue Authourity is charged with the responsibility of among others, assessment, collection, accounting and the general administration of tax revenue on behalf of the Government of Kenya.
3.The Appellant was awarded two public tenders by KETRACO upon which on 16th April 2013 Inabensa Spain entered into energy and procurement contracts with KETRACO for construction of 400 KV the Lessos Tororo electricity transmission and for the extension of an existing substation at Lessos.
4.The project comprised both offshore and onshore components. The offshore component works related to the preliminary design of works and mechanical and electrical, SCADA works and provision of spare parts for the project.
5.The offshore works were performed by Inabensa Spain while the Appellant undertook the onshore components which entailed construction. The onshore works were executed and invoiced to KETRACO by the Appellant in Kenya shillings while Inabensa Spain invoiced the offshore works to KETRACO in Euros.
6.Vide the letter dated 25th April 2016, KETRACO terminated the contracts. In line with the contracts, the dispute was referred to Arbitration. The Arbitral Tribunal found that KETRACO had breached the contracts and gave the final award dated 30th July 2019.
7.KETRACO applied to the High Court to have the arbitral Award set aside while the Appellant on the other hand filed an application to have the Award enforced.
8.The Respondent relied on the Award and issued assessments on 3rd August 2021 for taxes amounting to Kshs. 2,335,492,449.00, inclusive of penalties and interest.
9.The Appellant objected to the Respondent’s assessment by way of notice of objection dated 1st September 2021.
10.The Respondent revised the assessment to Kshs. 695,974,786.00 through its objection decision dated 20th April 2022.
11.The Appellant being dissatisfied with the Respondent’s objection decision filed a Notice of Appeal on 19th May 2022.
The Appeal
12.The Appeal is premised on the following grounds as stated in the Appellant’s Memorandum of Appeal dated and filed on 2nd June, 2022: -i.That the Respondent erred in fact and law by prematurely demanding income tax and VAT for 2019, taking into consideration the fact that the Arbitral Award is still undergoing an appeal process and any income arising therefrom is yet to crystallize;ii.That the Respondent erred in fact and law in demanding penalties and interest on prematurely assessed income tax and VAT, taking into consideration the fact that the Arbitral Award is still undergoing an appeal process and any income arising therefrom is yet to crystallize;iii.That the Respondent erred in fact and law by overstating the interest awarded under arbitration in relation to “Other claims”, by failing to appropriately apportion the interest to the deemed income and thereby demanding excessive income tax on the overstated interest amount of Kshs. 28,093,976.00;iv.That the Respondent erred in fact and law by demanding additional income tax for the period of 2019 relating to deemed “over-claimed expenses” of Kshs. 49,226,571.20, which are actually trading losses that the Appellant incurred between 2013 and 2015;v.That the Respondent erred in law and in fact by demanding VAT on taxable services for direct and exclusive use in the implementation of official aid-funded projects approved by the Cabinet Secretary to the National Treasury;vi.That the Respondent erred in law and in fact by failing to take cognisance of the express, clear and an unequivocal confirmation by the National Treasury that the Appellant’s project was an official aid funded project, and, as such, exempt from VAT under the provisions of the VAT Act;vii.That the Respondent erred in fact and law in its conclusion that the termination costs, other costs, the financial losses and legal costs did not relate to work done by the Appellant, and were therefore subject to VAT as distinguishable, non-work-related supplies;viii.That the Respondent erred in fact and law by demanding for VAT relating to elements of the award that are financial services items, including guarantee related claims, exchange variances and interest costs, which are clearly classified as VAT-exempt supplies under the VAT Act, 2013;ix.That the Respondent erred in law and in fact by demanding for VAT contrary to the spirit of the Project Agreements, the financing agreement and the contract between Kenya Electricity Transmission Company Limited and the Appellant, all of which provided that the Appellant shall be exempt from VAT for services under the projects;x.That the Respondent erred in fact and law by treating the interest awarded in relation to the arbitration claim as subject to VAT despite having accepted that Section 13(6) of the VAT Act, 2013 excludes interest on late payment in arriving at a consideration that is subject to VAT;xi.That the Respondent erred in law and fact as its assessments are generally excessive, erroneous and without legal basis.
Appellant’s Case
13.The Appellant’s case is premised on the following documents and proceedings before the Tribunal:-i.The Appellant’s Statement of Facts filed on 2nd June 2022 together with the documents attached thereto and proceedings before the Tribunal.ii.The Appellant’s witness statement of James Muthui dated 30th November and filed on 2nd December 2022 that was admitted in evidence on oath on the 26th day of January, 2023.iii.The Appellant’s written submission dated 9th February 2023 and filed on the same date.
14.That on 16th April 2013, Inabensa Instalaciones S.A. entered into two energy and procurement contracts with Kenya Electricity Transmission Company namely; –i.KETRACO/P/007/2012 LOT A, for the construction of 400KV Lessos Tororo electricity transmission line; andii.KETRACO/P/013/13 LOT B, for the extension of an existing substation at Lessos.
