A Nairobi restaurant has lost a bid to overturn a tax assessment after the High Court ruled that the law cannot assist a taxpayer, who files nil returns while failing to maintain statutory records to explain cash flows through its bank accounts.
The court dismissed an appeal by Avery Lounge Limited against the Commissioner of Domestic Taxes and upheld the Kenya Revenue Authority’s (KRA) use of bank deposits to reconstruct income.
The decision sets a precedent for businesses that declare zero income while actively operating, yet fail to produce proper accounting records when challenged.
"A court cannot aid a taxpayer who, having failed to keep statutory records, seeks to rely on generalities and summaries to defeat a specific, evidence-based assessment," the judge ruled.
Avery Lounge operates a restaurant and lounge along Nairobi’s Eastern Bypass. Incorporated in June 2019, its primary business involves hospitality services—a sector the court noted is "known for high volumes of cash and electronic transactions."
Despite registering for income tax, value-added tax and pay-as-you-earn, the company either filed nil returns or failed to submit any returns for years, earning classification as a ‘nil-filer’ or ‘non-filer.’
This stance contradicted reality following investigations. During a November 2021 inspection, KRA officers found Avery fully operational, serving customers and presumably generating revenue. The visit confirmed suspicions raised by KRA’s compliance systems: the business was trading while declaring no income.
KRA expanded its investigation, obtaining third-party records from banks and suppliers, which revealed substantial deposits flowing through the restaurant’s accounts.
With no credible books of account provided, the Commissioner issued default assessments on May 5, 2023, covering 2018 to 2021, using bank deposit analysis—a method treating gross deposits as taxable turnover unless proven otherwise.
Avery objected, arguing that not all deposits constituted income, citing loans and director advances, and accused KRA of disregarding business expenses.
The tax authority demanded supporting documents, including ledgers, invoices, audited accounts, loan agreements and M-Pesa statements.
However, Avery furnished only partial bank statements and a summary, leading KRA to reject its objection. The Tax Appeals Tribunal upheld the assessment in a June 2024 ruling, prompting Avery’s High Court appeal.
Central to the appeal was the burden of proof. The court affirmed that Section 56 of the Tax Procedures Act places this burden on taxpayers to disprove KRA’s assessments.
While credible evidence can shift this burden, Avery failed to meet the threshold. The company relied solely on bank statements and self-prepared summaries, which the court deemed insufficient.
"Primary evidence consists of source documents—invoices, receipts, loan agreements, and transaction ledgers—that classify each entry at the time it occurs," the judge clarified. "A bank statement records fund movements, not their nature."
Without documentation distinguishing deposits as sales, loans or refunds, Avery’s claims remained unsubstantiated.
The court also validated KRA’s use of Section 29 of the Tax Procedures Act, which permits assessments based on the "best of judgment" when taxpayers fail to maintain records.
"Assessing a nil-filer based on bank deposits is a reasonable exercise of administrative power," the court ruled.
"To hold that the Commissioner cannot tax gross deposits in such a scenario would be to incentivise the destruction of records and the filing of nil returns," it added.
The judgment emphasised that this power does not authorise arbitrary estimates but allows KRA to act on available evidence when taxpayers neglect record-keeping.
Bank deposit analysis, the court noted, is a legitimate tool—particularly against nil-filers visibly operating businesses—since it presumes unexplained deposits are income unless rebutted. Avery failed to isolate and prove non-income deposits.
Regarding expenses, the court upheld Section 15 of the Income Tax Act, permitting deductions only for costs "wholly and exclusively" tied to income generation, with taxpayers bearing the proof burden. Avery’s lack of documentation undermined its expense claims.
Finally, the court dismissed Avery’s argument that its rights to fair administrative action and hearing were violated, noting the company received notices, contested assessments, participated in tribunal proceedings, and was repeatedly asked for documents.
Dissatisfaction with the outcome, the judge concluded, does not equate to procedural unfairness.
The court potentially backed KRA’s authority to combat tax evasion through rigorous scrutiny of nil-filers, underscoring taxpayers’ obligation to maintain accurate records or face assessments based on available financial evidence.
