A tax tribunal has delivered a landmark ruling, slamming the brakes on the Kenya Revenue Authority’s ability to impose Value Added Tax (VAT) on county governments’ own-source revenue. This move is poised to have a far-reaching impact on the management of Kenya’s decentralised revenue collection system.

In a judgment dated 26 March, the Tax Appeals Tribunal noted that the taxman erred by attempting to charge VAT on licences, fees, and other charges paid by individuals and businesses to the County Government of Kiambu.

In the Kiambu County vs KRA’s Commissioner of Domestic Taxes case, the tribunal set aside VAT assessments of KSh 17.9 million plus withholding taxes, noting that slapping duty on such revenues is equivalent to “unlawful duplication of taxation.”

The dispute in question related to KRA’s additional assessments issued in August 2024 for the 2019-2023 period, initially totalling KShs 559.9 million. After a partial objection decision, KRA confirmed that KShs 194.6 million was due, including VAT on market fees, licences, and hire charges for stadiums and social halls.

Market fees not ‘taxable business income’

At the core of the judgment was the question: can a county government, while performing its constitutional functions, be deemed to be undertaking a “business” transaction for VAT purposes?

In its defence, Kiambu County explained that its functions, as spelled out in the Fourth Schedule of the 2010 Constitution, only provide services and social welfare, not a profit. However, KRA countered that the county’s revenue collections from rent on market stalls, houses, and stadium hire are subject to output VAT.

While agreeing with the county, the tribunal stated, “a county government cannot be termed as engaged in a business while performing constitutionally decreed functions.”

According to the judgment, Paragraph 9 of the First Schedule to the VAT Act, exempts “community, social, and welfare services provided by the National Government, County Government, or any political sub-division thereof.”

The tribunal added that the taxman did not file any “cogent evidence” that Kiambu breached its mandate to engage in a taxable supply. “The assertion by the appellant that it was engaged in the carrying out of its functions and was thus not liable to pay VAT was sufficient evidence,” the ruling states in part.

Double taxation

Additionally, the tribunal addressed the question of double taxation. KRA contended that own-source revenue, such as fees, levies, permits, and similar charges, is itself a form of statutory taxation. By imposing VAT on top, the tribunal explained, it would force citizens to be taxed twice on the same transaction.

The tribunal stated that subjecting county levies to VAT “would amount to an unlawful duplication of taxation,” effectively breaching constitutional principles of fairness and equity.

The latest judgment gives clarity on the fiscal autonomy of Kenya’s 47 county governments. “The Constitution intended to grant counties a degree of fiscal autonomy by allowing them to collect own-source revenue,” the tribunal observed, noting that taxing this revenue stream “is an encroachment on county powers and an obstacle to their financial independence.”

The case for PAYE and withholding tax (WHT)

While the VAT victory was clear, the tribunal delivered a mixed verdict on other taxes. For instance, it set aside PAYE assessments on imprests, which are the advances given to employees for official duties. The tribunal noted that imprests “are recoverable from an employee… It is never his/her money.”

However, the tribunal upheld PAYE assessments on motor vehicle benefits for senior officials, including the Governor and County Executive Committee members. It noted that Kiambu failed to provide vehicle logs to prove the cars were pool vehicles rather than for exclusive personal use. 

On withholding taxes (WHT), the tribunal faulted the KRA for issuing blanket confirmations without providing a breakdown of which transactions actually attracted WHT. By doing this, the tribunal faulted KRA for breach of Section 51(10) of the Tax Procedures Act, which requires reasons for any objection decision.

Tax lesson for other counties

While KRA argued that Kiambu failed to discharge its burden of proof under Section 56 of the Tax Procedures Act, the tribunal applied a nuanced standard. Citing its own precedent in Abyssinia Iron and Steel Ltd, the judgment explained that once a taxpayer provides evidence that an assessment is wrong, “the respondent [KRA] must push back and show that its assessment was not arbitrary, capricious, or imagined.”

Because the KRA did not adequately rebut Kiambu’s prima facie case, the tribunal found the county had discharged its burden. Each party was ordered to bear its own costs.

The decision in Kiambu County vs KRA will be studied closely by other counties facing similar demands from Times Tower. With many units struggling to raise their own revenue amid tight fiscal transfers from the National Treasury, the ruling removes a significant potential tax liability. 

For the KRA, which has increasingly sought to broaden the tax base, this judgment represents a clear legal setback. While the taxman might file an appeal at the High Court, counties have won a critical defence of their constitutional power to levy fees without the taxman taking a cent from their collections.

[email protected]