The Tax Appeals Tribunal has ruled that microfinance lender, Premier Credit Limited, cannot deduct the principal of unrecovered loans from its taxable income, a decision that sharpens the line between capital and income for the lending sector.
- •According to the ruling, only interest and fees on loans qualify as tax-deductible losses.
- •The case began after Premier Credit was audited for 2018 and issued a tax bill of KSh 138.4 million, including penalties and interest.
- •Through partial settlements and alternative dispute resolution, most issues were resolved, but roughly KSh 30 million remained in dispute, tied largely to loans written off as bad debts.
“Principal loan repayments are not [] revenue but a reduction of the loan asset and such repayments result in an increase into the cash account which is also a balance sheet item. The principal loan element remains a balance sheet item and the only impact it has on the Income Statement is the interest element generated,” the tribunal ruled.
Premier Credit argued that loan defaults are a normal business cost and showed that it pursued extensive recovery measures such as reminders, restructuring, legal action, repossession, and debt collectors before writing off loans.
A “bad debt,” in business terms, is a loan that has not been repaid, is unlikely to be repaid, and has been formally written off in the company’s accounts.
The Kenya Revenue Authority (KRA) countered that loan principal is capital, not income. Since the principal was never taxed, it cannot be deducted when a borrower defaults. The tribunal agreed, emphasizing that Premier only reports interest and fees as income and cannot claim a deduction for the unrecovered capital.
“Premier Credit failed to differentiate between the unpaid principal element of the loan and the unpaid interest element of the loan in its claim for the bad debts expense,” the ruling added.
The microfinance institution also challenged the interpretation of a 2011 legal notice, which explicitly excludes bad debts of a capital nature from deductible expenses. It argued that the regulation contradicted the Income Tax Act and should be declared invalid.
However, the tribunal declined to rule on the constitutional or statutory validity, noting that its jurisdiction is limited to reviewing tax decisions and does not extend to invalidating laws or regulations.
“The jurisdiction conferred upon this Tribunal is to hear appeals against decisions of the tax Commissioner and not to determine whether laws or regulations are inconsistent with each other,” the tribunal said.
The ruling carries broad implications for banks, microfinance companies, SACCOs, and digital lenders. Lenders must now bear the full cost of defaulted principal without tax relief, a factor that may influence loan pricing, credit risk assessment, and overall business strategy.
