REPUBLIC OF IN THE TAX APPEALS TRIBUNAL APPEAL NO.8 OF 2017

M-ORIENTAL BANK L1MITED APPELLANT

VS

THE COMMISSIONER OF DOMESTIC TAXES. . RESPONDENT

JUDGEMENT

BACKGROUND:

1. The Appellant M-Qriental Bank Limited Oriental 'it-- Ltd), is a li~ited [ability company incorporated in Kenya under Companie ct, Ca / ~ws of Kenya, licensed under The Banking Act Lawssof Kenya and registered by The Kenya ? Revenue Authority as a tax payer, PIN number P0006056 74D. 2. :rlje Resl?~ndent is the PrinciJl g'ent of the Government of Kenya in ''1 ~~ ,I'" Charge of'collection of revenue and ensuring compliance with the Tax Laws and is established by Section 3 of the Kenya Revenue Authority ~ >Nlf/ Act, Cap 469. ' , CAUSE OF ACTION: 3. The Respondent carried out an audit of the Appellant's records for the period 2014 to 2016 and issued an assessment for Capital Gains Tax

(CGT) on 26th September 2016. The Appellant objected through a

Notice of Objection dated 10th October 2016 and received by the Respondent on the following day. After an exchange of

Judgement Appeal No.8 of 2017 eM-Oriental Bank Limited) Page 1 correspondence and further discussions, the Respondent issued an Objection Decision by way of a Confirmed Assessment dated 6th December 2016. 4. The Appellant being dissatisfied with the Objection Decision filed a

Notice of Appeal dated 5th January 2017 with this Tribunal and served the same upon the Respondent on the same day. The Objection Decision was for CGT amounting together with penalties and interest am ,unted to Kshs.26,000,364.20. 5. The Appellant argues that the( Respontlenf without any legal basis or just~tion issue assessment, since this was a fresh issue and allotment of shares at a premium and could n 6. The Appellant prays

,? A APPELLANT'S~AS 7. Th~APpellant argues that on 9th October 2014, the Appellant entered into a' s'e subscription agre'*- rt- with M-Holding Limited (MHL) to acquire 510~Of the post inves ment issued share capital by way of subscription of the Initial Subscription Shares of 34% and purchases of certain issued the company from existing shareholders at 17%. ,

8. The Appellant argues that the purchase agreement defines Initial Subscription Shares as 42,281,893 shares and the process of subscribing for these shares was provided for in the Subscription Agreement at Parts 3 and 4 thereof. The Appellant further argued that it advertised

Judgement Appeal No.8 of 2017 eM-Oriental Bank Limited) Page 2 their plan to issue new shares from its authorized share capital to expand equity. 9. The Appellant submitted that of the 42,281,893 ordinary shares it

issued 20,358,000 ordinary shares on 25th November 2015 and

21,923,893 ordinary shares on 2nd June 2016 to MHL Ltd which were not sold or transferred to MHL Ltd, but were issued at a premium, through allotment from the Appellant's therefore there was no gain realized ..• 10. The Appellant submitted that it to obtain the necessary approvals from of Kenya ("CBK") and Competition Authority of Kenya ("CAK") in compliance with tn BK Act Section 13.4 and Section 3f Amalgamation, Transfe e rS;iand Liabilities for the whole process ~ comprising of two ph~ses which approval was granted on 18th

February 2015 and reiterated by CBK n 6th January 2017. The % app Loval by CAK was granted on lI" December 2014 and copies of

.t "'e7 reGluiHe correspondence i :tained in the Appellant's Statement

11. The Appellant argues that in the two phase process MHL Ltd would acquire 51% control of the Appellant through a two-step process which would involve: i. The Appellant issuing 42,281,893 ordinary shares to MHL (34%) and ii. MHL acquiring further shares from existing shareholders through an open offer to take their holding from 34% to 51% in the Appellant.

