[2022] KEHC 173 (KLR)

Thika Water & Sewarage Company Limited v Commissioner of Domestic Taxes (Tax Appeal 8 of 2020) [2022] KEHC 173 (KLR) (Commercial and Tax) (4 February 2022) (Judgment)

Neutral citation number: [2022] KEHC 173 (KLR)

Republic of Kenya

In the High Court at Nairobi (Milimani Commercial Courts Commercial and Tax Division)

Tax Appeal 8 of 2020

DAS Majanja, J

February 4, 2022

Between

Thika Water & Sewarage Company Limited

Applicant

and

Commissioner of Domestic Taxes

Respondent

(Being an appeal against the judgment of the Tax Appeals Tribunal at Nairobi dated 4th March 2020 in Tax Appeal No.23 of 2017)

Judgment

Introduction and Background 1. The Appellant is a limited liability company limited by Guarantee and wholly owned by the County Government of Kiambu whose core function is the provision of water and sanitation services to the residents of Thika town and its environs, under a service provision license from the Tanathi Water Service Board. The Respondent (“the Commissioner”), in the exercise of its mandate of collection and receipt of all revenue and administration and enforcement of all relevant tax laws, carried out a VAT and withholding tax audit of the Appellant’s tax affairs for the income period January 2011-December 2015.

2. By the letter dated 22nd March 2016, the Commissioner communicated the results and findings of the audit to the Appellant where it determined that the Appellant had misclassified its sales as zero-rated contrary to the VAT Act (Chapter 476 of the Laws of Kenya) (Repealed) (‘the VAT Act (Repealed)’’) and the VAT Act, 2013. It stated that according to Part A, Para. 16 of the 5th Schedule of the VAT Act (Repealed) and Part A, Para.8 of the Second Schedule of the VAT Act, 2013, only the supply of natural water (excluding bottled water) is zero rated. The Commissioner thus reclassified income arising from sewerage services provided by the Appellant based on the provisions of the VAT Act, 2013 in operation during the period of supply. The Commissioner also concluded that sewerage services enable the Appellant to provide safe disposal of sanitary waste and that prior to September 2013, supply of sanitary services was exempt as per Paragraph 5 of the Third Schedule of the VAT Act (Repealed) but that from September 2013 to 11th June 2015, the supply of sewerage services were taxable services under the VAT Act, 2013. The Commissioner added that section 5(c) of the Finance Act, 2015 amended Part II of the First Schedule of the VAT Act, 2013 with effect from 12th June 2015 making supply of sewerage services exempt from VAT.

3. The Commissioner further found and held that the miscalculation of income from sewerage services as zero rated instead of taxable resulted in the Appellant being in a perpetual credit position and thus, the correct classification resulted in the tax payable of KES 52,883,888. 00 being a refund paid in error. The Commissioner also accused the Appellant of under declaring its other incomes including meter replacement, Turn-On Fees, New Connection, Unmetered Water, Exhauster Income and Application Fees and after reclassifying the same, raised the amount of KES 14,826,975. 91 inclusive of interest. The Commissioner also found that some VAT returns were filed late and hence subjected to default penalties amounting to KES 220,000. 00. The Commissioner concluded that the total VAT payable inclusive of penalties for late filing and interest was KES 67,930,864. 08. The Commissioner further held that the Appellant was not withholding tax as an appointed VAT agent and thus computed its tax liability under this tax head at KES 13,047,365. 00. In sum, the Commissioner held that the Appellant’s total tax liability was KES. 80,978,230. 00 inclusive of penalties and interest.

4. The Appellant rejected the Commissioner’s findings in its letter dated 11th April 2016. It faulted the Commissioner’s interpretation of natural water under the VAT Act, 2013, that the Appellant’s sewerage service was a social and essential service exempt by the First Schedule, Part II of the VAT Act, 2013 and that during period of the audit no provision was ever made for VAT in the gazetted tariff for meter replacement, meter testing, connection fee, water and sewerage services and hence it could not charge VAT for these services. The Appellant also argued that sewerage is a by-product of piped natural water supplied to the populace and its transportation, treatment and disposal is part of the process of supplying clean water to the public and cannot be delinked. The Appellant maintained that it is owed VAT refunds by the Commissioner and denied that it was appointed a withholding VAT agent during the audit period and only received the appointment letter on 3rd March 2016. The Appellant thus urged the Commissioner to vacate the audit as soon as possible in order to close the matter

