[2025] KETAT 232 (KLR)

KB Cottages Nairobi Limited v Commissioner of Domestic Taxes (Tax Appeal E1072 of 2024) [2025] KETAT 232 (KLR) (16 May 2025) (Judgment)

Neutral citation: [2025] KETAT 232 (KLR)

Republic of Kenya

In the Tax Appeal Tribunal

Tax Appeal E1072 of 2024

CA Muga, Chair, BK Terer, EN Njeru & E Ng'ang'a, Members

May 16, 2025

Between

KB Cottages Nairobi Limited

Appellant

and

Commissioner of Domestic Taxes

Respondent

Judgment

Background 1. The Appellant is a private limited company incorporated in Kenya under the Companies Act, CAP 486 of the Laws of Kenya (hereinafter “Companies Act”) whose principal business activity is provision of hotel and accommodation business in Nairobi.

2. The Respondent is a principal officer appointed under Section 13 of the Kenya Revenue Authority Act, CAP 469 of Kenya’s Laws (hereinafter “the Act”). Under Section 5 (1) of the Act, the 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 functions under subsection (1), the Authority is mandated to administer and enforce all provisions of the written laws as set out in Part 1 and 2 of the First Schedule to the Act for the purposes of assessing, collecting and accounting for all revenues in accordance with those laws.

3. The Respondent conducted compliance check in the tax affairs of the Appellant for the period 2020 to 2022. During the audit, the Respondent noted that the Appellant had under-declared their income and over claimed expenses which could not be explained. Upon conclusion of the audit process, the Respondent issued assessment amounting to principal of Kshs 12,843,558. 00 vide notice of assessment dated 6th June 2024.

4. The Appellant lodged notice of objection vide letter dated 28th June 2024. The Respondent reviewed the objection Application and proceeded to issue objection decision vide letter dated 23rd August 2024 confirming the assessment.

5. Being dissatisfied with the Respondent's decision, the Appellant filed this Appeal vide its notice of appeal dated 23rd September 2024 was deemed as having been filed on even date upon the Appellant being granted leave to file its Appeal out of time on 7th November, 2024.

