A loan seems like a straightforward financial arrangement, funds lent by one party to another with an expectation of repayment. Yet, the distinction between a genuine loan and taxable income can have profound implications for businesses and tax authorities.
Many companies finance their operations through loans from formal lenders like banks but also often turn to informal loans from shareholders, driven by factors such as convenience and cost savings. However, without proper and sufficient documentation, the Uganda Revenue Authority ("URA") can recharacterise these loans as taxable income.
Two recent decisions of the Tax Appeals Tribunal ("TAT"), Bullion Refinery Limited v URA, and Explorer Limited v URA, have raised questions on the evidence required to validate a loan and the limitations of URA's recharacterisation powers.
In one case, the Tribunal upheld URA's recharacterisation of a loan as income, citing the taxpayer's failure to provide sufficient supporting evidence. On the other, the Tribunal overturned URA's decision, ruling that the demand for documentation dating back over two decades was both unreasonable and impractical.
These divergent outcomes raise fundamental questions about the criteria for substantiating a loan, the fairness and rationality of the URA's document requests, the Commissioner General's discretionary power to characterise transactions, and the evidential burden involved.
Bullion Refinery v URA
URA raised assessments against Bullion, reclassifying a sum that it claimed was a loan from a company in UAE, for purposes of procuring refining equipment, as taxable income.
URA argued that the Commissioner General has the power to characterise transactions where they do not reflect economic or substantive effects. It also contended that Bullion did not have sufficient documentation including a board resolution authorising the borrowing, a valid loan agreement, and bank statements to demonstrate the movement of loan monies from UAE to Uganda, and in the absence of such documentation, it was justified to recharacterise the loans as taxable.
Bullion contended that URA lacked sufficient grounds to characterise the loan as taxable income, especially as the loans had been recorded in its financial statements.
The Tribunal found that at the time of signing the loan agreement, it had not been translated from Arabic to English as required by the Illiterates Protection Act. As a result, there was no way of ascertaining whether the Director who signed on behalf of Bullion was aware of the contents of the loan agreement.
TAT concluded that URA was right to query the authenticity of the loan agreement presented by Bullion, given the inconsistencies in the borrower's name and the names of the directors signing on behalf of the borrower. There was also no board resolution authorising the borrowing and no evidence of movement of the loan monies to Bullion. Additionally, the receipts tendered by Bullion were made out to an individual rather than the stated lender. Consequently, the Tribunal upheld the re-characterisation of the loan as undeclared income. Companies should be mindful of the importance of properly documenting loans received. For further insight on this, read our previous article here.
Explorer v URA
Explorer was issued assessments on the grounds that it had an unsupported loan as income. The URA argued that the taxpayer bore the burden to prove that the amount in question was indeed a loan, by providing supporting documentation such as a company resolution to borrow, bank statements showing the receipt of funds, receipts evidencing withdrawals and evidence of how the money was utilised, or that the amount was utilised for the purpose for the intended purpose. Explorer failed to provide such documentation.
Explorer presented financial statements, a loan agreement and a letter from its shareholders extending the loan term. They argued that the liability arises from a loan extended to it by its shareholders, which has been reported in its financial statements and rental income returns since 2004 when the loan was initially advanced. It also argued that if the loan had been extended from 2004, URA could not 14 years later raise an additional assessment as such an assessment is time barred. (URA has three years from the date the taxpayer furnishes the self-assessment return to raise an assessment except where there is fraud or discovery of new information.) Explorer did not fall within the exception to the three-year limit).
The Tribunal deemed it unreasonable for URA to expect the taxpayer to produce bank statements showing the receipt and expenditure of funds 20 years later. It held that requesting evidence of receipts for purchases made and wages paid to the workers who carried out the renovations of the property in 2004 was not only onerous but also impractical and inconsistent with business management principles.
The Tribunal found that Explorer had proved, on a balance of probabilities, that it had obtained a loan. It found that the URA was holding the taxpayer to a very high standard of proof given the passage of time. Further, the Tribunal found that URA's recharacterisation of the loan as income was irrational, as it had failed to provide any evidence to demonstrate how or where the taxpayer earned the purported income.
Notably, each decision is rooted in the specific facts of the respective case.
Both decisions reinforce URA's authority to recharacterise transactions to reflect the economic substance while highlighting clear limitations on that power. In Bullion, the Tribunal validated the recharacterisation as taxable income due to serious doubts about the authenticity of the transaction. At the same time, in Explorer, the Tribunal effectively placed a check on URA's recharacterisation power, arguing that while it need not be restricted to tax avoidance schemes and that it can extend to transactions where the form does not reflect the substance, it must be exercised rationally and applied within practical and reasonable time limits.
Regarding evidence, the Tribunal's approach aligns with established rules of evidence and the legislative intent. By insisting on concrete evidence in Bullion, the Tribunal upholds Parliament's intent in granting URA the power to recharacterise transactions to promote tax transparency and guard against potential misuse of loans for tax avoidance. On the other hand, in Explorer, the Tribunal's position acknowledging the inherent limitations of long-term recordkeeping is an appreciation for real-world business conditions and supports a tax environment where compliance is attainable. The five-year record-keeping requirement in the Income Tax Act provides a balance where URA is given enough time to investigate potential discrepancies without imposing an indefinite burden on taxpayers.
Additionally, URA often takes advantage of the Tax Appeals Tribunals Act, which places the burden of proving that a taxation decision or assessment is excessive or unjustified on the taxpayer. While the Tribunal upheld this position, it also acknowledged that the evidential burden is not static. In Explorer, after the taxpayer provided sufficient supporting documentation and demonstrated, on a balance of probabilities, that the transaction was a loan, the evidential burden then shifted to URA. It was then URA's responsibility to show how and from where the purported income had arisen to counter the taxpayer's evidence, which it failed to do.
The above notwithstanding, the Tribunal's position in Explorer raises an important question on the criteria for shareholder loans; Is it unreasonable for URA to request specific supporting documents, for instance, a board resolution, to verify the legitimacy of a loan?
While board resolutions can confirm the formal approval of financial transactions, requiring them in all cases may be unnecessary and should be assessed on a case-by-case basis. Drawing from the Companies Act, transactions undertaken by authorised individuals, such as directors, are generally considered binding and valid, especially when the third party is acting in good faith, even in the absence of a specific board resolution to approve the transaction. Therefore, the lack of a board resolution does not necessarily invalidate a transaction.
In Bullion, considering the facts of the case, non-compliance with the requirements of the Illiterates Protection Act, discrepancies in the loan agreement, lack of bank statements given the amount of the loan, attempts to circumvent the anti-money laundering Act, and the kind of receipts presented, the request for supporting documents such as a board resolution, was very reasonable, as the transaction appeared highly suspicious. In Explorer, the taxpayer presented a loan agreement, and a letter extending the term of the loan, and the loan had always been reflected in its financial statements and rental income returns since 2004. Given the loan amounts, the relationship between the borrower and lender, the statutory time limit and how much time had elapsed, the request for other supporting documents like board resolutions seemed unreasonable.
Whereas the differing positions of the Tribunal raise concerns about consistency and the apparent lack of standardised evidential requirements, its approach is firmly grounded in the specific facts of each case. This ensures that evidentiary standards remain flexible enough to accommodate the unique circumstances of each situation.
*Reviewed by Phillip Karugaba, an Executive in Uganda.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
