Judgment summary
The Appellant, a company incorporated in Kenya that owns property yielding rental income, appealed against an Objection Decision dated 25th June 2025 that confirmed assessments totalling Kshs 34,252,436 in principal tax [1], [5].
The assessments followed a Respondent audit of the Appellant's records for Income Tax, VAT and Withholding Tax covering January 2019 to December 2023, with findings communicated by letter dated 28th March 2025 [3]. The Appellant objected on 27th April 2025 and filed the appeal by Notice of Appeal dated 25th July 2025 [4], [6].
The Tribunal identified four issues: the disallowance of interest expense for 2019 to 2021, the application of the 30% EBITDA restriction on interest deductions, the treatment of residential rental income as commercial income subject to VAT, and the disallowance of input VAT on a mixed-use development [83].
The Tribunal found the appeal partially meritorious. It upheld the VAT assessment, upheld the disallowance of interest expense for 2019 to 2021 under Section 15(1) of the ITA, and set aside the corporation tax assessment relating to the EBITDA interest restriction under Section 16(2)(j) [124].
Background
The Appellant is a company incorporated under the laws of Kenya and the registered proprietor of property from which rental income is derived [1]. The Respondent is the Commissioner for Domestic Taxes, an officer of the Kenya Revenue Authority [2].
The Respondent conducted an audit of the Appellant's records relating to Income Tax, VAT and Withholding Tax for the period January 2019 to December 2023, and communicated audit findings by a letter dated 28th March 2025 [3]. The Respondent's statement of facts referred to an audit notice dated 23rd August 2024 [54].
The Appellant lodged a Notice of Objection dated 27th April 2025 [4]. The Commissioner issued an Objection Decision dated 25th June 2025 confirming assessments totalling Kshs 34,252,436 being the principal tax [5]. The Appellant filed the appeal by Notice of Appeal dated 25th July 2025 and a memorandum of appeal dated 12th August 2025 [6], [7].
On 25th August 2019 the Appellant entered a construction agreement with Endeavor Construction Limited for a mixed-use property in the Pangani area of Nairobi County at a contract sum of Kshs 852,969,200, financed through a commercial loan from Equity Bank and additional funding from related parties [9]. The Respondent stated that the majority of the construction costs were funded through a loan of Kshs 667,022,228 from Equity Bank Limited [55]. The Appellant validated its objection by paying tax not in dispute of Kshs 577,479 on 9th May 2025 [73].
Core dispute
The parties disputed four matters. First, whether the Respondent erred in disallowing interest expense claimed for the period 2019 to 2021. The Appellant argued the interest was incurred wholly and exclusively in the production of taxable income under Section 15 of the ITA, while the Respondent argued no income was generated during construction and the interest should have been capitalised in line with IAS 23 [84], [89].
Second, whether the Respondent erred in applying the 30% EBITDA restriction under Section 16(2)(j) of the ITA to the Equity Bank loan. The Appellant argued the loan was from a licensed Kenyan bank that is excluded from the restriction, while the Respondent argued the Finance Act 2021 amendment applied the restriction to all loans for the period 1st January 2022 to 31st December 2023 [24], [64].
Third, whether the Respondent erred in treating deposits received under business names as commercial rental income subject to VAT, resulting in an assessment of Kshs 2,963,098. The Appellant argued these were residential rents deposited by Equity Bank agents on behalf of individual tenants [39], [40].
Fourth, whether the Respondent erred in disallowing input VAT of Kshs 112,284,651.77 claimed on the mixed-use development without apportionment under Section 17 of the VATA [42], [46], [67].
Court findings
On the interest expense for 2019 to 2021, the Tribunal noted that although it was not disputed that the Appellant took a loan, no loan statement or evidence of loan terms was filed, so it could not verify the interest charged or the claimed figures [91], [100]. The Appellant did not provide lease agreements or link its income schedules to the property constructed under the Endeavor Construction Limited agreement, and did not file a certificate of completion or occupancy [93], [96], [99]. The Tribunal found the Appellant failed to demonstrate a nexus between the expenses and the income and held the Respondent did not err under Section 15(1) of the ITA [95], [101].
On the 30% EBITDA restriction, the Tribunal considered Section 16(2)(j) as it stood at the time of assessment, which applied to gross interest paid to a non-resident and expressly excluded banks or financial institutions licensed under the Banking Act [104], [105]. The Tribunal found no ambiguity between Section 16(2)(j)(ii)(A) and Section 16(2)(j)(iii)(A) [106]. It held that Equity Bank is a resident entity not covered by the paragraph addressing non-residents, and that the Respondent erred in relying on Section 16(2)(j)(ii)(A). The Respondent did not pinpoint the related parties it referred to [107], [108], [109].
On the VAT on rental income, the Tribunal examined evidence of rent deposits with house numbers and tenant names, but the Appellant did not file bank statements to allow verification, and failed to provide the entire evidence needed. The Tribunal held the Appellant failed to demonstrate the Respondent erred [112], [113].
On the input VAT, the Tribunal noted that leasing residential premises is an exempt supply under Paragraph 8, Part II of the First Schedule to the VATA, and referred to the apportionment formula in Section 17(6) and the former Section 17(7) [116], [117], [118], [121]. The Appellant did not define the commercial portion and failed to demonstrate that turnover from leasing commercial premises exceeded 10% of total turnover, so it did not prove entitlement to claim input tax [119], [122], [123].
Outcome
The Tribunal found the appeal partially meritorious and partially allowed it [124].
The Objection Decision dated 25th June 2025 was varied as follows: the VAT assessment was upheld; the corporation tax assessment in respect of disallowed interest expense under Section 16(2)(j) of the Income Tax Act (EBITDA) was set aside; and the corporation tax assessment in respect of the balance of the disallowed interest expense was upheld [124].
Each party was ordered to bear its own costs [124].
Major issues / areas of contention
- Whether the Respondent erred in disallowing interest expense for the period 2019 to 2021 under Section 15(1) of the Income Tax Act.
- Whether the Respondent erred by applying the 30% EBITDA restriction under Section 16(2)(j) of the Income Tax Act to a loan from a resident licensed bank.
- Whether the Respondent erred by treating residential rental income received from tenants as commercial income subject to VAT.
- Whether the Respondent erred by disallowing input VAT claimed on a mixed-use development without apportionment under Section 17 of the VAT Act.