Does VAT Apply to Auction Sales for Debt Recovery?

Case Study: KCB Bank Kenya Limited v Commissioner Legal Services & Board Co-ordination (Tax Appeal E023 of 2024) [2025] KETAT 2 (KLR) (17 January 2025) (Judgment)

KRA carried out an audit for the period 2018 to 2022 and issued assessments for Corporation tax, VAT, PAYE and Withholding Tax. KRA then issued a notice of assessment dated 31st August 2023 wherein it demanded a total of Kshs. 1,190,578,054.00 in taxes. KCB objected to the assessments vide Notice of Objection dated 29th September 2023.

In this article we will focus on VAT.

KRA issued its Objection Decision through a letter dated 27th November 2023 wherein the interest was revised upwards leading to a revised additional assessment of Kshs 1,216,775,932.00.

KCB being dissatisfied with KRA’s Objection Decision, filed  an appeal  to the Tax Appeal Tribunal.

Among the grounds of appeal was:

• That KRA erred in law and fact by failing to appreciate that VAT is not chargeable on the disposal of seized assets as the seizure and auction of vehicles is intrinsically linked to the making of advances and granting of credit, which is a VAT – exempt service;

KCB argued that:

• Part 2 of the First Schedule to the VAT Act, under Paragraph 1 (h) exempts from VAT “the making of any advances or the granting of any credit.”
• any bank offers credit and seeks to mitigate the risk of default by requiring the placement of security against the credit. This same principle applies where the bank secures car loans through the holding of special rights to repossess and auction vehicles to the extent that a customer defaults.
• in the Bank’s operations, the disposal of seized goods through auction is part and parcel of the provision of credit facilities and that the disposed goods are not intended to reap a profit; rather, the reserve price is specifically set in order to recover unpaid loan facilities that the bank has incurred/may incur owing to the default in the primary supply, which is the issuance of credit.
• it is an internationally accepted VAT principle that where a supply is incidental to another, the incidental supply assumes the VAT treatment of the principal supply.
• in Mayfair Insurance Company Limited vs. Commissioner of Domestic Taxes (TAT) No. 47 of 2016, the Tribunal held, at Paragraph 101 that, “the sale of salvages constitutes part of insurance services as opposed to insurance business and, thus, cannot constitute supply of goods for purposes of taxation.” KCB argued that this is similar to the instant case to the extent that the Bank seizes and auctions motor vehicles to recover defaulted loans.
• While in the case of loans for motor vehicles, the logbook is maintained in the names of both the customer and the bank pending settlement of the loan obligation, KCB contended that the bank’s name on the logbooks is in no way an indication of ownership. Rather, it is a declaration that the property in question carries a charge, to which the bank has first rights on any default in its capacity as a secured creditor

KRA Replied That:

• VAT is not chargeable on the disposal of seized assets as the seizure and auction of vehicles is intrinsically linked to the making of advances and the granting of credit, a VAT exempt financial service and that no supply of goods is present between the loan defaulters and the bank at any point throughout the transaction rather, the bank only exercises a special right of repossession, KRA noted that the bank is co-registered in the vehicle titles with the loans and that KRA assessed on sale commercial vehicles.
• the primary supply in this transaction is the sale of a motor vehicle to a non-related third party by the bank, a VAT registered person. KRA added that the VAT Act does not expressly provide an exemption for this kind of supply and as such the supply is taxable as provided under the VAT Act. Consequently, KRA maintained that it was right in charging VAT on the same and hence the assessment is upheld.

In its judgement on 17/01/2025, the TAT observed that:

• Part 2 of the First Schedule Paragraph 1 (h) to the VAT Act exempts loan amount from VAT. The said paragraph does not exempt from VAT the process of recovery of credit from the debtor. Therefore, KCB’s assertion that disposal of seized goods through auction is part and parcel of the provision of credit facilities amounts to stretching the provisions of Paragraph 1 (h) to areas that the Parliament did not provide for.
• there exists no proviso under the VAT Act that exempts sales by auction in recovery of credit from VAT. It then follows that KCB being registered for VAT had a duty to remit VAT to KRA.
• sale by auction is referred to as ‘a hostile sale’ where the property of the debtor is sold by force. The creditor steps in the foot of the debtor to effect the sale for the debtor. It then follows that the creditor has to discharge all duties that debtor would have discharged and that includes paying taxes and levies on the property in issue. The creditor then ought to recover the debt and any balance remitted to the debtor. Secondly, KCB herein being the creditor and the vehicles being charged in favour of KCB, it means that KCB acquired the right to sale the vehicles to recover loan amounts. KCB became a seller within the meaning of Section 2 (1) of VAT.

As such KCB lost

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Input VAT attributable to exempt sales is not claimable