NAIROBI, Kenya, June 6 – Kenya Electricity Generating Company (KenGen) has lost a tax appeal challenging a Sh2.36 billion compensating tax assessment imposed by the Kenya Revenue Authority (KRA), in a ruling that could have significant implications for companies distributing dividends while reporting tax losses.
The Tax Appeals Tribunal upheld KRA’s assessment, finding that KenGen failed to prove that dividends paid to shareholders between 2020 and 2023 were sourced from gains or profits that had already been subjected to tax.
The dispute arose after KRA reviewed KenGen’s tax affairs for the period between 2019 and 2024 and assessed additional taxes amounting to Sh2.95 billion. The assessment comprised Sh2.36 billion in compensating tax and Sh586.2 million in withholding tax.
The withholding tax component was subsequently settled through an Alternative Dispute Resolution process, leaving the compensating tax dispute as the only matter before the Tribunal.
At the heart of the case was whether KenGen’s dividend payments originated from retained earnings that had previously been taxed or from gains and profits that had not attracted tax, thereby triggering compensating tax under Section 7A of the Income Tax Act.
KenGen argued that it was in a tax loss position during the years under review and therefore had no untaxed gains or profits that could attract compensating tax. The company said it had recorded losses running into tens of billions of shillings, largely due to allowable deductions and capital allowances, while taxes had been fully paid on rental income, interest income and other taxable earnings.
The power producer further maintained that the dividends were paid from accumulated retained earnings rather than profits generated during the assessment period.
However, the Tribunal rejected the argument, noting that a tax loss position does not necessarily mean a company lacks gains or profits for purposes of compensating tax.
“During the period under review, the Appellant generated substantial revenues from the sale of electricity, which exceeded its operating expenses. The business produced gains. Those gains were, however, sheltered from corporation tax by capital allowances amounting cumulatively to approximately Sh66.6 billion,” the Tribunal stated.
The judges observed that capital allowances are designed to encourage investment and reduce tax liabilities but do not eliminate the existence of underlying economic gains.
KRA argued that KenGen distributed dividends worth Sh6.92 billion during years in which it paid no corporation tax on its core electricity generation business, raising questions about the source of the funds used for the distributions.
According to the tax authority, taxes paid on rental income, interest income and other earnings could not offset a compensating tax liability arising from separately computed business income.
The Tribunal agreed that KenGen bore the burden of proving that the dividends originated from gains on which tax had already been paid.
Although KenGen cited retained earnings ranging between Sh86.6 billion and Sh113.2 billion during the period under review, the Tribunal said the company failed to provide a detailed reconciliation showing which portions of those reserves represented taxed income.
The judges also dismissed KenGen’s challenge to KRA’s method of calculating the compensating tax. The company had argued that KRA relied on a gross-up formula derived from a repealed dividend tax account regime that assumed dividends represented 70 percent of pre-tax profits.
While the Tribunal acknowledged that the methodology is not expressly provided for under the current law, it ruled that KRA was justified in reconstructing the tax position using available information after concluding that KenGen had failed to provide sufficient records tracing the source of the dividend payments.
The Tribunal further rejected KenGen’s argument that taxes paid in earlier years amounting to more than Sh514 million should have reduced the compensating tax liability, saying the company had not established a direct link between those tax payments and the retained earnings used to finance the dividends.