5. In its response dated 13th October 2016, the Commissioner maintained its earlier position and reasoning on VAT and reviewed the withholding VAT upwards to KES 14,412,409. 00 inclusive of penalties and interest. On the withholding VAT, the Commissioner reasoned that the Appellant was appointed as a withholding VAT agent through the enactment of section 26 of the Finance Act, 2014 effective 19th September 2014 and that section 25A of VAT Act, 2013 required Government Ministries, Departments and agencies, on purchasing taxable supplies, to withhold 6% of tax payable thereon and remit the same directly to the Commissioner. Thus, it held that the effective date for withholding VAT was the stated 19th September 2014.

6. The Commissioner thus issued an amended assessment totalling KES 82,343,273. Aggrieved, the Appellant filed a formal objection under section 51 of the Tax Procedures Act (“the TPA”).

7. After reviewing the objection, the Commissioner, in its decision dated 28th December 2016 (“the Objection Decision”) reduced the Appellant’s liability to KES 57,930,864. 00 inclusive of penalties and interest. In its reasoning, the Commissioner denied that the Appellant was offering welfare services as welfare services offered by the government, whether national or county, would refer to services offered to the needy in society and that such services are normally fully funded by the government and offered free of charge. The Commissioner held that sewerage services on the other hand are offered by county governments through the Water Companies such as the Appellant to all in society, whether rich or poor, at a fee and therefore do not fall under welfare services offered by county governments. The Commissioner maintained its position that Sewerage services was exempt in the period prior to September 2013 as per Paragraph 5 of the Third Schedule to the VAT Act (Repealed) and therefore taxable at 16% for the period September 2013 to 11th June 2015 and that from 12th June 2015, sewerage services provided by County governments are specifically exempted from VAT under Paragraph 23 of Part II to the First Schedule to VAT Act, 2013.

8. The Commissioner also reiterated its position that the supplies made by the Appellant that were incidental to its services were taxable and thus chargeable to VAT. On withholding VAT, the Commissioner agreed with the Appellant and dropped its demand. On input VAT, the Commissioner held that the Appellant failed to provide schedules for common input tax and input tax attributable to exempt supplies even after the Commissioner’s request for the same, therefore the Commissioner maintained its view.

9. The Appellant was dissatisfied with the Commissioner’s Objection Decision and lodged an appeal at the Tax Appeals Tribunal (“the Tribunal”). The Tribunal heard the parties’ arguments and submissions and in its decision framed three issues for determination;(a)Whether supply of sewerage services by the Appellant is taxable at a general rate of 16% or zero rated or exempt from VAT in the period January 2011 to October 2015. (b)Whether the sewerage service charge should be treated as incidental costs to natural water supply and Whether sewerage charges should be treated separately from provision of water service.(c)Whether there is value addition by the Appellant in waste water disposal that would qualify for VAT charge.

10. On the first issue, the Tribunal held that sewerage services fall under Paragraph 5 of the Third Schedule to the VAT Act (Repealed) under ‘Sanitary and Pest Control services’ and was exempt in the period prior to September 2013. As for the period 2nd September 2013 to 11th June 2015, sewerage services were taxable at the general rate of 16%. However, from the period 12th June 2015 they were exempted from VAT. Cconsequently, the Tribunal disagreed with the Appellant's arguments and held that sewerage services having not been listed as an Exempt service under Part II of the First Schedule was taxable at 16% for the period September 2013 to 11th June 2015.

11. On the second issue, the Tribunal found that the income directly related to the sewerage services rendered to domestic households and ought to be excluded from the taxable value and therefore directed the Commissioner to exclude the same from its computation. The Tribunal further held that section 9(3) of the VAT Act (Repealed) and section 13(5) of the VAT Act, 2013 provide for costs incurred by the supplier of the service in the course of supplying the service, which costs are to be included in calculating the value of the service for VAT purposes. The Tribunal noted that VAT is chargeable on provision of a taxable supply by a person regulated in Kenya as provided for both under section 6(1) of the repealed VAT Act (Repealed) and section 5(1) of the VAT Act, 2013 and consequently found that the supply of sewerage services by the Appellant cannot be treated as incidental costs to natural water supply and the supply of sewerage services is taxable at the rate of 16%.