15.The Appellant averred that on 25th April 2016, KETRACO purported to terminate the contracts, which led to a dispute between the parties, and in line with the contracts, the dispute was referred to arbitration.
16.That by way of an Arbitral Award dated 30th July 2019, the Arbitral Tribunal found that KETRACO had breached the contracts and awarded the Appellant as follows:i.EURO 30,887,820.39 plus interest of EURO 6,477,870.77 which interest continues to attract further interest from the date of the Award until payment in full; andii.Legal costs of Kshs 102,165,744.20 and interest thereon at 12% until payment in full.
17.That by way of Chamber Summons dated 20th November 2019, KETRACO applied to the High Court to have the Arbitral Award set aside, which application eventually led to a different application for review of a Ruling by the High Court, also seeking stay of execution until the hearing and determination of the application for review. That on 1st July 2021, the High Court made an order for maintenance of status quo (in essence staying execution), which Order is still active, and the application for review and interim stay is therefore pending before the High Court.
18.That on 3rd August 2021, the Respondent issued notices of assessment on income deemed to have accrued to the Appellant in 2019, from the Arbitral Award of 30th July 2019, as summarised below:
| Tax Head | Principal(Kshs) | Penalty(Kshs) | Interest(Kshs) | Total(Kshs) |
| Income Tax | 1,223,319,617 | 61,165,981 | 330,296,297 | 1,614,781,895 |
| VAT | 599,191,070 | 28,599,625 | 120,118,426 | 7 747,909,121 |
| Total | 1,795,312,120 | 89,765,606 | 450,414,722 | 2,335,492,448 |
19.That by way of notices of objection dated 1st September 2021, it objected to the Respondent’s notices of assessment. That the Objection relating to the income tax assessment was raised on the following grounds:i.That the two energy and procurement contracts awarded to Inabensa Spain by KETRACO, comprised of both offshore and onshore components and therefore it is necessary to appropriately allocate income attributable to the Appellant;ii.That the Respondent erroneously assessed to tax income earned by the Appellant because the transfer pricing policy indicates that the offshore works executed outside Kenya constituted 75% of the contract value, while onshore works executed by the Appellant constituted 25% of the contract value;iii.That the Appellant and its Head office invoiced KETRACO separately for the onshore works and offshore works, respectively, and only the income attributable to the Appellant is eligible for income tax assessment in Kenya;iv.That the arbitration claim made by the Inabensa entities constitutes the cost of works done and other costs following termination of contracts and amounts remaining unpaid. That as such income earned by the Appellant relates to only work done which is income also earned by Inabensa Head office;v.That the interest awarded by the Arbitral Tribunal in respect of late payments has not yet been earned by the Appellant since there is an undergoing appeal;vi.That if interest is awarded by the Arbitral Tribunal, the interest will be split between Inabensa head office and the Appellant based on the principal amount earned by each office.vii.That the appeal processes challenging the Arbitral Award are still before the High Court and the Court of Appeal hence the income can only accrue once the appeal process is finalized;viii.That the Respondent did not take into account the income declared in its financial statements for the years 2014 to 2016 and failure to deduct this income would amount to subjecting the same income to tax twice.ix.That the Appellant vide a separate notice of objection dated 1st September 2021, objected to the Respondent’s VAT notice of assessment on the following grounds:a.That the projects implemented by the Appellant were official aid-funded projects as confirmed by the National Treasury in a letter dated 7th August 2013. That accordingly, services under the project were and are exempt in accordance with the provisions of the VAT Act, 2013;b.That the Appellant and its head office invoiced KETRACO separately for the onshore works and offshore works respectively and should it emerge that the Appellant’s income is subject to VAT, it will be critical that only the income attributable to the Appellant is subjected to VAT;c.That the award amounts in relation to other costs and loss of profits are mostly claims for reimbursement following termination of contracts hence do not relate to a supply under the VAT Act and ought not, therefore, be treated as income that should be subjected to VAT;d.That interest on late payments is expressly VAT-exempt under the VAT Act;e.That the appeal processes challenging the Arbitral Award are still before the High Court and the Court of Appeal hence the income can only accrue once the appeal process is finalized.
20.That the Appellant provided all relevant and required documentation to the Respondent, in support of the grounds of objection laid out in the notices of objection, including letters of exemption in respect of the KETRACO contracts, transfer pricing policy, invoices issued to KETRACO by both Inabensa head office and Inabensa Kenya Branch, the detailed Arbitral Award, and a breakdown of the Arbitral Award.
