Capital Gains Tax in Transactions entered into pursuant to the Chargee’s Statutory Power of Sale not Payable before Completion of Sale of the Charged Property

By an administrative action announced in a notice published in the Daily Nation newspaper on October 4, 2016 the Respondent discontinued the manual payment of both stamp duty and Capital Gains Tax (CGT) and required the simultaneous online payment of both stamp duty and CGT. It is alleged that the effect of the announcement was that stamp duty had to be paid through the Respondent’s I-tax system simultaneously with the CGT. It was also alleged that the I-tax system did not permit the payment of stamp duty on a transfer unless an acknowledgment number for the payment of CGT on that sale was entered into the I-tax system. Aggrieved by the Respondent’s administrative action the Applicant filed the instant Application.

Kenya Bankers Association v Kenya Revenue Authority [2018] eKLR
Miscellaneous Civil Case No. 510 of 2017
High Court at Nairobi
G. V. Odunga, J
March 13, 2018.
Reported by Kakai Toili
Download the Decision

Tax Law – taxes – types of taxes - capital gains tax - obligation to pay capital gains tax – chargee’s obligation to pay capital gains tax - in respect of all transactions entered into pursuant to the chargee’s exercise of its statutory power of sale – where the sale had not been completed - whether it was proper for a chargee to pay capital gains tax in respect of all transactions entered into pursuant to the chargee’s exercise of its statutory power of sale before such a sale could be completed – Constitution of Kenya, 2010, articles 47 (1), 209 & 210; Income Tax Act, section 3

Land Law-- charges – chargee – chargee’s statutory power of sale – powers of a chargee exercising statutory power of sale – powers of the chargor - whether a chargee exercising statutory power of sale possessed the absolute powers of the chargor – Income Tax Act, eighth schedule, paragraph 5(2) 
Land Law-- charges – charged property - chargee’s interest in charged property - what was the extent of a chargee’s interest in charged property - Land Registration Act, 2012 sections 2 & 56; Land Act, 2012 section 2, 98 (3) & (4) 
Tax Law – taxes – obligation to pay taxes - what were the conditions for an obligation to pay tax to accrue – Income Tax Act, section 15 (3) (f), eigth schedule, paragraph 4 (1) & 8
Land Law- charges – chargee – chargee’s statutory power of sale – powers of a chargee exercising statutory power of sale – trustee for a chargor - whether a chargee was a trustee for a chargor in the exercise of the chargee’s statutory power of sale – Land Act, 2012, section 97 (1)
Judicial Review – judicial review applications – parties – applicant – State - what was the rationale for having the State at the applicant in judicial review applications

Words and Phrases – nominee – definition of nominee – a person designated to act in place of another, usually in a very limited way; a person who holds bare title for the benefit of others or who receives and distributes funds for the benefit of others - Black’s Law Dictionary, 9th Edition at page 1149
 

Brief Facts:

By an administrative action announced in a notice published in the Daily Nation newspaper on October 4, 2016 the Respondent discontinued the manual payment of both stamp duty and Capital Gains Tax (CGT) and required the simultaneous online payment of both stamp duty and CGT. It is alleged that the effect of the announcement was that stamp duty had to be paid through the Respondent’s I-tax system simultaneously with the CGT. It was also alleged that the I-tax system did not permit the payment of stamp duty on a transfer unless an acknowledgment number for the payment of CGT on that sale was entered into the I-tax system.
Aggrieved by the Respondent’s administrative action the Applicant filed the instant Application.

 

Issues:

  1. Whether it was proper for a chargee to pay capital gains tax in respect of all transactions entered into pursuant to the chargee’s exercise of its statutory power of sale before such a sale could be completed.
  2. Whether a chargee exercising statutory power of sale possessed the absolute powers of the chargor as the proprietor of the charged property.
  3. What was the extent of a chargee’s interest in charged property?
  4. What were the conditions for an obligation to pay tax to accrue?
  5. Whether a chargee was a trustee for a chargor in the exercise of the chargee’s statutory power of sale.
  6. What was the rationale for having the State at the applicant in judicial review applications.

