The High Court has quashed regulations that came into force last year, requiring banks and other institutions such as airlines to remit a 15 percent withholding tax on trading gains made by foreign entities.
The Income Tax (Financial Derivatives) Regulations, 2023 were introduced by Finance Act, 2022, and came into force in January last year, requiring foreign investors who gain from hedges made by local entities such as banks and airlines to pay 15 percent of the gain.
High Court judge John Chigiti agreed with Kenya Bankers Association (KBA) that the regulations are illegal, unreasonable, impracticable, and unclear and also create uncertainty.
He said rules require a resident person to assume that their loss on a derivative transaction equates to the gain of the non-resident person, and against such presumed outcome, to withhold tax on a payment.
“The regulations do not provide at all on how gains will be computed for non-residents. It is practically impossible for a resident person to calculate the gains of a non-resident person,” said the judge. They require Kenyan entities engaging in transactions with foreigners to cushion them from volatility in financial markets, to account for any profit made by foreign parties, and to remit the tax to the Kenya Revenue Authority (KRA).
Justice Chigiti said in the absence of a deeming provision under Section 10 of the ITA, the entire premise of the Regulations fails as the “gains from financial derivatives,” of a non-resident person cannot be deemed to be income that accrued in or was derived from Kenya, for tax purposes.
“An order of prohibition is hereby issued directed at the Kenya Revenue Authority (KBA) either by itself, its agents, or employees restraining it from taking any steps, actions, or measures to impose or collect any taxes from the members of the ex-parte applicant engaged in transactions involving financial derivatives and/or enforcement or implementation of the Income Tax (Financial Derivatives) Regulations, 2023,” said the judge.
Banks engage in long-term foreign currency-denominated borrowing that requires them to hedge against interest and exchange rate risk, while entities such as Kenya Airways engage in hedging to cushion themselves against volatility in the price of fuel.
The law requires that when a non-resident entity in a transaction makes a gain, the Kenyan entity is required to account for the gain and remit tax at 15 percent withholding tax.
The KBA submitted that the Regulations are inaccurate as they assume that one party’s gain is equal to another party’s loss and there was no basis or methodology to determine the realised gains of the non-resident person.
KRA opposed the petition arguing that the Regulations are to aid in the collection of taxes and the application was prejudicial and to the detriment of the government, having included the collections into its fiscal budget for the current and the next financial year.
The taxman added that the amount of taxes to be collected runs into the hundreds of millions, and is used to finance the government’s projects.