The Appeal 6. The Appellant’s memorandum of appeal dated 26th of September 2024 was filed on even date wherein the Appellant raised the following grounds of appeal:a.That the Respondent misapprehended nature of the Appellant's nature of business thereby reaching an erroneous conclusion that the Appellant has Two (2) separate sources of income.b.That the Respondent erred in fact and in law by failing to consider that the Appellant's treatment of income and expenditure and thereby assumed an arbitrary position to allocate the expenses as if there were Two (2) income streams.c.That the Respondent erred in fact and in law by using a speculative approach in the treatment of expenses as provided in Section 15 and 16 of the Income Tax Act, CAP 470 of the Laws of Kenya (hereinafter “ITA”) and thereby unreasonably charging tax even after being supplied with a working formula from the Appellant.d.That the Respondent thereby erred in fact and in law by failing to provide a framework and reasons for the identification of various expenses as allowable expenses.e.That the Respondent erred in fact and in law by concluding that the Appellant did not have a breakdown of expenses although the Appellant operated a single hospitality business.f.That the Respondent erred in law and in fact in pro-rating income over a period of a year instead of verifying the Appellant's actual income on a monthly basis.g.That the Respondent erred in law and in fact by failing to reckon that not all credits provided in the bank statements related to sales and thereby neglected to include pertinent adjustments to the credits provided by the Appellant including bounced cheques, interbank transfers, loans, pre-paid accommodation, deposits on accommodation and intercompany transfers.h.That the Respondent failed to exercise the best judgement as provided in Section 31(1) of the Tax Procedures Act, CAP 469B of the Laws of Kenya (hereinafter “TPA”) and thereby misapplied the banking test leading to the Respondent levying an unrealistic and untenable assessment upon the Appellant.i.That the Respondent erred in law and in fact by requiring an irrelevant sale agreement from a third-party transaction through the Appellant and thereby choosing to issue its objection decision on immaterial facts and consequently, the reasons for its decision were based on extraneous considerations.j.That the Respondent erred in law and in fact by assuming the said sale transaction would vary the taxable position of the Appellant.k.That the Respondent erred in fact and in law in failing to appreciate that the Appellant has qualified staff with the requisite experience to prepare accurate financial statements and there by disregarded the Appellants reported financial position.l.That the Respondent erred in fact by not appreciating that once bank reconciliations are completed a trial balance is created and that the accuracy of the trial balance was not in question.m.That the Respondent erred in fact and in law by not appreciating that accommodation paid in advance ought not to be considered as income in the instant financial year.n.That the Respondent erred in law and in fact by disregarding the fact that the Appellant accounted for and converted foreign exchange transactions on the date they were recorded in the books of account. On the other hand, the Respondent used the average annual rates thereby creating a difference which was not taxable especially to VAT.o.The Respondent confirmed the notice of assessment without due regard to all records, explanation and information provided by the Appellant, thereby failing to appreciate all issues presented by the Appellant before confirming the assessments.p.That the Respondent erred in fact and in law by disregarding the aerial view of the Appellant's premises in determining the relationship of the Appellant and its related parties.q.That the Respondent failed to concede to some of the Appellant's expenditure that are not associated with any part of the Appellant's premises.r.That the Respondent erred by allocating expenses as if specific customers use facilities related to specific areas of the Appellant's expense the Respondent failed to concede some of the Appellant's expenditure that are not associated with any part of the Appellant's premises.s.That the Respondent erred by allocating expenses as if specific customers use facilities related to specific areas of the Appellant's expenses. the Respondent erred in law and in fact by assessing taxes and demanding the production of documents in contravention to section 23 (1) of the TPA by requiring the Appellant to produce documents relating to third party transactions.t.That the Respondent failed to concede some of the Appellant's expenditure that are not associated with any part of the Appellant's premises.u.That the Respondent erred in law and in fact by assessing taxes and demanding the production of documents in contravention to section 23 (1) of the TPA by requiring the Appellant to produce documents relating to third party transactions.v.That the Respondent’s objection decision was unreasonable and contrary to Section 59 of the TPA and in violation of the Appellant’s legitimate expectation created under Article 47 of the Constitution of Kenya, 2010 (hereinafter “the Constitution”).w.That by dint of Article 210 of the Constitution, the entire assessment is erroneous as the Respondent failed to give regard to clear legal provisions and failed to take into account of the relevant considerations, materials, information and documentation to prove that indeed, there was no tax due from the Appellant.

The Appellant’s Case 7. The Appellant lodged its statement of facts dated and filed on 8th October 2024 and relied on the testimony of Simon Ngararu dated 17th April 2025 which was admitted in evidence by the Tribunal. The Appellant also filed written submissions dated 7th May 2025 on even date in compliance with the Tribunal’s directions on 24th April, 2025.

8. The Appellant stated that the Respondent issued the Appellant with a pre-assessment notice for the period 2020 to 2022 for VAT and income tax obligations amounting to Kshs 6,023,636. 00 and Kshs 10,441,283. 00 respectively vide a letter dated 29th April 2024. The Appellant replied to the pre-assessment notice by the Respondent vide a letter dated 15th May 2024.

9. On 31st May 2024, the Respondent issued the Appellant with a letter of final return review findings covering VAT and Income Tax Liability for the period 2020 to 2022 and amounting to Principal tax of Kshs 3,593,826. 00 and Kshs 8,988,731. 00 respectively and penalties and interest amounting to Kshs 867,417. 00 and Kshs 1,452,552. 00 respectively.

10. The Respondent further issued the Appellant with Assessment Orders for the period 2020, 2021 and 2022 on 31st May 2024 and 4th June 2024 thereby confirming assessments on VAT of Kshs 224,004. 75, Kshs 61,781. 18, Kshs 3,903,486. 82 for the said years and income tax–company of Kshs. 1,364,845. 35, Kshs 4,529,333. 98 and Kshs. 2,804,137. 00 respectively.

11. On the 6th June 2024, the Respondent then issued the Appellant with a notice of assessment confirming a VAT tax assessment and an income tax assessment of Kshs. 4,461,243. 00 and Kshs 11,742,757. 00 for the years 2020 to 2022.

