[2023] KETAT 263 (KLR)

Davis & Shirtliff Limited v Commissioner of Customs & Border Control (Appeal 368 of 2021) [2023] KETAT 263 (KLR) (Commercial and Tax) (12 May 2023) (Judgment)

Neutral citation: [2023] KETAT 263 (KLR)

Republic of Kenya

In the Tax Appeal Tribunal

Commercial and Tax

Appeal 368 of 2021

E.N Wafula, Chair, EK Cheluget, RO Oluoch & RM Mutuma, Members

May 12, 2023

Between

Davis & Shirtliff Limited

Appellant

and

Commissioner of Customs & Border Control

Respondent

Judgment

Background 1. The Appellant is a limited liability company incorporated in Kenya whose principal business activity is the importation, manufacture, assembly, installation and distribution of water and energy related equipment.

2. The Respondent is a principal officer appointed under Section 13 of the Kenya Revenue Authority Act Cap 469 laws of Kenya. Under Section 5(1) of the Act, Kenya Revenue Authority is an agency of the Government for the collection and receipt of all tax revenue. Further under Section 5(2) of the Act with respect to the performance of its function under subsection (1), it is mandated to administer and enforce all provisions of the written laws as set out Part 1 & 2 of the First Schedule to the Act for the purposes of assessing, collecting and accounting for all revenue in accordance with those laws.

3. The Respondent conducted a Customs Post Clearance Audit (“PCA”) on the Appellant’s business operations for the period between January 2016 to December 2020 on the Appellant’s solar water heaters (“SWH”) and issued its preliminary audit findings to the Appellant vide a letter dated 11th February 2021.

4. In its letter, the Respondent assessed additional custom duties amounting to KShs 83,026,198. 00 on the grounds that the Appellant failed to comply with the provisions of the East African Community Common External Tariff, 2017 (“EAC CET”) by classifying imported solar water heaters under HS Code 8419. 19. 00 rather than code HS Code 8516. 10. 00. HS Code 8419. 19. 00 is zero-rated whereas HS Code 8516. 10. 00 attracts 25% Import Duty.

5. The Appellant responded to the Respondent’s preliminary audit findings vide a letter dated 4th March 2021 and disputed the Respondent’s findings and assertions in their entirety.

6. The Respondent however proceeded to confirm its demand for the additional taxes of KShs 83,026,198. 00 and issued a demand letter dated 23rd March 2021.

7. Aggrieved by the Respondent’s demand letter, the Appellant lodged an application for review through a letter dated 22nd April 2021 pursuant to Section 229 of the East African Community Customs Management Act, 2004 (“EACCMA”). The Appellant objected to the amount demanded by the Respondent and maintained that the products had been properly classified under HS Code 8419. 19. 00.

8. In a letter dated 19th May 2021, the Respondent issued its decision on the Review Application and maintained its earlier stance that the correct code was HS 8516. 10. 00 thereby affirming its demand for payment of the additional customs duties amounting to KShs 88,995,375. 00 inclusive of penalties and interest.

9. Dissatisfied with Respondent’s review decision, the Appellant lodged an appeal at the Tribunal as provided for under Section 230 of EACCMA vide a Notice of Appeal dated 18th June 2021 and filed 5th July, 2021.

The Appeal 10. In its Memorandum of Appeal filed on 5th July 2021 and Amended Memorandum of Appeal dated and filed on 4th March 2022, the Appellant’s grounds for appeal are:i.That the Respondent erred in law and on by holding that the Appellant’s SWHs with an electric booster are classifiable under Tariff Code 8516. 10. 00 of the EAC CET.ii.That the Respondent erred in law and on in failing to appreciate that the Appellant had correctly classified the SWHs under Tariff Code 8419. 19. 00;iii.That the Respondent erred in law and on by holding that SWHs with an electric booster do not exclusively use or store solar power hence did not qualify for the VAT exemption under Paragraph 45 of the VAT Act, 2013;iv.That the Respondent’s demand for additional VAT on the SWHs violates the Appellant’s right to legitimate expectation;v.That the actions of the Respondent to retrospectively implement a change in tariff classification on the Appellant’s goods is a violation of the Appellant’s protection against unfair tax burden;vi.That the Respondent erred in law and infact by demanding penalties amounting to KShs 2,747,027. 00 based on erroneous assessment; andvii.That the Respondent erred in law and infact by demanding late payment interest amounting to KShs 31,307,814. 00 based on erroneous assessment.

