Agribusiness firm Del Monte Kenya Limited has won a Sh270 million tax dispute with the Kenya Revenue Authority (KRA) over deductions linked to foreign exchange losses arising from Sh3.9 billion in shareholder loans.
The Court of Appeal ruled that companies can deduct foreign exchange losses incurred when settling foreign-currency loans through the issuance of shares rather than cash payments.
The decision upholds earlier High Court findings in favour of the fruit juice producer and dismisses an appeal by the KRA Commissioner of Domestic Taxes.
The court found that Del Monte was entitled to deduct Sh401.3 million in foreign exchange losses arising from the settlement of shareholder loans through a debt-to-equity conversion.
The ruling preserves tax assessments challenged by Del Monte after KRA disallowed the deductions and sought to recover an additional Sh270.7 million in taxes arising from the debt restructuring.
Loan dispute
The case centred on foreign currency loans obtained by Del Monte from a related company, Del Monte International Incorporated, a Panama-incorporated entity, beginning in 2001.
The loans comprised $28.2 million (Sh3.6 billion) and £1.46 million (Sh253.5 million), bringing the total to about Sh3.9 billion. The facilities were unsecured and interest-free.
According to the judgment, Del Monte used the funds to finance ordinary business operations, including paying suppliers, purchasing raw materials and meeting salary obligations.
As the Kenya shilling fluctuated against the US dollar and pound sterling over the years, the company recorded foreign exchange gains and losses when translating the outstanding balances into shillings in its financial statements.
The gains and losses remained unrealised because the loans had not been repaid. By the end of 2008, the outstanding debt stood at $28.25 million and £1.46 million.
In 2009, the loans were assigned to Del Monte Kenya Holdings. Del Monte subsequently settled the obligations by offsetting a small portion against intercompany receivables and converting the balance into 41,625 ordinary shares issued to the related company.
The transaction triggered realised foreign exchange losses amounting to Sh401.3 million, which Del Monte claimed as deductible expenses in its tax computations for the year ended December 2009.
KRA later audited the company’s accounts for the 2009 to 2011 income years and rejected the deductions, arguing that losses arising from the debt-to-equity conversion were capital in nature and therefore not deductible under the Income Tax Act.
The Tax Appeals Tribunal (TAT) partly agreed with the tax authority in 2016. It found that while the conversion extinguished the debt and realised the foreign exchange losses, the portion linked to the issuance of shares constituted capital expenditure.
Del Monte successfully challenged that finding at the High Court in 2019, which ruled that foreign exchange losses incurred through the conversion of debt into equity were tax deductible under Section 4A of the Income Tax Act.
The Court of Appeal has now endorsed that position.
“We also uphold the findings of the TAT and the High Court that realisation of the loan does not only occur when the debt is paid in cash, but it is also possible for a debt to be extinguished through payment in kind or exchange of goods and services, conversion of debt to equity or even amortisation against receivables between parties,” the judges said.
Wider impact
The appellate judges held that the foreign exchange losses arose from the value of the loans themselves and not from the issuance of shares used to settle them.
“The foreign exchange losses arose from the value of the loan and not at the time of issuance of the shares,” they said.
The court added that converting the outstanding loans into equity extinguished Del Monte’s liability and, for the purposes of Section 4A of the Income Tax Act, amounted to realised foreign exchange losses that had to be recognised as deductible expenses.
“We uphold the submission made for the respondent that conversion of the outstanding loans into equity resulted in payment of the loans, meaning that the respondent’s liability was extinguished,” the judges said.
In a finding likely to resonate beyond the Del Monte dispute, the court reaffirmed that tax statutes must be interpreted strictly and that tax obligations cannot be imposed through implication.
“The taxing authority cannot exercise its powers based on generalized opinion, implication or conjecture. The taxpayer, on the other hand, must know with specific clarity what it is he is surrendering in terms of tax,” the judgment said.
Rejecting KRA’s argument that the losses should be treated as capital expenditure, the judges said Section 4A expressly governed the taxation of realised foreign exchange gains and losses.
“The method or mode of realisation, capital or revenue, appears immaterial in the wording of Section 4A of the Act,” the court said before dismissing KRA’s appeal.