12. On the third issue, the Tribunal explained that it had studied the Appellant’s documents, specifically, the Water Services Regulatory Board (WASREB) Water Tariff Guidelines which both parties relied on and tendered in evidence and found that the same provides that the costs for the supply of water and sewerage services ought to be treated separately with a provision for the criteria that a water service provider can use to cost the sewerage services. The Tribunal concluded that sewerage charges should be treated as a separate service rendered by the Appellant and that the same was chargeable to VAT

13. The Tribunal dismissed the Appellant’s appeal, upheld the Commissioner’s assessment of KES 57,930,864. 00 dated 28th December 2016 subject to the same being computed by excluding the income directly related to sewerage services rendered to domestic households and that each party was to bear its costs.

14. The Appellant appeals against the Tribunal’s decision which is grounded on its Memorandum of Appeal dated 28th April 2020. In essence, the Appellant faults the Tribunal’s interpretation of the applicable laws in upholding the Commissioner’s decision and avers that the Tribunal did not adjudicate its appeal in accordance with principles of law that govern taxation as provided for in the VAT Act (Repealed) and the VAT Act, 2013 and the amendments thereto thereby reaching an erroneous decision. The Appellant also states that the Tribunal failed to give it the benefit of doubt where and when the law was silent on the Appellant’s tax obligations and that the Tribunal considered and adopted extraneous factors in its decision as a basis for rejecting its appeal thereby rendering an erroneous Judgement. For these, the Appellant prays for inter alia the quashing of the Tribunal’s judgment and a substitution of an order allowing its appeal as amended on 22nd February 2017.

15. The Commissioner opposed the appeal. It filed a Statement of Facts. The appeal was canvassed by way of written submissions with the parties advancing their respective positions.

Analysis and Determination 16. The substance of this appeal turns on the interpretation of the legal provisions and from the arguments and responses throughout the process I have set out above, I take the view that the Appeal will be disposed if the court deals with two issues;(a)Whether the sewerage services offered by the Appellant were zero-rated or exempt from VAT(b)Whether the costs incidental to the Appellant’s services were subject to VAT.

Zero-rating or Exemption of the Sewerage services 17. That the Appellant offers sewerage services is not in dispute. The point of difference is whether the sewerage services were zero rated or exempted from VAT during the subject income period.

18. It is not in dispute that the Finance Act No. 14 of 2015 introduced and expressly exempted the supply of sewerage services by the national government, a county government, any political subdivision thereof or a person approved by the Cabinet Secretary for the time being responsible for water development under Paragraph 23, Part II of the First Schedule of the VAT Act, 2013 with effect from 12th June 2015. The Commissioner concluded and the Tribunal agreed that sewerage services involve disposal of sanitary waste which therefore fell under Paragraph 5 of the Third Schedule to the repealed VAT Act (Repealed) which prior to September 2013, when the new VAT Act, 2013 came into effect, was exempt from VAT. However, between the period 2nd September 2013 to 11th June 2015, the same was not listed as an exempt service and was thus taxable at the standard rate.

19. As stated in the introductory part, the audit was for the income period January 2011 to December 2015. From the above and having gone through the applicable statutory provisions, it follows that the Appellant’s sewerage services was exempt from VAT between 1st January 2011 to 1st September 2013 but was then liable to VAT from 2nd September 2013 to 10th June 2015 at the standard rate. Thereafter between 11th June 2015 to 31st December 2015, the same was exempt from VAT.

20. Further, in classifying its income as zero-rated, the Appellant also argued that sewerage services could also be considered and interpreted as incidental to the supply of natural water, at least going by the Water Acts of 2002 and 2016 and that the VAT Act, 2013 ought to be interpreted and read to include the sewerage services unless the same is specifically excluded since both services are defined as “water service” under both “Water Acts”.

