• Introduction:

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• In a landmark decision with far-reaching implications for the real estate and banking sectors in Kenya, the Court of Appeal has ruled that the sale of commercial properties is subject to VAT under the Value Added Tax Act, 2013. The case of Kenya Revenue Authority v David Mwangi Ndegwa [Civil Appeal No. 65 of 2019] settles the long-standing ambiguity on whether commercial premises qualify for VAT exemption, providing much-needed clarity for property developers, financiers, and investors.
  
  

Background of the Case

1. On 11 December 2013, David Mwangi Ndegwa (hereafter, “the Respondent”), purchased from Standard Chartered Bank Kenya Ltd the property known as Kiambu Town Block 11/74, together with all the buildings erected thereon, for Kshs.70,000,050.00. Following the transaction, the Kenya Revenue Authority (hereafter, “KRA”) issued a demand and the Respondent paid Kshs.11,200,080.00 in VAT, calculated at 16% of the purchase price. The Respondent made the payment under protest, maintaining that the sale of land was exempt from VAT under the provisions of the VAT Act.

2. On 30 October 2015, the Respondent filed a suit in the High Court at Nairobi being HCCC No. 541 of 2015, seeking inter alia, a declaration that no VAT was payable on the sale or purchase of land, whether or not the premises erected thereon were residential or commercial. He further sought an order for a refund of the VAT paid, together with interest, and the costs of the suit.

3. KRA opposed the suit, arguing that VAT was lawfully levied on the transaction because the sale involved commercial premises, which were not exempt from VAT under the VAT Act. KRA maintained that the distinction between residential and commercial premises was deliberate under the VAT Act and that the sale of commercial premises was always intended to attract VAT.

High Court’s Judgement:

4. The High Court (Kasango, J.) held that the sale of land and any buildings erected thereon, whether residential or commercial, was exempt from VAT under paragraph 8 of Part II of the First Schedule to the VAT Act. The court reasoned that the definition of “land” under Article 260 of the Constitution includes the surface of the earth, subsurface rock, and any buildings erected thereon. The VAT Act’s reference to “land” was, therefore, broad enough to cover both land and buildings. The court applied the principle that any ambiguity in tax legislation should be interpreted in favour of the taxpayer.

5. The High Court also ruled that the respondent was entitled to a refund of the VAT paid, even though the claim was made outside the 12-month limitation period set out in Section 30 of the VAT Act. The court reasoned that the payment was not made in error but under protest and that the refund was, therefore, justified.

6. Aggrieved by the High Court’s judgement, KRA preferred an appeal to the Court of Appeal in Civil Appeal No. 65 of 2019.

Proceedings before the Court of Appeal:

KRA’s Case

7. KRA’s appeal was premised on 3 key grounds. First, it argued that the High Court erred in holding that “land”, as defined under Article 260 of the Constitution, includes buildings. KRA maintained that the VAT Act distinguishes between land and buildings, treating them as separate taxable goods. KRA relied on the Land Act and dictionary definitions to assert that “land” and “buildings” are distinct terms.

8. Second, KRA submitted that paragraph 8 of Part II of the First Schedule to the VAT Act is not ambiguous because it expressly exempts only land and residential premises from VAT but makes no mention of commercial premises. KRA argued that the specific mention of residential premises implied the deliberate exclusion of commercial premises from the exemption.

9. Third, KRA argued that the refund ordered by the High Court was unlawful because Section 30 of the VAT Act sets a 12-month limitation period for refunds of taxes paid in error. Since the respondent’s payment was not made in error but under protest, the refund could not be granted outside the statutory limitation period.

Respondent’s Case

10. In opposing the appeal, the Respondent argued that the definition of “land” under Article 260 of the Constitution includes any structures erected on the land. He maintained that there was no legal basis for distinguishing between land and commercial buildings for VAT purposes. 