Appellant’s Case 11. The Appellant’s case is premised on its Statement of Facts dated 4th March, 2022, the witness statement of Norman Chege Muigai dated on 31st March, 2022 and filed on 28th June, 2022 that was admitted in evidence on 25th August, 2022 and the written submissions dated and filed on 17th October, 2022. The Appellant identified the issues falling for determination and addressed them separately a hereunder.

a) On whether the Appellant’s SWHs utilize fuel to heat water and whether the Respondent’s classification of the SWHs under HS Code 8516. 10. 00 on the basis that it heated water electrically or by connection to fuel was correct? 12. The Appellant submitted that its SWHs do not utilize fuel to heat water and do not have any provision for a fuel tank. That the basis of the Respondent’s classification of the SWHs under HS Code 8516. 00 is evident from paragraph 18 of the Respondent’s Supplementary Statement of Facts filed on 8th March 2022 and paragraph 3 of the Respondent’s witness statement filed on 25th August 2022 whereby he states that: “The Respondent conducted an audit on the Appellant’s importations and established that the goods imported by the Appellant had a dual system whereby water is heated either electronically or by connection to a fuel heated water system.”

13. The Appellant further submitted that the Respondent’s witness further acknowledged during cross examination that Heading 85. 16 did not apply to the Appellant’s SWHs since the dual system anticipated in the said classification referred to systems either heated electrically or by fuel. That upon further cross examination the witness submitted that the Appellant’s products had been classified as a ‘dual solar water heating system’, and not as a dual water heating system which is expressly provided for under Heading 85. 16.

14. The Appellant submitted that a dual water heating system, as anticipated under Heading 85. 16 describes a heater in which water is heated either electrically or by a connection to a fuel heated hot water system.

15. The Appellant argued that solar energy is derived from sunlight and not from a fuel-based energy source. The term “fuel” is defined by The Concise Oxford Dictionary of Current English as: “Material, esp., coal, wood, oil etc, burnt or used as a source of heat or power…”

16. The Appellant also submitted that the Respondent made no attempt to defend its classification of the Appellant’s SWH under HS Code 8516. 10. 00 save for a casual reference to a World Customs Organisation (“WCO”) advisory opinion.

17. The Appellant took issue with the admissibility of WCO advisory opinion on the grounds that the said opinion was neither mentioned nor referred to by the Respondent in its Statement of Facts or Supplementary Statement of Facts. Furthermore, that was it not annexed to the said statements.

18. It is the Appellant’s submission that the Tribunal cannot therefore make a finding in respect of an advisory opinion which was not produced before it and had not been disclosed to the Appellant. The Appellant argued that it would be denied its right of fair hearing granted by Article 50 of the Constitution should the advisory opinion be admitted by the Tribunal. Lastly, the Appellant is of the view that the advisory opinion which was received in November 2021 cannot be retrospectively applied to a review decision issued on 19th May 2021.

b) On whether the Appellant correctly classified its solar water heater under Tariff Code 8419. 19. 00 19. The Appellant submitted that the product it imports utilizes solar energy to heat water. That the SWH comprises solar collectors which absorb solar energy and a storage tank that holds the water. The system heats water using solar energy absorbed through its solar collectors and can operate solely and independently on the solar energy absorbed by the solar collectors.

20. The Appellant submitted that it was compelled to install an auxiliary backup electric heating component to its SWH products to ensure compliance with Regulation 9 of the Solar Water Heating Regulations (“SWH Regulations”) and the Kenya Bureau of Standards Quality Standards No. KS 1860. 2009 (“KEBS Quality Standards”). The regulations and standards require that all solar water heaters imported or sold in Kenya be fitted with an auxiliary electric heating element as a backup.

21. The Appellant contended that its SWH products can operate exclusively on solar energy and the auxiliary electric heating element only acts as back up to boost the temperature of the water.

22. The Appellant submitted that the integration of a conventional backup heating system to its SWH is done purely in compliance with the statutory requirements and does not in any way take away the essential character of solar water heaters being apparatus designed to utilize solar energy to heat water. A customer will activate the backup only when necessary, such as when there is a solar energy deficit.

23. The Appellant submitted that the SWHs still operates effectively and efficiently to serve its purpose in areas with no electricity connections. Also, that the Appellant’s customers do not activate the electricity connection in areas where there is sufficient sunlight all year around such as the Coast and the Northern part of Kenya.

24. The Appellant argued that its SWHs imported by the Appellant can only use one energy source at a time, with the predominant source being solar energy. That, contrary to the Respondent’s assertions at paragraph 20 of its Supplementary Statement ofFacts, the system cannot be said to be a dual or hybrid. That when solar energy is sufficient, the system operates exclusively on solar power to heat water. When there is a down time and the electric booster is activated, the system will only use electricity to boost the temperature of the water which has already been heated by the available sunlight to a certain temperature. Tha the system does not automatically switch on to electric energy when solar energy is low. That rather the user has to manually switch on the electrical heater.

