BY BOSIRE NYAMORI
A High Court decision delivered on November 29 2018 has highlighted the complexity in determining the VAT payable on land and property transactions and the consequences that can follow where the parties disagree on the tax liability.
In David Mwangi Ndegwa v Kenya Revenue Authority, Civil Suit No. 541 of 2015, the High Court held that, “sale or purchase of land, together with residential premises and commercial premises erected on the land’, is VAT-free. Further, it ordered Kenya Revenue Authority (KRA) to refund the plaintiff, David Mwangi Ndegwa Sh11.2m, which he had paid as VAT when he bought the property (land and the buildings standing on the land).
When Standard Chartered Bank sold the property to the Plaintiff they imposed VAT of Sh11.2m on the selling price. The Bank’s position was that the property were commercial premises, so were not exempt from VAT under Item 8 of Part II (paragraph 8) in the First Schedule (Schedule) to the Value Added Tax Act, No 35 of 2013 (VAT Act).
Paragraph 8 exempts from VAT consideration arising from, “[s]upply by way of sale, renting, leasing, hiring, letting of land or residential premises.”
When interpreting this paragraph – and indeed the entire Schedule – the approach is to treat goods and services – or, supplies in VAT parlance – not explicitly listed on it as chargeable to VAT. For instance, item 8 does not provide for commercial premises so using the general rule of interpretation the Bank inferred the property attracts VAT.
The Plaintiff paid the VAT and acquired the property although he disagreed with Bank’s VAT treatment of it. He requested for refund of the VAT, but KRA refused. As a result, he approached the High Court for a declaratory order that VAT is not applicable to the, “sale or purchase of land, regardless of whether or not the buildings standing thereon are residential or commercial buildings.” He also asked for an order forcing KRA to refund the VAT he paid.
The Plaintiff’s case was that the real subject of the agreement between him and the Bank was land, which was exempt from VAT under paragraph 8. Citing Article 260 of the Constitution, he said “land’ includes “the surface of the earth” with any structures and objects attached to the land. He contended that item 8 contemplated two independent and separate transactions, namely, “letting of residential premises” and “sale, renting, leasing, and (sic) hiring of land” and that sale of land fell under the second limb. In any event, he submitted that it’s difficult to separate land and/or building when carrying out a sale or purchase transaction, a situation contemplated and legislated in the Constitution and section 2 of the Land Act, No 6 of 2012.
KRA opposed the Plaintiff’s case on four grounds. First, they submitted that only supplies set out in the First Schedule are VAT-free. As commercial premises are not one of the items listed in the schedule, they reasoned these are taxable. They defined commercial premises as, “land or building not occupied or not capable of being occupied as residential premises.” Item 8 defines residential premises, so KRA inferred that what is not covered in the definition is logically commercial premises.
Second, the Plaintiff had implied that paragraph 8 is vague and ambiguous, but KRA opposed this. When doing so, KRA appears not to have responded to the Plaintiff’s parsing and interpretation of the paragraph.
Third, they argued that it’s the Bank that collected and remitted VAT to KRA, so should claim the refund and, presumably, pay the refund to the Plaintiff.
Lastly, KRA submitted that the claim for refund of VAT was time-barred by virtue of paragraph 30 of the VAT Act, which allows a person who pays tax in error to claim a refund within “twelve months from the date the tax became due and payable.” Paying tax on a non-taxable item is an error.
The issue for consideration was whether KRA’s VAT treatment of land and buildings erected on land was proper and in accordance with the VAT Act.
The High Court delivered judgment on 29 November 2018 and found in favour of the Plaintiff. It found the Constitution treats land as including, among others, buildings.
Paragraph 8 uses the conjunction “or”, which ordinarily implicates another possibility. Using this, the Court found that paragraph 8 implicates two supplies, namely, ““sale, renting, leasing, and (sic) hiring of land” and “sale, renting, leasing, and (sic) hiring of residential premises.” As the transaction under dispute involved the sale of land, the Court found it was exempt from VAT.
In addition, the Court held that VAT was not applicable to the transaction because of the ambiguity of paragraph 8, which allows a “presumption that the purchase of land where there is a commercial premises is not exempt from VAT”.
KRA had contended that its’ the Bank that paid VAT, so should claim refund of the tax and not the Plaintiff. The Court refused this position noting that it’s the Plaintiff who had borne the economic incidence for the tax and so, rightly require a refund.
With regard to tax paid in error and, therefore, time-barred by paragraph 8 of the VAT, the court found KRA’s understanding of the law was wrong. It found that the VAT was not paid in error and, is therefore not amenable to paragraph 30 of the VAT Act. Factually, the Court found that the Plaintiff had made a claim for refund of the VAT in time, but KRA rejected this.
The Court found a person who owns an interest in land usually has the same interest in anything on the land such as buildings. Implicitly, the Court held that land cannot be separated and sold independently from buildings erected on it. Case law relating to land supports the Court’s analysis and findings in this particular case.
Overall, paragraph 8 is not a model for statutory drafting. First, there is no consensus on what land actually means yet Parliament did not give much thought to this when legislating paragraph 8. As such, it is difficult to assert that the policy intention for legislating paragraph 8 is being met in the best way possible and with the least unintended consequences. Secondly, how the commas- a common mark of punctuation and often troublesome- and the conjunction “or” have been used in the paragraph also makes interpretation difficult. As a result, there is room for ambiguity in interpretation, defeating policy intents that informed legislation.
The Court found paragraph 8 ambiguous for allowing a “presumption that the purchase of land where there is commercial premises is not exempt from VAT.” This is problematic. The accepted principle and practice is that that which is not explicitly stated in the schedule is subject to VAT. However, it implicitly rejected this approach, without giving an alternative one. Perhaps the Judge was subtly criticising the tax administrator and practitioners for using the term “commercial premises” although it is neither referred to nor defined in the VAT Act.
When interpreting paragraph 8, the Court said it referred to two supplies, to wit, ““sale, renting, leasing, and (sic) hiring of land” and “sale, renting, leasing, and (sic) hiring of residential premises.” By saying so, it implied that the drafting was proper. Yet on another level, the Court concluded that the drafting of the paragraph was vague and ambiguous. This contradiction in approach further confuses taxpayers and tax administrators
What does this case mean for VAT on land and property?
The utility of the decision is very much limited to the facts of this particular case and thus does not address the broad spectrum of issues that land and property pose for the VAT Act. The sector involves many parties and varied transactions, which often present complex and ever-changing challenges for taxpayers. Thus, it is evident that the decision in this matter will not be the last word on the issue, and that further disputes are likely to arise.
KRA will certainly appeal the decision as it has adverse implications for tax collections and enforcement.
In the long run, the National Assembly should amend paragraph 8 to address poor drafting, which creates room for ambiguity in interpretation.
Writer is an advocate of the High Court