The Court of Appeal recently ruled that Commercial premises are not exempt from Value Added Tax (VAT). This decision resulted from KRA’s appeal against David Ndegwa, following the High Court’s declaration that Paragraph 8 of Part II of the First Schedule of the VAT Act was ambiguous, thereby exempting commercial buildings from being classified as a taxable supply. 

Paragraph 8 of Part II of the First Schedule states that Supply by way of sale, renting, leasing, hiring, letting of land or residential premises. “Residential premises” means land or a building that is occupied or capable of being occupied as a residence, but does not include hotels or holiday accommodations. Provided that this paragraph shall not apply where such services are supplied in respect of car park services, or conference or exhibition services, except where such services are provided to educational institutions as part of their academic activities.

David Ndegwa purchased land, together with the building erected thereon, from Standard Chartered Bank Kenya Limited. The Kenya Revenue Authority demanded VAT at the rate of 16% on the purchase price of the property, and the taxpayer paid under protest. 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, regardless of whether the premises thereon were residential or commercial.

The High Court judge adopted the definition of land under Article 260 of the Constitution, which stipulates that land encompasses everything on the surface of the earth and the airspace above it. Based on this, the High Court found that the VAT Act was ambiguous in light of the definition of land in the Constitution. 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.

In the Appeal, KRA stated that the VAT Act treats land and buildings as distinct VATable goods and that whether a building is residential or commercial is a relevant consideration for VAT purposes. The KRA averred that, under the VAT Act, commercial buildings were not exempt from VAT, based on the legislative history that demonstrated the legislature has always distinguished between land and buildings, as well as between residential and commercial buildings. Furthermore, the KRA noted that there is no ambiguity regarding 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 based 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.

The Court, in its findings, stated that the High Court found the contested provision to be ambiguous because, in its appreciation, the Act defines land differently from the Constitution, under which land includes everything on it.  By attempting to define residential premises differently from the definition of land in the Constitution, the Act becomes unclear, and that unclarity leads to ambiguity. As far as the High Court is concerned, anything situated on land, whether residential premises or commercial premises, is exempt from VAT because it is located on land as defined by the Constitution.

Regarding the issue of defining land, the Constitution must be applied in context, and there is nothing that prevents the Legislature, in a particular legislation like the Act, from defining land differently from the definition in the Constitution. There was no ambiguity as far as paragraph 8 of Part II of the First Schedule to the Act. 58. In a spirited attempt to persuade the Court that the provision in issue is ambiguous, the respondent argued that it was not clear how VAT is charged on supply of mixed-user premises, and in a bid to understand the issue better, the Court posed the question whether supply of a commercial ranch would constitute exempted land or non-exempted commercial premises. KRA responded that the difficulty was not accurate because there was an established industry practice regarding the apportionment of supply for mixed-use premises.

Moving forward, this ruling clarifies the application of VAT to commercial and mixed-use properties in Kenya. The Court of Appeal has set a precedent that commercial premises are not exempt from VAT, meaning that businesses or individuals purchasing commercial properties will be required to pay VAT on the sale price. Additionally, for mixed-use properties (those that have both residential and commercial components), VAT will be apportioned based on the proportion of space used for each purpose. This means that the VAT charged on such properties will be divided between the residential and commercial portions, with the commercial portion subject to VAT.

For the Kenya Revenue Authority (KRA), this ruling solidifies their position that commercial properties are taxable, and there is an established industry practice for dealing with mixed-use properties, ensuring consistent application of VAT in these cases.

For taxpayers and property buyers, it means they need to be aware that commercial buildings and any mixed-use properties they acquire will likely incur VAT charges. The apportionment method will be applied depending on the proportion of the property used for commercial purposes.

In practice, businesses and property developers might need to engage with tax professionals to accurately calculate and manage VAT obligations, especially for properties with multiple uses. Additionally, this decision may prompt further clarification or updates to the tax laws, ensuring all parties have clear guidance on handling VAT for mixed-use properties.