25. The Appellant argued that the integration of an electric booster does not in any way deprive the SWH of its essential characteristics, i.e., use of solar power to heat water. That if this was the case, the Appellant submitted that there would be no need for customers to invest in solar water heaters – they would simply use electricity. That the whole purpose of customers purchasing solar water heaters is to reduce reliance on grid electricity which is more expensive than using solar energy. The Appellant contended that it cost approximately KShs 170,000. 00 to install a SWH whereas an electric water boiler would cost in the range of KShs 20,000. 00 to KShs30,000. 00. That the reason for customers’ investing in SWHs is due to savings made on electricity bills.

26. The Appellant submitted that in interpreting EACCET, one must be guided by the General Interpretation Rules (“GIRs”) for the classification of goods. GIR, which are the globally accepted rules for classification as adopted by the EAC CET, are the legal basis that provides guidance on the classification of all goods in international trade.

27. That Rule 1 of the GIRs (“GIR 1”) provides that:“The titles of Sections, Chapters and sub-chapters are provided for ease of reference only; for legal purposes, classification shall be determined according to the terms of the heading and any relative Section or Chapter Notes…”

28. That further, Rule 6 of the GIRs (“GIR 6”) provides that:“For legal purposes, the classification of goods in the subheadings of a heading shall be determined according to the terms of those subheadings and any related Subheading Notes and, mutatis mutandis, to the above Rules, on the understanding that only subheadings at the same level are comparable…”

29. The Appellant submitted that in accordance with GIR 1, its products being solar water heaters were classifiable under HS code 8419. 19. 00 and Heading 84. 19 covers storage water heaters.

30. The Appellant further submitted that classification of composite goods is governed by GIR 3(b) which states that goods will be classified on the basis of the component that gives them their essential character. That GIR 3(b) provides that:“(b)Mixtures, composite goods consisting of different materials or made up of different components, and goods put up in sets for retail sale, which cannot be classified by reference to 3 a), shall be classified as if they consisted of the material or component which gives them their essential character, insofar as this criterion is applicable.”

31. The Appellant submitted that based on the foregoing classification should be determined by the component which performs the principal function in tandem with GIR 3(b). That the Appellant’s products fit within HS Code 8419. 19. 00 and is in accordance with the terms of the Explanatory Notes since the essential character of the Appellant’s product is a solar water heater.

c) Whether the letters from the Ministry of Energy, the National Treasury and the Respondent created a legitimate expectation that no VAT would be charged on the Appellants SWH. 32. The Appellant argued that prior to 30th June 2020, the Appellant’s SWHs qualified for VAT exemption under Paragraph 45 of the VAT Act, 2013, which exempted specialised equipment for the development and generation of solar energy from sunlight. However, an amendment by the Finance Act, 2019 required the Appellant to obtain a recommendation for exemption from VAT for every solar water heating system consignment that was imported before it was cleared for entry into Kenya by the Respondent.

33. The Appellant submitted that the said exemption was obtained through a recommendation from the Cabinet Secretary for Energy which was sent to National Treasury and Planning. That the National Treasury would then share the recommendation with the Respondent which then confirmed that VAT was not due.

34. The Appellant submitted that the VAT exemption provision was deleted by the Finance Act 2020 which deletion came into effect on 30th June 2020. That the exemption was however reintroduced on 1st July 2021 vide the Finance Act No. 8 of 2021.

35. The Appellant argued that the Ministry of Energyhad analysed the Appellant’s SWH and recommended the product for VAT exemption to the National Treasury. That the National Treasury in turn confirmed to the Respondent that VAT was not chargeable, and the Respondent wrote to the Appellant confirming this position.

36. It is the Appellant’s submission that an express representation was made by the Respondent that no VAT was chargeable on the Appellant’s SWH, a fact not denied by the Respondent. That this express representation created a legitimate expectation that no VAT was due.

37. The Appellant contended that the Respondent is therefore in breach of the legitimate expectation by seeking to re-classify the SWH under a different tariff code and also levy VAT.

