On 29 November 2018, High Court Judge Justice Mary Kasango delivered a judgment in the case of David Mwangi Ndegwa (the Plaintiff) v. the Kenya Revenue Authority (the KRA). In brief, the Plaintiff had brought an action against the KRA seeking a declaration that Value Added Tax (VAT) is not payable on a transaction for the sale or purchase of land, regardless of whether or not the buildings standing on it are residential or commercial. The Plaintiff had also sought a refund of KES 11,200,000 of VAT he had paid for the purchase of a commercial property. The key question for determination was whether transfer of commercial premises is a taxable or exempt supply under the provisions of Part II, paragraph 8 of the First Schedule to the VAT Act (the Exempt Status).
The High Court ordered that VAT is not payable on a transaction relating to the sale or purchase of land, whether or not the buildings thereon are residential or commercial.
The VAT Act provides the following as a VAT exempt supply:
“[the] supply by way of sale, renting, leasing, hiring, letting of land or residential premises. [The term] ‘residential premises’ [is defined to] mean land or a building occupied or capable of being occupied as a residence, but not including hotel or holiday accommodation.”
The crux of the Plaintiff’s case was that the KRA was creating a legal distinction between land and buildings that stand on it. Further, as the VAT Act does not provide for the definition of “land”, it would follow that the constitutional definition ought to be adopted, where “land” includes the surface of the earth and the airspace above the surface, i.e. includes the buildings thereon. Since the sale of land is exempt from VAT, it therefore follows that the sale of a commercial building, whether on the surface of the earth or above the surface, would similarly be exempt from VAT.
On the other hand, the KRA was of the view that paragraph 8 of the First Schedule to the VAT Act only exempts sale of residential premises, but not the sale of commercial premises. In their view, “commercial premises” ought to be defined as “land or a building not occupied or not capable of being occupied as residential premises,” which is an extrapolation given that only residential premises are defined under the VAT Act.
The Court wholly agreed with the Plaintiff’s interpretation of the constitutional definition of “land” and was of the view that the construction of a commercial building on the property does not of itself alter the nature of the property as “land” within the constitutional definition, with any contrary interpretation leading to the erroneous creation of a legal distinction between “land” and buildings erected thereon. While the Court acknowledged the ambiguity in the law, it upheld the taxation principle that taxing laws must be clear and unambiguous and, where there is ambiguity, it must not be interpreted to the detriment of the taxpayer.
We are aware that the KRA prayed for and was granted a stay of execution on the judgment for 30 days following the High Court determination. There is also a pending application before the Court of Appeal seeking a stay of execution until the intended appeal is heard and determined. Should this application before the Court of Appeal be granted, then the status quo (i.e. VAT at 16 percent on sale of commercial buildings) will apply until the Court of Appeal determines the issue. As such, at the time of this alert, the 30-day stay is in force and VAT at 16 percent on commercial buildings remains applicable.
In a recent private ruling to a taxpayer, the KRA took the view that even where a property is not capable of being occupied as a commercial property, i.e. land on which an incomplete commercial building is in the process of being constructed, VAT would still be applicable on the transfer of the property on the basis that the intention is for the property to be occupied as a commercial property once construction is finalised. In light of this judgment, it is clear that this argument is no longer tenable in law.
While we keep an eye on the developments at the Court of Appeal and potentially the Supreme Court, we note that the KRA and the National Treasury could use this opportunity to clarify the law relating to the disposition of residential and commercial property for VAT purposes, which could be achieved through Finance Bill amendments in 2019 once the 2019/2020 Budget cycle begins.
The content of this alert is intended to be of general use only and should not be relied upon without seeking specific legal advice on any matter.