High Court judge George Odunga found that a bank’s interest in any property used as a collateral is only to the extent of the sum due to it, and that the lenders are not in a position to ascertain if there were gains made after the sale or not.
Capital gains tax was re-introduced in 2015 after more than a decade-long freeze, when it was suspended to allow the property market to grow.
Justice Odunga ultimately declared that the burden of paying the tax be placed on the charger and not the purchaser or chargee of the property (the bank).
The Kenya Revenue Authority’s (KRA) race to meet the set revenue targets has suffered yet another blow after the High Court quashed regulations requiring commercial banks to pay capital gains tax on all land sold to recover bad loans.
High Court judge George Odunga found that a bank’s interest in any property used as a collateral is only to the extent of the sum due to it, and that the lenders are not in a position to ascertain if there were gains made after the sale or not.
Banks, through the Kenya Bankers Association (KBA), had asked the High Court to place the responsibility of paying capital gains tax on loan defaulters upon auction of their property.
Capital gains tax was re-introduced in 2015 after more than a decade-long freeze, when it was suspended to allow the property market to grow.
“In this case, implementation of the impugned administrative decision amounts to imposition of tax upon the applicant’s members in situations where they may well not be obliged to pay the same,” said the court.
Justice Odunga ultimately declared that the burden of paying the tax be placed on the charger and not the purchaser or chargee of the property (the bank).
“A declaration that on the sale of land by a charge pursuant to a chargee’s statutory power of sale, capital gains tax is payable upon registration of the transfer by the charger of the land…and not by the chargee or purchaser, unless there is a surplus from the proceeds of sale as to constitute the charge a trustee for the charger,” he said.
The finding amounts to a huge blow to the KRA, which has been struggling to meet revenue targets in the wake of the economic slow-down caused by severe drought and prolonged electioneering in the past 12 months.
The judgment comes a few days after the High Court declared the planned levying of excise duty on bottled water, juices, soda, other non-alcoholic beverages and cosmetics unconstitutional, offering consumers relief from an impending price increment.
Justice Odunga agreed with KBA that for the capital gains to accrue, the cost incurred by the owner to acquire, develop the land and preserve it has to be established, a task it said is not within its purview but that of the borrower.
The judge allowed the KRA to demand capital gains from any surplus amounts after the bank has recovered its money from the sale proceeds – a decision that is likely to create a logistical nightmare for the taxman who has to pursue the borrower and ascertain how much they had spent on the property, to know if indeed there are capital gains.
Banks and the KRA have not indicated the total tax bill arising from the capital gains tax requirement, but this is estimated to run into hundreds of millions of shillings based on the many land auctions on defaulted loans.
The KRA’s total collection from capital gains tax peaked at Sh3.8 billion in 2015 after re-introduction, before dropping to Sh3 billion in 2016, according to the Kenya National Bureau of Statistics.
Justice Odunga further agreed with KBA that the decision to order for simultaneous payment of capital gains tax and stamp duty after scrapping manual remittance of the two levies was misguided since the capital gains can only be calculated after the sale of the property while stamp duty is required to effect the transfer.
This means the taxman must now allow payment of stamp duty upon request for transfer without demanding payment of capital gains tax beforehand.
The KRA had put up spirited defence in the case, insisting that the banks should pay capital gains tax on the properties disposed of in case of loans default as directing otherwise will lead to huge revenue loss.
The taxman further held that the borrower is not involved in the sale and transfer of the land and therefore it’s illogical to ask such an individual to pay capital gains tax.
The KRA said that at the point of forced sale, the bank becomes the proprietor since it is the one that authorises the sale and transfer.
It further argued that the banks do valuation before accepting the collateral and are therefore the custodians of information that can determine the capital gains.
It further told the court that the land sale is income for the banks and not the affected borrower.
Justice Odunga while agreeing that it is unreasonable to ask the borrower whose property has been auctioned to pay capital gains tax observed that it is equally unreasonable to pay the tax before the sale, noting that the bank becomes a trustee only when there is a surplus of the sale.
“Therefore a chargee’s interest in a charged property is only to the extent of the sum due under a charge and not in the property. Therefore he does not acquire any proprietary right in the property as such,” observed the judge.
