The High Court has reinstated a Sh3 billion tax demand against spirits manufacturer London Distillers (K) Limited (LDK), overturning a decision by the Tax Appeals Tribunal that had quashed the assessment issued by the Kenya Revenue Authority (KRA).
The disputed assessment, issued in April 2021, comprised corporation tax, excise duty and value-added tax (VAT) for the period between 2015 and 2019.
The Tax Appeals Tribunal had earlier faulted the Commissioner of Domestic Taxes for relying mainly on an input-output analysis based on bottles purchased by the company while excluding other factors.
The tribunal said it could not verify the accuracy of the number of bottles used by KRA in arriving at the assessment and consequently quashed the tax demand.
However, the High Court ruled that the tribunal failed to appreciate that the assessment was based on unexplained variances uncovered during investigations.
The court noted that although tax assessments should not be based on assumptions of income, and not all money deposited in business accounts relates directly to product sales, the taxpayer bore the burden of disproving the assessment once discrepancies had been identified.
‘I am also aware of the argument that insistence that all purchased bottles ended up in production and the market would be dangerous proposition. I agree. But, again, the basis for the assessment in question was unexplained variances and it was the onus of the respondent (LDK) to prove the assessment was excessive or the tax decision was incorrect on that basis,’ the court said.
The judge further held that the tribunal erred in finding that the distiller had sufficiently explained the discrepancies relating to bottles purchased and wastage of excise stamps above one percent.
‘I further find that the Tribunal erred by making findings on the production records, flow meter readings, data from accounting system and resident’s officer’s involvement which were not grounds in the objection. Section 56 (3) of TPA,’ the court said.
Method dispute
The Commissioner said it established unexplained production variances after reviewing the company’s tax returns, bank statements, invoices, receipts and purchase ledgers. Bank deposits were also found to be higher than the turnover declared for tax purposes.
KRA argued that the tribunal failed to recognise that the bottle method was the most accurate and reliable means of estimating production volumes. The tax authority maintained that different analytical methods could be used interchangeably where justified.
London Distillers, however, argued that it had provided adequate explanations regarding bottle purchases and wastage. The company also maintained that KRA failed to physically verify the bottles and wastage at its premises before issuing the objection decision.
The tribunal had found that the assessment was primarily based on an input-output analysis of bottles to estimate production.
But KRA maintained that the assessment stemmed from an analysis of activations and deliveries under the Excise Goods Management System (EGMS), which revealed variances in ready-to-drink products.
KRA said the discrepancies pointed to unaccounted production. The findings were further supported by banking analysis, which showed turnover inconsistent with declared sales, leading to the conclusion that revenue had been understated.
The Commissioner then used the bottle method to estimate actual production volumes under Section 12 of the Excise Duty Act.
Numbers trail
Court records show that after reconciling excise stamps for the period between 2016 and 2018, KRA found that the company activated 1.61 million excise stamps equivalent to 527,250 litres of finished product after stock adjustments.
However, the distiller declared and paid taxes on 359,162 litres, leaving a variance of 168,088 litres that triggered additional excise duty and VAT assessments.
An input-output analysis based on bottles purchased also revealed significant variances amounting to 9.97 million litres. KRA obtained bottle supply data from suppliers Vivek Investments Ltd and Milly Glass Works Ltd.
Further banking analysis showed the company received more than Sh23 billion in sales revenue during the review period. KRA compared the turnover declared in annual returns with estimated sales based on bottle usage, resulting in an initial principal tax liability of Sh2.68 billion.
KRA later adjusted the assessment after considering explanations from the company, including reconciliations involving several banks and excise stamp records. It also factored in breakages of more than 11 million bottles.
The taxman ultimately concluded that the company had failed to satisfactorily account for more than 21.3 million second-hand bottles and assessed tax amounting to Sh2.05 billion after determining that sales exceeded Sh25 billion during the review period.
In its objection, London Distillers argued that not all money deposited in business accounts represented sales income and that KRA’s assumption that all purchased bottles ended up in the market was flawed. The company also claimed that the analysis wrongly classified caps and labels as bottles and confused second-hand bottles with new ones.
However, the Commissioner maintained that the company failed to provide sufficient supporting documents and did not adequately explain the production variances identified during the investigations. In its last assessment, the taxman demanded Sh3.02 billion.