12. The Appellant objected to the Notice of Assessment vide an objection letter dated 28th June 2024 and further furnished the Respondent with relevant supporting document in a bid to have the matter amicably resolved.

13. The Appellant averred that it does not have two (2) sources of incomes (rental and hotel and accommodation business) as alluded to by the Respondent. The Appellant has only one source of income (hotel and accommodation business) which has two streams; a restaurant and cottages for accommodation. This accommodation is used by the guests while the restaurant is used by both the guests and third parties who can afford their services.

14. The Appellant further averred that it runs one business that comprises of a restaurant, accommodation and administrative sections and as a result, the accounts are prepared as one business resulting in a single reported Profit and Loss account. As a result, the cost allocation can therefore not be separated as has been done by the Respondent.

15. The Appellant stated that the Respondent in its notice of assessment averred that it identified allowable expenses. however, the Appellant stated that no method was provided as an explanation of how the Respondent came about the allowable expenses.

16. The Appellant averred that the Respondent assumed an arbitrary position given the centrality of services and the de-centrality of costs. It highlighted that the swimming pool expense, a central service, was charged entirely to “rental income.”

17. According to the Appellant, the Respondent lacked the adequate knowledge of the running of the Appellant’s business and further lacked the capacity to make management decisions for the sake of obtaining a taxable position.

18. The Appellant stated that the Respondent, in its objection decision averred that the Respondent’s requested its sale agreement, cottages/restaurant leases, contracts and receipts issued for hospitality activities undertaken during the review period in order to establish whether or not the Appellant had two sources of income as provided under section 15 of the ITA. The Respondent further stated that the Appellant failed to produce the requested documents thereby failing to discharge its burden of proof as prescribed under section 56 (1) of the TPA.

19. In response to the Respondent’s assertions, the Appellant averred that following the meeting held on 19th August 2024 between the two parties, the Appellant was given time to share the documents with the Respondent and the document was shared to the Respondent on the 30th August 2024, however, the Respondent failed to acknowledge receipt of the said document.

20. The Appellant asserted that although the Appellant may have implied that it was a party to the sale agreement, the correct position was shared vide the email dated 30th September 2024, where the Appellant confirmed that it was not a party to the agreement and that further the same was inconsequential in determining the taxable position.

21. The Appellant categorically stated the following:i.That it was unreasonable for the Respondent to require the Appellant to produce documents that are outside the scope of Section 23 (1) of the TPA;ii.It was unreasonable and untenable for the Respondent to require the Appellant to produce documents within Three (3) days and proceed to issue an objection decision soon thereafter;iii.It was unconscionable for the Respondent to base the entirety of the objection decision on the impugned document which would not in any way affect the taxable position of the Appellant and thereby disregarded the Appellant’s objection and grounds thereof as supported by the documents annexed;iv.This Tribunal ought to make a finding in line with the precedent in Kenya Revenue Authority vs. Man Diesel Se (K) Ltd, where the court held as follows:“…To expect the taxpayer to produce documents it did not have, or in the hands of third party amounts to overstretching the ambit of sections 23, and 56(1) of the TPA, and section 30 of the TAT Act….”.v.In requesting for the sale agreement, the Respondent misapplied the best Judgment as provided in the TPA.

22. With regards to income tax 2020 year of income, the Appellant averred that it only had one source of income and that was the restaurant as the cottages were undergoing renovation in readiness for occupation. However, the Appellant reported the income from the restaurant as Rental income. The Appellant did not anticipate renting out the restaurant at any time.

23. The Appellant emphasized that between the year 2020 to June 2022, there was a third-party lease that had not expired and the Appellant continued to receive agreed income from the restaurant. It further averred that upon expiry of the lease, it took over the actual operations of the restaurant. It contended that the Respondent therefore erred by bringing to charge the restaurant income as a separate source of income purely because it was described as rental income and it was never the intention to rent it out.