Judgement Appeal No.8 of 2017 (M-Oriental Bank Limited) Page 3 12. According to the Appellant, they have so far only completed the first phase of the two steps which is to issue ordinary shares to MHL and no shares have been acquired by MHL from the existing shareholders as was intended. The Appellant argues that the Respondent has noted the two phase process and has further acknowledged validity of the

process by accepting the resolutions authorizi e-; the Appellant to issue and allot the shares to MHL at the Appell" 13. On the basis of the above facts the Pf. ~ provisions of the law in support of its App i) Section 3(2)(f) of the Income Tax Act charge a tax on 6~ainsaccruing in the circumstances prescribed in. and compounded in accordance with the Eighth Schedule" and Paragraph 2 he Eigtit Schedule to the ITA which provides that "subiect to this Schedule. incam inrespect of which tax is ~ chargeable under section 3(2)(1) i 'he whole of a gain which

st W rues to a comp n. or an individual on or after 1 snu ry.2015 on the trans er of property situated in Kenya. whe her, or not the p~ perty was acquired before ,st January 2015" known as CGT at a rate of 50/0. ~'1' ii) The definition of transfer is provided for at Paragraph 6 of the Eighth Schedule of the ITA and in particular Paragraph 6(1) of

the Schedule which provides that; a 66 'transfer' occurs where: a) A property is sold, exchanged. conveyed or otherwise disposed of in any manner including gifting, whether or not for consideration.

Judgement Appeal No.8 of 2017 (M-Oriental Bank Limited) Page 4 b) On the occasion of the loss, destruction or extinction whether or not a sum by way of compensation received including under a policy of insurance, unless the sum received is utilized to reinstate the property essentially in the same form and in the same place within 1year or such longer period as the Commissionet:-mayapprove. c) The abandonment, surrender, c. IIat/on or forfeiture of, or

or debentures on the

III. Paragraph 6(2) of the Eighth Schedule deals w which are not sfers for the purposes GT and the Appellant submit' r-- raph 6(2)(b) clearly states that there is no transfer "inl:the case ~ the issiJanceby a company of its own shares~ or debentures". 14. TheA{pellant therefore argues that since there was no transfer of ~ ~ares but-a mere issuance of - S, CGT was not chargeable and that an issuance ef shares by a company does not amount to transfer of shares as per Paragraph ~6(2) of the Eighth Schedule to the ITA and therefore not chargeaBle to CGT. 15. The Appellant urged the Tribunal to appreciate the difference between issuance of shares and a transfer of shares; i) The Appellant submitted that the issuance of shares by a company refers to the process of offering for subscription of new shares of a company and the subsequent taking up of subscription of the offered shares through allotment of issue

Judgement Appeal No.8 of 2017 eM-Oriental Bank Limited) Page 5 by the existing or new members. However, a company must have sufficient authorized capital which is unissued before it issues new shares for subscription. ii) The Appellant argued that the shares which are signed by the signatories to the Memorandum of Association are deemed to have been issued when the com y is incorporated and other shares are issued when allotted such shares and th into the Register of Me 16. In respect to the process of issuanc a company, the

.4", Appellant summarized this in the context of how it ~.S'. new shares as follows; i) The Appellant h red Million (10 ,000,000) shares and in June 2012 same to One Hundred shares by the creation The ilin increased these shares to One lion (175,000,000) shares by creation n (50 000,000) shares with a share value of Kenya shs.20) per share.

ii) The Appellaf submitted that by 31st August 2015, it had issued a total of 82,275,660 shares of Kshs.20 and filed their Annual Returns thereto. This left a balance of 92,724,340 shares that had been created but had not been issued from its authorized share capital of 175,000,000 ordinary shares. The Respondent has not disputed the process that the Appellant followed in

Judgement Appeal No.8 of 2017 eM-Oriental Bank Limited) Page 6 i) The allotment must be sanctione y a Director's Resolution " which the Appellant complied witH and this process has not been disputed by the Respondent. ii) Upon the said allotment, the Appellant filed the Return of Allotment in strict compliance with the Repealed Companies Act, Cap 486. iii) The Appellant then filed an interim annual return reflecting the

additional shares allotted and issued by it as at 31st August 2015 and the Appellant had issued a total of 82,275,660 ordinary

~ , ~ shares of Kshs. 20. rRe -Appellant then issued 20,358,000 "'2 ordinary shares on 25th Novemberr. 2015 which reflected the new shareholder MHL as the holder of those shares. Further • allotment of 21,923,893 ordinary shares on 2nd June 2016 was undertaken by the Appellant to MHL bringing the total issue of new shares to MHL to 42,281,893. iv) The Appellant in compliance with the law then notified CBK on the allotment of the shares and the subsequent issue. This allotment was for the first issue of 20,358,000 ordinary shares and the subsequent issue of 21,923,893 ordinary shares.

