Genesis and Background of the Case

This case arose from an appeal filed by the Commissioner of Domestic Taxes (KRA) challenging a decision by the Tax Appeals Tribunal delivered on 27 March 2020 in favor of Sony Holdings Ltd. The dispute originated from the terrorist attack on the Westgate Mall on 21 September 2013, which led to the destruction of property and loss of rent.

Sony Holdings, the owner and developer of the Mall, held an insurance policy with Kenindia Assurance for KES 6 billion (property) and KES 1.2 billion (loss of rent). Following the attack, Sony received compensation. The core dispute was whether KES 600 million of this insurance compensation was taxable as income, whether the taxpayer was entitled to a Commercial Building Allowance, and whether unrecovered service charge expenses were deductible. KRA issued an additional assessment of KES 380,388,596 for Income Tax, VAT, and Withholding Tax.

Background of the Case – Key Points

1. Insurance Compensation: Sony received KES 600M for property damage and KES 1.2B for loss of rent. The dispute concerned the taxability of the KES 600M.
2. KRA Assessment: On 18 May 2018, KRA issued an additional tax assessment totaling KES 380M (principal tax, penalties, and interest).
3. Tribunal’s Ruling (March 2020): Found that the KES 600M was capital (not income), granted Commercial Building Allowance, and allowed deduction of unrecovered service charges.
4. Appeal to High Court: KRA appealed the Tribunal’s ruling, alleging legal errors on tax treatment of compensation, allowance eligibility, and deduction standards.

Appellant’s Submissions (KRA)

1. KES 600M Is Taxable: Claimed that the insurance payout qualified as income under Section 4(c) of the Income Tax Act (ITA), being compensation for loss of profits.
2. Burden of Proof Misplaced: Argued the Tribunal wrongly shifted burden of proof to KRA, whereas under Section 56(1) of the TPA, the taxpayer must prove the assessment is excessive.
3. Inadequate Documentation: Claimed Sony failed to submit adequate evidence like assessor’s reports or account breakdowns justifying the use of the KES 600M.
4. Commercial Building Allowance Rejected: Contended that Sony didn’t meet Paragraph 6A requirements, as roads, water, and electricity infrastructure already existed in Westlands.
5. Service Charge Not Deductible: Asserted the unrecovered expenses were related to an ongoing building extension and thus should have been capitalized.
6. Private Ruling Not Binding: Pointed out that the private ruling issued earlier was not a statutory decision and could not be relied upon to demand allowance.

Respondent’s Submissions (Sony Holdings Ltd)

1. KES 600M Was Capital: Submitted that compensation was for reconstruction of buildings—not profits—and supported by Kenindia’s letter and discharge vouchers.
2. Audit History Supports Position: Claimed that KRA’s own prior audits (2013 and 2016) had accepted treatment of the amount as non-taxable.
3. Commercial Building Deduction Valid: Showed compliance with Paragraph 6A, including construction of roads, lighting, sewer, and water infrastructure—supported by a BOQ, contracts, and County approval.
4. Legitimate Expectation: Pointed to KRA’s private ruling confirming eligibility for the allowance, which was never withdrawn.
5. Service Charges Were Revenue Expenses: Asserted that KES 49.3M (2015) and KES 112.8M (2016) were incurred in maintaining partially occupied premises, and thus deductible under Sections 15(1) and 16(1).
6. No Prejudice to KRA: Argued that all documents had been submitted in past audits and were accepted by KRA.

Court’s Decision – Key Points

1. KES 600M Not Taxable: Held that the amount was compensation for buildings, not profits, and therefore not taxable under Section 4(c) of ITA.
2. Commercial Building Allowance Granted: Affirmed that Sony met all the conditions under Paragraph 6A, including infrastructure provision, and even received prior confirmation from KRA.
3. Service Charge Expenses Allowed: Recognized the unrecovered charges as ordinary business expenses necessary for generating income.
4. No Error in Tribunal’s Decision: Concluded that the Tribunal applied the law correctly and was justified in dismissing KRA’s position.
5. Appeal Dismissed: The High Court upheld the Tribunal’s judgment.
6. Costs Awarded: KRA to pay costs of the appeal.