Inside ghost supplier scheme that caused Family Fashion Clothing Limited Sh360m tax pain
Times Tower, the Kenya Revenue Authority's head office in Nairobi.
What you need to know:
- Family Fashion Clothing Limited is involved in the business of purchasing fabric, accessories, and related items and using them to manufacture garments, which are sold locally and overseas.
The scheme is used by traders for tax evasion purposes, where fictitious invoices are generated to depict a business transaction whereas there was no actual supply or movement of goods and services.
In 2018 the Kenya Revenue Authority investigated the tax affairs of Family Fashion Clothing Limited, a garment manufacturing company accused by the tax collector of having dubious suppliers.
The analysis carried out by the Commissioner of Investigations and Enforcement found out that the firm's suppliers were non-existent.
This was even as it emerged that Family Fashion had lodged a claim at KRA seeking a refund of input tax -the VAT incurred on supply of goods or services to the vendor.
The commissioner said no transaction had taken place between the garment manufacturer and suppliers it claimed had provided goods or services.
It emerged that the mysterious businesses printed and sold invoices with ETR receipts to the company at a commission to reduce its tax liabilities, the commissioner stated in court.
In addition, a review of the company's ICT systems revealed that the manufacturer had not disclosed most of its sales.
Family Fashion Clothing Limited is involved in the business of purchasing fabric, accessories, and related items and using them to manufacture garments, which are sold locally and overseas.
Having failed to show the commissioner that the invoices provided related to an actual supply or importation acquired by a trader to make a taxable supply, the commissioner identified the company as one of the beneficiaries of the "missing trader fraudulent scheme”.
The scheme is used by traders for tax evasion purposes, where fictitious invoices are generated to depict a business transaction whereas there was no actual supply or movement of goods and services.
From the investigations, the company was found to be a beneficiary of the scheme as it would pay very little or no VAT at all or carry huge liabilities as trade creditors from one year to another owing to huge input VAT claims, yet the "purported creditors were, in essence, the missing traders".
In the dispute that started at the Tax Appeals Tribunal before escalating to the High Court, KRA stated that the company had claimed input VAT from seven suppliers all of whom were found to only exist on paper as they did not buy or sell any goods to the garment manufacturer.
The commissioner said there was no proof that the goods were purchased by the company. This is because most of the businesses that the firm claimed to have purchased goods from do not exist, do not import, do not manufacture, and neither do they buy goods from any local company to be able to supply the garment maker.
The commissioner also found that though the company had claimed VAT for imported goods, it was unable to provide import entries to justify the same.
After investigations, KRA issued the company with a tax investigation finding dated April 18, 2018, in which it demanded a sum of Sh359,542,702. The amount comprised the Value Added Tax (VAT) of Sh125,058,331 and corporation tax of Sh234,484,371.
Attempts by the company to ward off the tax assessment at the Tax Appeals Tribunal proved futile after the tribunal upheld the KRA's decision and the findings of the commissioner.
Lack of documents to prove purchases from its suppliers was the main disadvantage of the firm's case against the taxman. It failed to provide evidence in support of its objection against the tax claim.
The company suffered a second blow last week after High Court judge Josephine Mong'are dismissed its appeal against the decision of the tribunal.
"I note further that in this appeal and the one before the tribunal, the company did not adduce the documents that it claimed it had provided to the commissioner of investigations and enforcement to prove purchases from its suppliers. Therefore, this court, just like the tribunal, cannot analyse the said documents in order to determine whether the company acquired stock from the suppliers in question," said Justice Mong'are.
She said the company did not discharge its burden of proof despite having the opportunity to furnish sufficient proof.
The judge said the burden of proof was still on the company to prove the tax assessment wrong even though it had earlier provided some documents such as invoices, corresponding ETRs, delivery notes, proof of payments, and store records to prove purchases from its suppliers.
"For instance, the company could have provided additional documents such as PIN Certificates of its suppliers to prove that they are registered persons capable of making taxable supplies and witnesses including some from its suppliers to prove that they actually supplied goods to it," said Justice Mong'are.
Citing Section 59 of the Tax Procedures Act and Section 43 of the VAT Act, which gives power to the commissioner to request additional information to satisfy himself on the taxable income declared or matters tax, the judge said the commissioner discharged this obligation in the case at hand. The commissioner asked for more documents but was not furnished with the same, the court found. "Once the commissioner found that the documents adduced by the company were insufficient the burden lay squarely on the company to disprove this. Further, the law allowed the commissioner could ask for additional documents/evidence if it found that the ones provided were not sufficient, which he did, and the company was under an obligation to satisfy the said demand, in order to sustain its claim and discharge its burden as set by the law," said the judge.
John Ekadah, an officer in KRA’s Investigations & Enforcement Department, contended that the company claimed local purchases from traders during the period 2015 to 2017 but investigations revealed that the said traders only existed on paper.
The court dismissed the appeal filed by the company and said it was satisfied by the finding of the tribunal that the assessment and objection decision was valid.
On December 29, 2021, the company was dealt a setback after the court dismissed its request to adduce additional evidence in support of its appeal.
The additional evidence documented in support of the disputed transactions comprising VAT payment slips, returns, invoices with corresponding ETRs, VAT monthly returns Bank statements among other documents.
The company’s director, Mohamed Hussein, said the company tax advisers had provided the commissioner with all the original documents in support of the disputed transactions.
In the investigations, the KRA commissioner analysed the company’s VAT returns for the period 2015-2018 and discovered that the suppliers of the company only existed on paper as they did not actually sell anything.
Most of the traders that the company claimed inputs from were not registered persons in the KRA’s records as taxpayers, the court heard.
The commissioner said investigations proved that no taxable supplies were made to the company by the suppliers referred as “missing traders” from whom the company obtained purchase invoices and ETR receipts, which it used to account for its input VAT and reduce their income tax liabilities.
As a result, the commissioner said the tax shown on the tax invoices “for the fictitious sales/purchases was due and payable”.
The commissioner further stated in its investigation report, which was later adopted as its assessment, that the company had claimed local purchases from fictitious traders and that it claimed imports whose entry numbers did not belong to the company.
Additionally, the commissioner discovered that the company had claimed imports whose entry numbers did not belong to it and that a further review of its ICT systems revealed that the firm had not disclosed most of its sales.
Based on the said findings, the commissioner required the garment manufacturer to provide justifiable grounds for the input VAT and costs claimed.
The company opposed the tax assessment through its notice of objection letter dated June 7, 2018. Its grounds of objection were that it received goods from the suppliers and that they had supporting documentation and payments were made to the respective suppliers.
The commissioner issued its decision on the objection and disallowed the company's assertion that the company had maintained full records for the purchases.
"The commissioner has established that there was no supply of taxable goods made by the suppliers highlighted on our letter of April 16, 2018," said the commissioner in the letter.
While the commissioner agreed that Section 15 of the Income Tax allowed the deduction of all the expenditure incurred exclusively in the production of income, he said the company had to prove the same to the satisfaction of the commissioner.
In its appeal, the company argued that the tribunal erred in failing to take cognisance of the fact that the firm duly issued the commissioner with copies of invoices and corresponding ETR, proof of payments, delivery notes, and store records for all its purchases as is normal business practice. It said this fact was confirmed by the commissioner’s witness and their authenticity remained uncontested.
