Kb Cottages Nairobi Limited V Commissioner Of Domestic Taxes (tax Appeal E1072 Of 2024)

 This case centered on Section 15(7)(a) and (b) of the Income Tax Act, which requires income from specified sources such as rent, employment, or agriculture to be computed separately. Losses from one specified source can only be offset against future income from that same source.  

The Tribunal found that KB Cottages earned rental income from allowing a third party to occupy the restaurant space and was therefore required to treat it as a separate source, distinct from its hotel and accommodation business. 

Background 

The Appellant, KB Cottages Nairobi Limited was incorporated on 6th February 2020 to operate a restaurant and hotel facility in Karen. Upon leasing the property, the Appellant undertook renovations. During the renovation period (2020–2022), the restaurant was operated by a third party under a lease agreement, from which the Appellant received agreed periodic payments. 

In 2022, after the 3rd party’s lease expired and the Appellant assumed direct operations of the restaurant. The Kenya Revenue Authority ("KRA") audited the Appellant and concluded that it had two separate sources of income: 

1. Rental income (from leasing the restaurant to the third party), and 
2. Hotel and accommodation business income. 

Accordingly, the KRA applied Section 15(7) of the ITA, which mandates the separate computation of specified sources of income, including rental income. The Respondent proceeded to reallocate expenses across these income streams and disallowed the consolidation of losses from one stream against the profits of another. 

Appellant’s Submissions 

KB Cottages argued that the restaurant was not intended to be rented out, and the temporary arrangement with the third party was not a commercial rental but part of the broader business setup. 

It claimed that its financial accounts reflected a single business entity and thus, separate treatment of income and expenses by the KRA was inappropriate. 

For the 2020 year of income, KB Cottages asserted that the only income earned was from the restaurant (operated by the third party), which had been mistakenly reported as rental income due to its presentation, not its substance. 

KRA’s Submissions 

The KRA maintained that the Appellant earned rental income from the third party during 2020–2022 and business income from hotel and accommodation services thereafter. 

Citing Section 15(7) of the ITA, the KRA argued that each specified source of income must be accounted for separately and that losses from one source cannot be used to offset profits from another. 

Tribunal’s Analysis and Determination 

Relying on Black’s Law Dictionary’s definition of rent:  

“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” 

the Tribunal held that the consideration paid by the third party for the occupancy of the premises constituted rental income, as it was a payment for the use or occupation of immovable property. 

The Tribunal emphasized that under Section 15(7)(e)(i) of the ITA, rental income is a specified source and must be accounted for independently. 

It concluded that the Appellant had derived rental income during 2020–2022 and should have prepared separate accounts for it, distinct from the hotel and accommodation business. 

How we can Assist  

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Contributors:
Tabitha Muchiri - Tax Associate