Judgement Appeal No.8 of 2017 eM-Oriental Bank Limited) Page 7 19. As a result of the allotment of the 20,358,000 shares the Appellant received Kshs.610,740,000 from MHL of which Kshs.407, 160,000 was credited to the account of Paid-up Capital and the balance of Kshs.203,580,00 to Share Premium account in accordance with the Provisions of Section 58 of the Repealed Companies Act. This Treatment which reflects the issue of new capital is not disputed by the Respondent. A share premium ac ' is ~ non- distributable reserve in company law. The Appell

with the 21,923,893 shares. Thi t been disputed by the Respondent. 20. The Appellant has further explained to the Tribuna process of sale and transfer of shares ., allows;

i) A new person ~.r an ~ing shareholder enters into an agreement with another shareholden "'aequire a certain number of shares at an agreed pri~e and wil~~enter the sale details in the rescribed Share Transfer Form. The Board of Director~t~eJX pproves the Share Transfer subject ~ ~, - to it being stamped withthe relevant Stamp Duty being 10/0 of the consideration payable and thereafter stamped by the ~ Collector of Stamp duty. iii) Upon completion of the stamping, the Company Secretary reflects the transfer in the Register of Members and cancels the Shares Certificate held by the Seller and issues a new share certificate to the buyer. iv) The Transfer is reflected in the next Annual Return showing the new shareholder as a new member and the old shareholder as

Judgement Appeal No.8 of 2017 eM -Oriental Bank Limited) Page 8 the transferor. This is clearly reflected in the Appellant's Statement of Facts at annexure 84 being the List of Past and Present shareholders. The Appellant submits that this list demonstrates that there was no transfer of shares but issuance of new shares to MHL. v) The Appellant submitted that the transferor would accrue the gain being the difference between consideration received as a gai this would be gain that woul?fS~ su 21. As respects the issue as to whether a paid to a company is subject to CGT, the Appellant buttresse . s arguments by p relying on the follow,·"" rovision of Section 58 (1 f the Repealed Companies Act, Cap 4 ~ >, "where a company i:1uesshares at a Rremium whether for cash or otherwise, a sum equal to the aggregaJe amount or value of the premiums on those shares be transferred to an account, to be called ~lJe share" " remium account af.he provisions of this Act relating to the reduc 'I" of the share ""capitalof a company shall, except as provided in this section, apply as if the share premium account were paid-up share capital of the company" It is thus not subject to CGT. 22. The Appellant submits that the share premium forms part of the equity of a company and as such is non-distributable and it relied on the case of Commissioner of Income Tax v Cagandeep Infrastructure PVt. ltd wherein it was held that: "Further the Tribunal while upholding the finding of CIT (A) also that the amount received on issue of share

Judgement Appeal No.8 of 2017 (MvOriental Bank Limited) Page 9 capital along with the premium received thereon, would be on capital receipt and not the revenue field" for thisproposition. RESPONDENTS CASE: 23. The Respondent states that it became aware that the Appellant intended to dispose 51% of its shares to a company designate MHL through a media publication in the Business .,aily newspaper of 18th May 2015. In view of the impending sal pellant's shares, the

Respondent then sought to audit the4y it was tax compliant.