21.That the Respondent vide a letter dated 20th April 2022 issued its objection decision on the additional income tax and VAT, indicating that a revised tax amount of Kshs. 695,974,786.00 is due from the Appellant. That the revised demand is summarised as follows:
| Tax Head | Principal (Kshs) | Penalty (Kshs) | Interest (Kshs) | Total (Kshs) |
| Income Tax | 416,947,127 | 20,847,356 | 116,745,195 | 554,539,678 |
| VAT | 106,342,186 | 5,317,109 | 29,775,812 | 141,435,108 |
| Total | 523,289,313 | 2 26,164,465 | 146,521,007 | 695,974,786 |
22.That the objection decision was issued based on the following conclusions:a.That the Respondent is not a party to the ongoing appeal challenging the Award and as such the arbitral Award still stands.b.That despite the process of seeking VAT exemption for the services under the Project having not been properly completed, the projects were nevertheless VAT-exempt.c.That the awarded amounts in relation to “Other costs”, “Loss of profits”, and other non-work-related items are deemed as separate supplies for VAT purposes and hence subject to VAT.d.That the award amounts that would be subject to tax in Kenya could be distinguished separately as work done in Kenya, compensation in regards to expenses incurred in Kenya by the Appellant and late payment interests relating thereto, and so there is no need for a transfer pricing policy.
23.That the Appellant having been aggrieved by the Respondent’s objection decision, filed with the Tribunal, on 19th May 2022, a Notice of Appeal against the Respondent’s objection decision.
24.The Appellant was of the view that the following issues stand out for determination by the Tribunal:i.Both from an Income tax and VAT perspective, whether the Respondent can deem income to have accrued while the legitimacy of that income is being challenged through Court of Appeal processes;ii.From an Income tax perspective, whether the Respondent can treat claims for reimbursement of costs as income without allowing for deduction of the costs that form the basis of the claim;iii.From a VAT perspective, whether the Respondent can treat costs wholly incurred in relation to carrying out a project as distinguishable supplies from the work done under the project;iv.Whether the Respondent can assess VAT on interest earned from late payment of a taxpayer’s income.
i. Both From An Income Tax And Vat Perspective, Whether The Respondent Can Deem Income To Have Accrued While The Legitimacy Of That Income Is Being Challenged Through Court Appeal Processes;
25.The Appellant stated that there was an ongoing Court matter that was challenging the Arbitral Award of 30th July 2019: High Court Misc. Application No 445 of 2019 – that this application for review last came up on 16th March 2022. KETRACO's advocates indicated that they had appointed lead counsel who needed to familiarize themselves with the matter. That the application was adjourned to 4th July 2022.
26.That based on the fact that the above-referenced court matters were still in progress, it was grossly erroneous for the Respondent to conclude that the arbitration process is complete and that the Appellant had realised any income from the arbitration process, and what portion of any such deemed income had indeed accrued on the Appellant.
27.That it is the prerogative right of the Courts of Kenya to determine a matter brought before them, and in this case, the Courts could rule either in favour of the Appellant or against the Appellant and any income accruing to the Appellant can only be clearly determined upon conclusion of the appeal processes, or alternatively if KETRACO withdraws its appeals.
28.That under Section 37 of the Arbitration Act, 1995, a number of circumstances are laid down under which “recognition …of an arbitral award …may be refused”, and this is indicative of the fact that an arbitral award that has been subjected to a Court of Appeal process may either be recognised/ confirmed, or refused.
29.That in the ruling of Boleyn Magic Wall Panel Limited v Nesco Services Limited [2020] eKLR, the Court agreed with an earlier decision where the Court had pronounced itself that:
30.The Appellant averred that based on the fact that the Arbitral Award of 30th July 2019 is undergoing an appeal process that may end up being favourable for either party, any income arising from the Arbitration Award is indeterminable and cannot be subjected to income tax or VAT until the appellate process is conclusively exhausted. That the Respondent has, therefore, erred in law and in fact by assessing income tax and VAT on the Arbitral Award of 30th July 2019.
31.That by virtue of the fact that any income arising from the Arbitral Award has not yet accrued, crystallised or been earned, it is grossly erroneous for the Respondent to assess any penalties and interest on the assessed income tax and VAT. That any penalties and interest that may be due will only legitimately begin accruing upon conclusion of the appeal process relating to the Arbitral Award.
32.That without prejudice to the above submissions, in the objection decision workings, the Respondent apportioned an erroneous amount of interest relating to “Other Claims” to the Appellant vis-à-vis the Appellant’s head office.
33.That the arbitration claims under the heading “Other Claims” was made up of five items namely; intellectual property, other financial costs, loss of profit, professional legal fees, and insurance costs all totalling EUR 8,974,407.15.
34.The Appellant stated that in the course of reviewing the Appellant’s notices of Objection, on 22nd February 2022, the Respondent provided tentative workings that indicated findings to the effect that an amount of Kshs. 137,038,053.00 relating to financial costs (interest expense) together with EUR 2,506,364.34 relating to loss of profit, professional legal fees, and insurance costs were deemed to have accrued in the hands of the Appellant. That total deemed income was Kshs. 514,143,946.00. That based on this finding, interest relating to “Other Claims” was computed and allocated to the Appellant to the tune of Kshs. 96,629,766.00.
