The Kenyan taxation framework operates on a self-assessment basis, susceptible to manipulation, filing errors, income understatement, and expense overstatement, among other vulnerabilities. To comprehend the foundation of this system, it is essential to explore the underlying legal framework. Under the Judicature Act (CAP 8), the High Court, Court of Appeal, and subordinate courts are mandated to operate in accordance with;
- The Constitution of Kenya
- Written Laws
- Common Law
- African Customary Law
The Kenyan tax system, therefore, derives its authority from the supreme law of the land, the Constitution of Kenya, particularly;
- First, Article 209 of the constitution empowers the government of Kenya to impose taxes.
- Secondly, Article 210 confers that no tax shall be imposed as provided by the legislation.
- Thirdly, Article 94 gives the parliament the power to make provisions in the law as in the case of yearly finance act changes.
- Fourth, In the case of double tax treaties, article 2 of the constitution of Kenya confers that any treaty ratified by Kenya shall form part of the law of Kenya.
- Lastly, article 201 of the constitution asserts the principle of good public finance to prevail that is openness, accountability, equity and fairness.
The Kenya Revenue Authority (KRA) derives its authority from the Income Tax Act, with its administrative actions bound by Article 47 of the 2010 Constitution, which allows individuals to challenge infringements of fundamental rights or freedoms through court proceedings.
The High Court safeguards taxpayers’ rights through Article 23, granting it the power to uphold and enforce the bill of rights against public authorities through judicial review. This review is based on the principle that public authorities must operate within the confines of the law, adhering strictly to their statutory jurisdiction and ensuring their decisions align with legal provisions.
Given this legal backdrop, when examining a case involving firms facing a KES 1.1 billion tax demand, it is imperative to scrutinize the due process followed by the KRA. The KRA’s audit and issuance of tax assessments are governed by Sections 29 to 31 of the Tax Procedures Act (TPA), authorizing the commissioner to issue default, amended, or advance assessments. The TPA mandates taxpayers to maintain tax records in an official language.
Upon the conclusion of an audit, the KRA issues an assessment, specifying the tax amount owed based on the audit findings. The TPA allows taxpayers to object to the assessment, appealing to the Commissioner.
In this specific case of Mayfair and other firms selling transferring their shares, the Kenya Revenue Authority (KRA) is demanding over KES 1.14 billion from shareholders of three companies due to alleged underpayment of taxes related to the sale of shares.
Initially as of last year December 2022, CGT was applicable to the net gain resulting from the transfer of property in Kenya, effective January 1, 2015, at a rate of 5% of the net gain. Property encompasses land, buildings, and marketable securities, excluding listed securities. A transfer takes place upon the sale, exchange, conveyance, disposal, loss, destruction, abandonment, surrender, cancellation, forfeiture, or expiration of property rights.
As of Effective January 2023, KRA calculates capital gains as the excess of the transfer value over the adjusted property cost, subjecting the difference to a 15% tax. CGT is transaction-based and must be paid no later than the 20th day of the month following the transfer, paid by the transferor, whether an individual or corporate entity.
According to the Income Tax Act of 2022, Section 34(1)(j) imposes a 15% tax on capital gains, exempting firms certified by the Nairobi International Financial Centre Authority, provided they invest a substantial amount that is Kenya Shillings five billion in Kenya and transfer investments after a specified duration which is five years. Transfers of immovable property to a family trust are also exempt from this tax.
However, in the case of Naivas shareholders selling its stake of 31.5%, the transaction was subjected to the corporate income tax instead of Capital Gain Tax. This is because the transaction was classified as profit seeking motive instead of long-term investment. In such instance the transfer of shares as an adventure is subjected to corporate tax at the rate of 30%.
The KRA alleges that the shareholders of Mayfair and others collectively paid KES 569.9 million for share transfers, significantly below the KES 1.7 billion owed. The tax authority contends that these individuals and companies, including 37 Mayfair Bank shareholders, filed CGT returns for share transfers in December 2022 for transactions finalized in 2023, thus underreporting their tax liabilities. The government has recently increased the CGT rate from 5% to 15% as part of efforts to regulate the burgeoning property market and the surge in mergers and acquisitions.
In conclusion, the Kenyan tax system’s foundation in constitutional and legal principles is essential for maintaining transparency, accountability, and fairness in tax collection and administration. It is encouraging to see that taxpayers have avenues to challenge assessments they believe to be incorrect, as this protects their rights and ensures that tax authorities adhere to the rule of law.
However, the recent increase in the CGT rate from 5% to 15% should be considered carefully. While it may be aimed at regulating the property market and mergers and acquisitions, such a significant hike could have unintended consequences, including discouraging investment and economic activity. The government should continually assess the impact of such tax policy changes to strike a balance between revenue generation and economic growth.
Ultimately, a fair and well-regulated tax system is essential for any country’s fiscal health, and Kenya’s adherence to legal principles in its tax administration is a positive step in this direction. Nonetheless, tax policies should be carefully calibrated to encourage economic growth while ensuring that the burden is equitably shared among taxpayers.
Author: Eddie Opiyo