24. Consequently the Respondent wrote to the ;A.ppellant on 30th July

2015 and 19th August 2015 calling for the docurriefifs relating to the said disposal of shares. In response thereto the Appellant by its letter

dated 2nd September 2015 informed the Respondent that it had acquired the requisite approval from the various regulators for the said sale and the said MHL had confirme~~1 s intention to remit the

·Li \I'f:. f h . f h consi eration or t e acquistt~jon.r0 s ares. 25. ~.~dent states that it s$informed by the Appellant that the Gisposal of the shares had been a two-step transaction namely the \ allotment of 42,281,893 shares by the Appellant to MHL and the • acquisition of furth shares by MHL through an open offer to key shareholders so as to achieve a total shareholding of 51%. 26. The Respondent then conducted an audit of the shares that had already been disposed to MHL, whose outcome it communicated in its letter

of 2nd September 2016 and since there was no response from the Appellant, the Respondent issued an assessment vide their letter 26th September 2016.

Judgement Appeal No.8 of 2017 eM-Oriental Bank Limited) Page 10 27. Upon the Appellant objecting to the assessment and the Respondent confirming the same, the Appellant lodged this Appeal challenging the

CGT in the sum of Kshs.26,003,364.20 on 18th January 2017. 28. The Respondent confirms that the Appellant did increase the shares as captured in paragraph 15(1) of this judgment. 29. The Respondent states that the value of each share was Kshs.20/= and

that by the 31st August 2015 the Appella~had~lIotted 82,275,660 shares and therefore had a balance 09 , '''<,; 30. On 25th November 2015 the Appellant resolved to dispose some of its shares by allotting MHL 20,358,O~p shares a share thus making a gain of sh.l0 per share. 31. On 2nd June 2016 the~Appellant further resolved to dlspose to MHL are thus making Kshs.10 gain per share. The§.Respondent rther 11 27th July 2016 the Appellant had given due recognition to M~L as one of its shareholders • thereby confirming that the A pellant had transferred its shares.

32. ,'tb"tResR ¥ dent further state hatsunder Section 13(4) of the Banking ~ Act Cap 488, Laws of Kenya,,, 'no institution shall transfer more than five percent o£ its Sh:;;' Capital to an individual or an entity except with prior written approval of the Central Bank". The Respondent relied on the aforesaid provision of law that the approval given to the Appellant was therefore for transfer of shares as the intention of the Appellant was to dispose of its shares at a gain of Kshs.l0 per share. The Respondent avers that the CBK being the Regulator of the Appellant correctly classified the transaction between the Appellant and MHL as a sale.

Judgement Appeal No.8 of 2017 [lvl-Orlental Bank Limited) Page 11 33. The Respondent states that the Approval granted by CAK also mentions the proposed acquisition of 51% of the issued shares by the Appellant to MHL. 34. The Respondent argues that the disposal of the 42,281,893 shares was a transfer of shares and therefore chargeable to CGT on the gain as the Appellant had made a gain of Kshs.10 per s '. from the disposal of the shares. 35. In view of the above facts the Resp Section 3 (2) (f) of the ITA to ch said shares at the rate of 5% on t e subject matter of the Appeal. THE HEARING 36. The hearing commence ~fithe Appellant calling testify on its behalf. The

37. '.6' the subject of this Appeal were an company and not a transfer of shares. llotment of shares takes place when the company e not in existence before. On the other hand the transfer of sh~res occurs when an existing shareholder moves his shares from himself to somebody else. 38. Mr. Kamau further distinguished the documentation process of the allotment of shares with that for the transfer by stating that in respect to the transfer of shares, a transfer form is filled in the prescribed manner, assessed for stamp duty and payment is effected. This process

Judgement Appeal No.8 of 2017 eM -Oriental Bank Limited) Page 12 involves two parties and the company is not involved as either a buyer or seller. 39. In respect to the allotment of shares he continued, such an allotment is entered into the register of members where the allottee is entered as a new shareholder. He emphasized that in respect to a transfer the new buyer is only entered into the register of members after presenting the duly registered shares transfer from the shareholder is either issued with share c #'" 40. It was his evidence that shares bought at capital item unlike revenue wh~ can be distributed, premium on shares is not distributable which can only be issued