Relevant Provisions of the Law:
Constitution of Kenya, 2010
Article 47 – Fair administrative action.

(1) Every person has the right to administrative action that is expeditious, efficient, lawful, reasonable and procedurally fair.
(2) If a right or fundamental freedom of a person has been or is likely to be adversely affected by administrative action, the person has the right to be given written reasons for the action.
(3) …
 

Income Tax Act, Cap 470 Laws of Kenya
Section 3 – Charge of tax

(1) Subject to , and in accordance with, this Act, a tax to be known as income tax shall be charged for each year of income upon all the income of a person, whether resident or non-resident, which accrued in or was derived from Kenya. 
(2) Subject to this Act, income upon which tax is chargeable under this Act is income in respect of - 

(a) gains or profits from - 
 

(i) a business, for whatever period of time carried on; 
(ii) employment or services rendered 
(iii) a right granted to another person for use or occupation of property; 
 

(b) dividends or interest; 
(c)
 

(i) a pension, charge or annuity; and 
(ii) any withdrawal from, or payments out of, a registered pension fund, or a registered provident fund or a registered individual retirement fund; and 
(iii) any withdrawals from registered home ownership savings plan. 
 

(d) (Deleted by 14 of 1982, s.17); 
(e) an amount deemed to be the income of a person under this Act or by rules made under this Act; 
(f) gains accruing in the circumstances prescribed in, and computed in accordance with, the Eighth Schedule. 
 

(3) For the purposes of this Section -

(a) "person" does not include a partnership; and 
(b) a bonus or interest paid by a designated co-operative society, as defined under section 19A, shall be deemed to be a dividend.
 

Section 15 – Certain income exempt from tax.

(3) A notice under subsection (2) shall be laid before the National Assembly without unreasonable delay, and if a resolution is passed by the assembly within twenty days on which it next sits after the notice is so laid that the notice be annulled, it shall thenceforth be void, but without prejudice to the validity of anything previously done thereunder, or to the issuing of a new notice.
 

Eighth Schedule paragraph
Section 4 – Computation of gains. 

(1) The gain which accrues to a person on the transfer of property is the amount by which the transfer value of the property exceeds the adjusted cost of the property.
 

Section 5 - Dealings by nominees, trustees and liquidators, and for the enforcement of securities

(2) Where a person entitled to property by way of security or to the benefit of a charge or encumbrance on property, deals with the property for the purpose of enforcing or giving effect to the security, charge or encumbrance, his dealings with it shall be treated as if they were done through him as nominee by the person entitled to the property subject to the security, charge or encumbrance, and this subparagraph shall apply to the dealings of a person appointed to enforce or give effect to the security, charge or encumbrance as receiver and manager as it applies to the dealings of the person so entitled.
 

Land Act, 2012
Section 2 – Interpretation

“charge” means an interest in land securing the payment of money or money’s worth or the fulfillment of any condition, and includes a subcharge and the instrument creating a charge, including -
(a) an informal charge, which is a written and witnessed undertaking, the clear intention of which is to charge the chargor’s land with the repayment of money or money’s worth obtained from the chargee; and
(b) a customary charge which is a type of informal charge whose undertaking has been observed by a group of people over an indefinite period of time and considered as legal and binding to such people;
“interest” means a right in or over a land;
“proprietor” means—

(a) in relation to land or a lease, the person named in the register as the proprietor; and
(b) in relation to a charge of land or a lease, theperson named in the register of the land or
lease as the person in whose favour the chargeis made;

Section 97 – Duty of chargee exercising power of sale.

1. A chargee who exercises a power to sell the charged land, including the exercise of the power to sell in pursuance of an order of a court, owes a duty of care to the chargor, any guarantor of the whole or any part of the sums advanced to the chargor, any chargee under a subsequent charge or under a lien to obtain the best price reasonably obtainable at the time of sale.
 

Section 98 - Powers incidental to the power of sale.

