Kenafric Bakery Limited V Commissioner, Domestic Taxes (income Tax Appeal E070 Of 2020) [2023]

Tax Laws Are Dynamic. What Happens When a Previously Exempt Good or Service Becomes Zero-Rated? Can the Law Apply Retrospectively to Allow Taxpayers to Deduct Input VAT Incurred on Supplies Made Before the Change?

To clarify, Zero-rated VAT means that the supply of goods or services is still subject to VAT, but the rate is 0%. As a result, a supplier does not need to charge VAT on their sales but is still eligible to claim back any VAT incurred on their inputs. On the other hand, VAT-exempt means that the supply of goods or services is not subject to VAT at all. A supplier of exempt goods cannot charge VAT on their sales and is also unable to claim VAT on their inputs.

The difference between VAT-exempt and zero-rated goods and services has a significant impact on businesses. A business selling zero-rated goods can reclaim input VAT, while one dealing with exempt goods cannot,

Facts of the Case

Kenafric Bakery Limited is primarily engaged in the manufacture and sale of bread to various retail outlets, including schools and colleges. The dispute arose from Kenafric’s claim for input VAT of Kshs. 91,381,817, which was incurred between April 2015 and March 2017, prior to the change in VAT status of ordinary bread.

Prior to April 3, 2017, ordinary bread was VAT-exempt, meaning Kenafric was unable to claim VAT on inputs related to its bread production. However, following the amendment introduced by the Finance Act, 2017, the VAT status of bread was changed from exempt to zero-rated, effective from April 3, 2017. Kenafric sought to claim back the VAT on inputs incurred during the period from April 3, 2015, to April 3, 2017, based on the assumption that Section 18 of the VAT Act would allow them to retroactively claim input VAT.

The Law:

Section 18 of the VAT Act provides the following guidance for businesses that were previously engaged in the sale of exempt supplies, but whose goods or services are subsequently classified as taxable

18. Tax paid prior to registration

(1) Where,

a) on the date exempt supplies made by a registered person become taxable, and the person had incurred input tax on such supplies; or

b) on the date he is registered, a person has incurred tax on taxable supplies which are intended for use in making taxable supplies, the person may, within three months from that date, claim relief from any tax shown to have been incurred on such supplies:

Provided that this subsection shall apply where such supplies are purchased, within the period of twenty-four months immediately preceding registration or the exempt supplies becoming taxable.

(2) Where the Commissioner is satisfied that the claim for relief is justified, he shall authorise the registered person to make an appropriate deduction of the relief claimed under subsection (1) from the tax payable on his next return.

Submissions

Kenafric took the view that section 18 (1)(a) and 18 (2) of the VAT Act permits deduction of input tax on all supplies made within a period of twenty-four months preceding the date when exempt supplies become taxable. As such, it was of the view that the law would apply retroactively and that input tax for supplies made between April 3, 2015 and April 3, 2017 ought to be allowed.

The Kenya Revenue Authority (KRA), however, took the position that the tax relief provisions of Section 18 should only apply to inputs incurred after the VAT status change came into effect. The KRA argued that input VAT could only be claimed if the materials were purchased after the law was amended to zero-rate ordinary bread.

To support this, the KRA referenced Section 23(3) of the Interpretation and General Provisions Act (Chapter 2, Laws of Kenya), which stipulates that an amending law generally does not have retroactive effects unless explicitly stated by the legislature.

Court’s Analysis and Decision

The High Court, agreed with the KRA’s argument that, as a general rule, amendments to tax laws do not apply retroactively. The Tribunal cited the principle that legislative amendments generally take effect from the date of enactment, and any exceptions to this rule must be clearly expressed by the legislature.

However, the Tribunal also acknowledged that retroactive application is permissible under certain conditions. It emphasized that the intention of the legislature must be the determining factor in deciding whether a law should apply retroactively. The Tribunal referenced the case Samuel Kamau Macharia and Another v Kenya Commercial Bank Ltd and 2 Others, where the Supreme Court held that retroactive laws are not inherently unconstitutional unless they violate specific constitutional principles, such as impairing vested rights or obligations under contracts.

It also looked at Municipality of Mombasa vs Nyali Limited [1963] EA 374

“Whether or not legislation operates retrospectively depends on the intention of the enacting body as manifested by the legislation. In seeking to ascertain the intention behind the legislation the courts are guided by certain rules of construction. One of these rules is that if the legislation affects substantive rights, it will not be construed to have retrospective operation unless a clear intention to that effect is manifested; whereas if it affects procedure only, prima facie it operates retrospectively unless there is a good reason to the contrary. But in the last resort it is the intention behind the legislation which has to be ascertained and a rule of construction is only one of the factors to which regard must be had in order to ascertain that intention.”

Against this background and in the complete appreciation of these interdicts, The Tribunal proceeded to determine the import of section 18 (1)(a) of the VAT Act.

The Tribunal ruled that since the change in VAT status was meant to provide relief to businesses like Kenafric, it should be interpreted in a manner that preserves the right to claim input tax incurred during the period prior to the VAT status change. The Tribunal thus upheld Kenafric’s claim for input tax relief for purchases made between April 3, 2015, and April 3, 2017, as this was within the 24-month window specified by Section 18(2) of the VAT Act.

HOW WE CAN HELP

At CM Advocates LLP, our tax dispute resolution team is fully equipped to assist from the moment a taxpayer receives an intention to audit through to the final resolution of the matter. We possess deep knowledge of procedures and the law, ensuring that taxpayers can effectively and comprehensively fulfill all their obligations under the law. This allows you to concentrate on your core business while we focus on resolving the matter conclusively. For any inquiries, please contact Tabitha Muchiri at tmuchiri@cmadvocates.com