Court of Appeal 2025: VAT on Commercial Property Sales
The landmark Court of Appeal 2025 ruling in KRA v David Mwangi Ndegwa settled a long-standing area of uncertainty: VAT at 16% applies to the sale of commercial property. The court held that the supply of a commercial building constitutes a taxable supply under the VAT Act 2013, and developers must charge VAT on the sale price of commercial premises.
Key Holding from the Ruling
The court distinguished between commercial property (taxable) and residential premises (exempt). The determining factor is the use of the property, not its physical characteristics. A building constructed for commercial purposes — regardless of whether it could also be used for residential purposes — is subject to VAT.
For developers and real estate investors, this means:
- If you sell a commercial unit (office, shop, showroom, warehouse), charge 16% VAT on the sale price.
- If you sell a residential unit (apartment, house for dwelling purposes), no VAT is charged.
- If you are a VAT-registered developer, you can claim input VAT on construction costs attributable to commercial units.
- The ruling applies retroactively — developers with ongoing or prior transactions should review their VAT position.
Developers should seek professional advice on past transactions
If you completed commercial property sales before the 2025 ruling and did not charge VAT, you may have exposure to a KRA assessment. Contact a VAT specialist to review your position and consider a voluntary disclosure if necessary. The penalty for undeclared VAT can be up to 100% of the tax due plus interest.
Land vs Buildings: What Is Taxable?
The distinction between land and buildings is critical for VAT purposes. The VAT Act 2013 treats them differently, and getting it wrong can lead to significant tax exposure.
| Transaction Type | VAT Treatment |
|---|---|
| Sale of bare land (no buildings) | Exempt — no VAT |
| Sale of land with residential building | Exempt — no VAT (residential use) |
| Sale of land with commercial building | 16% VAT on building portion only |
| Lease of commercial property | 16% VAT if landlord is VAT-registered |
| Lease of residential property | Exempt — no VAT |
When a property includes both land and a commercial building (e.g. a building on a plot being sold together), the developer must apportion the sale price between the land (exempt) and the building (taxable). KRA expects a reasonable apportionment method — typically based on the ratio of construction cost to land value, or a professional valuation.
The same logic applies to input VAT. A developer constructing commercial buildings can claim input VAT on materials and services used for the building, but not on land acquisition costs (which are exempt).
Withholding VAT on Construction Services
Kenya operates a withholding VAT system for construction services. If you engage a contractor for construction work, you may be required to withhold VAT from their invoice and remit it directly to KRA, rather than paying the full amount to the contractor.
| Contractor Type | Withholding Rate | Remittance Timeline |
|---|---|---|
| Resident contractor (Kenyan company or individual) | 2% | Within 5 working days of payment |
| Non-resident contractor (foreign company) | 6% | Within 5 working days of payment |
How it works:
Failure to withhold VAT is a common audit finding
If you engage a construction contractor and fail to withhold VAT, KRA can recover the withholding VAT from you plus a 50% penalty. This applies even if the contractor was not registered for VAT at the time. Always verify your contractor's VAT status before making payments.
Scope of “construction services”:Withholding VAT applies to building, civil engineering, electrical, plumbing, painting, roofing, and related services. It also covers the supply of labour plus materials where the contractor provides both. Pure supply of materials without installation may not be subject to withholding VAT — consult a tax professional for borderline cases.
Subcontractor VAT Obligations
Subcontractors in the construction sector are treated as independent suppliers for VAT purposes. This means they have their own VAT registration and filing obligations, separate from the main contractor.
Subcontractors must register for VAT if turnover exceeds KES 5M
Subcontractors whose annual turnover from all projects exceeds KES 5 million must register for VAT, charge 16% VAT on invoices to main contractors, file monthly VAT returns, and issue eTIMS-compliant invoices. Below the threshold, they do not charge VAT but cannot claim input VAT either.
Main contractors should verify subcontractor VAT status:
- Request the subcontractor's KRA VAT registration certificate before engaging them.