24. With regard to year of Income 2021, the Appellant averred that, as per the workings shared to the Respondent during the review stage, the total expected banking’s amounted to Kshs. 20,004,938. 00 and this was shared as rental income of Kshs. 19,233,361. 00 and Kshs. 771,577. 00 the deemed businesses income.

25. The Appellant failed to agree with the Respondent’s income ratio allocation of expenses. The Appellant contended that the Respondent proceeded to arbitrarily apply the treatment of expenses under Section 15 and 16 of the ITA. The Appellant in an attempt to justify cost allocation, it maintained that a justification of the method was necessary.

26. The Appellant in disputing the Respondent’s method applied the income ratio. It asserted that the income ratio, in the disallowed expenses by the Respondent demonstrated that there was no tax liability.

27. The Appellant was of the view that the only other method that could have been used is the physical area covered by each activity. The Appellant affirmed that the cost ratio application would have remained the same as in the income ratio. It added that in any case, substantial estimates would be required to use this method.

28. The Appellant invited the Tribunal to find in line with the Keroche Industries Ltd vs. Kenya Revenue Authority & 5 others which was cited with approval in Seroney v Commissioner of Legal Services and Board Co-ordination (Tax Appeal E183 of 2023) [2024] KETAT 942 (KLR) (12 July 2024) where the court held as follows:“A taxing authority is not entitled to pluck a figure from the air and impose it upon a taxpayer without some rational basis for arriving at that figure and not another figure. Such action would be arbitrary, capricious and in bad faith. It would be an unreasonable exercise of power and discretion and that would justify the court in intervening.”

29. With regard to 2022 year of income, the Appellant pointed out that, the operations resulted in a loss amounting to Kshs 13,667, 637. 00 and therefore loss had to be taken into account first before any tax was calculated. It stated that the Respondent completely disregarded this information in its computation and further, has not challenged the loss at all.

30. The Appellant failed to agree with the Respondent’s income ratio allocation of expenses and thereby the Respondent proceeded to arbitrarily apply the treatment of expenses under Section 15 and 16 of the ITA.

31. The Appellant in an attempt to justify cost allocation, it maintained that a justification of the method was necessary. Further, the Appellant in disputing the Respondent’s method applied the income ratio. According to the Appellant, the Income ratio, in the disallowed expenses by the Respondent demonstrated that there was no tax liability.

32. With regard to VAT for year 2020, the Appellant averred that for the year 2020, it provided the Respondent with supporting documents and the Respondent went ahead to provide them with an Amended Assessment. The Appellant further averred that in the said Amended Assessment by the Respondent, the undeclared tax amount was Kshs. 1,600,034. 00. In its explanation made in the objection, the Appellant stated that this amount was made up of rejected bounced cheque, exchange rate of the Dollar Accounts, Prepaid and Misstated loan balances amounting to Kshs. 738,000. 00, Kshs. 195,591. 00, Kshs. 66,912. 00 and Kshs. 599,531. 00 respectively.

33. The Appellant also averred that it demonstrated that the cheque amounting to Kshs 738,000. 00 was from a related company and was not a bounced cheque therefore a classification error by the Respondent. This cheque was a deposit for accommodation as indicated in the ledger and receipt and therefore it was not income.

34. The Appellant further averred that the exchange rate was confirmed by the fact that both parties were in agreement of the actual USD amount balance of USD 57,766. 00. However, the Appellant valued the entries on the date of the transaction while the Respondent used the annual average rates.

35. The Appellant was of the view that an exchange rate variation cannot be subjected to VAT. Instead, the Appellant averred that foreign exchange gain or loss would have been accounted for under Section 4A of the ITA.

36. The Appellant further stated that Kshs. 66,912. 00 was a prepayment and was accounted for in the following year of income. Consequently, it asserted that no VAT liability would have arisen once all the information had been taken into account.

37. The Appellant averred that Kshs 599,531. 00 comprised of a misstatement by the Respondent. The Appellant stated that the loan amount was Kshs 2,995,952. 00 while the Respondent’s conversion was 2,490. 273. 00 thereby making the overstated amount to Kshs. 505,679. 00. These overstated amounts arose due to the fact that the Respondent used an annual average exchange rate while the Appellant converts on the date of the transaction at the time of updating the accounts leading to an exchange difference and therefore could not be subjected to VAT by the Respondent.

