The refund of VAT on bad debts is governed by Section 31 of the VAT Act, 2013. This section allows businesses to claim a refund of output VAT paid on supplies where payment has not been received. A registered person who has accounted for and paid VAT on a supply but has not received payment from the buyer can apply for a refund after three years from the date of supply, or if the recipient has been placed under statutory management (e.g., liquidation, administration, or receivership).

Certain conditions apply to VAT refund claims on bad debts, including specific timelines and obligations for both taxpayers and the Kenya Revenue Authority (KRA). These include:

• Refund applications must be submitted within 10 years from the date of supply.
• The refund process is governed by Section 47 (5) of the Tax Procedures Act, 2015, which requires the Commissioner to process refunds within two years of the application. If this deadline is missed, the outstanding refund amount will accrue interest at 1% per month (or part thereof) after the two-year period.
• Refunds may be credited to the taxpayer’s VAT account for offsetting future liabilities.
• If the debt is later recovered from the buyer, the business must repay the refunded amount to KRA within 60 days.
• Interest at 2% per month (or part thereof) will be charged, with a cap of 100% of the refunded VAT amount.

These provisions are designed to cushion businesses from being unduly burdened by VAT on unpaid debts, while offering a clear mechanism for recovery and compliance. They help mitigate the cash flow impact of unpaid debts, particularly for businesses with high transaction volumes or long credit periods. However, businesses must maintain accurate records and adhere to KRA procedures to successfully claim a VAT refund on bad debts.

Case Law

Hotpoint Appliances Limited v Commissioner of Domestic Taxes (Tax Appeal 1526 of 2022) [2024] KETAT 487 (KLR) (19 April 2024) (Judgment)

Background

Hotpoint Appliances Limited (“Hotpoint”) applied for a VAT refund of KShs. 61.8 million in March 2019 for the periods January 2016 to July 2017, relating to output VAT paid for supplies made to Nakumatt Holdings Limited (“Nakumatt”). KRA partially approved the claim of KShs. 6.9 million and rejected a claim of KShs. 54.8 million. The respondent stated that the refund application was partially rejected because it was filed before the 3-year period had elapsed from the date the goods were supplied.

Appellant’s Case

• The appellant maintained that their refund claim was based on Nakumatt’s insolvency, not the 3-year rule. Section 31 of the VAT Act, 2013, allows for a refund application either within 3 years from the supply date or if the recipient is legally insolvent. Nakumatt was placed under administration in January 2018, meeting the insolvency condition under Section 31 (1) (b).
• They also contended that they submitted their refund application in March 2019, but partial approval and rejection were issued in November 2022, more than 3 years later. This delay violated Section 4 (1) of the Fair Administrative Action Act, 2015, which guarantees the right to expeditious, efficient, lawful, reasonable, and procedurally fair administrative action. The appellant argued that the Respondent’s unreasonable delay denied them the opportunity to reapply for the refund.

Respondent’s Case

The respondent agreed that Section 31 (1) of the VAT Act allows a refund claim to be lodged either on the 3-year rule or on the grounds of insolvency. However, they contended that the supplier did not meet the insolvency criteria since Nakumatt had not been legally declared insolvent by the court, and the debts owed were still under litigation.

Issues for Determination

• Whether there was a misinterpretation of Section 31 (1) of the VAT Act, 2013.
• Whether Nakumatt was legally insolvent at the time of the appellant’s application for a refund.
• Whether the respondent erred in disallowing the appellant’s claim for bad debts against the supplies to Nakumatt.

Court’s Determination and Verdict

The court found that the conditions for insolvency under Section 31 (1) of the VAT Act were met and it ruled that the fact that Nakumatt was legally declared insolvent was sufficient to qualify Hotpoint for a VAT refund. The court also determined that KRA had used extraneous reasons to reject the refund application.

Legal Principle

The legal principle in this case centers on the interpretation of Section 31 (1) of the VAT Act, 2013. The ruling establishes that businesses can claim VAT refunds on bad debts based on insolvency, even before formal insolvency procedures are complete, as long as the recipient has been declared insolvent. Additionally, the court reinforced the importance of timely administrative actions and the need for fairness in processing VAT refund claims.

Implications of the Ruling

The court’s ruling has several important implications for VAT refund claims on bad debts and administrative processes in Kenya:

• The ruling confirms that businesses can apply for VAT refunds either after three years or if the recipient is legally declared insolvent, offering greater flexibility to taxpayers.
• Businesses can claim a VAT refund on bad debts if the recipient is declared insolvent, even if formal insolvency proceedings like liquidation are not complete, provided an administrator has been appointed.
• The delay in processing Hotpoint’s refund violated the Fair Administrative Action Act, 2015, establishing the need for administrative bodies to follow reasonable timelines.
• KRA must process VAT refund claims based on legal grounds, ensuring transparency and consistency in tax administration.
• The decision empowers taxpayers to challenge delays in administrative actions, potentially improving dispute resolution and promoting greater trust in the fairness and timeliness of the tax system.

This ruling highlights the need for clear guidelines and prompt processing of VAT refund claims, particularly when dealing with insolvent debtors. Emphasizing fairness and timeliness strengthens the tax administration system and ensures that businesses are not unduly burdened by unpaid VAT on bad debts.

This material is intended solely for informational purposes and should not be relied upon as professional advice. We recommend consulting a qualified professional before making decisions based on the information presented here.

By

Irene Masecko,

Tax Associate, Andersen, Kenya

irene.masecko@ke.andersen.com