41. The Appellant, throf "'c its witness explained that shares the subject of~pea, . ere was a Subscription Agreement dated 9th October 2014 between the MHL and certain key shareholders of Oriental Comm~rcial Bank Ltd. There was therefore no Agreement for Sale or Transfer of shares. The Appellant further arg CI~that the subscription ol ~shares could not attract CGT under ? ~~,... Section 3 (2)(f) ITA as read with Paragraph 6 Eighth Schedule thereto '" which provides a ~~'trensters' occurs where: ~ a) A prop'eJ1Y is sold, exchanged, conveyed or otherwise disposed of in any manner including gifting, whether or not for consideration. b) On the occasion of the loss, destruction or extinction, whether or not a sum by way of compensation is received including under a policy of insurance, unless the sum received is utilized to reinstate the property essentially in

Judgement Appeal No.8 of2017 eM-Oriental Bank Limited) Page 13 the same form and in the same place within 1year or such longer period as the Commissioner may approve. c) The abandonment, surrender, cancellation or forfeiture of, or the expiration of substantially all rights to, property, including the surrender of shares or debentures on the dissolution of a company. " ~ The Appellant argued that CGT is only c 42. The Appellant further stated that Para Schedule deals with transactions wfilch ar of CGT. This provision therefore applies to tlj surrent transaction. ~' The Appellant further stated that CGT is paid in cas altransfer of share at the time of the stamping of the transfer of shar 43. n allotment of shares there must be ~he Company in order to allot snares which is followed by a Director's resolution to allot these shares to a new shareholder. Thereafter a return of allotment is Jii.t'W~ the Registrar of .JlJ3anies and this is what happened between MHb and the Appellant. As evidence of this allotment the Appellant provided the return of allotment duly filed with the Registrar of Com "j't.;-here is also evidence of the interim annual J?f return which reflects the new shares issued to MHL. 44. The Appellant summarized its position in this Appeal by averring that no consideration changed hands between the two entities which would attract payment of CGT and what happened in the present case was a mere subscription of the shares of the company for valuable consideration. If there was a sale and transfer of shares there would

Judgement Appeal No.8 of 2017 eM-Oriental Bank Limited) Page 14 have been an agreement between the existing shareholders or new shareholders for the transfer of their shares to third parties and in the event there was a gain CGT would be payable. 45. The Respondent on the other hand argued that the Appellant made a profit at the rate of Kshs.10 per share and it is that profit that the Respondent was subjecting to CGT. It was the Respondent's further argument that the approvals by the regu s C ~and CAK was for a transfer and therefore CGT was due an Respondent. WRllTEN SUBMISSIONS 46. On conclusion of the hearing the Tribunal'"' ordere their written submisf~'" they duly did. T ppellant filed their written submission t:lly 2017 with the Respondent filing ~ on 24th July 2017. APPELANT'S WRllTEN SUBMISS ONS 47. The AI:>pellant in its written ~submissions defines the main issue for

de r rmll1~tion as being whet a,.,fresh issuance of shares also referred ~ V~ to as an allotment of shares by the Appellant to MHL amounts to a transfer and ttierefore subject to CGT under the Eighth Schedule of the ITA. The Appellant in addressing this issue has reiterated the arguments and facts as stated in their case hereinabove. The Appellant therefore urges the TAT to find that there was neither a sale nor transfer of shares and in this case therefore no CGT was payable in accordance with the provisions of Paragraph 6 of Eighth Schedule of ITA Paragraph 2 of the same schedule and Section 3 (2) (f) of the ITA.

Judgement Appeal No.8 of 2017 (M-Oriental Bank Limited) Page 15 48. In conclusion therefore, the Appellant urges the Tribunal to allow its Appeal as it claims that it strictly complied with the law in the process of issuance of new shares in compliance with the Companies Act Cap 486 (now repealed). The Appellant further prays that the costs of this Appeal be borne by the Respondent who issued the assessment in blatant disregard of the law. RESPONDENTS WRITTEN SUBMISSIONS 49. The Respondent on its part reiterated and insists that the transaction bet\:veen th transfer of shares since the approvals granted to CBK and CAK classified that transaction as Transfer. It therefore urges the TAT to uphold its a sessment of Kshs.26,003,364 and dismiss the Appeal with costs in it's favour. APPELLANTS SUPPLEMEI'JTARY SUBMISSI@NS-