38. It further averred that the difference of Kshs. 93,852. 00 is an exchange rate difference given that both parties agreed that the total bankings were made up of: Kshs 24,831,319. 00/ 24,635,728. 00 and USD 57,766. 00. Consequently, it argued that no VAT liability would have arisen once all the information had been taken into account.

39. According to the Appellant, in respect of the year 2021, the Respondent established an underdeclared sales amounting to Kshs. 386,136. 00. The Appellant conceded to the liability of Kshs. 61,782. 00 and the same was cleared before the institution of this said appeal.

40. Regarding the year 2022, the Appellant stated that under declared amount as indicated by the Respondent amounted to Kshs. 20,675,248. 00 and resulting to a VAT amount of Kshs. 3,308,040. 00. The Appellant stated that the main issue arising from this year was the difference between the Gross Banking as per the Respondent and the adjusted gross banking per the Appellant which were Kshs. 148,474,734. 00 and Kshs. 144,840,675. 00 respectively. The difference amounted to Kshs. 3,634,059. 00.

41. The Appellant averred that it provided all the workings and supporting documents of all the adjustments. However, the Respondent chose to ignore staff tips amounting to Kshs. 546,597. 00 and errors in the Respondent's analysis amounting to Kshs. 2,761,443. 00 which were not chargeable to VAT.

42. The Appellant further averred that in the summary of the bank reconciliation for year 2022, the Respondent agreed with the Appellant’s gross banking of Kshs. 144,840,675. 00 and then proceeded to disallow an amount of Kshs. 3,634,059. 00 This amount was a conversion of USD 30,000. 00 that related to a customer prepayment for 2023 and 2024.

43. The Appellant averred that all the documents requested for by the Respondent pursuant to Section 59 of the TPA were produced at the review stage and that the Respondent's allegations that the Appellant failed to produce supporting documentation has never been supported.

44. In its written submissions, the Appellant submitted that Respondent mischaracterized the Appellant’s business structure and income streams and that the Respondent erred in assessing VAT and income tax.

45. The Appellant also submitted that the Respondent failed to utilize the best judgment when dealing with the Appellant’s objection. It submitted that it provided documents to support the notice of objection. It therefore, submitted that it discharged the burden of proof.

46. To support the objection, the Appellant cited a number of case laws including the following: Ex-parte Jeffer Mohamed and Family Signature Ltd

Keroche Industries Ltd v KRA [2007] eKLR

Seroney v Commissioner of Legal Services (Tax Appeal E183 of 2023)

Ikiarav Commissioner of Legal Services and Board Co-ordination (Tax Appeal No. E235 of 2023) [2024]

Republic v Kenya Revenue Authority Ex-Parte Universal Corporation Ltd [2016] eKLR

Republic v Commissioner of Domestic Taxes Ex Parte Barclays Bank of Kenya Ltd [2012] eKLR

Kenya Revenue Authority v Man Diesel & Turbo Se, Kenya [2021] KEHC.

47. Based on the foregoing, the Appellant prayed for the following Orders:a.That the Tribunal do issue a declaration that the Appellant has a single source of income which has no pending tax liability;b.That the Appeal be allowed and the Respondent's assessment of tax liability and penalties amounting to Kshs. 16,478, 171. 00 be set aside;c.That this Court does uphold the objection dated 28th June 2024; andd.The costs of this Appeal and proceedings be provided for.

The Respondent’s Case 48. In response to the appeal, the Respondent filed a Statement of facts dated 5th December 2024 on 6th December, 2024. The Respondent filed written submissions dated 7th May 2025 on even date as directed by the Tribunal on 24th April, 2025.

49. In response to the Appeal and contrary to the Appellant’s assertions that the Respondent did not understand its business model and hence reached an erroneous conclusion in its assessment; the Respondent stated that during the audit, the Respondent undertook a banking tests analysis which established that sales for the years 2020 and 2022 amounting to Kshs 3,252,617. 00 and Kshs 7,930,812. 00 respectively were under declared. The Appellant responded to the initial findings and after further analysis and verifications on the documents provided, the same was revised.

