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TAX CHANGES EFFECTIVE FROM 1ST JANUARY 2023

The Finance Act, 2022 (“The Act”) was assented by the former president Uhuru Kenyatta on 21st June 2022. The Act brought about some changes in tax law which became effective from 1 st July 2022 and some changes from 1st January 2023.

In this alert we highlight the changes that came into effect from 1 st January 2023.

Increase in Capital Gains Tax (“CGT”) from 5% to 15%.

In a move to widen the tax base, tap into the booming property market and align Kenya’s CGT rate to that of the region. The Act amended Section 34(1)(j) of the Income Tax Act (“ITA”) by increasing the CGT rate from 5% to 15%. The rate is applicable on the net gain upon transfer of property.

The CGT rate of 5% shall continue to apply for firms certified by the Nairobi International Financial Centre Authority provided that;

• The investment in Kenya is five billion shillings or more; and
• The transfer of the investment is made after five years.

Both local and foreign direct investments in eligible marketable securities and in the real estate sector will be largely hit by the increase.

There is need to introduce indexation in computation of CGT so that the effect of inflation can be eliminated on the net gains subject to CGT. In most cases a significant portion of capital gains on properties is largely attributable to inflation.

15% WHT on gains accruing to Non-residents from financial derivates.

The Finance Act, 2022 amended Section 3(2)(i) and Section 9(3) of the ITA by introducing a 15% Withholding Tax (“WHT”) on gains accruing to non-residents from transactions involving financial derivatives such as hedging, futures and options.

To ensure protection and promotion of the capital markets, financial derivates traded at the Nairobi Securities Exchange have been exempted from the WHT.

The ITA defines a financial derivative as financial instrument whose value is linked to the value of another instrument underlying the transaction which is to be settled at a future date.

In compliance with the Statutory Instruments Act, the Commissioner General on behalf of the Cabinet Secretary, the National Treasury and Planning has published the draft Income Tax (Financial Derivatives) Regulations, 2022 and invites interested members of the public and stakeholders to submit their inputs and comments for consideration before enactment.

The amendment will ensure equity and fairness as previously this income was not subject to WHT.

The amendment will ensure equity and fairness as previously this income was not subject to WHT.

The Finance Act, 2022 repealed section 18(A) on gains or profits of business in a preferential tax regime and replaced it with a new provision which directs that transactions with enterprises operating in a preferential tax regime shall be required to meet the arm’s length principle even when the entities do not have any corporate relationship.

A “preferential tax regime” has been defined as:

1. Any Kenyan legislation, regulation or administrative practice which provides a preferential rate of tax to such income or profit, including reductions in the tax rate or the tax base; or
2. A foreign jurisdiction which –

   1. does not tax income;
   2. taxes income at a rate that is less than twenty per cent;
   3. does not have a framework for exchange of information; or
   4. lacks transparency on corporate structure, ownership of legal entities located therein, beneficial owners of income or capital, financial disclosure, or regulatory supervision.

The provision seeks to widen the scope of transactions eligible for transfer pricing compliance. This will lead to increased scrutiny by the KRA on the affected taxpayers and as a consequence it is desired that compliance and proactive measures be instituted by the affected entities.

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30% interest restriction (Thin capitalization rules)

The Finance Act, 2021 overhauled Section 16(2)(j) of the ITA on the basis for interest restriction under thin capitalization rules from using the ration of debt to equity of 3:1 previously in use to restrict the allowable interest to 30% of Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”). Any income which is exempt from tax shall be excluded from the calculation of EBITDA.

The provision applies to:

1. interest on all loans;
2. payments that are economically equivalent to interest; and
3. expenses incurred in connection with raising the finance.

A reprieve has been given to the following entities which shall be exempt from the new interest restriction rule:

1. banks or financial institutions licensed under the Banking Act; and
2. micro and small enterprises registered under the Micro and Small Enterprises Act, 2012;
3. microfinance institutions licensed and non-deposit taking microfinance businesses under the Microfinance Act, 2006 (No. 19 of 2006);
4. entities licensed under the Hire Purchase Act (Cap. 507);
5. non-deposit taking institutions involved in lending and leasing business;
6. companies undertaking the manufacture of human vaccines;
7. companies engaged in manufacturing whose cumulative investment in the preceding five years from the commencement of this provision is at least five billion shillings;
8. companies engaged in manufacturing whose cumulative investment is at least five billion shillings: Provided that the investment shall have been made outside Nairobi City County and Mombasa County; and
9. holding companies that are regulated under the Capital Markets Act (Cap.485A).
10. an amount of deemed interest where the person is controlled by a non-resident person alone or together with not more than four other persons and where the company is not a bank

The move will be ensuring that highly geared entities are subjected to a higher tax on the disallowed interest as the 30% threshold is minimal.

The amendment was effective from 1 st January 2022 and entities with a December year end will be implementing the provision for the period ending 31 st December 2022.

' The amendment was effective from 1 st January 2022 and entities with a December year end will be implementing the provision for the period ending 31 st December 2022.

The Act also provided for the deferment of realized foreign exchange loss for a company whose gross interest paid or payable to related persons and third parties exceeds thirty per cent of the company’s EBITDA in any financial year.

These provisions, do not apply to persons exempted from thin capitalization rules.