Sale of salvage motor vehicles by insurance companies is exempt from Value Added Tax (VAT), the High Court in Nairobi has declared, handing insurers a major victory against the taxman.
The court dismissed the Kenya Revenue Authority’s (KRA) appeal, upholding a Tax Appeals Tribunal decision that earlier ruled in favour of ICEA Lion General Insurance Company.
The judgement has also prevented the increase in the the cost of salvaged cars by 16 percent.
Citing The First Schedule of the VAT Act on exemption for ‘insurance and reinsurance services”, the court explained that sale of salvage vehicles is aimed at mitigating the loss incurred from paying the claim and cannot be deemed as income.
Salvaged cars are vehicles declared total loss due to accidents or vandalism and whose repair costs exceed or a near their market value.
They can be repaired or dismantled for parts.
“When an insured’s motor vehicle is written off and the insurer pays the agreed value, the insurer acquires a right to the salvage. This is not a commercial purchase. No separate consideration is paid for th”Sale of the motor vehicles salvages is part of insurance compensation,” the tribunal ruled.
In the appeal, the KRA’s Commissioner of Domestic Taxes argued that the tribunal failed to appreciate that the VAT Act 2013 does not list the sale of motor vehicle salvages as an exempt or zero-rated supply.
“The tribunal erred in law and in fact in failing to appreciate that the proceeds collected from the sale of motor vehicle salvages is to be treated as income and not compensation,” argued the Commissioner.
Another argument was that it was wrong for the tribunal to conclude that disposal of salvages is part of insurance industry business and does not attract any VAT liability.
However, the High Court’s decision to dismiss the appeal was hinged on three critical legal principles, including the insurance indemnity and subrogation doctrine.
The court affirmed that when an insurer compensates a policyholder for a total loss vehicle, it acquires salvage rights under the principle of subrogation, where the insurer steps into the shoes of the insured.
“The disposal of salvage is not a commercial sale but a recovery mechanism to mitigate losses,” the court ruled. “The transaction is one of recoupment, not of trade,” it added.
The court declined KRA’s argument that salvage sales were distinct taxable transactions. The court adopted European VAT jurisprudence to hold that salvage disposal is incidental to insurance services and cannot be artificially separated for taxation.
“The European Union VAT jurisprudence, which heavily influences Kenyan VAT structure, dictates that where two or more elements supplied to the customer are so closely linked that they form, objectively, a single indivisible economic supply, they must not be artificially separated,” said the court.
Further, the court embraced the principle of harmonious interpretation of tax laws.
The judge rejected KRA’s strict reading of the VAT Act, instead interpreting it alongside the Insurance Act, which defines insurance business broadly to include “any business incidental to insurance.”
“To read the VAT Act in isolation would ignore legislative intent,” the court stated, emphasising that tax exemptions should be resolved in favour of taxpayers where ambiguity exists.
The ruling provides much-needed clarity for insurers, who routinely sell salvaged vehicles recovered from claims.
Had KRA succeeded, insurers would have faced additional VAT burdens, potentially increasing premiums for policyholders.e wreck. The acquisition of the salvage is a legal consequence of the contract of indemnity,” affirmed the court in a judgment that sets a precedent that may influence similar disputes involving financial services and VAT exemptions.
The case stemmed from a Sh88.8 million VAT assessment imposed by the KRA on ICEA Lion for the sale of salvage motor vehicles between 2015 and 2018.
KRA had initially demanded Sh122.1 million in corporation tax and Sh88.8 million in VAT from ICEA Lion following an audit.
While the corporation tax dispute was settled through alternative dispute resolution, the VAT issue remained unresolved, leading to litigation.
The Tax Appeals Tribunal ruled in May 2023 that salvage disposal was an integral part of insurance services, which are VAT-exempt, prompting KRA to challenge the decision in the High Court.
The tribunal found that income from sale of salvaged vehicles is part of VAT exemption for insurance services.