50. According to the Respondent, for the year 2020, reconciliation items that included bounced cheques, dollar Conversion, and intercompany transfers were factored in. Therefore, the revised banking test established that sales amounting to Kshs 1, 600,034. 00 were under-declared in the year 2020. This was brought to charge resulting in an additional VAT of Kshs 327,047. 00.

51. The Respondent contended that for the year 2021, the Appellant agreed with the VAT computation by the Respondent of Kshs 98,387. 00. For the year 2022 the Respondent after taking into account the Appellant’s sales and banking it issued assessment of Kshs 4,035,808. 00.

52. The Respondent maintained that the Appellant had separate sources of income (rental and hotel & accommodation business) and therefore ought to have prepared a separate account in respect of each specified source of income. It added that if the Appellant had separated it sources of income, in the event of a loss, the loss may only be deducted from gains or profits of that person derived from the specified source in the following year or subsequent years of income in so far as the loss has not already been deducted pursuant to Section 15(7)(a) and (b) of the ITA.

53. It contended that despite the same being brought to the attention of the Appellant, the Appellant failed to account for expenses related to the rental income and those relating to the hotel business. As a result, the Respondent disallowed expenses relating to the hotel business such as hired services, staff uniforms, staff meals, room linens and towels, internet costs, licenses, security among others in computing rental income.

54. It averred that from the trial balances provided and expenses supported for both rental income and hotel accommodation, such as waste management, generator repairs, plumbing, pathway maintenance, swimming pool maintains, legal cost, office expenses, auditing and financial services the same were prorated and allowed by the Respondent in computation of the corporation tax.

55. The Respondent averred during the objection review stage, it held a meeting with the Appellant on 19th August 2024 with the view of understanding the Appellant’s business model and grounds of objection. The Appellant explained that it acquired the business as a going concern, and that there were subsisting tenants from whom it was receiving periodic rental income through the previous owner which rental income was recognised as ordinary business income that was part of its operations as hotel business.

56. In order to support this assertion, the Appellant was requested for transaction documents supporting the transition from the previous owners and the manner in which they conducted their business during the period under review. Specifically, the Respondent stated that it requested for the sale agreement, cottages / restaurant leases, contracts, and receipts issued for the hospitality activities undertaken during the period under review as the said documents were critical in settling the contention that there were separate sources of income as provided for under section 15 of the ITA. The Respondent added that the above information was equally requested vide email reminder sent on 21st August 2024.

57. It maintained that the said critical documents were never provided and even before the Tribunal, the Appellant did not bother to provide copies of the said documents that could have assisted in discharging its burden. The Respondent averred that any transaction that was supported, was adjusted during the review process.

58. The Respondent relied on section 56(1) of the TPA which provides that in any proceedings under this Part, the burden shall be on the Appellant to prove that a tax decision is incorrect. It maintained that the Appellant failed.

59. In its written submissions, the Respondent submitted that the Appellant had more than one income stream yet the Appellant failed to disclose them. It submitted that it requested the Appellant to provide a number of documents including the following:i.lease agreement between the Appellant and Karen Blixen Limited,ii.Tenancy agreement between either the Appellant and Tamarind or between Karen Blixen and Tamarindiii.Bank statementsiv.Trail balancesv.Invoicesvi.Expenses ledgersvii.Audited Financial Statementsviii.General Ledgersix.Asset movement ledgers

60. It submitted that the Appellant provided the documents sought except the Lease agreement between the Appellant and Karen Blixen Limited, Tenancy agreement between either the Appellant or Tamarind between Karen Blixen and Tamarind.

61. It submitted that The Appellant having failed to provide the lease agreements, left it with no option but to ascertain the rental income using its best judgement from the amounts indicated in the bank statement in accordance with section 15(7) of the ITA.