- Verify the subcontractor's VAT PIN on iTax to confirm it is active and VAT-registered.
- If the subcontractor is not VAT-registered, no VAT is charged, but the main contractor cannot claim input VAT on that subcontractor's invoices.
- If a subcontractor is VAT-registered, the main contractor must issue an eTIMS-compliant invoice showing 16% VAT.
- KRA audits in the construction sector frequently target the main contractor-subcontractor chain, looking for missing VAT charges and unregistered subcontractors.
Practical risk: If a main contractor engages a non-registered subcontractor whose turnover actually exceeds KES 5M, and KRA discovers this on audit, both parties may face penalties. The subcontractor for failing to register, and the main contractor for claiming input VAT on an invalid invoice or failing to withhold.
Mixed-Use Developments: Apportionment Rules
Many modern developments combine residential and commercial units — ground-floor shops with apartments above, or office blocks with residential wings. These mixed-use developments require careful VAT apportionment because the two use types have different VAT treatments.
| Component | Output VAT | Input VAT Recovery |
|---|---|---|
| Residential units (sale or rent) | Exempt — no VAT | No input VAT recovery on costs attributable to residential portion |
| Commercial units (sale or rent) | 16% VAT | Full input VAT recovery on costs attributable to commercial portion |
| Common areas (lobby, corridors, parking, gardens) | N/A | Apportioned based on commercial/residential floor area ratio |
Apportionment methodology:
- Use floor area (square metres) as the primary apportionment basis. This is the most commonly accepted method by KRA.
- Calculate: Commercial floor area / Total floor area = Apportionment percentage.
- Apply the percentage to shared costs (common areas, project management, professional fees) to determine the deductible input VAT portion.
- Directly attributable costs (e.g. materials used only in commercial units) are fully deductible.
- Directly attributable costs for residential units are not deductible at all.
- Maintain detailed records of the apportionment calculation and be prepared to justify it to KRA on audit.
Capital Goods Adjustment (CGA) applies to construction
Buildings are classified as capital goods under the VAT Act. Input VAT on construction costs is claimed over a 5-year period through the Capital Goods Adjustment mechanism. In the year of completion, you claim one-fifth of the input VAT, and you adjust annually for 5 years based on actual use. If a commercial unit is later converted to residential use, a clawback of input VAT may apply.
Frequently Asked Questions
- Is VAT charged on the sale of commercial property in Kenya?
- Yes. Following the Court of Appeal 2025 ruling in KRA v David Mwangi Ndegwa, VAT at 16% applies to the sale of commercial property. Residential premises remain exempt from VAT. The ruling confirmed that the supply of a commercial building is a taxable supply under the VAT Act, and developers must charge VAT on the sale price.
- Is land subject to VAT in Kenya?
- No. The sale of land (bare land without buildings) is exempt from VAT under the First Schedule to the VAT Act 2013. However, if you sell land with a commercial building on it, the building portion is subject to 16% VAT. Developers should apportion the sale price between the land (exempt) and the building (taxable).
- What is the withholding VAT rate for construction services?
- Withholding VAT on construction services is 2% for resident contractors and 6% for non-resident contractors. The person receiving the construction service must withhold the VAT and remit it to KRA within 5 working days. The contractor can claim the withheld amount as input VAT when filing their monthly return.
- Do subcontractors need to register for VAT?
- Yes, if a subcontractor's annual turnover exceeds KES 5 million. Subcontractors must be VAT-registered and charge 16% VAT to main contractors. Main contractors should verify that their subcontractors are VAT-registered before engaging them, as input VAT on invoices from unregistered subcontractors may be disallowed on audit.
- How is VAT handled for mixed-use developments with residential and commercial units?
- Mixed-use developments require apportionment between the exempt residential portion and the taxable commercial portion. The developer must calculate input VAT on construction costs and apportion it based on the ratio of commercial to total floor area. Output VAT is charged only on the sale or rental of commercial units. The apportionment method should be consistently applied and disclosed to KRA.