When is a loan not a loan for tax purposes?

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 by factors such as convenience
and cost savings. However, without proper and sufficient documentation, 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. In 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 recharacterise 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 powers to recharacterise transactions
where they do not reflect economic or substantive effect. It also contended that Bullion did not
have sufficient documentation including a board resolution authorising the borrowing, a valid
loan agreement, bank statements to demonstrate 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 recharacterise 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 director
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.
Explorer v URA
Explorer was issued assessments on grounds that it had an unsupported loan as income.
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 URA was holding the taxpayer to very high standard of proof given the
passage of time. Further, the Tribunal found that URA’s recharacterisation of the loan as
income was irational, 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, 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 lapsed, the request for other supporting document like board resolutions
seemed unreasonable.
Whereas the differing positions of the Tribunal raises 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.
*Authored by Mugisha Jennifer Ruth- Tax Lawyer