On 11 December 2013, David Mwangi Ndegwa, (the taxpayer) purchased from Standard Chartered Bank Kenya Limited land together with the building erected thereon. The Kenya Revenue Authority (the KRA) demanded VAT at the rate of 16% on the purchase price of the property and the taxpayer paid under protest.
Subsequently, the taxpayer lodged a claim against the KRA at the High Court seeking a declaration that VAT was not payable on the sale or purchase of land, whether the buildings erected thereon were residential or commercial, pursuant to Paragraph 8 of Part II of the First Schedule to the VAT Act (the VAT Act) and prayed for an order for refund of the VAT paid together with interest thereon.
Proceedings at the High Court
The High Court held that the relevant provision of the VAT Act was ambiguous and ruled in favour of the taxpayer concluding that the sale and purchase of land was an exempt supply for VAT purposes whether the premises thereon were residential or commercial.
The High Court judge adopted the definition of land under Article 260 of the Constitution which provides that land includes what is on the surface of the earth and the airspace above the surface. Based on this, the High Court found that the VAT Act was ambiguous in light of the definition of land in the Constitution and as a demonstration of the ambiguity, the High Court wondered whether under the relevant provision of the VAT Act, a building which was partly residential and partly commercial would attract payment of VAT.
Proceedings at the Court of Appeal
The KRA being aggrieved by the judgment of the High Court appealed against the decision to the Court of Appeal. In its appeal, the KRA stated that the VAT Act treats land and buildings as different vatable goods and that whether a building was residential or commercial was a relevant consideration for purposes of VAT. The KRA averred that under the VAT Act, commercial buildings were not exempt from VAT based on the legislative history that demonstrated that the legislature has always distinguished between land and buildings and between residential and commercial buildings. Furthermore, the KRA noted that there is no ambiguity on the VAT treatment of a building that is partially commercial and as a result vatable, since the practice is to apportion the charging of VAT depending on the usage of the building.
On the other hand, the taxpayer contended that no distinction should be made between the sale of land and the sale of buildings standing thereon and that the sale of buildings is not a legal term. The taxpayer averred that exempting the sale of land from VAT but subjecting the sale of buildings thereon to VAT is a legal absurdity because one cannot sell land without necessarily selling the buildings standing thereon.
Determination of the Court of Appeal
In setting aside the High Court judgment, the Court of Appeal noted that the definition of land in the Constitution is not intended for all contexts and the definition applies if and only if the context permits. In this regard, the Court of Appeal noted that the definition in the Constitution cannot be applied to the VAT Act. The Constitution allows the legislature (depending on context) to define land in a manner that is different from that given in the Constitution which in this case is the VAT Act.
The Court of Appeal clarified that under the VAT Act, the exemption in the VAT Act only applies to the supply of bare land and residential premises. The Court of Appeal further held that the law intentionally distinguishes between land, residential premises, and commercial premises and that the definition of residential premises compels the conclusion that the supply of any building that is not occupied or capable of being occupied as a residence is not exempt from VAT. Since the VAT Act does not mention commercial buildings among the exempt items, they remain taxable at the standard rate of 16%.
Having determined that the supply of commercial premises is not exempt from VAT, the Court of Appeal determined that the KRA lawfully levied VAT on the taxpayer’s transaction and therefore the VAT paid was not refundable.
Putting it into perspective
The decision reinforces the fact that provided an item is not contained in the exempt list in the VAT Act, it is subject to VAT (whether at the standard rate (16%) or zero per cent). Accordingly, since the VAT Act only provides an exemption for the supply of land and residential premises anything else other than those items for example the transfer, sale, or lease of commercial premises is subject to VAT at the standard rate of 16%.
Given the determination by the Court of Appeal, VAT at the rate of 16% must be considered in the pricing and structuring of transactions involving commercial properties in Kenya.
