High Court of Kenya Shakes Up Financial Sector: Income Tax (Financial Derivatives) Regulations, 2023 Overturned

Background
ALN Kenya | Anjarwalla & Khanna, representing the Kenya Bankers Association (KBA), the leading advocacy body for Kenya’s financial sector, comprising 46 financial institutions, challenged the Regulations. Acting on behalf of KBA, we P filed a judicial review application seeking to:

• Prohibit the Kenya Revenue Authority (KRA) from enforcing the Regulations.
• Quash the Regulations on the grounds of illegality and procedural impropriety.
• Declare that the failure by the Cabinet Secretary to act in accordance with the Income Tax Act (ITA) violated the public’s (including KBA’s) constitutional rights, including the right to fair administrative action and a fair tax burden.

Key Arguments
We argued that the Regulations were fundamentally flawed, both substantively and procedurally, and that Sections 3 and 4 of the Regulations were ultra vires the ITA. The ITA only provides for the taxation of gains from financial derivatives under Section 3, with no provision for the taxation of losses. However, the Regulations sought to impose a withholding tax on resident persons based on their losses in derivative transactions, presuming that these losses corresponded to the non-resident counterparty’s gains—an assumption without legal basis in the ITA.

Furthermore, we submitted that the Regulations were:

• Illegal for imposing taxes not anchored in the parent statute.
• Unreasonable and impractical as they created an onerous and speculative tax regime.
• Unclear and uncertain, rendering them inoperable and unsuitable for business planning.

We emphasized that taxation laws, given their penal nature, must be free from ambiguity to uphold fairness and certainty.

Court’s Findings
The Court quashed the Regulations on several grounds, including:

• The ultra vires nature of the Regulations, which went beyond the powers granted under the ITA;
• The lack of clarity on how to compute non-resident gains for tax purposes, making the Regulations unreasonable and oppressive.
• The unconstitutional imposition of withholding tax on presumed gains, violating the certainty principle of the rule of law under Article 10 of the Constitution of Kenya,2010.
• The Court further held that the Cabinet Secretary’s failure to adhere to statutory and constitutional standards in formulating the Regulations breached KBA’s rights to fair administrative action under Article 47 of the Constitution.

Impact of the Decision
This Judgment reinforces the importance of clear and well-structured tax laws, especially in complex areas such as financial derivatives. By quashing the Regulations, the Court has provided significant relief to financial institutions and other parties engaging in derivative transactions, ensuring that tax laws align with business realities and legal principles. Certainty in tax laws remains critical for sound business planning and investment decisions.

Should you require more information please do not hesitate to contact Daniel Ngumy or Faith Macharia-Okaalo.

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Contributors
1. Edel Ouma – Senior Associate
2. Salma Khamala – Principal Associate
3. Daki B. Guyo – Principal Associate

The content of this alert is intended to be of general use only and should not be relied upon without seeking specific legal advice on any matter.