38. The Appellant submitted that in the case of the Kenya Revenue Authority-vs-Export Trading Company Limited [Petition No. 20 of 2020], the Supreme Court of Kenya considered a legitimate expectation claim where KRA’s Tradex System had charged import duty at a rate of 35% on all rice imports and which KRA later claimed to have been a system error. The taxpayer however argued that it was unfair for KRA to claim the tax and that any such claim breached its legitimate expectation. The Supreme Court (at paragraph 50 to 51 of its decision) set out the principle of legitimate expectation in the following manner:“In the 4th Edition, Vol. 1 (1) At Page 151, Paragraph 81 of the Halsbury’s Laws of England, legitimate expectation is described as follows:A person may have a legitimate expectation of being treated in a certain way by an administrative authority even though he has no legal right in private law to receive such treatment. The expectation may arise either from a representation or promise made by authority, including an implied representation, or from consistent past practice.”“Further according to De Smith Woolf & Jowell, “Judicial Review of Administrative Action”6th Edn, Sweet & Maxwell page 609;A legitimate expectation arises where a person responsible for taking a decision has induced in someone a reasonable expectation that he will receive or retain a benefit of advantage.”

39. That the Supreme Court then stated (at paragraph 55) as follows:“We also note that in the English case of Council of Civil Service Unions and Others-vs-Minister for the Civil Service [1983] UKHL6; [1984] 3 All E.R 935, it was held by the House of Lords, inter alia that:An aggrieved person was entitled to invoke judicial review if he showed that a decision of a public authority affected him by depriving of some benefit or advantage which in the past he had been permitted to continue to enjoy and which he could legitimately expect to be permitted to continue to enjoy either until he was given reasons for its withdrawal and the opportunity to comment on those reasons or because he had received an assurance that it would not be withdrawn before he had given the opportunity of making representations against the withdrawal. As can be discerned from these two definitions, legitimate expectation may take many forms. It may take the form of an expectation to succeed in a request placed before the decision maker or it may take the objective form that a party may legitimately expect that, before a decision that may be prejudicial is taken, one shall be accorded a hearing.”

40. The Supreme Court held that KRA had breached the taxpayer’s legitimate expectation and acted unreasonably in demanding the extra duty whereas it was KRA’s own system that had set the tax rate and KRA had allowed the taxpayer to import the goods at the rate in question for a number of years

41. The Appellant submitted that on the basis of the Supreme Court’s decision in the above case, it would follow that the Respondent had been expressly permitting it to import the SWH without VAT on the basis of confirmations given by both the Ministry of Energy and the National Treasury. That the Appellant legitimately expected that no tax claim would be made by the Respondent which legitimate expectation was breached by the Respondent by seeking to re-classify the Appellant’s SWH under a different HS Code.

42. The Appellant prays the Respondent be estopped from acting unreasonably and breaching the legitimate expectation it created through its express representation that VAT was not chargeable.

Appellant’s Prayers 43. The Appellant’s seeks for the following prayers from the Tribunal:i.That the Respondent’s review decision dated 19th May 2021 be set aside;ii.That the Respondent’s assessment of additional customs duties amounting to KShs 88,995,375. 00 be vacated in its entirety;iii.That the costs of and incidental to this Appeal be awarded to the Appellant; andiv.Any other orders that the Tribunal may deem fit.

Respondent’s Case 44. The Respondent’s case is premised on the hereunder documents and proceedings before the Tribunal:-a.Statement of Facts dated and filed on 12th July, 2021, Witness statement of Bernard Oyucho dated and filed on 5th August, 2022 that was admitted in evidence on oath on 20th September, 2022 and the written Submissions dated and filed on 11th October, 2022.

45. The Respondent’s case is premised on the following arguments:i.That the Appellant’s SWHs are dual system water heaters by virtue of containing both electrical and solar components;ii.That the SWHs with provisions of electric heating element are classifiable under HS Code 8516. 10; and not HS Code 8419. 19. 00 as per the Appellant’s declaration of Customs Duty; andiii.That the Respondent is empowered to conduct PCA by EACCMA and demand for any taxes arising as a result of the exercise of under-declaration.

a) On Whether the Respondent erred by classifying the Appellant’s SWH under HS Code HS Code 8516. 10. 46. The Respondent submitted that on 3rd November 2021, its Policy and International Affairs Division received a WCO advisory opinion on the classification of dual system water heaters in response to a request by the Division sent to the WCO Secretariat on 30th August 2021. That the advisory opinion classified the product under HS Code 8516. 10. 00 based on the application of GR 1 and WCO explanatory notes.

47. The Respondent submitted that it conducted a PCA of customs entries pursuant to Sections 235 and 236 of EACCMA whereupon it was established that the Appellant’s SWHs had an electric component and were therefore dual water heaters classifiable under HS Code 8516. 10. 00.

48. The Respondent argued that the Harmonized Commodity Description and Coding System Explanatory Notes as well as the Additional Notes Constitute the official interpretation of the Common External Tariff and provide the scope of each heading under the EAC CET. That in accordance with GIR and explanatory notes the items are classifiable under HS Code 8516. 10. 00.