35.That in the final objection decision workings, the Respondent had reduced the deemed assessable income relating to “other claims'' to a total of Kshs 364,662,599.00, but the proportionate interest erroneously remained at Kshs 96,629,766.00. That based on the Appellant’s workings, the interest apportioned and allocated to the Appellant should have equally reduced to Kshs. 68,535,790.00, in which case the interest assessed to income tax and VAT was overstated by Kshs 28,093,976.00.
ii. From An Income Tax Perspective, Whether The Respondent Can Treat Claims For Reimbursement Of Costs As Income Without Allowing For Deduction Of The Costs That Form The Basis Of The Claim
36.The Appellant stated that the arbitration claim made by the Appellant could be summarised as below:
| Heading of Claim | Description of Claim | |
| 1 | Cost of works/facilities executed | Work done but remained unpaid for by KETRACO. |
| 2 | Interest on late payments | Interest for late payment of Appellant’s invoices. |
| 3 | Termination costs | Reimbursement for costs incurred by Appellant in terminating contracts with various suppliers |
| 4 | Change Order rejected | Change order rejected by KETRACO. |
| 5 | Other costs incurred | Reimbursement of other costs incurred in executing the contracts. |
| 6 | Performance Guarantees | Reimbursement of performance guarantees called-up by Appellant’s banks |
| 7 | Financial Losses | Interest/costs on called-up Performance Guarantees |
| 8 | Legal costs | Arbitration and legal expenses incurred by Appellant |
37.The Appellant stated that the arbitration claims relating to termination costs, performance guarantees costs, legal costs and other costs incurred were expenses incurred by the Appellant in the course of rendering the projects, and which were reimbursable by KETRACO in case of a termination of the contracts or any similar event.
38.That since these elements of the Arbitral Award relate to costs incurred by the Appellant, or some costs that the Appellant can reasonably anticipate will be incurred due to termination of the contracts, these are costs that fall under Section 15 of the Income Tax Act as “expenditure wholly and exclusively incurred in the production of income”.
39.That by virtue of the fact that these are costs incurred to generate business income, these are deductible in computing or arriving at a taxpayer’s income chargeable to tax. That in the event that the Respondent concludes that certain income has been earned, it goes without saying, therefore, that expenses incurred to generate such income should be deducted in arriving at a net position of taxable income.
40.That the Respondent therefore erred in law and in fact by failing to treat reimbursable costs as deductible expenses against deemed income earned from the arbitral award.
41.The Appellant stated that the Respondent in its objection decision workings had erroneously disallowed an amount of Kshs 49,226,517.20, on the assumption that these are over-claimed expenses, whereas these are losses incurred by the Appellant between 2013 and 2015, as tabulated below:
| Year | Adjusted loss(Kshs) | Loss in Return(Kshs) | Variance(Kshs) |
| 2013 | 20,714,568 | NIL | 20,714,567.83 |
| 2014 | 19,852,718 | 18,719,136 | 1,133,581.67 |
| 2015 | 28,109,003 | 730,635 | 27,378,367.70 |
| Total | 68,676,289 | 19,449,771 | 49,226,517.20 |
42.The Appellant submitted that since these losses were properly incurred by the Appellant in the course of conducting its business, the amounts were indeed deductible under the provisions of Section 15 (7) (b) of the Income Tax Act, and the Respondent therefore erred in law and in fact by disallowing the amount of Kshs 49,226,517.20.
iii. From A Vat Perspective, Whether The Respondent Can Treat Costs Wholly Incurred In Relation To Carrying Out A Project As Distinguishable Supplies From The Work Done Under The Project
43.The Appellant submitted that Section 2 of the VAT Act, 2013 defines an “official aid funded project” to mean
44.It averred that based on all the project documents, and even as conceded by the Respondent in the objection decision, the projects implemented by the Appellant were official aid funded projects, financed by the African Development Bank and implemented by the Ministry of Energy and Petroleum, through KETRACO.
45.The Appellant stated that Paragraph 20 of Part II of the First Schedule to the VAT Act, which is one of the items specifically recognized as a VAT- exempt supply under the statute, provides for:
46.That the National Treasury, in a letter dated 7th August 2013, wrote to the Respondent confirming that the project is an official aid funded project and accordingly, services to the project are exempt in accordance with the provisions of the VAT Act, 2013. That further, the National Treasury advised the Ministry of Energy and Petroleum to provide the Appellant with the relevant documents to facilitate the processing of VAT exemption without recourse to the National Treasury.
47.That based on the guidance of the National Treasury in its letter dated 7th August 2013, the projects implemented by the Appellant are exempt from VAT under Paragraph 20 of Part II of the First Schedule to the VAT Act, and it is grossly erroneous for the Respondent to assess any VAT relating to the projects.
48.The Appellant explained that the Respondent, in its objection decision, conceded that supplies under the contracts were not subject to VAT, but concluded that only “Work Done” amounted to a supply under the contracts. That by virtue of this erroneous conclusion, the Respondent erroneously assessed VAT on amounts that were deemed non-work-related supplies, including termination costs, other claims, financial losses, legal costs, and interest awarded in relation to the arbitral claims.