21. Both parties have submitted on the issue of interpretation. This principle governing the interpretation of tax statutes was summarized by the Court of Appeal in Mount Kenya Bottlers Limited and Others v Attorney General and 3 Others NRB CA Civil Appeal No. 164 of 2013 [2019] eKLR as follows:[49] … This common law position is what pertains here and has been adopted by our courts as good law. In our view there cannot be an equitable construction of income tax legislation. The norm is that a taxing legislation must be construed with perfect strictness whether or not such construction is against the State or against the person sought to be taxed. If however there is any real ambiguity in a taxing Act, such ambiguity may be resolved in favour of the taxpayer, or, as it is sometimes stated: contra fiscum.

22. I agree with the Commissioner’s submission that the court cannot second-guess or imply into the provisions of tax statutes. The court cannot begin to draw a conclusion into what the intendment of the legislature was when it zero-rated the supply of water. It cannot thus import a definition from a different statute that is not pari materia with the administration of taxes into a tax statute as the Appellant suggests. The VAT Act, 2013 and other tax legislations ought to be read without leaving any room for implication or intendment. If Parliament intended to zero-rate sewerage services or include its meaning into the supply of natural water, nothing could have been easier than to say so. I thus reject the Appellant’s entreaty to find that sewerage services were zero-rated because the supply of water was also zero-rated as they meant one and the same thing.

23. I therefore find that the Commissioner’s Objection Decision was sound in its finding that Sewerage services was exempt in the period prior to September 2013 as per Paragraph 5 of the Third Schedule to the VAT Act (Repealed) and taxable at 16% in the period between September 2013 to 11th June 2015 and that from 12th June 2015, sewerage services provided by County governments were specifically exempted from VAT under Paragraph 23 of Part II to the First Schedule to the VAT Act 2013.

Incidental costs of the sewerage services 24. The next issue was that of water meters supplied by the Appellant to its customers. The Appellant argued that this supply was done at cost and no profit was made over and above the cost of the meters. The Commissioner on the other hand stated that the selling or renting of the meters is an incidental cost of supply of water and forms part of the value of service. The Commissioner relied on section 9(5) of VAT Act (Repealed) and section 13(5) of the VAT Act, 2013 which mirror each other as follows:In calculating the value of any services for the purposes of subsection (1), there shall be included any incidental costs incurred by the supplier of the services in the course of making the supply to the client: Provided that, if the Commissioner is satisfied that the supplier has merely made a disbursement to a third party as an agent of his client, then such disbursement shall be excluded from the taxable value.

25. The supply of the meters is not exempt or zero-rated from VAT and is thus considered a taxable supply, whether or not the supply made a profit. That the supply is incidental to the Appellant’s services is not in dispute, therefore, it ought to be included in calculating the taxable value unless the Appellant satisfied the Commissioner that it was a mere disbursement. The Black’s Law Dictionary (11th Ed.) defines ‘disbursement’ as “the act of paying out money, commonly from a fund or in settlement of a debt or account payable or; any amount given for a particular purpose”. Once the Commissioner makes the decision to tax the supply, it then ought to be offset against any input taxes to determine the VAT payable.

26. The Appellant’s case is that the meters were sold or rented out at cost thus, this they could not be used to calculate the taxable value. I have already stated that whether or not a profit was made from a taxable sale, VAT is still applicable and that such supplies made that are incidental to the services provided are included in calculating the taxable value unless they are exempt by the Commissioner for being a disbursement. The Appellant did not argue that they made any disbursements to its customers and even if they did, the selling or renting of the meters at cost does not qualify within the definition of a disbursement.

27. I hold that the Tribunal did not err in concluding that the Commissioner was right to include the cost of the meters in calculating the value of the supply of water for VAT purposes and finding that the said supply of the meters was taxable for purposes of VAT.

Disposition 28. For the reasons I have set out above, I find and hold that the Appellant failed to surmount its burden of showing that the Commissioner was wrong in its decision. The Appellant’s appeal lacks merit and is now dismissed.

DATED AND DELIVERED AT NAIROBI THIS 4TH DAY OF FEBRUARY 2022. D. S. MAJANJAJUDGEMr Okeyo instructed by Otieno Okeyo and Company Advocates for the Plaintiff.Mr Chabala Advocate, instructed by Kenya Revenue Authority for the Appellant.