On October 15, 2012, High Court Judge Eric Ogola delivered a ruling that dented the taxman’s pursuit of millions of shillings in rental income tax from Ecobank Kenya’s 20-storey Fedha Towers in Nairobi and its other properties spread out across the country.
For 25 years, the bank, which had declared numerous losses in that period, would add income from renting out its properties onto that of its core banking business before calculating income tax due to Kenya Revenue Authority’s (KRA).
This computation would result in a net full-year loss as the higher losses in banking dwarfed the rental income, which relieved the lender from paying tax on it.
But in October 2009, KRA popped Ecobank’s party by assessing its income for 2006, 2007 and 2008, separated rental income from banking income, and demanded the bank to pay the tax due on rental income for that period.
Separate income accounts
However, the bank appealed KRA’s tax demand, arguing that KRA had, decades earlier, waived the requirement for the bank and other large companies to operate separate income accounts for their various income sources, through a letter dated February 7, 1979, addressed to the Institute of Certified Public Accountants (Icpak).
“I have decided to waive the “separate sub-accounts” requirement in the case of the larger companies. This group will consist of the finance institutions, insurance companies, the oil companies, the banks, the large manufacturing concerns and all companies quoted on the Nairobi Stock Exchange. This waiver will not apply, however, to any company whose business activities include those of agriculture,” the letter said.
The letter effectively waived Section 15(7) of the Income Tax Act of 1975, which requires taxpayers to separately compute their income from seven specified income sources for the purposes of tax payment.
The seven are business income, rent, capital gains, pension, agriculture, employment and investment income.
In his ruling, Justice Ogola stated that KRA did not raise any issue with how Ecobank was computing its taxes for all that time, and therefore the lender was entitled to reasonably expect that the practice would continue until KRA communicates otherwise.
Various revenue streams
Most businesses are increasingly diversifying their portfolio and earn revenue from various streams apart from their core business, which allows them to weather market shocks in performance of one of the revenue streams.
“I would add that the expectation herein is not just a legitimate expectation. It is an expectation backed by a written express waiver and a passive conduct in relation thereto for a period of 25 years. All this time, the respondent (KRA) was aware of section 15 (7) of the Income Tax Act,” Justice Ogola ruled. He continued: “I am aware that the respondent is entitled to exercise its authority in performing its public duties, and the court does not intend to impede or interfere with the said authority.”
“However, the same should be exercised in a manner which recognises and honours existing contractual arrangements, which remain in place until effectively withdrawn in an appropriate communication. In light of the foregoing, I allow the appellant’s appeal with costs,” the judge ruled.
But, stung one too many times by the decades-old letter, KRA has, 42 years later, now finally revoked the waiver that firms have been using to justify bundling together their income sources before computing tax.
“In line with section 64(1) of the Tax Procedures Act, KRA informs the public of the withdrawal of the waiver of this requirement granted through a letter dated February 7, 1979 addressed to Icpak with effect from 1st October 2021,” KRA said.
“Henceforth, all taxpayers will be required to prepare a separate account in respect of each specified source of income and in the event of a loss, that loss may only be deducted from gains or profits of that person derived from the specified source in the following year or subsequent years of income in so far as the loss has not already been deducted,” it said.
Tax experts say KRA’s official revocation of the waiver means firms will no longer use it as a basis for mixing revenue from separate sources, and that it will see losses incurred by businesses only deducted from profits of that particular source.
This means that all businesses currently making losses from one or several of their income sources and then using them to lower their overall tax expense will no longer legally be able to do so.
“It is puzzling why KRA has taken so long to officially revoke that waiver because the Income Tax Act clearly specifies that different sources of income should be taxed separately,” said Mr Nikhil Hira, a tax expert at Bowmans.
“Many firms really have been operating separate tax sub accounts, but what this now means is that those who have not been doing so will no longer have a legal claim as to why they are not operating separate accounts as required,” Mr Hira said.
Kenya Private Sector Alliance (Kepsa) Chief Executive Carole Karuga says unbundling of income taxes for taxation will be costly and cumbersome for businesses.
“What is important for businesses is to have most of these taxes combined for ease of administration by both the government and the businesses. Many separate taxes make it hard to handle and costly,” Ms Karuga said.