49.That all the items that the Respondent considered to be non-work done items were expense items that the Appellant incurred in the course of rendering the projects for its client KETRACO, and these expenses ordinarily build up into an invoice for work done. That it is only because KETRACO terminated the contracts prematurely that the Appellant raised arbitration claims for individual expense items, but if the projects were carried out to their end, all the expense items would have been recovered from KETRACO through invoices for work done.
50.That the Respondent was therefore splitting hairs in concluding that expense items claimed under the arbitration proceedings were not related to work done on the projects, thus arriving at an erroneous conclusion that some of the items do not relate to work done.
51.That by virtue of the fact that all expenses incurred by the Appellant and claimed under arbitration were wholly incurred towards delivering the projects to KETRACO, the Respondent erred in law and in fact by attempting to delink the expenses from work done and concluding that the claimed expenses amount to distinct supplies that fall outside the ambit of VAT exemption.
iv. Whether The Respondent Can Assess Vat On Interest Earned From Late Payment Of A Taxpayer’s Income
52.The Appellant submitted that the Respondent in its objection decision workings, treated deemed non-work done items as Vatable supplies, yet there are elements of the award that are specifically VAT-exempt under the VAT Act especially financial service items such as finance guarantee related claims, exchange variances, and interest costs.
53.That under Paragraph 1 of Part II of the First Schedule to the VAT Act, “financial services” are specified as VAT-exempt supplies, and the listing of items that fall under “financial services” clearly indicates that VAT- exempt income is all income relating to dealings in money, which would include finance guarantee income, interest income, gains relating to foreign exchange variances, and financial losses.
54.It added that under Paragraph 2 of Part II of the First Schedule to the VAT Act, “insurance services” are specified as VAT exempt supplies, but the Respondent erroneously assessed to VAT the Appellant’s claim of Kshs. 13,525,777.00 that relates to insurance costs.
56.That based on Section 13 (6) of the VAT Act, interest on late payment together with overall interest awarded under the arbitral award is clearly excluded from the consideration for computing VAT, and the Respondent therefore erred in fact and in law by assessing VAT on the Appellant’s claim for interest on late payment of its invoices as well as the interest awarded by the Arbitral Tribunal.
Appellant’s Prayers
58.The Appellant prayed that the Tribunal holds:a.That the Appeal be allowed, the demand for taxes be set aside and the assessment quashed.b.That the Respondent’s actions to demand additional taxes on income deemed to have accrued to the Appellant from the Arbitral award dated 30th July 2019 be declared arbitrarily, unreasonable, and unfair since the Arbitral award is undergoing a court appeal process which is yet to be concluded.c.That the Respondent’s employees, agents or any other person purporting to act on behalf of the Respondent be barred and estopped from demanding or taking any further steps towards enforcement or recovery mechanism of the principal tax, penalties and interest.d.That only upon conclusion of the Court of Appeal process relating to the Arbitral award shall the Respondent, its employees, agents or any other persons purporting to act on behalf of the Respondent as permitted to assess income tax on any deemed income arising from Arbitral award, taking into consideration the ground of appeal herein, and treat such deemed income as exempt from VAT.e.That only upon the conclusion of the Court of Appeal process relating to the Arbitral award shall any penalties and interest relating to unpaid income tax begin accruing upon the Appellant, at which point the Respondent, its employees, agent or any other person purporting to act on behalf of the Respondent shall be permitted to demand and take steps toward enforcement or recovery of the assessed principal tax, penalties and interest against the Appellant.f.That the Honourable Tribunal awards the costs of this Appeal and any other remedies that it deems just and reasonable to the Appellant.
Respondent’s Case
59.The Respondent’s case is premised on the hereunder filed documents and proceedings before the Tribunal: -i.The Respondent’s Statement of Facts dated 30th June 2022 and filed on 1st July 2022 together with the documents attached thereto.ii.The Respondent’s written submissions dated 10th November 2022 and filed on the even date together with the legal authorities filed therewith.iii.The Respondent’s Further Written Submissions dated 13th February 2023 and filed on the same date.
60.The Respondent is of the view that the issues for determination are as follows:a.Whether the Respondent was justified to invalidate the Appellant's objection and proceed with confirmation of the assessment.b.Whether the grounds of Appeal raised before this Tribunal are valid for the Tribunal to entertain the same.