49. The Respondent submitted that since the Appellant's products have an electric component, they are considered to be dual water heating systems which use both solar energy and electricity. That in the absence of the electricity component the system would not effectively heat water when solar energy is inadequate, That however, that the system would work perfectly without the solar component.

50. The Respondent argued that where the PCA exercise establishes that taxes were under-declared or erroneously refunded, the Respondent is empowered to recover any amounts short levied or erroneously refunded together with interest at a rate of two percent per month for the period the taxes remain unpaid pursuant to Sections 135 and 249(1) of EACCMA.

51. The Respondent submitted that failure to apply the correct tariff amounts to a breach of the law and hence an illegality. That in the case of Republic-vs-Commissioner General & Another ex-parte Awal Ltd [2008] eKLR, which was quoted in the case of Associated Battery Manufacturers Limited-vs-Commissioner of Customs Services [2020] eKLR, the court when faced with a dispute on product classification expressed itself as follows:-“In the end I must conclude that looking at the material placed before me and the submissions tendered by learned counsels, the Respondents had the statutory duty to impose duty according to the tariff classification provided by law under the Customs and Excise Act and under the Harmonised Commodity Description and Coding System provided by the World Custom Organization explanatory notes in which Kenya is a signatory.”

52. The Respondent argued that it carried out a PCA exercise, pursuant to the provisions of Sections 235 and 236 of the EACCMA, on the Appellant’s imported goods which goods had been declared and documented as solar water heaters and established that the goods had been wrongly classified.

53. The Respondent submitted that solar water heaters with both solar and electrical components are dual water heaters and dual water heaters ought to be classified under HS Code 8516. 10. 00.

b)On whether legitimate expectation had been created that the Appellant’s SWHs were exempt from VAT 54. The Respondent stated that legitimate expectation does not mean than an error or illegality should be left to be committed to eternity without being corrected. That the Respondent is allowed to depart from its previous decisions where there is good reason to do so.

55. The Respondent argued that change in the classification of the tariff was grounded on good reasons and based on the law, and was not merely an afterthought.

56. In support of its argument, the Respondent refers to H. W. R. Wade & C. F. Forsyth where the subject of legitimate expectation was addressed. At pages 449 – 450), the authors stated as follows:“It is not enough that an expectation should exist; it must in addition be legitimate.... First of all, for an expectation to be legitimate it must be founded upon a promise or practice by the public authority that is said to be bound to fulfil the expectation..... Second, clear statutory words, of course, override an expectation howsoever founded..... Third, the notification of a relevant change of policy destroys any expectation founded upon the earlier policy...." "An expectation whose fulfilment requires that a decision-maker should make an unlawful decision, cannot be a legitimate expectation. It is inherent in many of the decisions, and express in several, that the expectation must be within the powers of the decision-maker before any question of protection arises. There are good reasons why this should be so: an official cannot be allowed in effect to rewrite Acts of Parliament by making promises of unlawful conduct or adopting an unlawful practice.”

57. The Respondent submitted that the change of classification was based on good reasons. That even in legitimate expectation a party can depart from the earlier position with a good reason. That the WCO advisory opinion and the establishment that the Appellant’s SWHs had both electrical and solar energy components was a good reason for re-classification under a different tariff and legitimate expectation cannot override the tax laws.

58. The Respondent also submitted that that prior to July 2018, Paragraph 45 of the VAT Act 2013 only exempted VAT for specialized solar equipment and accessories, including solar water heaters and deep cycle - sealed batteries which exclusively use or store solar power. That after 30th June 2018, this Paragraph was amended to only exempt specialized equipment for development and generation of solar and wind power including deep cycle batteries which use and/or store solar power.

59. The Respondent posited that based on the foregoing dual solar water heaters were not exempt from VAT since they do not exclusively use and/or store solar power.

Issues for Determination 60. The Tribunal upon consideration of the pleadings filed, evidence adduced and the submissions made by the parties was of the considered view that the following are the issues that fall for its determination:-i.Whether the Respondent erred by classifying the Appellant’s SWH under HS Code 8516. 10; andii.Whether the letters from the Ministry of Energy, the National Treasury and the Respondent created a legitimate expectation that no VAT would be charged on the Appellant’s SWH.

Analysis and Findings i. Whether the Respondent erred by classifying the Appellant’s SWH under HS Code 8516. 10 61. The Appellant submitted that the SWHs were classifiable under Heading 84. 19 and HS code 8419. 19. 00 which code covers storage water heaters. The Appellant further argued that this classification is not only supported by GR 1 but also the guidelines for classification of composite goods per GIR 3(b) which provides that goods will be classified on the basis of the component that gives them their essential character.