3) A sale of the charged land by a chargee in exercise of the power of sale shall be made in the prescribed form and the Registrar shall accept it as sufficient evidence that the power has been duly exercised.
4) Upon registration of the land or lease or other interest in land sold and transferred by the chargee the interest of the chargor as described therein shall pass to and vest in the purchaser free of all liability on account of the charge, or on account of any other charge or encumbrance to which the charge has priority, other than a lease easement to which the chargee had consented in writing.
 

Land Registration Act, 2012
Section 2 - Interpretation.

In this Act, unless the context otherwise requires—
“proprietor” means—

(a)in relation to land or a lease, the person named in the register as the proprietor; and
(b)in relation to a charge of land or a lease, the person named in the register of the land or lease as the person in whose favour the charge is made;

Section 56 - Form and effect of Charges.

(1) A proprietor may by an instrument, in the prescribed form, charge any land or lease to secure the payment of an existing, future or a contingent debt, other money or money’s worth, or the fulfillment of a condition and, unless the chargee’s remedies have been by instrument, expressly excluded, the instrument shall, contain a special acknowledgement that the chargor understands the effect of that section, and the acknowledgement shall be signed by the chargor or, where the chargor is a corporation, the persons attesting the affixation of the common seal.
(2) A date for the repayment of the money secured by a charge may be specified in the charge instrument, and if no such date is specified or repayment is not demanded by the charge on the date specified, the money shall be deemed to be repayable three months after the service of a demand, a written, by the chargee. 
(3) The charge shall be completed by its registration as an encumbrance and the registration of the person in whose favour it is created as its proprietor and by filing the instrument.
(4) The Registrar shall not register a charge, unless a land rent clearance certificate and the consent to charge, certifying that no rent is owing to the Commission in respect of the land, or that the land is freehold, is produced to him or her.
(5) ...
(6) …
 

Held:

