Judgment summary
The Appellant, a construction company, was awarded compensation by an Arbitrator after the Ministry repudiated a contract for a Disaster Data Recovery Centre. The award, later recognised and enforced by the High Court, comprised sums for idle resources, loss of profits, retention and arbitration and legal costs, plus interest. Following partial payment of the award in 2024, the Respondent assessed corporation tax on the amounts received, treating them as business income. The Appellant objected, and upon confirmation of the assessment, appealed to the Tribunal.
The Tribunal applied the surrogatum principle, holding that the tax character of an award depends on what it replaces rather than on the fact that it was embodied in a decree or arbitral award. It found that the loss of profits award was capital in nature, compensating the extinguishment of the Appellant's contractual rights rather than trading receipts. The idle resources and arbitration and legal costs awards reimbursed expenditure that had not been shown to have been previously deducted, and the retention sum represented income already invoiced and recognised in earlier years, so a further charge would amount to double taxation. The Tribunal also found the Respondent's determination on interest premature, as no interest amount had been ascertained or computed.
The Tribunal allowed the appeal and set aside the objection decision dated 6th March 2026, with each party bearing its own costs.
Background
The Appellant, a private company incorporated in Kenya, was awarded a contract on 13th August 2009 by the Office of the Deputy Prime Minister and Ministry of Finance for construction of a Disaster Data Recovery Centre at Naivasha, at a contract price of Kshs 782,499,814.30.
A dispute arose over the scope and completion of the works, referred to arbitration. The Arbitrator published an award dated 3rd August 2021 finding that the Ministry had repudiated the contract, and awarded the Appellant Kshs 167,748,234 for idle resources, Kshs 3,680,909,970 for loss of profits, Kshs 25,792,371 for retention fees and Kshs 57,438,038 for arbitration and legal costs, totalling Kshs 3,931,888,613, plus simple interest at 12% per annum from the date of the award until payment in full.
The Ministry applied to the High Court to set aside the award, and the Appellant applied for recognition and enforcement. The High Court upheld the award in its entirety and directed that it be recognised and enforced as a judgment of the Court.
Pursuant to the award, the Ministry paid the Appellant Kshs 700,000,000 in the 2024 year of income. On 15th December 2025, the Respondent issued an additional corporation tax assessment on this basis. The Appellant objected on 14th January 2026 and paid the undisputed withholding tax of Kshs 1,969,340 on 22nd January 2026. The Respondent issued an objection decision confirming the assessment on 6th March 2026, and the Appellant filed a Notice of Appeal on 22nd April 2026.
Core dispute
The dispute concerned whether the components of the arbitral award received by the Appellant, namely idle resources, loss of profits, retention fees and arbitration and legal costs, constituted chargeable income under Section 3 of the Income Tax Act, Cap 470, or were capital receipts or reimbursements falling outside the charge to corporation tax.
The Appellant argued that the idle resources and arbitration and legal costs sums were reimbursements of expenses actually incurred, that the retention sum had already been billed and declared as income such that a fresh charge would amount to double taxation, and that the loss of profits sum was capital in nature, being compensation for termination of the contractual framework rather than business income, since no business was carried on with the Ministry after repudiation. The Appellant also argued that the interest component had neither been ascertained nor paid and could not properly be determined as chargeable.
The Respondent maintained, applying the surrogatum principle, that all components of the award, save arbitration and legal costs to the extent not previously deducted, replaced business income or trading receipts and were accordingly chargeable as business income under Section 3(2)(a) of the ITA, with interest chargeable under Section 3(2)(b) once computed. The Respondent also contended that the Appellant had not discharged its burden under Section 56(1) of the Tax Procedures Act, 2015 to prove the assessment incorrect.
Court findings
The Tribunal held that a sum is not rendered chargeable to income tax merely because it is embodied in an arbitral award recognised as a judgment of the Court; the surrogatum principle requires an inquiry into what each head of compensation replaced.
On loss of profits (Kshs 3,680,909,970), the Tribunal found that this sum compensated the Appellant for the extinguishment of its contractual rights under the Contract Agreement dated 13th August 2009, not for profits earned in carrying on business, since the repudiation ended the contractual framework before any Phase 3 works were performed. This receipt was held to be capital in nature and outside Section 3(2)(a)(i) of the ITA.
On idle resources (Kshs 167,748,234), the Tribunal found this reimbursed revenue expenditure occasioned by the repudiation, and the Respondent had not assessed it as a recovery of a previously deducted expense, so it was not chargeable on the basis assessed.
On arbitration and legal costs (Kshs 57,438,038), the Tribunal found the Respondent made no finding that the Appellant had previously deducted these costs, so no charge arose.
On retention (Kshs 25,792,371.55), the Tribunal found this represented deferred payment for Phase 1 works already invoiced and recognised as income, and a further charge on release would result in double taxation.
On interest, the Tribunal found the Respondent's determination premature, as no interest amount had been ascertained or computed, and Section 3(2)(b) of the ITA presupposes an ascertained amount in an identified year of income.
The Tribunal found that the Appellant discharged the burden of proof under Section 56(1) of the Tax Procedures Act, 2015 and Section 30 of the Tax Appeals Tribunal Act, 2013, having produced the contract, the arbitral award, the High Court decision, and the objection correspondence, leaving only the legal characterisation of undisputed facts in contention.
Outcome
The Tribunal allowed the appeal, set aside the Respondent's Objection Decision dated 6th March 2026, and ordered that each party bear its own costs.
Major issues / areas of contention
- Whether the sums awarded to the Appellant under the arbitral award dated 3rd August 2021 constitute income chargeable to tax under Section 3 of the Income Tax Act.
- Whether the Respondent was justified in charging the individual components of the award, namely idle resources, loss of profits, retention and arbitration and legal costs, to corporation tax for the 2024 year of income.
- Whether the Respondent was justified in determining the tax treatment of the interest awarded on the arbitral sums.
- Whether the Respondent was justified in confirming the assessment in the objection decision dated 6th March 2026.