The High Court has delivered a victory for the Kenya Revenue Authority (KRA) in a tax dispute with a building and civil engineering contractor, reinstating a Sh773 million tax assessment that had been partially overturned by the Tax Appeals Tribunal last year.
The court ruled that the Tribunal erred in law by dismissing KRA’s findings on Dinesh Construction Ltd's alleged tax evasion through 'missing trader' schemes and unexplained bank deposits.
The dispute stemmed from KRA's audit covering Dinesh Construction's business operations for the period 2016 to 2021. The scope of the audit was extensive, encompassing multiple tax obligations: corporation tax, value added tax (VAT), pay as you earn (PAYE) and withholding tax.
The audit initially calculated a tax liability of Sh1.1 billion, which was later reduced to Sh773 million in 2022 following engagements with the company.
At the heart of the case were two major findings by KRA investigators. The audit flagged Sh689 million in purchases from suppliers suspected to be 'missing traders' —entities that issue invoices but do not supply actual goods.
It also uncovered Sh187 million in unexplained bank deposits that did not match the company's declared income.
The tax agency accused the company of underreporting income, inflating input VAT claims through transactions with non-existent suppliers, and failing to declare employee benefits.
When Dinesh Construction challenged these findings at the Tax Appeals Tribunal, the tribunal partially ruled in its favor in last June slashing the assessment and dismissing claims related to missing traders as unproven.
It also declared part of the demanded taxes as time-barred and accepted the company's argument that it could not be held responsible for its suppliers' tax compliance failures. The tribunal also questioned KRA's banking analysis methodology.
It held that the company had provided sufficient documentation to support its purchases and that the KRA had failed to prove fraud regarding the alleged missing traders. Consequently, the Tribunal set aside the assessments related to disallowed purchases.
However, while allowing KRA's appeal, the court found the Tribunal erred in law by ignoring binding precedents on tax fraud investigations.
The court emphasized that taxpayers must provide concrete proof—such as delivery notes, purchase orders, or transport records—when KRA raises credible doubts about suppliers.
"An invoice alone cannot prove its own validity when the supplier’s existence is disputed," the court stated, dismissing Dinesh Construction’s reliance on invoices and ETR receipts as insufficient.
The ruling emphasised that companies must provide supporting documents like delivery notes, purchase orders and goods movement records - not just tax invoices.
The court found Dinesh Construction failed this test despite holding ETR receipts, as it could not substantiate actual receipt of goods from some of the suppliers. The ruling established that commercial transactions involving hundreds of millions must leave verifiable footprints.
"Commercial reality dictates that the movement of goods worth hundreds of millions of shillings leaves a footprint beyond a paper invoice. A prudent business dealing in construction materials must have LPOs, Delivery Notes, Weighbridge tickets, stock records and site usage logs," said the judge.
On the company's argument that it was not required to keep such elaborate records or police its suppliers, the court said this defence is legally unsustainable under section 23 of the Tax Procedures Act and section 43 of the VAT Act, which mandates the keeping or records to ascertain tax liability.
On the statute of limitations issue, the judge ruled the Tribunal miscalculated the five-year window for tax assessments, which actually expired on December 14, 2022 - coincidentally the same day KRA issued its final demand to the company.
"Taxpayers cannot benefit from their own delays in filing returns to avoid scrutiny," the judge observed.
More significantly, the judgment establishes stricter evidentiary standards for businesses claiming input VAT deductions.
Overturning the Tribunal's approach, the judge cited binding precedents which held that once KRA presents credible evidence of "missing trader" fraud, the burden shifts to the taxpayer to prove the legitimacy of transactions.
The judge held that the right to deduct input tax under the VAT Act is premised on a valid supply. If the supplier is a "missing trader" who never bought or possessed the goods they purportedly sold, then no supply took place in law.
"The transaction is a fiction. If the respondent cannot prove —via delivery notes and transport logs— that it actually received goods from these specific suppliers, it cannot deduct the input VAT, regardless of whether it holds a tax invoice," said the judgment.
The judge concluded: "The Tribunal's approach would make it an unwitting facilitator of the very fraud the tax system seeks to prevent."
According to the court, the correct position is that where the KRA Commissioner alleges missing trader fraud and provides evidence, the taxpayer must prove the transactional reality of the supply. In this instance, Disnesh failed to do so.
Regarding the Sh187 million in bank deposits, the court upheld KRA's banking analysis method as legally sound under Section 24(2) of the Tax Procedures Act.
The judge dismissed the company's explanation that these were inter-account transfers or director loans, noting the complete absence of supporting documentation like bank reconciliations or loan agreements.
Despite this verdict, the company may still appeal to the Court of Appeal.