62. The Appellant also submitted that the presence of an auxiliary electric back up heating element does not in any way alter the main character of the system which is a solar water heating system. The electric back up heating system is not automatically or simultaneously used when the solar water system is installed. The user will activate the backup only when necessary, such as when there is a deficit of solar energy and the electrical heater is manually activated.

63. Lastly, the Appellant submitted that the SWHs could function solely on solar energy, and the auxiliary backup electric heating component was requirement imposed by Regulation 9 of the Solar Water Heating Regulations and KEBS Quality Standards which provided for the use of a backup heating system when there is solar energy deficit due to adverse weather conditions.

64. On its part, the Respondent argued that the PCA exercise it conducted established that the SWHs have an electric component and are therefore dual water heaters classifiable under HS Code 8516. 10. 00. The Respondent also argued that a WCO advisory opinion dated 3rd November 2021 in response to the Respondent’s request had classified the product under HS Code 8516. 10. 00 based on the application of GR 1 and WCO explanatory notes.

65. The Tribunal notes that there is no dispute between the parties that water heaters which rely solely on solar energy to heat the water are classifiable under Heading 84. 19 whereas water heaters that use electricity or another fuel are classifiable under Heading 85. 16. There is also no dispute as to the identity of subject goods; that they are solar water heaters which have been modified to use electricity when solar energy is inadequate.

66. The Tribunal further notes that in the current dispute, the water heating systems are solar water heaters with heat collectors running either an active or passive system, and are also fitted with electric immersion heaters which can enable them to function as electric water heaters.

67. Under the General Rules for the Interpretation of the Harmonized System, the General Interpretative Rule 1 (GIR 1) is the foremost rule of classification. For legal purposes classification is determined by the terms of the headings, the Section or Chapter Notes where relevant, and, if necessary and allowable, the other GIRs.

68. Rule 1 of the GIRs (“GRI 1”) provides that:“The titles of Sections, Chapters and sub-Chapters are provided for ease of reference only; for legal purposes, classification shall be determined according to the terms of the headings and any relative Section or Chapter Notes and, provided such headings or Notes do not otherwise require, according to the following provisions, i.e.: GR 2 to 6.

69. According to the terms of Heading 84. 19, solar water heaters are ideally non-electric equipment correctly classifiable under Heading 84. 19.

70. The solar water heaters in question are however fitted with auxiliary electric immersion heating element to enable them use electricity when solar energy is down. Explanatory Notes to Heading 84. 19 provides that:“…….. the heading also covers non-electric instantaneous water heaters and storage water heaters, including solar water heaters, domestic or not. If electrically heated, such appliances are excluded (heading 85. 16).

71. Water heaters which use electricity are correctly classifiable under HS Code 8516. 10. 00 which provides as follows:8516 10 00- Electric instantaneous or storage water heaters and immersion heaters.

72. The solar water heaters with an electric immersion heating element cannot be deemed to be a dual system. Paragraph A (3) of the Explanatory Note to Heading 85. 16 identifies dual systems to be “those in which the water is heated either electrically or by connection to a fuel-heated hot water system; they are often equipped with a thermostatic control to operate them electrically only when the alternative is insufficient”.

73. From the foregoing description, the Tribunal is inclined to believe the “alternative means” referred to must be of a fuel source. In the instant case, the solar water heaters in question cannot be considered as fuel-heated water systems.

74. However, the paragraph A (5) of the Explanatory Notes to Heading 85. 16 states that: “the Assemblies consisting of immersion heaters permanently incorporated in a tank, vat or other vessel are classified in heading 84. 19 unless they are designed for water heating only or for domestic use, in which case they remain in this heading. Solar water heaters are also classified in heading 84. 19. ”

75. Based on the foregoing, the SWHs are potentially classifiable under two headings, namely 84. 19 and 85. 16. The goods can function as a solar heating system and also as electric water heaters. They have all the characters of a solar water heater and also the characteristics of an electric water heater. Rule 1 cannot be used to classify the goods because it results into two possible classifications.

