The Kenya Revenue Authority vs
Kenya Bankers Association.
COURT OF APPEAL RULING BARS THE KENYA REVENUE AUTHORITY FROM COLLECTING CGT LAND SOLD TO RECOVER DEFAULTED LOANS
In a notice published in one of the daily newspapers dated 4th October 2016, the Kenya Revenue Authority (KRA) discontinued the manual payment of both stamp duty and Capital Gains Tax (CGT) and required the simultaneous payment of the same online. As a result, in the instance where the bank is auctioning off property that was taken as security for a now defaulted loan, iTax would not accept payment of stamp duty on a transfer until CGT was also paid. The Kenya Bankers’ Association (KBA) was aggrieved by this provision as they argued that this would amount to infringement of right to property for both the chargee and purchaser of the property. In the bankers’ opinion the title to the property lies with the person who took the loan (chargor), and not the bank (chargee), in which case any gain realized from sale of the property accrues to the chargor. This being the case, CGT should be a chargor liability/ responsibility, and not a chargee responsibility. It is for this reason that KBA filed a judicial review case, challenging this provision. In a High Court ruling passed on 13th March 2018, the Court made the following declaration: the requirement to pay both CGT and stamp duty simultaneously was unfair and unreasonable; action by the KRA to require payment of CGT without ascertaining whether there was any gain on the sale of land by a chargee is unfair and unreasonable; and stamp duty should be payable following sale of land by a chargee, without requiring payment of CGT. KRA was dissatisfied with the above outcome because their position on the entity having rights over the property differed from that of KBA, and hence appealed to the Court of Appeal. In its Memorandum of Appeal, KRA stated that the High Court judge had erred by finding that: a chargee does not acquire right of property in a chargors’ property by exercising power of sale; a chargee has proprietary rights only on the charge and not the charged land; a chargee is not in a position to calculate CGT when exercising power of sale; and the Court ignored provisions of the Income Tax Act (ITA) and the Land Act requiring a chargee to pay CGT.
Appellant’s (KRA’s) Submissions 1. That the Judge failed to give consideration to the meaning of proprietor as per the Land Registration Act i.e once a charge is created in favour of a bank, the latter becomes the proprietor of the charge; 2. That the Judged erred in finding that a chargee has proprietary rights only on the charge and not the charged land; 3. That the chargor has no role to play in the exercise of power of sale by the chargee hence the Bank is supposed to pay taxes in respect of the charged property, that is CGT; 4. Valuations are carried out before the lending in order to establish the forced sale value of property hence calculating the CGT is not an impossibility for the chargee; 5. Pursuant to the Land Act, the money received by a chargee who has exercised power of sale should be applied in the payments of any rates, rents, taxes, charges or any other sum owing and required to be paid on the charged land (including CGT). Respondent’s (KBA’s) Submissions 1. The Land Act provides that the chargee is only a proprietor of the charge but the chargor remains a proprietor of the land until when the chargee exercises the power of sale; 2. CGT is a tax imposed on the income of a person and is not tax on land and hence demanding the chargee to pay CGT is unfair; 3. Under the Eighth Schedule to the ITA, it would be difficult for the banks to ascertain the taxable gain. The Judgement 1. A charge is an instrument that facilitates the transfer upon failure by a chargor to pay the sum secured by the charge; 2. Chargee does not become the proprietor of the land, but is proprietor of the charge (the instrument); 3. Placing a chargee and chargor on equal footing will blur the distinction; 4. A bank remains a chargee and not owner of the property; 5. The chargee exercising statutory power of sale does that in his capacity as a nominee and not as the owner of the property; 6. It is money received by the chargee that should be applied to pay rates, rents and taxes. It is therefore improper for the KRA to demand money that has not been received by the chargee since the sale or purchase has not been concluded; 7. CGT is chargeable on the gain accrued from the transfer of the property (Gain = Transfer Value – Adjusted Cost of Property). It is not part of the “taxes to be paid on the charged land” referred to in Section 19 of the Lands Act. 8. The decision to demand that KBA members collect CGT from its defaulting borrowers by twinning the payments of CGT and stamp duty is unfair and irregular.
Remarks This landmark ruling marks a major win for the banks as they are not required to pay CGT upon the sale of land held as security to recover bad loans. It would, therefore, be expected that the banks will credit any surplus funds from sale of property to the defaulting customer’s account, so that the customer can compute any gain realized from the sale and settle any due CGT with the KRA. Probably KRA should develop some rules or regulations that will mandate a bank that has sold a defaulting customer’s property to report such sale to KRA within a certain timeframe and also hold onto any surplus funds for a certain amount of time before releasing the same to the customer. The proposed time should ideally be adequate for KRA to reach out to the customer, ask him/ her to declare any gains, and indeed settle any CGT liability, failure to which the KRA can appoint the bank as a collecting agent for the tax, with the tax being payable from the surplus funds held by the bank. We wait to see how this will pan out. This ruling also calls for KRA to reconfigure the iTax platform so as to allow the payment of stamp duty without requiring prior payment of CGT. Whether and how this reconfiguration can only be limited to the benefit of banks who have exercised their statutory power of sale remains to be seen.
Carol Muasya is a Senior Advisor at Andersen Tax, Kenya: carol.muasya@AndersenTax.co.ke Tel: +254 20 2199064 or +254 20 5100263
Andersen Tax, Kenya is a member firm of Andersen Global. Andersen Global is an international association of legally separate, independent member firms comprised of tax and legal professionals around the world. Established in 2013 by U.S. member firm Andersen Tax LLC, Andersen Global now has nearly 5,000 professionals worldwide and a presence in over 167 locations through its member firms and collaborating firms.