Monthly Rental Income (MRI) For Residential & Not Commercial

Case Study : Community Health Promotion Kenya Limited v Commissioner of Domestic Taxes (Tax Appeal E367 of 2025) [2026] KETAT 19 (KLR) (9 February 2026) (Judgment)

Background of the Dispute

• KRA conducted an audit of CHPK’s business affairs for the years 2021 to 2023.
• The audit revealed that CHPK was declaring all its rental income under the Monthly Rental Income (MRI) regime.
• MRI regime is a final tax structure that applies exclusively to residential properties.
• Upon reviewing lease agreements, audited financial statements, and withholding tax records, KRA established that a significant portion of the premises were leased as office space, Tenants were institutional in nature, This constituted commercial rental income, not residential.

KRA’s Position

• Commercial rental income should be subject to: Corporation Tax (not the MRI regime), Value Added Tax (VAT) (commercial leases are taxable)
• The company had under-declared rental income.
• CHPK claimed expenses that were either, Unsupported by documentation, or Incapable of verification.
• The company had failed to register for VAT despite meeting the statutory threshold.
• Material variances existed between, Staff costs in Corporation Tax returns, and Amounts declared in PAYE returns.

CHPK’s Grounds of Appeal

1. Rental Income: KRA relied on unreliable third-party data instead of the legally binding lease agreements provided by CHPK.
2. Double Taxation: KRA assessed Corporation Tax on income already taxed under the MRI regime, which is meant to be a final tax.
3. Disallowed Expenses: KRA wrongly disallowed legitimate business expenses (Kshs. 4.7 million) despite supporting documents being provided.
4. Income Source: KRA incorrectly separated income into multiple streams (land, office, accommodation) instead of treating it as a single “rental income” source, ignoring accumulated losses.
5. VAT on Exempt Supplies: KRA erroneously charged VAT on the lease of land and residential premises, which are exempt from VAT by law.
6. VAT Registration Threshold: KRA incorrectly included exempt income when calculating whether the VAT registration threshold had been met.
7. PAYE Assessments: KRA wrongly charged PAYE on reimbursements and statutory contributions (pension, medical insurance) that are not taxable employment income.

Issues for Determination by the Tribunal

The Tribunal identified three main issues to resolve:

1. Whether the rental income earned was taxable as commercial rental income.
2. Whether the Respondent lawfully disallowed the claimed expenses and made PAYE adjustments.
3. Whether the Appellant proved that the Respondent’s tax assessments were incorrect.

Tribunal’s Analysis and Key Findings

Issue 1: Commercial vs. Residential Rental Income

• Finding: The lease agreements clearly showed the properties were used as office space by institutional tenants.
• Principle Applied: “The character of income is determined by the nature and use of the property from which the income is derived.”
• Conclusion: Office space constitutes commercial premises and falls outside the scope of the residential MRI regime under Section 6A of the Income Tax Act.
• Verdict: KRA was entitled to reclassify the income and subject it to Corporation Tax.

Issue 2: Disallowed Expenses

• Finding: A substantial portion of the claimed expenses related to: Directors’ travel, Accommodation, Allowances, Professional licensing, & Cash withdrawals.
• Principle Applied: Under Sections 15 and 16 of the ITA, only expenditure wholly and exclusively incurred in the production of income is allowable.
• Conclusion: The Appellant failed to demonstrate a direct nexus between these expenses and the earning of commercial rental income.
• Verdict: The disallowance of expenses was justified.

Issue 3: PAYE Adjustments

• Finding: Discrepancies existed between staff costs in Corporation Tax returns and amounts in PAYE returns.
• Conclusion: The Appellant failed to provide a satisfactory reconciliation or supporting documentation.
• Verdict: KRA was entitled to make the PAYE adjustments.

Issue 4: VAT

• Finding: While the supply of land and residential premises is exempt under the VAT Act, the exemption does not extend to commercial premises.
• Finding: The Appellant’s own declarations and lease agreements showed taxable turnover exceeded the statutory threshold.
• Principle Applied: Section 34 of the VAT Act empowers the Commissioner to register a person who qualifies but fails to do so voluntarily.
• Verdict: The VAT assessment was lawful.

Burden of Proof

• Legal Provisions: Section 56(1) of the Tax Procedures Act and Section 30 of the Tax Appeals Tribunal Act.
• Principle: The burden of proof rests squarely on the taxpayer to demonstrate that an assessment is incorrect.
• Application: An assessment by the Commissioner is presumed to be correct until the taxpayer produces sufficient evidence to the contrary.
• Tribunal’s Finding: The Appellant failed to discharge this burden. It did not:

Final Orders of the Tribunal

1. The Appeal was dismissed.
2. KRA’s objection decision dated 21st February 2025 was upheld.
3. Each party is to bear its own costs.