62. The Respondent relied on a number of case laws as follows: The Commissioner of Investigations & Enforcement v Doshi Enterprises Limited Income Tax Appeal number E112 of 2024

Kenya Revenue Authority v Maluki Kitili Mwendwa [2021] eKLR

Alfred Kioko Muteti v Timothy Miheso & another [2015] eKLR

63. Consequently, the Respondent urged the Tribunal to uphold the objection decision and dismiss the appeal with costs.

Issues For Determination 64. Having considered the parties’ pleadings, documentation and written submissions the Tribunal puts forth the following three issues for determination:a.Whether the payment made by the Restaurant to the Appellant was rental income.b.Whether the Respondent erred in its application of the provisions of Section 15 (7) of the ITA.c.Whether The Respondent erred in confirming the VAT assessment.

Analysis And Findings 65. The Tribunal will proceed to analyse the issues identified for determination as hereinunder:

A a. Whether the payment made by the Restaurant to the Appellant was rental income. 66. This dispute arose when the Appellant stated that it was incorporated on 6th February, 2020 to run a restaurant and hotel facility in Karen. The Appellant stated that it leased the property in Karen and found it necessary to renovate it. The Appellant further stated that during the pendency of the renovations, the restaurant was run by a third party whose lease expired in 2022. The third party occupied the premises between 2020 and 2022 and paid the Appellant a consideration for occupancy. The Appellant admitted that it took over the operations of the Restaurant when the lease of the third party expired and did not therefore manage the Restaurant business between the years 2020 and 2022. The Respondent on the other hand identified the consideration as rental income.

67. The Tribunal having reviewed the trial balance and Financial Statements in respect of the 2020 to 2022 years of income adduced by the Appellant in evidence; notes that the Appellant identified the consideration from the third party as rental income. The Appellant further admitted at paragraph 25 of its Statement of Facts that its income of Kshs. 20,004,938. 00 was analyzed as rental income of Kshs. 19,233,361. 00 and business income of Kshs. 771,577. 00. The Appellant’s witness, during cross examination also admitted that the consideration was rental income.

68. The Black Laws Dictionary defines “rent" as follows:“Generally, refers to a periodical payment, typically monetary, made for the use or occupancy of real property, whether it's land or a building. It's the consideration given in exchange for the right to use someone else's property, a kind of "chattel real interest in land”

69. The view of the Tribunal is that the Appellant purchased the business and was granted a right to use the whole of the property in Karen vide a lease. Therefore, the consideration paid to it in exchange for part of the property could only be construed to be rental income.

70. Accordingly, the Tribunal finds that the payment made by the Restaurant to the Appellant was rental income.

b. Whether the Respondent erred in its application of the provisions of Section 15 (7) of the ITA. 71. The Tribunal notes the Respondent’s averment that the Appellant had a separate source of income, namely rental income and hotel accommodation business income and that therefore, ought to have prepared separate accounts in respect of each specified sources of income. The Appellant on its part did not dispute having two streams of income but disputed “restaurant income” to be rental income. Section 15 (7) (a) (b) and (e [i]) of ITA provides as follows:“(7)Notwithstanding anything contained in this Act–(a)the gains or profits of a person derived from any one of the seven sources of income respectively specified in paragraph (e) of this subsection (and in this subsection called "specified sources") shall be computed separately from the gains or profits of that person derived from any other of the specified sources and separately from any other income of that person;”“(b)where the computation of gains or profits of a person in a year of income derived from a specified source results in a loss, that loss may only be deducted from gains or profits of that person derived from the same specified source in the following year and, in so far as the loss has not already been so deducted, in subsequent years of income…”“(e)the specified sources of income are–(i)rights granted to other persons for the use or occupation of immovable property;…”

72. The Tribunal notes from a reading of the cited provisions of the Law, that it can infer that income generated from the use or occupation of immovable property such as ‘rental income’ is a specified source of income and ought to be accounted for separately from any other income.

73. The Tribunal having so concluded that the Appellant generated rental income, is of the view that the Appellant ought to have accounted for what it saw as compensation for occupancy as rental income; separately from all its other business income.