11. The Respondent further submitted that the term “land” under paragraph 8 of the VAT Act was ambiguous, and such ambiguity should be resolved in favour of the taxpayer. He also argued that the payment of VAT was made under compulsion and was not voluntary. He maintained that the limitation period under Section 30 of the VAT Act should not apply to payments made under protest or compulsion.

Court of Appeal’s Determination

12. The Court of Appeal overturned the High Court’s decision and allowed the appeal in favour of KRA. The Court held that the definition of land in Article 260 of the Constitution applies only when the context permits. The VAT Act treats land and buildings as separate taxable goods, and the specific reference to residential premises implies that other types of premises (such as commercial premises) are subject to VAT.

13. The Court found that paragraph 8 of Part II of the First Schedule to the VAT Act is clear and unambiguous. The specific reference to residential premises and the omission of commercial premises indicate a deliberate legislative intent to subject commercial premises to VAT. The Court ruled that since the sale involved commercial premises, the VAT was lawfully charged. Consequently, the order for a refund was overturned. The Court awarded KRA the costs of the suit and the appeal.

Implications for Players in the Banking and Construction Sectors

1. The Court of Appeal’s determination provides clarity on the application of VAT to property transactions. The sale of commercial premises is now firmly established as taxable, while the sale of residential premises remains VAT-exempt.

2. For banks, the decision reinforces the importance of assessing the VAT implications of properties used as loan collateral or in debt recovery transactions. Where banks dispose of commercial properties through public auction or private sale, they must account for VAT liability. This may affect the pricing and overall attractiveness of commercial properties as security for loans.

3. For property developers and financiers involved in mixed-use developments, the ruling creates a need for more detailed tax planning. Mixed-use premises could face partial VAT charges depending on their commercial and residential components. Developers may need to clearly allocate the value of residential and commercial portions to avoid disputes with tax authorities.

4. Buyers of commercial properties should anticipate higher costs due to the confirmed VAT liability. This may affect demand for commercial properties and pricing strategies. Developers and property owners may need to adjust their pricing structures to account for VAT and other transactional costs.

5. The judgment reinforces the principle that tax statutes must be interpreted strictly. The courts are unlikely to expand statutory exemptions beyond their express wording. Taxpayers can no longer rely on constitutional definitions or broad statutory interpretations to escape VAT liability on commercial property transactions.

6.The decision also highlights the importance of strict adherence to refund timelines under the VAT Act. The limitation period under Section 30 of the VAT Act is now firmly established, and taxpayers seeking refunds of wrongly charged VAT must act promptly.

7.Banks and construction firms should consider engaging tax experts when structuring commercial property transactions to mitigate exposure to VAT liability and potential disputes with the KRA. Careful contract drafting and tax planning will be necessary to minimize the impact of VAT on commercial property transactions.

Conclusion

The judgment of the Court of Appeal establishes a clear distinction between land and commercial premises for VAT purposes. This decision reinforces the principle that tax statutes must be interpreted strictly, and where the legislature expressly includes or excludes certain items, the courts must uphold that intent.

Understanding the impact of VAT on property deals can be challenging, but our Banking & Finance and Tax teams are here to assist. We advise developers, lenders, and property owners on structuring transactions, minimising tax exposure, and ensuring compliance with the law.

If you are purchasing or selling commercial property, using it as loan security, or simply require clarification on VAT regulations, please contact OLM Law LLP today to discover how we can assist your business.

For any enquiries on this or any other matter do not hesitate to contact us via email at info@olmllp.com.

 Disclaimer: This article has been prepared for informational purposes only and is not legal advice. This information is not intended to create, and receipt of it does not constitute a lawyer-client relationship. Nothing in this article is intended to guarantee, warranty, or predict the outcome of a particular case and should not be construed as such a guarantee, warranty, or prediction. The authors are not responsible for any actions (or lack thereof) taken as a result of relying on or in any way using information contained in this article and in no event shall be liable for any damages resulting from reliance on or use of this information. Readers should take specific advice from a qualified professional when dealing with specific situations.