Is It a Good or a Service? Why VAT Classification Matters

For Kenyan VAT, whether a transaction is a supply of goods or a supply of services depends on what the supplier actually provides, not only the heading on the contract or invoice. Goods are generally tangible property; services are broadly everything other than goods or money, including rights, facilities, advantages and certain obligations to refrain or tolerate. The classification can affect place of supply, time of supply, VAT treatment, invoicing and evidence. A business should therefore classify the economic substance of each material supply before applying the VAT rate or claiming input tax.

The VAT Act starts with broad statutory definitions

The Value Added Tax Act, 2013 defines goods as tangible property, whether movable or immovable, and includes items such as electrical or thermal energy, gas and water. Money is excluded. A supply of goods can include a sale, exchange or transfer of the right to dispose of goods as owner. The practical inquiry is often whether the recipient obtains the relevant power over a tangible item, rather than whether the item was physically handed over at a particular moment.

A service is defined residually: anything that is not goods or money. The definition is deliberately wide. It can include performing work for another person; granting, assigning or surrendering a right; making a facility or advantage available; agreeing to refrain from an act; or tolerating a situation. A supply does not become a supply of goods simply because a service provider uses equipment, produces a report, gives access to a platform or delivers something tangible at the end of the engagement.

The statutory definitions are a starting point, not an answer to every commercial arrangement. The business must identify the supply for which the customer pays and the legal relationship created. That may require reading the full contract, statement of work, order form, delivery terms, acceptance criteria, invoice description and the parties’ actual conduct together. The title “sale,” “licence,” “management fee,” “subscription” or “reimbursement” is useful evidence, but it is not decisive.

Classify the supply from the customer’s perspective

A practical way to begin is to ask what the customer receives for the consideration. Where the customer acquires a tangible item and the right to dispose of it as owner, the supply will usually be goods. Where the customer receives expertise, use, access, a right, a facility or an ongoing performance obligation, the supply will usually be services. The answer should be grounded in the agreed deliverables and the commercial reality, not in a preferred VAT outcome.

For example, a manufacturer selling finished stock normally supplies goods. A consultant preparing a report normally supplies services, even if the report is delivered in printed form. A cloud-software arrangement may involve access to functionality and data-processing capability rather than a transfer of a tangible product. A licence to use intellectual property, a franchise right or a right to occupy advertising space requires analysis of the right or facility made available. Physical media, devices or promotional materials supplied alongside the main arrangement may be ancillary or may constitute separate goods, depending on the facts.

Construction and installation arrangements require particular care. A contract may involve materials, equipment, design, labour, project management and an interest in land. The correct VAT analysis cannot safely be inferred from the fact that materials are visible on site. Identify whether the supplier has agreed principally to transfer goods, carry out work, create an agreed outcome, grant a right or deliver a combination of distinct supplies. The contract allocation, ownership provisions, risk transfer and acceptance process can all be relevant.

The same principle applies to agency. An agent may arrange a supply on behalf of a disclosed principal and supply only its own agency service. A person who contracts in its own name and controls the customer relationship may instead be making the underlying supply. Commission statements, customer invoices, contractual authority and the flow of money must be reconciled before deciding what each party supplies for VAT purposes.

Mixed supplies require a disciplined analysis

Many transactions contain both goods and services. A sale of equipment may include installation, training and maintenance. A hospitality package may include accommodation, meals, access to facilities and transport. A technology arrangement may combine hardware, licence rights, implementation and support. Calling the whole package “a service” or “a sale” may be convenient, but it can obscure supplies with different tax consequences.

First consider whether there is one composite supply with a dominant element, or several distinct supplies for separate consideration. Indicators include whether the elements can reasonably be supplied and purchased independently, whether the contract prices them separately, whether a customer could decline one element, how the parties market the arrangement and whether one element is merely incidental to the effective use of another. There is no universal formula; the analysis must explain why the proposed treatment follows from the actual bargain.

Where supplies are distinct, account for each one using the relevant VAT rules. Where an element is genuinely ancillary, do not artificially split it merely to obtain a preferred result. The business should document the decision in a short tax memorandum, particularly for a recurring product, a material tender or a cross-border contract. That memo should identify the goods and services definitions, the contractual facts, the commercial objective and any consequences for rate, place, time, input tax or invoicing.

Bundles also raise valuation and record issues. Invoice descriptions should be accurate enough to show what has been supplied. A generic description such as “professional package” may be unhelpful where the tax position depends on separately identifiable goods, rights or services. Part 21 addresses invoice and credit-note compliance; the classification work should precede the invoice design, not be reconstructed from it after an audit begins.

Why classification changes the VAT analysis

Classification is rarely an isolated exercise. The VAT Act has separate rules for the place and time of supply of goods and services. A cross-border service may require analysis of where it is supplied or consumed, whereas imported goods engage customs processes. Imported services can raise reverse-charge questions for the recipient. Parts 17 and 18 address those issues; this article establishes the first step of identifying the supply.

Classification may also affect whether a supply appears in a schedule, whether a particular exemption or zero rating is available and whether input tax is recoverable. The relevant schedules and Finance Act amendments must be checked as at the transaction date. A business should not assume that a product’s physical form, or the language of a procurement document, decides a special VAT treatment. The statutory item, conditions and period in force must be matched to the actual supply.

The evidential consequence is equally important. A taxpayer asserting a particular VAT treatment should be able to show the contract, specifications, customer acceptance, delivery or performance record, invoices, payment trail and accounting treatment. In Highway Furniture Mart Ltd v Commissioner of Value Added Tax & another [2015] eKLR, the Court of Appeal underlined the importance of establishing whether the taxpayer was actually making taxable goods or services in the period at issue. General business descriptions and annual accounts did not, by themselves, establish the necessary VAT facts.

A classification file prevents repeat disputes

Finance and commercial teams should build a supply map for the business. For each revenue stream, record the contract name, customer, deliverables, tangible items, rights or facilities, VAT classification, tax treatment, place and time considerations, invoice language and supporting documents. Update the map when products, terms or delivery models change. This is especially useful where sales staff use simplified terminology that does not capture the legal or tax structure.

For a material or uncertain arrangement, test the proposed classification before signing. Ask what the customer obtains, whether title or a right to dispose of goods passes, whether any right is granted, whether the elements are distinct, and how consideration is allocated. Then confirm the position against the current VAT Act and schedules. If the result turns on a novel technical or sector-specific feature, obtain advice or consider the available ruling process rather than relying on an old classification of a superficially similar transaction.

• Read the whole contract and identify what the customer receives for the price.
• Distinguish tangible goods from rights, access, facilities and performance obligations.
• Analyse mixed arrangements as composite or distinct supplies on their actual facts.
• Match the classification to place, time, rate and invoice consequences.
• Keep contracts, specifications, delivery records and payment evidence together.
• Review the classification when a product, delivery model or contract changes.

A good-or-service decision is therefore a factual and statutory exercise, not an invoice-label choice. The right classification provides the foundation for every later VAT question: where a supply is made, when tax is due, which treatment applies and what evidence is needed. Businesses that make that decision early and document it clearly are far better placed to price accurately and defend the position if KRA asks questions later.

Official source: Value Added Tax Act, 2013 — section 2 definitions of goods and services.