61.The Respondent avers that the assessments were correctly issued and conform to Value Added Tax Act. That the Appellant did not provide any evidence that would have altered the assessment. That the Tax Procedures Act places the onus of proof in tax objections on the taxpayer who in this case failed to avail evidence that would support a contrary assessment or that would have guided the Respondent at arriving to a different objection decision. That Section 56(1) of the TPA provides as follows with regard to burden of proof:-
62.The Respondent asserts that the Appellant lodged the objection on 1st September 2021 on iTax, however the same was received and acknowledged and treated as invalidly lodged as it did not have grounds for objection. The Respondent submits that the Tax Procedures Act empowers the Respondent to notify a party where an objection as lodged is invalid and the Appellant was notified and requested to provide documents. That however, the Appellant failed to provide documents as requested. That Section 51 of the TPA provides as follows with regard to notices of objection:-
63.The Respondent avers that the Appellant was uncooperative in the provision of the relevant records and failed to respond to the request for documents hence non-relevant documents or records were provided to support the objection by the Appellant. That as a result, the assessments were made based on the only available information and the best judgment by the Respondent. That the Tax Procedure Act empowers the Respondent or requires the production of such documents vide issuance of notice as deemed necessary in the determination of tax liability. That Section 59(1) of the TPA provides that:-
64.The Respondent avers that it conducted an in-depth examination of the records to analyse the Appellant's returns on VAT tax which were compared. That the Respondent disallowed the direct purchase amount in the Appellant’s income tax returns and instead relied on the invoice value as used in the determination of VAT payable as the true direct purchase cost. The Respondent insists that the objection decision provided a precise and clear breakdown of the workings used to reach the assessments.
65.The Respondent avers that the assessment was issued based on information provided and in the light of the inconsistencies within the Appellant’s VAT ledgers. That the Tax Procedure Act empowers the Respondent to make alterations or additions to original assessments from available information for a reporting period based on the best judgment. That Section 31 of the TPA provides that:-
66.The Respondent further avers that the Appellant failed to provide the documents requested in support of its objection hence input VAT was disallowed. The Respondent insists that the Value Added Tax Act empowers the Respondent to disallow such input VATwhere documents were not provided as follows:-
67.The Respondent insists that not all income earned by the Appellant was declared and hence the variances were brought to charge. That the Tax Procedure Act empowers the Respondent to carry out assessment based on the information available. That Section 28 of the TPA provides as follows:-
68.The Respondent asserts that examination of the Appellant’s records established that the Appellant earned income from projects in the period under audit, however these incomes were not declared for tax purposes for the year earned. The Respondent asserts that the Appellant carried on business in contravention of the Tax Procedure Act which requires such documents be maintained and for purposes of taxation the Section provides as follows: -
69.The Respondent submits that the Appellant did not file income tax returns for the accounting period in contravention of the requirements of the Tax Procedures Act and that estimated assessments were correct. That the Sections provides as follows:-
70.The Respondent avers that the Appellant supplied insufficient documents and the Respondent has embraced the self-assessment regime through trust and facilitation and only verifies information when in doubt of the decorations made in the tax returns. The Respondent deals with each taxpayer’s matter independently and based on available information. The Respondent has used Sections 15 and 16 of the Income Tax Act as follows:-
71.The Respondent denies that the Appellant has paid all its tax dues and reiterates that because of its under- declaration, the Appellant is in debt of Kshs. 695,974,786.00.
72.That the Arbitration Act provides that an arbitration award is final and binding upon the parties and no recourse is available against the Award otherwise than in the manner provided by the Act. That Section 32A of the Arbitration Act states that:-
73.That Section 34 of the Arbitration Act, states that:1.Within 30 days after receipt of the arbitral award, unless a different period of time has been agreed upon by the parties—(a)a party may, upon notice in writing to the other party, request the arbitral tribunal to correct in the arbitral award any computation errors, any clerical or typographical errors or any other errors of a similar nature; and(b)a party may, upon notice in writing to the other party, request the arbitral tribunal to clarify or remove any ambiguity concerning a specific point or part of the arbitral award.
74.The Respondent submits that either of the parties can apply to the court to have the arbitral award reviewed for any clerical, grammatical or typing errors. That however, the court must therefore be careful to avoid entering into the arena of an appellate court by reviewing the award and correcting errors of law and fact when the parties have agreed that a determination by the Arbitrator is final as underscored by the Court of Appeal in Kenya Shell Ltd vs. Kobil Petroleum Limited, Civil Appeal No. 57 of 2006 [2006] eKLR where the court held as follows;
75.The Respondent submits that in reference to the foregoing, the finality of an arbitral award is affected when either party files an application to set aside the award. In support of the position the Respondent quotes in the holding in the case of Boleyn Magic Wall Panel Limited v Nesco Services Limited [2020] eKLR where the court quoted and agreed with the holding in the case of Misc. App 780 of 2017 - Castle Investments Company Limited vs. Board of Governors – Our Lady of Mercy Girls Secondary School [2019] eKLR where the Court pronounced itself that:
76.That in the case of Century Oil Trading Company Ltd vs. Kenya Shell Limited Nairobi (Milimani) HCMCA No. 1561 of 2007 where the learned Judge stated that,
77.The Respondent further submits that the arbitral award becomes final when the arbitrator publishes the award and after which the party can apply to the High Court to have the same enforced. In addition, where the parties have agreed that the arbitral award becomes final after its publication, neither party can make an application to have it set aside or reviewed.
