THE TAXMAN SUFFERS ANOTHER BLOW

By Nikhil Hira,Alex Mathini,Alex Njage Friday, December 14, 2018
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On 29th November 2018, the High Court, in a decision by the Hon. Justice Mary Kasango delivered a judgement regarding Civil Suit No. 541 of 2015 (the Judgment) which sought to clarify the interpretation of paragraph 8 of Part II of the First Schedule to the Value Added Tax Act of Kenya, No. 35 of 2013 (the VAT Act). The suit had been filed by David Mwangi Ndegwa (the plaintiff) against the Kenya Revenue Authority (KRA) alleging that KRA had collected VAT in contravention of the VAT Act.

The gravamen of the suit was that paragraph 8 of Part II of the First Schedule to the VAT Act exempts the supply by way of sale, renting, leasing, hiring, letting of land or residential premises from VAT and that the exemption from VAT was meant to also apply to the sale of commercial premises. The Plaintiff contended that the definition of “land” under the Land Act 2012, No. 6 of 2012, which makes reference to the definition under Article 260 of the Constitution of Kenya, provides that “land” includes the surface of the earth and the airspace above the surface. Thus, the plaintiff argued that since the sale of land is exempt from VAT, it followed that the sale of a commercial building, whether on the surface of the earth or above the surface, was also exempt from VAT, since such commercial building was part of the “land” thereto. The plaintiff contended that in law, the sale of land and the buildings standing on the land cannot be done except in one indivisible sale transaction.

KRA rebutted the plaintiff’s argument by contending that paragraph 8 only exempts sale of residential premises from VAT and there was no mention of commercial premises, and KRA’s position therefore was that sales of commercial premises must therefore be subject to VAT.  KRA referred to the agreement of sale entered into by the plaintiff, which formed the subject of the suit, as having provided for the purchase of commercial premises. KRA further contended that the plaintiff’s claim for the VAT refund was time barred by Section 30 of the VAT Act and that since the Plaintiff had paid the VAT to the vendor, it was the vendor who ought to have made a claim for a refund.

The Court, while recognizing the ambiguity of paragraph 8 of Part II of the First Schedule of the VAT Act and the lack of a definition of “land” under the VAT Act, agreed with the Plaintiff’s arguments that the constitutional definition of “land” included all land both with commercial and residential premises; and that the plaintiff was not liable to pay VAT on the purchase price of the land regardless of the fact that such land comprised commercial premises. The Court further disagreed with KRA that the suit was time barred since Section 30 of the VAT Act only applied to refund claims of VAT paid in error and that the refund was recoverable from KRA by the Plaintiff, since the payment was by the Plaintiff and transmitted to the KRA.

Putting it into Perspective

The history of VAT on commercial premises in Kenya began with the Finance Act of 2007, which introduced VAT on rental income and leasing fees of commercial premises that took effect on 1 January 2008. The VAT Act of 2013 further introduced 16% VAT on the sale of commercial premises, which was the subject of the above suit.

The impact of the above ruling includes that leases of commercial premises would be exempt from VAT. If tenants were to stop paying VAT on their commercial premises, the impact to revenue collections would be huge.

This is the second judgement in the last six (6) months that will result in serious adverse repercussions for KRA in meeting their revenue targets. An earlier case declared a number of sections in the Tax Procedures Act, 2015 unconstitutional. One could argue that the shackles have been placed on KRA though in our view ambiguous drafting of legislation and failure to consider comprehensively the provisions of the Constitution, especially on matters touching on public interest is perhaps the bigger culprit.  The fact that the Courts are ruling on the constitutional applicability of some of our laws, is going to make life tougher for our revenue enforcer and there is clearly an urgent need on the part of the legislature to address the various ambiguities in our laws and on the part of KRA to ensure that their laws are in line with the spirit and letter of the Constitution.

It is likely that KRA will appeal against this judgement (as they have done in the earlier case) but until the appeal is lodged and a stay of the orders in the high court judgment is issued, they have no choice but to comply with the rulings.