Judgment summary
The Appellant, a Kenyan company investing in subsidiaries and holding rental property, was audited by the Respondent for the years 2020 to 2024 after a Capital Gains Tax declaration prompted review (paras 1-3).
The audit found no anomalies in PAYE, Capital Gains Tax or rental income, but the Respondent treated a bonus issue of 197,900 ordinary shares to the Appellant's sole member, Premchandbhai Foundation Registered Trustees, funded from retained earnings, as a deemed dividend under Section 7(1)(b)(ii) of the Income Tax Act (paras 5-8).
The Respondent assessed income tax under Section 7A of the ITA on untaxed reserves of Kshs. 138,414,182.00 and withholding tax under Section 35 of the ITA, issuing a Notice of Assessment for Kshs. 70,227,036.00 (paras 9-12). Following an unsuccessful objection, the Respondent confirmed the assessment by an Objection Decision dated 28th January 2026 (para 13).
The Tribunal held that no obligation measurable in money was owed by the Foundation to the Appellant, that the shares were credited as fully paid from capitalised reserves, and that no dividend had been distributed. It found the assessments under Section 7A of the ITA and the withholding tax assessment could not stand, and allowed the appeal, setting aside the Objection Decision.
Background
The Appellant was incorporated in Kenya on 14th May 1993 and is engaged in investment in subsidiary companies and holding rental property (para 1). The Respondent, a KRA principal officer, flagged the Appellant for review in January 2024 after noting a Capital Gains Tax declaration claiming a capital loss of Kshs. 10,858,312.00 against a capital gain of Kshs. 11,628,759.00 (para 3).
By letter dated 1st February 2024, the Respondent notified an audit covering 2020 to 2024 on Capital Gains Tax, PAYE and Income Tax (Company) (para 4). The audit disclosed no anomalies save on retained earnings and a share issue (para 5).
By Written Resolution of 1st December 2021, the Appellant increased nominal share capital from Kshs. 100,000.00 to Kshs. 400,000,000.00, partly financed by capitalising retained earnings (para 6). By resolution of 28th January 2022 and a Shareholders' Joint Venture Agreement dated 31st January 2022, the Appellant issued 2,000 ordinary shares to the Foundation for Kshs. 2,000,000.00, and a further 197,900 ordinary shares as bonus shares out of retained earnings, with 200,000 shares also issued to Costronal Holdings S.A. (para 7).
The Respondent treated the bonus issue as a deemed dividend under Section 7(1)(b)(ii) of the ITA, found Kshs. 138,414,182.00 of retained earnings to be untaxed gains chargeable under Section 7A of the ITA, and held withholding tax due under Section 35 of the ITA, the Foundation being an incorporated irrevocable trust rather than a company for purposes of Section 7(2) of the ITA (paras 8-10). A Notice of Assessment dated 29th October 2025 assessed Kshs. 70,227,036.00, comprising withholding tax of Kshs. 13,754,050.00 and Section 7A income tax of Kshs. 56,472,986.00, inclusive of penalties and interest (para 12). The Appellant's objection was rejected in full by Objection Decision dated 28th January 2026 (para 13), leading to the appeal filed 11th March 2026 (para 14).
Core dispute
The dispute centred on whether the issuance of 197,900 ordinary shares out of the Appellant's retained earnings to the Foundation constituted a deemed dividend distribution under Section 7(1)(b)(ii) of the Income Tax Act, on the footing that the Foundation was thereby discharged from an obligation measurable in money owed to the company.
The Appellant argued the transaction was a capitalisation of retained earnings, a bonus issue merely reclassifying shareholders' equity, involving no discharge of any debt and no economic benefit to the shareholder. The Respondent argued that Paragraph 56 of the Appellant's Articles of Association, requiring shares to be fully paid, created an obligation on the Foundation to pay for the shares, from which it was relieved by the bonus issue, thereby triggering Section 7(1)(b)(ii) of the ITA.
Consequential issues were whether income tax under Section 7A of the ITA was properly assessed on the basis that the deemed dividend was paid out of untaxed gains, and whether withholding tax was properly assessed under Section 35 of the ITA on the same footing.
Court findings
The Tribunal confined itself to the basis on which the assessment was raised, namely Section 7(1)(b)(ii) of the ITA alone, and did not consider whether other limbs of Section 7(1)(b) might apply (paras 51-52).
The Tribunal held that Paragraph 56 of the Articles of Association, which prohibits the company from issuing shares unless fully paid, is a restriction addressed to the company and does not create a debt owed by a member to the company (para 54). Where shares are allotted credited as fully paid out of capitalised reserves, no sum ever falls due from the allottee, so no obligation existed that could be discharged (para 55).
The model articles define 'paid' to mean 'paid or credited as paid', and the Shareholders' Joint Venture Agreement similarly defines 'Fully Paid' to include shares credited as paid, confirming that no payment obligation arose in respect of the bonus shares (paras 56-57). The recitals to the Agreement distinguished the 2,000 shares issued for cash consideration from the 197,900 shares issued out of retained earnings, showing only the former carried a consideration obligation, which was discharged in cash (para 57).
The Tribunal found the Respondent's figures internally inconsistent, since the alleged obligation of Kshs. 199,900,000.00 did not match the Kshs. 197,900,000.00 said to have been forgiven, the difference being the cash sum actually paid (para 58). It further found the Respondent's simultaneous reliance on Paragraph 74 (dividend payment mechanics) and Paragraph 56 (fully paid shares) to be inconsistent, since a dividend cannot simultaneously be payable and a share subscription debt simultaneously discharged for the same sum (paras 59-60).
Relying on Bouch v Sproule (1887) 12 App Cas 385 and Inland Revenue Commissioners v Blott [1921] 2 AC 171, the Tribunal held that a capitalisation issue involves no distribution of company assets, the shareholder's proportionate interest being unchanged, and that such an issue is not a payment of dividend (paras 61-63). It noted that Section 2 of the ITA defines a dividend as a distribution of cash or property, and Part XVII of the Companies Act fixes upon distribution of assets, neither of which occurred (para 64).
Applying the strict construction principle from Cape Brandy Syndicate v Inland Revenue Commissioners [1921] 1 KB 64, the Tribunal held that Parliament could have expressly deemed a capitalisation issue a dividend, as it did for other circumstances in Section 7(1)(b) of the ITA, but did not do so (paras 65-66). The Tribunal held that the burden of proof authorities cited by the Respondent (Rebecca Fashion and Sawa Sawa) did not assist, since the issue was one of statutory construction rather than a factual deficiency of records (para 67).
The Tribunal found that no dividend was distributed, so the charge under Section 7A of the ITA, which is conditional on distribution of a dividend, was never triggered (paras 69-71). It further found the withholding tax assessment wholly dependent on the deemed dividend premise, and that the Foundation's trust status and exemption certificate findings could not supply a dividend where none existed (paras 72-74).
Outcome
The Tribunal found the Appeal merited and allowed it. The Respondent's Objection Decision dated 28th January 2026 was set aside. Each party was ordered to bear its own costs (paras 75-76).
Major issues / areas of contention
- Whether the issuance of 197,900 ordinary shares out of retained earnings constituted a deemed dividend distribution under Section 7(1)(b)(ii) of the Income Tax Act.
- Whether the Respondent erred in assessing income tax against the Appellant under Section 7A of the Income Tax Act.
- Whether the Respondent erred in confirming the withholding tax assessment under Section 35 of the Income Tax Act.