  1. Whereas under the principles of interpretation of statutes, the general rule is that the Court should lean against the construction which reduces a statute to futility but lean in favour of an interpretation which makes it effective and operative. In tax legislation the Court ought not to strain the language with the intention of bringing taxpayers within an otherwise vague and ambiguous legislation. Where the legislation was vague or ambiguous the Courts ought to adopt an interpretation which best favoured the taxpayer.
  2. The basis upon which the Capital Gains Tax (CGT) was being imposed on the chargees exercising their statutory power of sale seemed to be paragraph 5(2) of the eighth schedule to the Income Tax Act (the Act) which provided that where a person entitled to property by way of security or to the benefit of a charge or encumbrance on property, dealt with property for the purpose of enforcing or giving effect to the security, charge or encumbrance, his dealings with it would be treated as if they were done through him as nominee by the person entitled to the property subject to the security, charge or encumbrance
  3. A chargee in his capacity of a nominee pursuant to paragraph 5(2) of the eighth schedule to the Act did not possess the absolute powers possessed the chargor, but as the paragraph expressly stated subject to the security, charge or encumbrance. In other words the chargee’s powers to step into the shoes of the chargor had to be read within the context of the security, charge or encumbrance in question.
  4. The fact that CGT was a species of income tax came from a reading of section 3(2)(f) of the Act which provided that income upon which tax was chargeable under the Act was income in respect of gains accruing in the circumstances prescribed in and computed in accordance with the eighth schedule. However, section 3(1) of the Act provided that subject to and in accordance with the Act, a tax to be known as income tax would be charged for each year of income upon all the income of a person, whether resident or non-resident which accrued in or was derived from Kenya.
  5. Income tax was only charged upon the income of a person. However, before a person could be compelled to pay tax, his liability had to be expressed in clear terms by a taxing Act and the amount of his liability had to be clearly defined.
  6. Section 56 of the Land Registration Act, 2012 (LRA) provided for the form and effect of Charges. A chargee’s interest in a charged property was only to the extent of the sum due under a charge and not in the property. He did not acquire any proprietory right in the property as such. The definition of a proprietor in section 2 of the LRA and in section 2 of the Land Act, 2012 meant:
    1. in relation to land or a lease, the person named in the register as the proprietor; and
    2. in relation to a charge of land or a lease, the person named in the register of the land or lease as the person in whose favour the charge was made.
      In other words the proprietary rights of a chargee were limited to the interests conferred by the charged document. The chargee was only the proprietor of the Charge, not the land. That position was supported by the provisions of section 98(3) and (4) of the Land Act
  7. The scheme of the land legislation was to create security over land which the chargee could sell after complying with the various statutory obligations and that at no time did the chargee step into the shoes of the owner of the land or become the owner of the land. However, for one to be obliged to pay CGT, it had to be shown that the person had in fact made a gain in income arising from the disposal of the property. The mere disposal of a property did not give rise to liability to pay the tax. A loss arising from the disposal of property could not give rise to liability to pay the tax that was clear from the reading of section 15(3)(f) of the Act.
  8. A loss made in the process of disposal of a property led to a deduction of any income tax payable or due from a tax payer. It was therefore necessary before the tax was imposed that the taxing authority established that a gain had in fact been made. The obligation to pay the tax only accrued after the conditions precedent necessary for it to arise had been satisfied, those conditions were:
    1. The disposal of an asset.
    2. The accrual from that disposal of a chargeable gain.
    3. The accrual of that gain to a person chargeable to CGT.
  9. The conditions necessary for an obligation to pay tax answered the question when liability to pay CGT accrued. Requiring payment of the tax before registration of the transfer essentially meant the tax was payable before the conditions. The effect was that a citizen could be called to pay tax before it was legally due, thereby creating an unfair tax burden to the citizens. The term unfair burden had to be defined taking specifically into account the degree and capacity of the citizens to shoulder the tax in question, bearing in mind what could be burdensome to one person could not be so to another.
  10. Before tax could be imposed there had to be a specific determination that the sum accruing from the exercise of the statutory power of sale was actually a chargeable gain. That was a determination that could only be made on a case to case basis and could not be made to apply generally to all sales made in pursuance of the exercise of statutory power of sale. Therefore there could not be an administrative fiat that CGT was payable at the same time as the payment of the stamp duty.
  11. Paragraph 4(1) of the eighth schedule to the Act stated that the gain which accrued to a person on the transfer of any property was the amount by which the transfer value of the property exceeded the adjusted cost of the property. Therefore in order to determine whether or not there was a gain a determination had to be made on the transfer value as well as the adjusted cost of the property which was defined in paragraph 8 of the eighth schedule. Those were not issues that could be within the knowledge of a chargee and only the chargor had the necessary information for the calculation of any gain since there was no way a bank would know how much the chargor spent to acquire the land or to construct buildings or to enhance the value of the property or whether the chargor had spent money to establish, preserve or defend the title or right to the property.
