Judgment summary
The Appellant, Fuse Holdings Limited, was assessed by the Respondent for corporation tax, VAT and withholding tax for the years of income 2020 and 2021, totalling Kshs. 45,867,327. The parties later reached a Partial Consent resolving the VAT and withholding tax elements and part of the corporation tax assessment, leaving only the disallowance of interest on thin capitalisation grounds for determination by the Tribunal.
The Tribunal found that although the Respondent had cited the version of Section 16(2)(j) of the Income Tax Act introduced by the Finance Act, 2021 (which only came into force on 1st January 2022), the substance of its computation applied the debt-to-capital ratio test that was actually in force in 2020 and 2021. The Tribunal held that the Appellant had failed to prove it was not under non-resident control, and had not substantiated its claims regarding interest-free loans or the composition of its bank borrowings.
The appeal was dismissed, and the objection decision disallowing interest expense of Kshs. 79,751,087 was upheld, with each party bearing its own costs.
Background
The Appellant is a private company incorporated in Kenya whose principal business is the ownership of property for rental income generation (para 1). The Respondent, a principal officer under the Kenya Revenue Authority Act, conducted a verification of the Appellant's tax affairs covering corporation tax, VAT, PAYE and withholding tax (paras 2-3).
Following this verification, the Respondent issued a notice of assessment dated 30th June 2025 for the years of income 2020 and 2021, demanding Kshs. 45,867,327, comprising corporation tax of Kshs. 41,443,222, VAT of Kshs. 4,268,641 and withholding income tax of Kshs. 155,464 (para 4). The Appellant objected on 24th July 2025 (para 5), and the Respondent issued an objection decision dated 19th September 2025 rejecting the objection and confirming the assessment (para 6).
The Appellant lodged a Notice of Appeal dated 14th October 2025 (para 7). The parties subsequently entered a Partial Alternative Dispute Resolution agreement dated 29th May 2026, reduced into a Partial Consent dated 4th June 2026 and filed on 18th June 2026 (para 8). Under the Partial Consent, the VAT assessment was reduced to Kshs. 94,138 and withholding tax to Kshs. 17,380, with the Appellant undertaking to pay Kshs. 111,518 by 25th June 2026 (para 9). The income tax assessment was revised from Kshs. 41,443,221 to Kshs. 26,090,873, comprising principal tax of Kshs. 16,531,053, penalties of Kshs. 826,553 and interest of Kshs. 8,773,268, but this revised assessment remained in dispute and was referred back to the Tribunal (para 10).
The Tribunal adopted the Partial Consent as a part-judgment on 18th June 2026, leaving only the thin capitalisation disallowance for determination (paras 11-12).
Core dispute
The issue for determination was whether the Respondent erred in disallowing interest expense of Kshs. 79,751,087 (Kshs. 40,334,290 for 2020 and Kshs. 39,416,797 for 2021) on account of thin capitalisation (para 38).
The Appellant argued that the Respondent had unlawfully applied Section 16(2)(j) of the Income Tax Act as amended by the Finance Act, 2021 (effective 1st January 2022) retrospectively to the 2020 and 2021 years of income, and had failed to consider EBITDA as required by that amended provision (paras 16-18). It further argued that, under the law properly applicable to 2020 and 2021, thin capitalisation rules applied only where a resident entity was controlled by a non-resident person alone or together with four or fewer other persons, which it said was not its case, and that all its interest-bearing loans were from local banks (paras 19-23).
The Respondent maintained that it had applied the Income Tax Act, Revised Edition 2019, under which thin capitalisation rules based on a 3:1 debt-to-equity ratio for foreign-controlled, non-financial companies subsisted, and that borrowings from directors and related parties, including Filmico Agencies Limited, Halogen Holding Limited and Jasmine Holdings Limited, exceeded three times the Appellant's capital (paras 27-31). It relied on Section 56(1) of the Tax Procedures Act and Section 30 of the Tax Appeals Tribunal Act to place the burden of proof on the Appellant (para 33).