78.That Section 36 of the Arbitration Act has the power to recognize and enforce domestic arbitral award on the following terms:-
79.Hinga vs Victoria Njoki Gathara Nairobi Civil Appeal No. 8 of 2009, where the Court of Appeal held that:-
80.Respondent avers that the Appellant has undeserving prayers sought due to the forestated reasons.
Respondent’s Prayers
81.The Respondent prays that this Tribunal considers the case and finds that:a.That the Respondent’s objection decision be upheld.b.That the outstanding arrears of Kshs 695, 974,786.00 are due and payable by the Appellant.c.The confirmed assessment dated 3rd August 2022 was proper in law.d.That the Appeal herein be dismissed with cost to the Respondent.
Issues For Determination
82.The Tribunal upon due consideration of the pleadings and the written submissions of the parties was of the considered view that the Appeal raises the following issue for its determination:a.Whether the Respondent’s assessment and subsequent confirmation for VAT from the Appellant were justified.b.Whether the Respondent’s assessment and subsequent confirmation for Income Tax from the Appellant were justified.
Analysis And Determination
83.The Tribunal having established the issues for its determination, proceeded to analyse the same as hereunder.
a. Whether The Respondent’s Assessment And Subsequent Demand For Income Tax And Vat From The Appellant Were Justified.
84.The VAT assessment emanated from an Arbitral Award dated 30th July 2019 in favour of the Appellant of which the KETRACO applied to the High Court to set the same aside. Based on the said Award, the Respondent issued assessments on 3rd August 2021.
85.The Respondent averred that the VAT assessments were correctly issued and conform to the Value Added Tax Act.
86.The Appellant argued that the projects it implemented were official aid-funded projects as confirmed by the National Treasury in a letter dated 7th August 2013. That accordingly, services under the project were and are exempt in accordance with the provisions of the VAT Act, 2013;
87.The Appellant submitted that based on all project documents, and as even conceded by the Respondent in its objection decision, the projects implemented by the Appellant were official aid funded projects, financed by the African Development Bank and implemented by the Ministry of Energy and Petroleum, through KETRACO.
88.The Tribunal having reviewed the parties’ pleadings in detail established that as the provision of the law is clear, and given the documents provided by the Appellant, there is a general consensus between the parties that the agreement between KETRACO and the Appellant was for Official Aid Funded Projects that were exempt VAT supplies.
89.As per the exemption letter by the National Treasury dated 7th August, 2013, the Appellant’s projects were exempted in accordance with the provisions of Part A, Item 10 of the 5th Schedule to the EAC Customs Management Act and Sections 23(1) and 23(3)3 (a) of the VAT Act as read together Legal Notice No. 67 of 12th June ,2003 and Regulations 38 A (7) of the Customs and Excise Act, the Cabinet Secretary approved , on 2nd August 2013, recommended for remission of duty, VAT and IDF fees in respect of motor vehicles, materials and equipment being imported or purchased by M/s Instalaciones Inabensa SA or Spain on behalf of M/s Kenya Electricity Generating Transmission Company Limited (KETRACO). That the project was being funded by African Development Bank (AfDB).
90.Section 2 of the repealed VAT Act (Cap 476) defined “official aid funded project” to mean a project funded by means of a grant concessional loan in accordance with an agreement between Government and any foreign government, agency, institution, foundation, organization or any other aid agency.
91.Section 2 of the VAT Act 2013 defines “official aid funded project” to mean a project funded by means of a grant concessional loan in accordance with an Agreement between Government and any foreign government, agency, institution, foundation, organization or any other aid agency.
92.Section 23 (1) and 23 (3) (a) and (e) of the repealed VAT Act (Cap. 476) that was the basis of the exemptions, by the National Treasury to the Appellant, stated as follows regarding remission:
93.In 2015, the Finance Act amended the VAT Act 2013 to include exemptions on official aid funded projects as follows:i.Part I of the First Schedule to the VAT Act 2013 to provide for exempt goods thus:“Taxable goods, imported or purchased for direct and exclusive use in the implementation of official aid funded projects upon approval by the Cabinet Secretary responsible for the National Treasury”.ii.Part II of Section B to the First Schedule to the VAT Act provides for exempt services as thus:“Taxable services for direct and exclusive use in the implementation of official aid funded projects upon approval by the Cabinet Secretary to the National Treasury.”
94.The Tribunal confirms that the provisions of the VAT as relates to the exemption from VAT of official aid funded projects is clear.
95.The Tribunal further finds that the Award was for work done but which remained unpaid for by KETRACO, reimbursement for costs incurred by the Appellant in terminating contracts with various suppliers, change order rejected by KETRACO, reimbursement of other costs incurred in executing the contracts, reimbursement of performance guarantees called-up by the Appellant’s banks forming part of the contracts between the Appellant and KETRACO which contracts are in furtherance of official aid funded projects and which are VAT exempt under Section 23 of the repealed VAT Act (Cap. 476), Part I, Section A of the First Schedule to the VAT Act 2013 and Part II of the First Schedule to the VAT Act 2013.
