Six years ago, when the corrugated pipe manufacturer Kirin Pipeline Limited was setting up its business in Kenya, it received Sh150 million from three Chinese entities to fund its business operations.
Like any other newly established business, Kirin needed money and resorted to raising funds through loans and capital injections from shareholders.
Additional funds were received in the form of advance payments from a Chinese firm for anticipated future sales.
But, as part of its expenditure after starting the business, a sum of Sh63.7 million was transferred from the bank and disbursed through M-Pesa account as payments to one of the directors and employees.
These transactions attracted the attention of the Kenya Revenue Authority (KRA), which demanded Sh21.6 million for corporation tax and value added tax (VAT).
This followed an investigation into the company's tax affairs for the years 2019 to 2022. The tax assessments conducted in June 2024 were arrived at using the banking analysis method.
Initially, the taxman had demanded Sh56.9 million, comprising income tax of Sh34.3 million and VAT of Sh22.6 million, but the figure was reduced to Sh21.6 million in September 2024 following an objection by the company.
Of particular interest to the KRA was the finding that one of the directors and three other expatriate employees had received money in the form of cash withdrawals and mobile money transfers to their M-Pesa accounts.
As there was no supporting documentation for the M-Pesa transfers and withdrawals, the KRA treated them as emoluments and taxed them under the Pay As You Earn (PAYE).
Kirin Pipes disputed the tax demand, resulting in a legal battle at the Tax Appeals Tribunal in Nairobi. The company's main argument was that the amounts deposited into its bank account were not income, but capital injection by the shareholders and loans advanced to it.
Therefore, it maintained that KRA could not charge VAT on these transactions as they were not sales.
At the heart of the dispute was whether the monies received from a customer as advanced payments for future sales, or from shareholders as capital injections could be subject to taxation.
According to the taxman, the company had failed to provide documentation to support its assertion that the sums received were not taxable.
Also missing was convincing information on the flow of cash to Kirin from a foreign entity, Zhonghao Overseas Construction Eng Co Ltd (China), which was not a shareholder of the company, but which claimed to have injected money on behalf of shareholders.
Wiring funds
Between 2019 and 2021, the Sh150 million was wired to Kirin in various tranches by Nanchang Municipal Engineering Development (Sh31.6 million), Zonghao Overseas Construction Eng Co. Ltd China (Sh54 million), and Zhonghao Overseas Construction Eng Co. Ltd Kenya (Sh65.3 million).
Documents filed at the Tax Appeals Tribunal show that Kirin began operations in Kenya in 2019, when the shareholders injected share capital.
The company's ordinary share capital was Sh10 million, but further capital was required to ensure the success of the venture as operations began.
The shareholders injected capital by depositing the total sum of Sh54 million into Zhonghao Overseas Construction Engineering Company Limited (China), which then transferred the sum to Kirin.
During its formative years, the company required funds to help cover the initial setup costs and operating expenses. To this end, Kirin acquired a Sh31.6 million loan from Nanchang Municipal Engineering Development.
In 2020 and 2021, Kirin received an advance payment totalling Sh65.3 million from Zhonghao Overseas Construction Eng Co Ltd (Kenya) for sales to be made at a later date.
Tribunal documents show that these advance payments were made in support of Kirin's business.
In its fight against the tax demand, the company said KRA erred in law and fact by equating all bank account credits with taxable income and sales revenue.
It also argued that it was wrong for the taxman to subject the deposits constituting shareholder capital injections and loans to corporation tax and VAT. The company also claimed that it was erroneous for KRA to tax advance payments for sales that were subsequently declared and taxed, resulting in double taxation.
The company presented bank SWIFT confirmations as part of its evidence, which it argued were ignored by the KRA.
"It (KRA) instead proceeded with a blanket equation of all bank deposits to turnover. This is not the "honest guesswork" permitted by law; it is a wilful disregard of available material," Kirin stated in its appeal against the KRA's demand.
But the tax tribunal ruled in favour of KRA, finding that all deposits to a bank account can be deemed as taxable income if the account holder fails to provide sufficient evidence proving that the deposits are not income or other non-taxable funds.
For instance, the company failed to prove that deposits of Sh54 million in its bank accounts were attributable to capital injections from its shareholders.
The tribunal noted that Kirin failed to provide an analysis of the specific deposits relating to capital injections, or to link the deposits to the shareholders indicated in the company's Official Company Search (formerly known as Form CR12).
Tribunal ruling
Since Kirin stated that Zhonghao Overseas Engineering Company Limited (China) was not a shareholder, but rather that its shareholders had made deposits through Zhonghao, the tribunal said it was incumbent upon Kirin to demonstrate how capital flowed from its owners to Zhonghao Overseas and how it was accounted for.
"The appellant provided uncertified bank statements and SWIFT confirmation slips which could not be attributed to capital deposits in the absence of other corroborative documents, such as an analysis and description of the deposits, meeting minutes/resolutions or any other document to demonstrate that indeed the amounts in question were capital injections in the appellant," said the tribunal.
In relation to the loans from Nanchang Municipal Engineering Development, the tribunal said Kirin did not provide evidence that the amount of Sh31.6 million was a loan.
The veracity of the loan agreement was called into question as the document indicated that the loan was interest-free and that it could be repaid at any time at the discretion of Kirin.
"The tribunal finds that the documents adduced by the appellant to support its claim that Sh31.6 million of the deposits in its accounts were proceeds of a loan advanced by Nanchang Municipal Engineering Development were insufficient and did not meet the evidential threshold of disproving that the loan was income chargeable to tax," ruled the tribunal.
It further stated that such open terms in the loan agreement made it difficult to verify whether the amount was indeed a loan, given that no interest was charged and there was no repayment date or period.
The tribunal also noted that although the loan was dated 2019, when KRA conducted tax assessments in 2024 (five years later), Kirin failed to provide evidence of any repayments made on the loan.
Regarding the advance payment of Sh65.3 million by Zhonghao Overseas Engineering Company Limited (Kenya) for future purchases, the tribunal ruled that Kirin failed to attach copies of the invoices for verification purposes.
"The appellant did not highlight the specific transactions or deposits which constitute the advance payments for future supplies. In addition, the bank statements provided were not certified, hence, their authenticity was not verifiable," it stated.
It further found that Kirin failed to provide a schedule comprising the specific deposits for the advance payments, copies of invoices, and evidence of the resultant tax payments. Therefore, Kirin did not discharge its burden of proof.
The tribunal concluded that KRA did not err in treating all bank deposits as income.