76. In view of the above, it is the considered view of this Tribunal that the solar water heaters in question are a combination of the two types of heaters and therefore should be classified using Rule 2(b) which provides as follows:“Any reference in a heading to a material or substance shall be taken to include a reference to mixtures or combinations of that material or substance with other materials or substances. Any reference to goods of a given material or substance shall be taken to include a reference to goods consisting wholly or partly of such material or substance. The classification of goods consisting of more than one material or substance shall be according to the principles of Rule 3. ”

77. To choose which of the two possible codes is applicable, guidance is therefore sought from Rule 3 which provides as follows:“When by application of Rule 2 (b) or for any other reason, goods are prima facie, classifiable under two or more headings, classification shall be effected as follows:(a)The heading which provides the most specific description shall be preferred to headings providing a more general description. However, when two or more headings each refer to part only of the materials or substances contained in mixed or composite goods or to part only of the items in a set put up for retail sale, those headings are to be regarded as equally specific in relation to those goods, even if one of them gives a more complete or precise description of the goods.(b)Mixtures, composite goods consisting of different materials or made up of different components, and goods put up in sets for retail sale, which cannot be classified by reference to 3 (a), shall be classified as if they consisted of the material or component which gives them their essential character, as far as this criterion is applicable.”

78. The water heaters cannot be classified according to Rule 3(a) because none of the two HS codes gives a more specific description of the imported goods than the other. Consequently, the goods must be classified according to Rule 3(b).

79. The question then to be asked is: “What gives the heaters, in their imported state, their essential character?” In other words, “what are the prominent characteristics which serve to distinguish the heaters?”.

80. Based on the submissions, the essential characteristics of the water heaters in question that distinguish them are the solar collectors commonly fitted to all solar water heaters. They are offered for sale as solar water heaters and must essentially be fitted in a location where they are able to collect solar energy. They mainly function as solar water heaters and revert to electricity only when there is inadequate solar energy. The immersion heaters which is a characteristic of electric heaters forms only a small percentage of the system. Furthermore, the electric component is fitted largely to ensure compliance with the regulatory requirements.

81. Based on the materials and submissions presented before the Tribunal, the heating system has the appearance and character of a solar heating system. It is the considered view of the Tribunal that the systems are not electric water heating systems fitted with solar components but rather solar water heating systems fitted with electric accessories to enable them to function as electric heaters.

82. Consequently, by dint of GIR 3(b), the subject water heaters as imported are most appropriately classifiable under Heading 84. 19.

83. The Tribunal therefore finds that the Respondent erred in re-classifying the Appellant’s SWHs under HS Code 8516. 10. 00.

ii. Whether the letters from the Ministry of Energy, the National Treasury and the Respondent created a legitimate expectation that no VAT would be charged on the Appellant’s SWH 84. The Appellant submitted that prior to 30th June 2020, its SWHs constituted specialised equipment for the development and generation of solar energy and hence qualified for VAT exemption under Paragraph 45 of Part I of the First Schedule to the VAT Act 2013 which was amended by Section 21(a)(i) of the Finance Act, 2019. The effect of the amendment was the introduction of a requirement that a recommendation for exemption from VAT for every imported solar water heating system consignment must be obtained from the Cabinet Secretary for Energy and the National Treasury and Planning prior to the consignment being cleared for entry into Kenya.

85. The Appellant submitted that the said exemptions were duly obtained. Firstly, a recommendation was obtained from the Cabinet Secretary for Energy which was then sent to the National Treasury and Planning. The National Treasury then shared the recommendation with the Respondent which then confirmed that no VAT was chargeable on the imports. The Appellant pointed out that this has not been denied by the Respondent in its Statement of Facts or Submissions.

86. The Respondent on other hand argued that an error or illegality cannot be left uncorrected on account of legitimate expectation. That the Respondent is allowed to depart from its previous decisions based on a good reason and re-classification of tariffs was grounded on good reasons.

87. The Respondent also argued that prior to July 2018, Paragraph 45 of the VAT Act 2013 only exempted VAT on “specialized solar equipment and accessories, including solar water heaters and deep cycle batteries which exclusively use or store solar power” and that after 30th June 2018, this paragraph was amended to only exempt “specialized equipment for development and generation of solar and wind power including deep cycle batteries which use and/or store solar power”. It was the Respondent’s contention that the Appellant’s products were dual water heaters and did not exclusively use or store solar energy.

