The contractors in these projects had an assurance that the tax cost would be catered for by the Government of Kenya and they proceeded with the projects in line with this until there was a challenge to the tax exemption in court. 

On 17 February 2023, the High Court declared Legal Notice 15 of 2021 (Legal Notice) unconstitutional. The notice sought to exempt Japanese companies, consultants, and employees involved in specified projects from payment of income tax. 

The National Assembly, National Treasury, and the Attorney General were aggrieved by the High Court’s decision. They appealed against it in the Court of Appeal. In this alert, we highlight the determination by the Court of Appeal on 30 December 2024 and the implications.

Background

Section 13(2) of the Income Tax Act empowers the Cabinet Secretary for National Treasury and Planning (CS Treasury) to, by notice in the gazette, exempt from tax any income or class of income that accrued in or was derived from Kenya to the extent specified in the notice. Exercising this power, the CS Treasury issued Legal Notice 15 of 2021 to exempt Japanese companies, Japanese consultants, and Japanese employees involved in projects under specified financing agreements from payment of income tax. 

National Treasury signed 16 financing agreements with the Government of Japan between 20 December 2007 and 18 September 2020. Among the projects covered in the tax exemption were the Mombasa Special Economic Zone Development Project, Olkaria V Power Development Project, Mombasa Port Development, and power distribution systems in Nakuru and Mombasa. 

Eliud Karanja Matindi challenged the constitutionality of the Legal Notice for being discriminatory as Kenyans working for Japanese companies did not receive the same exemption. He also contended that the CS Treasury had no power to issue the tax exemption and that the Legal Notice was invalid for want of public participation. 

The High Court agreed, and by extension declared section 13(2) of the Income Tax Act unconstitutional for being contrary to Article 210 of the Constitution of Kenya, 2010 (Constitution), which provides that no tax or licensing fee may be waived or varied except as provided by legislation. 

Additionally, it found that the mandate to issue an exemption or waiver of income tax lies with the National Assembly through the legislation process after it passes as a money bill, as provided for under Article 114(3) of the Constitution.

Dissatisfied with the High Court’s decision, the Attorney General, CS for National Treasury, and National Assembly filed separate appeals at the Court of Appeal faulting the judgment for, among other reasons, declaring the Legal Notice to be unconstitutional.

Issues before the Court of Appeal 

The Court of Appeal identified three issues for determination:

·        Whether Legal Notice 15 of 2021 was unconstitutional for entrenching discrimination on the grounds that it was never subjected to public participation.

·        Whether section 13(2) of the Income Tax Act was unconstitutional to the extent that it authorised an income tax waiver through a gazette notice instead of legislation.

·        Whether the exemption of income tax can only be granted by the National Assembly through legislation after it has passed as a money bill as provided under Article 114(3) of the Constitution. 

The court’s analysis and determination

Constitutionality of Legal Notice 15 of 2021

Eliud challenged the constitutionality of the legal notice for failure to comply with the requirements of Article 210 of the Constitution and for being discriminatory in nature, as no similar exemption was accorded to Kenyans working for Japanese companies. He also contended that the notice was never subjected to public participation. 

The Court of Appeal relied on Article 94(5) of the Constitution to rule that although legislative authority is a preserve of Parliament, there are instances when it may be delegated to any person, but only with the express authority of either the Constitution or legislation. The Court of Appeal found that the CS Treasury exercised their powers in accordance with Article 94(5) of the Constitution and section 13(2) of the Income Tax Act. Further, the Court of Appeal found that the Legal Notice was issued after negotiations between the Governments of Kenya and Japan and that the same was not restricted to Kenya only as it also applied to other countries that had financing agreements with the Government of Japan. 

The court further clarified that since the Legal Notice was issued after government-to-government negotiations, it was executive in character and did not require mandatory public participation as it was not a statutory instrument. 

Constitutionality of section 13(2) of the Income Tax Act

The High Court had declared section 13(2) of the Income Tax Act unconstitutional as it authorises an income tax waiver through a gazette notice instead of legislation. The Court of Appeal ruled that the alleged unconstitutionality of section 13(2) of the Income Tax Act was neither pleaded nor was it one of the requests sought in the petition before the High Court and the High Court in essence erred in making such a determination when it had not been so moved by any of the parties.

Whether income tax exemption can only be granted by the National Assembly through legislation

Eliud contended that an income tax exemption or waiver can only be granted by the National Assembly through legislation after it has passed as a money bill as provided under Article 114(3) of the Constitution. The Court of Appeal reiterated that although legislative authority is a preserve of Parliament, Article 94(5) provides that there are instances where such authority may be conferred on any person or body, but only with the express authority of either the Constitution or Parliament. 

The court affirmed that the authority to grant an income tax exemption is bestowed on the CS Treasury under the Income Tax Act (section 13(2)). This section empowers the CS Treasury to grant income tax exemption by way of a notice, which must be transmitted to the National Assembly for consideration, as was done in the case of Legal Notice 15 of 2021. 

Comment

Following the Court of Appeal’s decision declaring section 13(2) of the Income Tax Act and Legal Notice 15 of 2021 constitutional, all legal notices pegged on section 13(2) of the Income Tax Act – including Legal Notice 91 of 2015, which granted waivers on withholding tax on foreign-sourced loans meant for investment in energy, water and related sectors, and Legal Notice 165 of 2015, which exempts withholding tax on payments for services rendered by a non-resident person under a power purchase agreement – will now remain effective. 

All income tax accrued by Japanese companies, Japanese consultants, and Japanese employees who were engaged in the projects listed in the schedule accompanying the Legal Notice remains tax-exempt. 

The exemption is likely to boost confidence for countries that provide concessional loans or grants to Kenya in exchange for certain negotiated tax exemptions. We may see more robust development in renewable energy and roads if Kenya continues to attract funding from such countries. Tax exemptions do not automatically translate to completed projects; therefore the Government has to continue monitoring tax-exempt projects to ensure they are completed, and add value to Kenyans. 

The parties in this case have a right to appeal to the Supreme Court. The Supreme Court can vary the decision of the Court of Appeal.