  12. Section 97(1) of the Land Act did not necessarily constitute a chargee a trustee for a chargor in the exercise of the former’s statutory power of sale. Whereas a chargee was required to undertake a valuation of a property before accepting the same as security and at the time of the sale thereof, it did not necessarily follow that if a property was valued at a particular sum, that was the sum that would eventually be realised upon sale. The valuation was meant to ensure that the chargee obtained the best price reasonably obtainable at the time of sale but did not necessarily mean that it was the real price of the property.
  13. To expect a chargor to pay CGT in respect of a transaction which he had no control was unreasonable, it was equally unreasonable to demand that a chargee pay CGT upfront notwithstanding whether the property was sold at a profit or a loss and without first making a determination, based on the relevant factors, whether there was in actual fact a capital gain or loss. Whereas the chargee was a nominee of the chargor for the purposes of payment of CGT where after the sale of the property the same was found to be lawfully due and payable, such a decision had to be determined on a case to case basis.
  14. It was irrational to direct that CGT had to be paid in respect of all transactions entered into pursuant to the chargee’s exercise of its statutory power of sale before such a sale could be completed. The chargee was only a trustee for the chargor in respect of the surplus arising from the sale in which event the same could be defrayed towards the payment of any taxes due including the CGT.
  15. The chargee only became a trustee of the chargor in respect of the surplus realised from the sale of the charged property, if any. In that event he was obliged to remit to the tax authority any sum determined as payable in respect of the CGT. The distinction between situations where a proprietor sold land to another person directly and where the land was sold pursuant to the exercise of statutory power of sale was clear from a reading of paragraph 6 of the eighth schedule.
  16. In the instant case, the Applicant was not seeking any change in the law imposing the payment of CGT. What the Applicant was challenging was the administrative action taken by the Respondent in firstly requiring the payment of Stamp Duty through I-tax and secondly in setting up I-tax in such a way that stamp duty could not be paid without an acknowledgment number for payment of CGT. Article 209 of the Constitution gave the National Government power to impose income taxes and as long as such imposition was in accordance with article 210 of the Constitution, it was proper, the subject was not to be taxed unless the words of the taxing statute unambiguously imposed the tax upon him and that the legal provision being invoked was one that imposed a tax upon the subject.
  17. It was incumbent on the Tax Authority to establish that its claim came within the very words used in article 210 of the Constitution on imposition of tax and if there was any doubt or ambiguity that defect if it was indeed one, could only be remedied by legislation. The Tax Authority could not in those circumstances purport to remedy the defect by way of administrative or policy decision since imposition of tax had to be by an express provision in a legislation.
  18. In carrying out their statutory obligations the Respondents had to adhere to the law. Whereas the obligation to pay taxes was a statutory obligation and the failure to collect the tax by way of withholding and remitting taxes ought not to have been lightly excused, the Court had to not without a little anguish find that where the decision by the Respondent was unjustified under the law such a decision ought not to have been allowed to stand and the same had to be quashed.
  19. Article 47(1) of the Constitution marked an important and transformative development of administrative justice for, it not only laid a constitutional foundation for control of the powers of state organs and other administrative bodies, but also entrenched the right to fair administrative action in the Bill of Rights. The right to fair administrative action was a reflection of some of the national values in article 10 of the Constitution such as the rule of law, human dignity, social justice, good governance, transparency and accountability. The administrative actions of public officers, state organs and other administrative bodies were subjected by article 47(1) to the principle of constitutionality rather than to the doctrine of ultra vires from which administrative law under the common law was developed.
  20. In the instant case, the implementation of the impugned administrative decision amounted to imposition of tax upon the Applicant’s members in situations where they could well not be obliged to pay the same. That was unlawful. The said decision was further being taken without the Applicants’ members being afforded an opportunity of being heard as to whether in the exercise of their statutory power of sale they in fact made capital gains. That was procedurally unfair.
  21. The Notice of Motion was not properly intituled. In judicial review applications, the Applicant was always the Republic rather than the person aggrieved by the decision sought to be impugned. The rationale for that was that prerogative orders, like the old prerogative writs, were issued in the name of the Crown at the instance of the Applicant and were directed to the person or persons who were to comply therewith. Applications for such orders had to be intituled and served accordingly.

Application allowed.

  1. A declaration issued that the administrative action by the Respondent requiring simultaneous payment of Stamp Duty and Capital Gains Tax on sale of land by a chargee pursuant to a chargee’s power of sale was unreasonable, unfair and influenced by an error of law.
  2. A declaration issued that the administrative action by the Respondent requiring payment of Capital Gains Tax by the chargee or purchaser on the sale of land by a chargee pursuant to a chargee’s power of sale without first ascertaining whether there was in fact capital gain was unreasonable, unfair and influenced by an error of law.
  3. A declaration issued that on the sale of land by a chargee pursuant to a chargee’s statutory power of sale, Capital Gains Tax was payable upon registration of the transfer by the chargor of the land pursuant to paragraph 5(2) of the eighth schedule of the Income Tax Act and not by the chargee or purchaser, unless there was a surplus from the proceeds of sale as to constitute the chargee a trustee for the chargor.
  4. An order of mandamus issued compelling the Respondent to allow payment of Stamp Duty on an instrument of transfer following the sale of land by a chargee pursuant to a chargee’s power of sale without requiring payment of Capital Gains Tax or an acknowledgment number for payment of Capital Gains Tax.
  5. No order as to costs.

 

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