88. On the matter of legitimate expectation, the Tribunal refers to the High Court’s decision in Republic-vs-Kenya Revenue Authority Ex Parte M-Kopa Kenya Limited [2018] eKLR Where the court held that:-“The question that arises is whether the Respondent having in the past permitted the Applicant to import the said items without imposition VAT, it could suddenly make an about-turn as it were, and impose the said tax on the said items. In Attorney General of Hong Kong vs. Ng Yuen Shiu [1983] 2All ER 346 the court stated that:“when a public authority has promised to follow a certain procedure, it is in the interests of good administration that it should act fairly and should implement its promise, so long as implementation does not interfere with its statutory duty”.The Respondent has however insisted that its position was always clear that those items that did not deserve exemption would remain taxable. It is however clear that the Respondent’s conduct did not reflect this position. That a legitimate expectation may arise either from express stipulations or by conduct was appreciated in Keroche Industries Limited vs. Kenya Revenue Authority & 5 Others Nairobi HCMA No. 743 of 2006 [2007] KLR 240 where it was held that:“…….legitimate expectation is based not only on ensuring that legitimate expectations by the parties are not thwarted, but on a higher public interest beneficial to all including the respondents, which is, the value or the need of holding authorities to promises and practices they have made and acted on and by so doing upholding responsible public administration. This in turn enables people affected to plan their lives with a sense of certainty, trust, reasonableness and reasonable expectation. An abrupt change as was intended in this case, targeted at a particular company or industry is certainly abuse of power. Stated simply legitimate expectation arises for example where a member of the public as a result of a promise or other conduct expects that he will be treated in one way and the public body wishes to treat him or her in a different way…..Public authorities must be held to their practices and promises by the courts and the only exception is where a public authority has a sufficient overriding interest to justify a departure from what has been previously promised.…..In order to ascertain whether or not the respondent’s decision and the intended action is an abuse of power the court has taken a fairly broad view of the majorors such as the abruptness, arbitrariness, oppressiveness and the quantum of the amount of tax imposed retrospectively and its potential to irretrievably ruin the applicant. All these are traits of abuse of power. Thus I hold that the frustration of the applicants’ legitimate expectation based on the application of tariff amounts to abuse of power.”In this case the Respondent accepted the applicant’s past applications for exemptions and proceeded to exempt the applicant’s importation of the items in question. According to Ecobank Kenya Limited vs. Commissioner of Domestic Taxes ITA No.8 of 2010 where the Judge relied on the English Case of Council of Civil Services Unions vs. Minister for Civil Service 1985 AC 374:“In the English decision of Council Of Civil Services Unions V Minister For Civil Service 1985 AC 374 Lord Fraser stated as follows:-‘a legitimate expectation may arise – either from an express promise given on behalf of a public authority or from the existence of a regular practice which the claimant can reasonably expect to continue.’I would add that the expectation herein is not just a legitimate expectation. It is an expectation backed by a written express waiver and a passive conduct in relation thereto for a period of twenty-five years. All this time the Respondent was aware of section 15(7) of the Income Tax Act. In my finding, that expectation became so legitimate, and so strongly grounded, that it established an economic right that only an express, concise, and specific waiver clearly communicated and delivered, could uproot.”

89. In the more recent case of Kenya Revenue Authority-vs-Export Trading Company Limited (Petition no.20 of 2020), the Supreme Court of Kenya pronounced itself as follows on the question of legitimate expectation:“Respectfully, we take the view that the question of whether a legitimate expectation arose is more than aual question. It is not merely confined to whether an expectation exists in the mind of an aggrieved party, but whether viewed objectively, such expectation is in a legal sense, legitimate.This is the position taken by this Court in the CCK Case where it was held that legitimate expectation would arise when a body, by representation or by past practice, has aroused an expectation that is within its power to fulfill. For an expectation to be legitimate therefore, it must be founded upon a promise or practice by a public authority that is expected to fulfill the expectation. We then went on to find the emerging principles on legitimate expectation to be that;“a. there must be an express, clear and unambiguous promise given by a public authority;b.the expectation itself must be reasonable;c.the representation must be one which it was competent and lawful for the decision-maker to make; and(d)there cannot be a legitimate expectation against clear provisions of the law or the Constitution.”

90. The Tribunal having already determined that the Respondent erred in re-classifying the Appellant’s product then it cannot be argued that the legitimate expectation arising on account that decision would be an illegality.

91. The Tribunal thus concurs with the Appellant that the recommendation letters from the Ministry of Energy and the National Treasury as well as confirmation of the same by the Respondent that the Appellant’s product were exempt from VAT created a legitimate expectation that no VAT would be charged.

Final Decision 92. The upshot of the foregoing analysis is that the Appeal is merited and the Tribunal accordingly proceeds to make the following Orders:i.The Appeal be and is hereby allowed;ii.The Respondent’s review decision dated 12th January 2022 be and is hereby set aside;iii.The Appellant’s solar water heating systems are classifiable under Heading 8419; andiv.Each party to bear its own costs.

DATED AND DELIVERED AT NAIROBI THIS 12TH DAY OF MAY, 2023. ERIC N. WAFULACHAIRMANEDWIN K. CHELUGET RODNEY O. OLUOCH MEMBER MEMBERROBERT M. MUTUMAMEMBER