Treatment of Customer Deposits for Income Tax Purposes in the Property Development /Real Estate Sector

Case Study:Longonot Gate Development Limited v KRA

LGDL is a property developer.

On 21/08/2014 KRA assessed LGDL KES 185.52m in Income tax.

The dispute went all the way to the TAT

The issues of determination were:

• Whether deposits received by LGDL towards purchase of properties do count as revenue
• Whether expenses related to the above could be transferred to  Statement of Income and Expenditure from the Statement of Financial Position

LGDL argued that during the year 2011, upon signing of the Letters of Offer it received deposits by intending purchasers, amounting to Kshs.597,826,615/= and accounted for these payments in its Statement of Financial Position. At the same time, it accounted for the related development costs incurred together with the cost of land in its Statement of Financial Position under the account description "work in progress"

LGDL averred that the deposits received do not count as revenue since as per the agreement contained in the Letters of Offer between itself and the intending purchasers the deposits are refundable and so there is no sale as the transaction is incomplete.

LGDL also averred that the Cost of land and other cost related to these plots should not be transferred to the revenue statement since they relate to unfinished works of the project and cannot be deducted against the deposits received

LGDL argued that Internal Accounting Standards (IAS 18.14) provide guidelines for the recognition of income in such circumstances. These conditions are:

•  The seller has transferred to the buyer the significant risks and rewards of ownership.
•    The seller retains neither managerial involvement nor control over the goods sold,
•    The amount of revenue can be measured with reasonable accuracy,
•    It is probable that the economic benefits associated with the transaction will flow to the seller.
• The cost incurred in respect of the transaction can be measured reliably

LGDL averred that since the above stated conditions have not been fulfilled the sale of plots is incomplete and that the deposits collected cannot be transferred into income.

Similarly, the related infrastructural development cost and cost of land should not be transferred to the Statement of income since it is not in line with the matching concept

KRA argued that although LGDL claimed deposits are not chargeable to income, KRA  actually charged tax on gain i.e. deposit income less pro rata expenses.

KRA also argued that Section 3 of ITA allows the Commissioner to charge tax on an estimated basis where the tax payer has not provided requisite data

LGDL stated that it was wrong for KRA to create its own tax law and to use it to charge tax on the LGDL 

In its ruling on 06/12/2016, TAT observed that:

• Although the deposits for the plots have been received the developer is not in a position to deliver the plot to the buyer and therefore the deposit acts as basis for a promise for future delivery of the product. Since developer has not delivered anything at the time of receiving the deposit, the transaction is not yet complete and the developer has not yet earned the value in the deposit.
•  Though KRA is not bound by IFRS, IAS18. etc. these are international best practices and in Financial Accounting and Reporting Standards, Kenya is a signatory. Although there might be no legal provision to bar KRA from ignoring these standards and practices.
•  KRA cannot also be allowed to interpret the law in its own favor at will and to come with its own computations in order to boost revenue collection to the detriment of the tax payer.

The Tribunal Final Orders Were:

• Gains on deposits received by LGDL as part payment towards purchase of serviced plots do not count as revenue for the year of income and therefore are not taxable under income tax law for that year of income.
• Consequently the expenses related to the above deposits could not be transferred to the statement of income and expenditure from the Statement of Financial Position.

As such LGDL won the case

This implies that though there is no specific method of charging income tax on property developers, the provisions of the International Financial Reporting standards are persuasive enough.