96.Therefore, taxable goods and taxable services for direct and exclusive use in the implementation of official aid funded projects are exempt from VAT and cannot be charged VAT by the Respondent.
97.The Tribunal finds and holds that the Respondent was not justified in assessing tax relating to VAT.
b. Whether The Respondent’s Assessment And Subsequent Confirmation For Income Tax From The Appellant Were Justified.
98.The Income Tax assessment emanated from an arbitral award dated 30th July 2019 in favour of the Appellant of which the KETRACO applied to the High Court to set the same aside. Based on the said award, the respondent issued assessments on 3rd August 2021.
99.The Respondent was of the contention that whereas the goods were for official aid funded projects, the income tax assessment and subsequent demand issued was for the interest in the arbitral award which accrued interest thus giving the Appellant new income as the awarded amounts in relation to “Other costs”, “Loss of profits”, and other non-work-related items.
100.The Appellant averred that its arbitration claims related to termination costs, performance guarantee costs, legal costs and other costs incurred which were expenses incurred by the Appellant in the course of rendering the projects and which are reimbursable by KETRACO in case of a termination of the contracts or any similar events.
101.The Appellant further submitted that this was expenditure wholly and exclusively incurred in the production of income as provided for under Section 15 of the Income Tax Act and these are deductible in computing taxable income.
102.The Tribunal notes that the referral of the matter to the Arbitrator was based on a claim by the Appellant to their client, KETRACO, and financial statements of which an income had been declared. The claim basis is as here below; -
| Heading of Claim | Description of Claim | |
| 1 | Cost of works/facilities executed | Work done but remained unpaid for by KETRACO |
| 2 | Interest on late payments | Interest for late payment of Appellant’s invoices |
| 3 | Termination costs | Reimbursement for costs incurred by Appellant in terminating contracts with various suppliers |
| 4 | Change Order rejected | Change order rejected by KETRACO. |
| 5 | Other costs incurred | Reimbursement of other costs incurred in executing the contracts. |
| 6 | Performance Guarantees | Reimbursement of performance guarantees called-up by Appellant’s banks |
| 7 | Financial Losses | Interest/ costs on called-up Performance Guarantees |
| 8 | Legal costs | Arbitration and legal expenses incurred by Appellant |
103.The Tribunal noted that the objection decision workings ab initio was based on a 37.5% corporate tax element on the entire claim plus penalties and interest.
104.Similarly, the Arbitration and legal expenses that were incurred by the Appellant are in connection with the official aid funded projects and are reimbursements of costs which means there is no gain which can be subjected to tax and as such the Tribunal finds that the Respondent erred in charging taxes on these items.
105.On Financial losses carried forward in relation to the years of income preceding 2019 an amount of Kshs. 49,226,518.00 was omitted and termed “Over-claimed expenses”, yet these were losses incurred between 2016 and 2017, and eligible for deduction;
106.Further, the Tribunal established that the Appellant made a claim for loss of profits and the Tribunal is of the considered view that any profits made by an entity trading in Kenya are subject to income tax. Therefore, the claim on loss of profits would be chargeable to tax if paid by KETRACO as per Section 3 of the Income Tax Act.
107.Section 3(1) of the Income Tax Act states as follows regarding charge of tax:
108.Further, Section 3 (2) (i) of the Income Tax Act provides as follows in regard to income upon which tax is chargeable:
109.Due to the foregoing, the Tribunal concludes that the only items in the objection decision workings that qualify for income tax are cost of works done in Kenya and the related interest accruing on late payment of the same, interest for late payment of Appellant’s invoices and any claim paid on loss of profits as they are incomes earned by the Appellant and are not exempt from income tax hence chargeable to tax. In this regard, the Respondent did not err in charging tax on the same. Further, the income tax on these items would only crystallise once the claims are settled by KETRACO.
Final Decision
110.In view of the foregoing analysis, the Tribunal finds that the Appeal partially succeeds and accordingly proceeds to make the following Orders: -a.The Appeal is partially allowed;b.The Respondent’s objection decision dated 20th April 2022 be and is hereby varied as follows:-i.The tax assessment in relation to VAT amounting to Kshs. 141,435,108.00 is hereby set aside.ii.The Corporation tax assessment be and is hereby referred to the Respondent to recalculate Corporation tax assessed to exclude the termination costs, change order, other claims except loss of profits and legal costs in line with the Tribunal’s findings.iii.That the recomputed Corporation tax to be payable upon recovery by the Appellant from KETRACO.c.Each Party to bear its own costs.
111.It is so ordered.
DATED AND DELIVERED AT NAIROBI THIS 8TH DAY OF SEPTEMBER, 2023ERIC NYONGESA WAFULA.............CHAIRMANCYNTHIA B. MAYAKA............................MEMBERGRACE MUKUHA....................................MEMBERJEPHTHAH NJAGI...................................MEMBERABRAHAM K. KIPROTICH...................MEMBER