74. The Tribunal therefore finds that the Respondent did not err in its application of the provisions of Section 15 (7) of the ITA.

c. Whether The Respondent erred in confirming the VAT assessment. 75. The Tribunal notes that the Appellant conceded to the VAT assessment in respect of the year 2021. However, the VAT assessments in respect of the years 2020 and 2022 were in contention. The Respondent averred that upon undertaking a banking test analysis it established that the Appellant had under declared sales of Kshs. 3,252,617. 00 and Kshs. 7,930,812. 00 for the years 2020 and 2022, respectively. The Respondent further argued that upon taking into consideration the reconciling items, the assessment for the year 2020 resulted in an underdeclared sales of Kshs. 1,600,034. 00 resulting in an assessment of Kshs. 327,047. 00. The under declaration of income in respect of the year 2022 resulted in a VAT assessment of Kshs. 4,035,808. 00.

76. The Tribunal also notes the averment by the Appellant that the under declared sales (Kshs. 1,600,034. 00) in respect of the year 2020 of was made up of the following: Rejected bounced cheques of Kshs. 738,000. 00.

Difference in exchange rates used in the conversion of the dollar account Kshs. 195,591. 00.

Prepaid loan balances of Kshs. 66,912. 00.

Misstated loan balances of Kshs. 599,531. 00.

77. The Tribunal notes the Appellant’s averment that in respect of the year 2022, the variance in sales was as a result of non-income deposits that is; prepayments for accommodation for the year 2023 and 2024. The Appellant articulated these averments in its notice of objection and the Respondent rejected the Appellant’s averments in respect of the years 2020 and 2022 on the basis that the Appellant had not produced substantiating proof in support of its objection.

78. The Tribunal has reviewed the documentary evidence adduced by the Appellant in support of its Appeal and notes that the same is sufficient proof and supports the Appellant’s analysis of the variances. The Tribunal also notes that in contention was VAT charged on a variance in the bank which arose from a difference in the valuation of the dollar account.

79. The Tribunal is of the view that the variance arising out of the valuation of the dollar account is not a deposit. Pursuant to Section 5 of the VAT Act, VAT is chargeable on the supply of goods or services. A variance resulting from a difference of the exchange rate applied in conversion of the dollar to the Kenya Shilling is not construed to be a supply of goods or services as envisaged by the following provisions of Section 5 of the VAT Act:“5. Charge to tax(1)A tax, to be known as value added tax, shall be charged in accordance with the provisions of this Act on—(a)a taxable supply made by a registered person in Kenya;(b)the importation of taxable goods; and(c)a supply of imported taxable services.”

80. The Tribunal cites the case of Gleckman v. United States which was cited by Wondiye Birhanu in his article “Bank deposit method of proving Tax Evasion: the current litigation heresies” wherein he summarized the requirement for bank analysis method as follows:“As understood from Gleckman case, for the government to bring a charge based on bank deposit method of proof, government must fulfill the following yardsticks: 1. The taxpayer was engaged in a business or income-producing activity from which the investigation auditor/ court can infer that the unreported income arose;

2. Periodic and regular deposits of funds were made into accounts in the taxpayer’s name or over which the taxpayer had dominion and control.

3. An adequate and full investigation of those accounts was made in order to distinguish between income and non-income deposits;

4. Unidentified deposits have the inherent appearance of income, e.g., the size of the deposits, odd or even amounts, fluctuations in amounts corresponding to seasonal fluctuations of the business involved, source of checks deposited, dates of deposits, accounts into which deposited, etc.”

81. Accordingly, the Tribunal finds that the Respondent erred in confirming the VAT assessments for the 2020 and 2022 year of income.

Final Decision 82. The upshot to the foregoing is that the Tribunal finds and holds that the Appeal partially succeeds and makes the following Orders:a.The Appeal be and is hereby partially allowed.b.The objection decision dated 23rd August 2024 be and is hereby varied as follows:i.The Corporate income tax assessment be and is hereby upheld; andii.The VAT assessment be and is hereby set aside.c.Each party to bear its own cost.

83. It is so Ordered.

DATED AND DELIVERED AT NAIROBI ON THIS 16TH DAY OF MAY, 2025. .........................CHRISTINE A. MUGA - CHAIRPERSONBONIFACE K. TERER - MEMBERELISHAH N. NJERU - MEMBEREUNICE N. NG’ANG’A- MEMBER