Court findings
The Tribunal found that the Respondent had, in its objection decision and Statement of Facts, reproduced the version of Section 16(2)(j) of the Income Tax Act as amended by Section 9 of the Finance Act, 2021, which only came into operation on 1st January 2022, and so could not govern the years of income 2020 and 2021 (paras 42-45). The Tribunal recorded this as an error, noting that a taxing provision does not operate retrospectively absent clear words to that effect (para 45).
However, the Tribunal held that the citation of a wrong provision does not itself vitiate the act where the substance of the act is authorised by the provision in force at the material time (para 46). It found that the Respondent's actual computation measured total borrowings against three times the sum of paid-up share capital and revenue reserves, which was the test prescribed by the version of Section 16(2)(j) in force in 2020 and 2021, notwithstanding the misdescription (paras 47-48).
The Tribunal held that it was the Appellant's onus to prove it was not in the control of a non-resident person alone or together with four or fewer other persons in 2020 and 2021 (paras 52-53). It found the Appellant's sole evidence, an annual return (Form CR29) made up to 30th January 2025, was not contemporaneous with the years assessed and did not prove the control position in 2020 and 2021 (paras 54-56). No annual returns, registers of members, audited financial statements or statements of changes in equity for the relevant years were produced (para 57).
The Tribunal also found that the Appellant had not substantiated, by loan agreement, board resolution, ledger extract or audited financial statement, that any borrowings from directors and related parties were interest-free, nor had it established through Annexure IX (a facility summary as at November 2021) the full composition of its bank borrowings (paras 59-61). The Tribunal noted that three times the Appellant's total capital yielded at most Kshs. 23,528,238 for 2020 and Kshs. 25,047,702 for 2021, figures vastly exceeded by borrowings of Kshs. 499,293,963 and Kshs. 500,466,382 respectively (para 62).
Outcome
The Tribunal found that the Appellant had not discharged its burden of proving that the disallowance of interest of Kshs. 79,751,087 for the years of income 2020 and 2021 was excessive or erroneous (para 64), and held that the Respondent did not err in disallowing that interest expense on account of thin capitalisation (para 65).
The appeal, insofar as it concerned the thin capitalisation assessment referred back under the Partial Consent, was dismissed. The Respondent's objection decision dated 19th September 2025, disallowing interest expense of Kshs. 79,751,087 and confirming the income tax principal tax, interest and penalties for 2020 and 2021 on the ground of thin capitalisation, was upheld. Each party was ordered to bear its own costs (para 66).
Tp method highlighted
The thin capitalisation test applied was the debt-to-equity style ratio under Section 16(2)(j) of the Income Tax Act as it stood in 2020 and 2021, which disallowed interest deductions to the extent that the highest amount of all loans held by the company during the year exceeded three times the sum of revenue reserves and issued and paid-up share capital, or the sum of loans acquired before 16th June 1988 (paras 47, 49). The Respondent computed borrowings-to-capital ratios of 64 for 2020 and 60 for 2021 against this threshold (para 28), and the Tribunal found the threshold of Kshs. 23,528,238 for 2020 and Kshs. 25,047,702 for 2021 was exceeded many times over by borrowings of nearly half a billion shillings each year (para 62).
Major issues / areas of contention
- Whether the Respondent erred by disallowing interest expense of Kshs. 79,751,087 for the years of income 2020 and 2021 on account of thin capitalisation.
- Whether the Respondent applied Section 16(2)(j) of the Income Tax Act as amended by the Finance Act, 2021 retrospectively to the 2020 and 2021 years of income.
- Whether citation of the wrong version of Section 16(2)(j) vitiated the disallowance where the substance of the computation applied the provision in force at the material time.
- Whether the Appellant was in the control of a non-resident person alone or together with four or fewer other persons in 2020 and 2021.
- Whether the Appellant proved that certain borrowings from directors and related parties were interest-free and thus excluded from the definition of 'all loans' under Section 16(3) of the Income Tax Act.
- Whether the Appellant discharged its burden of proof under Section 56(1) of the Tax Procedures Act and Section 30 of the Tax Appeals Tribunal Act to show the assessment was excessive or erroneous.