Executive summary

On 11 October 2024, the High Court in Kenya (the Court) issued a decision in favor of the Kenya Bankers Association (Appellant) in a case that challenged the implementation of the Income Tax (Financial Derivatives) Regulations, 2023 (the Regulations).

The Appellant is an umbrella body of institutions that are licensed and regulated by the Central Bank of Kenya.

The judgment declared the Regulations unconstitutional and thus quashed by the Court. The implication of this judgment is that gains from financial derivatives derived by a nonresident person is not subject to income tax in Kenya.

Detailed discussion

The Regulations were introduced through Legal Notice No. 4 of 2023 and published in the Kenya Gazette Supplement No. 6 of 2023 on 27 January 2023.

The Regulations aimed to provide guidance on the determination of the tax base for imposing a 15% withholding tax on gains from financial derivatives earned by nonresident persons.

The Appellant raised various grounds, including an assertion that the Regulations were fatally defective and mired with procedural impropriety because the National Treasury did not prepare a regulatory impact statement prior to making the Regulations contrary to the provisions of Section 6 of the Statutory Instruments Act, 2013 (SIA).

Additionally, the Appellant asserted that the Regulations were ultra vires to (i.e., beyond the scope of) the Income Tax Act (ITA) as they sought to tax presumed gains of nonresident persons based on the losses suffered by resident persons. This approach was deemed impractical, unreasonable and oppressive, as it placed an unfair and uncertain tax burden on resident persons.

The Respondent, on the other hand, argued that the Finance Act, 2022 introduced a 15% withholding tax on gains from financial derivatives earned by nonresident persons. The Regulations were drafted pursuant to Section 9(4) of the ITA to facilitate the implementation of this provision.

Additionally, the Respondent contended that the Regulations had been subject to public participation in compliance with the Constitution and the SIA, and a regulatory impact statement was not required under Section 9 of the SIA because the Regulations were in line with the provisions of the ITA and were consistent with announced government policy.

High Court determination

The Court, after considering the arguments laid out by both parties, found that there was adequate public participation in the formulation of the Regulations, as required by the Constitution and the SIA. Additionally, the Court held that there was no requirement to prepare a regulatory impact statement because the proposed statutory instrument was a matter arising in the prevailing legislation.

However, the Court determined that the Regulations were ultra vires to the ITA. Specifically, the Court noted that the Regulations attempted to impose a withholding tax obligation on resident persons based on losses suffered in transactions with nonresident persons, which had no basis in the ITA. The ITA framework only allows for taxation on gains, not losses; thus, the Regulations could not be implemented because they required residents to assume their losses equated to nonresidents' gains without a clear method for calculating such gains, the Court reasoned.