Aquavita Revisited: The Decision that Clarified the Debt–Equity Distinction for Tax Purposes

While hindsight may offer greater clarity, revisiting past precedents can provide valuable perspective on contemporary tax controversies.

This alert revisits the Tax Appeals Tribunal’s decision of 19 April 2022 in Aquavita Kenya Limited v Commissioner of Domestic Taxes (Tax Appeal No. 292 of 2021). Although the appeal also covered VAT and procedural matters, this alert focuses on the income-tax treatment of the redeemable preference shares.

The Tribunal focused on the instruments’ substantive rights and obligations rather than their legal label. Because the holder could compel redemption on seven days’ notice, it characterised the preference shares as debt and upheld WHT on deemed interest. It rejected WHT on deemed dividends because the same proceeds could not also be treated as equity distributions. The decision is relevant to taxpayers using redeemable preference shares and other hybrid funding arrangements in Kenya. It highlights the need to align instrument terms, transaction documents, accounting treatment and tax reporting.

Background

Aquavita Kenya Limited, a Kenyan provider of eco-friendly point-of-use water services, is a subsidiary of Aquavita II UK Limited (Aquavita UK). Aquavita UK financed the business through ordinary and redeemable preference-share capital, including funds held pending allotment.

Following tax compliance checks, KRA treated the redeemable preference shares as interest-free loans subject to deemed interest and WHT.

Aquavita UK financed the Kenyan subsidiary through several issuances of redeemable preference shares. Ten preference shares were issued in August 2014 and another ten in December 2014, each at Kshs 2,610,000; a further 606,000 Class B preference shares of Kshs 100 each were issued in February 2016. Some issued shares were initially unpaid. Funds received and held pending allotment included Kshs 71,116,218 at the end of 2019, and these were applied when 1,411,254 additional Class B preference shares of Kshs 100 each were created in October 2020.

The Appellant challenged that characterisation, maintaining that the instruments were equity under the Companies Act, 2015. It also disputed KRA’s treatment of unpaid preference shares as deemed dividends.

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