KB Case: Specified Sources Of Income Cannot Be Mixed For Income Tax

Case Study: KB Cottages Nairobi Limited v Commissioner of Domestic Taxes (Tax Appeal E1072 of 2024) [2025] KETAT 232 (KLR) (16 May 2025) (Judgment)

Background

KB Cottages Nairobi Limited (KB) is a private limited company in Kenya primarily engaged in the hotel and accommodation business. The Commissioner of Domestic Taxes (KRA) conducted a compliance check for the period 2020-2022, asserting that KB had under-declared income and over-claimed expenses. This led to an income tax assessment against KB. It objected to this assessment, but KRA confirmed its decision. Dissatisfied, KB filed an appeal with the Tax Appeal Tribunal.)

KB argued that:

• It operates a single hospitality business (hotel and accommodation with a restaurant) and does not have two separate sources of income (rental and hotel business) as contended by KRA.
• KRA misapprehended the nature of its business and erred by arbitrarily allocating expenses as if there were two distinct income streams.
• KRA used a speculative approach in treating expenses under Sections 15 and 16 of the ITA, unreasonably charging tax despite KB providing a working formula.
• KRA failed to provide reasons for identifying allowable expenses and concluded that KB lacked an expense breakdown, even though it operated a single business.
• KRA erred by pro-rating income instead of verifying actual monthly income.
• KRA failed to reckon that not all bank statement credits were sales (e.g., bounced cheques, loans, pre-paid accommodation, intercompany transfers).
• For the year 2020, KB asserted its income was solely from the restaurant as cottages were under renovation, and while reported as “Rental income,” it was never intended to be rented out as a separate property.
• For 2021, KB disagreed with KRA’s income ratio allocation of expenses, stating that its own income ratio in disallowed expenses showed no tax liability.
• For 2022, KB argued that its operations resulted in a loss that KRA completely disregarded and did not challenge.

KRA contended that:

• KB had separate sources of income (rental and hotel & accommodation business) and was therefore obligated to prepare separate accounts for each, as per Section 15(7)(a) of the ITA.
• Since KB failed to separate these income sources, KRA disallowed expenses related to the hotel business when computing rental income.
• During the objection review, KRA requested specific documents (e.g., sale agreement, leases) to support KB’s assertion of a single business model, but these “critical documents” were not provided.
• KRA relied on Section 56(1) of the Tax Procedures Act (TPA), which places the burden of proof on the taxpayer, arguing KB failed to discharge this burden.
• KRA ascertained the rental income using its best judgment due to the lack of lease agreements.

Tribunal’s Analysis and Findings

1. On whether payment from the Restaurant was rental income: The Tribunal reviewed KB’s trial balance and financial statements for 2020-2022, noting that KB itself identified the consideration from the third-party restaurant operator as rental income. KB’s witness, during cross-examination, also admitted that the consideration was rental income. The Tribunal concluded that the payment made by the restaurant for the occupancy of part of the property was indeed rental income.
2. On whether KRA erred in applying Section 15(7) of the ITA: Section 15(7) of the ITA explicitly states that gains or profits from “specified sources” (which include “rights granted to other persons for the use or occupation of immovable property” i.e., rental income) shall be computed separately from other income. The Tribunal, having established that KB generated rental income, found that KB was legally required to account for this rental income separately from its other business income. Therefore, the Tribunal concluded that KRA did not err in its application of Section 15(7) of the ITA.

Final Decision and Orders

• The Corporate Income Tax assessment is upheld.

https://hisibati-consulting.co.ke/blog/

https://www.linkedin.com/pulse/specified-sources-income-cannot-mixed-tax-purposes-mwangi-gq1wf/?trackingId=IinRfCrUSJO7aPgV1D74HA%3D%3D