Court of Appeal Confirms VAT is Applicable on Sale of Commercial Property

Brief Background of the Case
The matter arose from the purchase of a parcel of land by David Mwangi Ndegwa (the Taxpayer) in December 2013. He had purchased a parcel of land on which commercial buildings had been erected. The vendor’s advocates demanded VAT at the standard rate of 16% on the purchase price, which the Taxpayer paid to Kenya Revenue Authority (KRA) under protest and later applied for a refund.

When the KRA failed to refund the Taxpayer, the Taxpayer filed proceedings at the High Court seeking a declaration that no VAT was payable on the sale or purchase of land irrespective of whether the buildings erected thereon were residential or commercial. This position was premised on an argument that paragraph 8 of Part II of the First Schedule to the VAT Act exempted “land” from VAT, as “land” would be considered to comprise any buildings erected thereon, irrespective of their use. On this basis, he sought a refund of the VAT paid, together with interest thereon.

In November 2018, the High Court ruled in favour of the Taxpayer, declaring that VAT was not payable on the sale or purchase of land, regardless of whether buildings on the land were residential or commercial. The High Court further held that “land” was defined broadly under Article 260 of the Constitution of Kenya 2010 (the Constitution) to include whatever was on the earth’s surface, subsurface, and airspace (and therefore by extension, any buildings erected thereon irrespective of their use).

The KRA then appealed against the High Court judgment to the CoA, and obtained stay pending the hearing and determination of the appeal. The CoA has now finally determined the appeal, as analysed below.

The Court of Appeal’s Analysis and Determination on Key Issues

1. Definition of land in the Constitution in relation to buildings

   The CoA found that the High Court erred in concluding that, “land” includes the buildings erected on it within the context of the VAT Act. It held as follows:

• the definition of “land” in the Constitution is context-specific and not universally applicable. The CoA found that in the context of the VAT Act, land would be interpreted to explicitly exclude buildings erected on it, given the fact that the VAT Act made references to residential premises as distinguished from “vacant” land. The VAT Act further distinguishes between land and buildings by defining buildings as separate structures;

• a statute must be interpreted to give effect to every word and clause, avoiding any interpretation that renders the Legislature’s clear language superfluous or suggests ignorance of its meaning;

• the explicit exemption of residential premises from VAT, with no mention of commercial premises, implies that commercial premises are not exempt from VAT. This reflects the principle that explicitly mentioning one or more items in a category within a statute would imply the exclusion of other items in the same category that are not mentioned; and

• the VAT Act’s legislative history shows that Parliament has consistently distinguished between land, residential premises, and non-residential premises for purposes of categorisation as standard rated taxable supplies or exempt supplies, as the case may be. Presently, only the supply of land and residential premises is exempt from VAT, while commercial premises remain taxable at the standard rate of VAT. The High Court’s conclusion that “land” under the VAT Act includes buildings erected on it was therefore incorrect. 

2. Ambiguity of the VAT Act
The CoA ruled that Paragraph 8 of the First Schedule to the VAT Act is clear and unambiguous. It found that the Legislature can interpret the term “land” differently in the VAT Act as contrasted with definitions in other statutes, and therefore there is no ambiguity in the provision. Additionally, tax statutes must be interpreted based on the ordinary meaning of their words.

3. Refund of VAT claimed by Taxpayer
The CoA held that the supply of commercial premises is not exempt from the applicable VAT and on this basis, the High Court had erred in ordering KRA to refund the VAT paid.

Our View
The CoA’s decision provides some respite on the question on the applicability of VAT on the sale, renting, leasing, hiring, or letting of commercial premises. Unless overturned by the Supreme Court upon appeal, it is now the case that the sale, renting or leasing of commercial property is subject to VAT at the standard rate.

Having said that, this ruling has far-reaching implications as there may now be room for interpretation of the CoA judgment beyond the specific circumstances of the David Mwangi case.

We have set out below some of the complexities in the practical interpretation that could arise, as follows:

• Definition of the term “vacant land”: Paragraph 8 of the First Schedule to the VAT Act exempts “sale, renting, leasing, hiring, or letting of land” from VAT. However, the lack of explicit reference to “vacant” land may continue to raise concerns necessitating the need for clarification on what constitutes vacant land;
• Development status: determining when land is considered “developed for commercial use” is critical in assessing whether VAT should be applied to a transaction. Any improvements thereon, such as buildings, roads or utility installations that are considered commercial may attract VAT. There is of course a further lack of clarity that may arise where a building is originally constructed as a residential building but subsequently utilised for commercial purposes.
• Impact of utilities and infrastructure: clarification is needed on whether construction of roads, sewerage systems and similar utilities for commercial purposes qualifies as “developments” for VAT purposes, which may affect taxability.
• Mixed use developments: the CoA highlighted challenges in determining VAT applicability for mixed-use developments, where properties combine residential (VAT-exempt) and commercial (taxable at standard rate of VAT) components. While KRA cited industry practices for apportionment, the CoA declined to rule on the issue, leaving such transactions open to inconsistent VAT treatment. Buyers and sellers must carefully document apportionments to ensure compliance, minimise disputes and meet compliance standards.
• Has property law been upended?: The Constitution of Kenya defines “land” to include whatever is on the earth’s surface, subsurface, and airspace. This definition in the Constitution was based on property law concepts developed over centuries, and which are enshrined in the latin maxim Quicquid Plantatur Solo, Solo Cedit which means “whatever is affixed to the ground belongs to the ground.” The principal question that now arises from the CoA decision is whether, solely for tax purposes, a building erected on property can be given a different treatment from the land on which it is built. Are the two separable for VAT purposes? Can one sell the “building” separately from the “land” for VAT purposes?

  These are the types of questions that arise in complex ownership structures, such as when one entity owns the land while another undertakes the construction of a commercial building on it. Although such scenarios are not common, they do occur, particularly in cases where one company owns the land and leases it to another entity for an extended period, allowing the latter to use it as it deems fit, including constructing commercial premises. The CoA decision appears to suggest that given the different interpretation of “land” under the VAT Act, a building may be separable from the land on which it is built for VAT purposes.

  These are questions which undoubtedly may lead to complex VAT structures being designed so as to only subject VAT to a commercial building and not the land on which it is built. We would foresee further future litigation in the courts arising in the future, as the interpretation of this CoA judgment is tested.

We are presently unaware as to whether the Taxpayer intends to appeal to the Supreme Court on this decision. Regardless of whether the case will be appealed, we would point out the need for property transactions to be reviewed carefully on a case-by-case basis, with detailed attention to the nature of the property, its classification under VAT legislation, and the specific terms of the transaction. This approach will help mitigate risks, ensure compliance and reduce the potential for disputes with tax authorities.

Should you have any questions regarding this article series, please do not hesitate to contact Daniel Ngumy or Kenneth Njuguna.

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Contributors
1. Priscilla Githinji – Principal Associate
2. Caleb Weisiko – Associate