11< 50. Upon being served with tile Respondent' submissions, the Appellant .eu Yp lernentarvementary susubrnirnlssions'. to buttressuttress ItsI arguments an d rep Iy to "Ii e

Judgement Appeal No.8 of 2017 (M-Oriental Bank Limited) Page 16 attract CGT under the ITA and The Companies Act Cap 486 now repealed. ANALYSISAND FINDINGS 52. The Tribunal has established that there were two transactions involved and that the only transaction the subject matter of this Appeal was the fresh issuance and/or allotment of a total of 42,281,893 shares. 53. The Respondent's assessment is therefo~r onl~ in respect of the issuance or allotment of the aforesaid Fe A 54. re is a difference between the process of issuance and allotment of fresh shares and the process of v sale and transfer of a share. The process of issuan allotment of shares is an internal process in the company which is reflected in the company's documents and re~ds. The Transfer of shares involves an existing shareholder tr~rlsferring party which ultimately involves the Registrar of Companies in relstering the said sale in its records. 55. I~~S instance once the tranftir iwtrument is presented by an existing shareholder and a purchaser to the Registrar of Companies and stamp duty paid it is only then that the new shareholder is reflected in the records and documents of the company. It is also at this stage that

Judgement Appeal No.8 of 2017 eM-Oriental Bank Limited) Page 17 57. No evidence was adduced either by the Appellant or the Respondent demonstrating the existence of any transfer of shares to MHL. The only documentary evidence relates to issuance or allotment of shares to MHL which is an internal process. 58. The Appellant clearly demonstrated by documentary evidence the

process of the issuance and allotment of share 0 MHL. 59. The Tribunal has established that in allot

there is no gain in terms of the pr~, realized as a result of the issuance 0f the component of the company's capital. 60. It is clear that the premium earned In the issuance or allotment of shares being a component of capital is not distributable and it can

61. In its assessment the ResRondent did no~t-~"'~""'mdeto the Tribunal any sale of shares

62. {['Indent claims that trlGe> the approvals by CBK and CAK categorized as sale and transfer". of shares, the said sale and transfer was in"accordance with the revisions of ITA. 63. The Respondent did not contextualize the said approvals with the correspondence available and in particular the Applications for Approval by the Appellant. It is clear that what was sought was not necessarily approval for sale and transfer of shares as the correspondence clearly shows that the approval by CAK was for a merger and not sale of shares.

Judgement Appeal No.8 of 2017 (M-Oriental Bank Limited) Page 18 64. The Tribunal finds that Respondent misdirected itself by adopting an untenable argument based on Section 63 (1)(a) of the repealed companies Act and Halsbury's Laws of England. TRIBUNAL DECISION 65. In view of the foregoing the Tribunal is satisfied that the Respondent's assessment is invalid and misplaced in that it was an assessment based

on issuance and allotment of shares whic IS speerfically excluded by paragraph 6(2)(b) of the Eighth Sche~ufe 0f the ITA. 66. The Tribunal is satisfied that the Appellant as discharged its burden of demonstrating that the Respondent~ Assessment and could not be sustained. 67. This Appeal therefore succeeds and the Respondent's assessment dated

the 26th September 201 .• her~y set aside. 68. The Appellant is entitled ,~costs a ".~~. 20,000/=. 69. Right of IXppeal ,explained.

Judgement Appeal No.8 of 2017 [lvl-Driental Bank Limited) Page 19 Qb~ . DATED and DELIVERED at THIS day of 2018

In the Presence of:

' ... -0.UiH\\-\ ~ U \<..., \ . . . h"A 1'1' ••.•••••••••••••••••••••••••••••• \ •• 'l. ••••••••••••• t e I"'\ppe ant·

..R.~s.~~~.....~~~~. . ~~~.....the Respondent 1'"",

~-=====~ A.G.N. KAMAU CHAIRPERSON

JOSEPHINE MAANGI LILIAN RENEE OMONDI MEMBER MEMBER

AWUOR DIMMO NCIS KIVULLI Iv.r-,lv·BER MEMBER

Judgement Appeal NO.8 of 2017 eM-Oriental Bank Limited) Page 20