Introduction
1. This ruling determines the Applicant’s Notice of Motion dated 3rd September 2024 brought under Section IA&B,3A, & 34 of the Civil Procedure Act, Section 10 of the High Court (Organization and Administration) Act; Rules 3(2), 15, 16 and 17 of the High Court (Organization & Administration) (General) Rules 2016, Section 3 of the Income Tax Act, Cap. 470 (Laws of Kenya) by which the Applicant/Decree Holder, sought orders that; -
a) spent
b) spent.
c) The 1st Judgment Debtor do file under oath within 7 days of the order of the court an account of all Withholding Tax of 15 per cent deductions on the decretal amount from inception till the date of the order of the court.
d) The 1st Judgment Debtor be ordered to forthwith cease making any further deductions of Withholding Tax of 15 per cent on the decretal amount and be ordered to refund all past Withholding Tax of 15 per cent deductions within 30 days of the order of the court with interest at court rates on each individual monthly deduction from the date of deduction until payment in full.
e) The costs of this application be awarded to the Decree holder in any event at the higher scale.
2. The application is premised on the grounds stated on its face and is supported by an Affidavit sworn by Basil Criticos on the 3rd day of September 2024 together with annextures thereto.
Background
3. The background of the matter is that on 28th April 2022, the Court of Appeal in the matter of Criticos v National Bank of Kenya Limited (as the successor in business to Kenya National Capital Corporation Limited “Kenyac”) & another (Appeal 80 of 2017) [2022] KECA 870 (KLR) (28 April 2022) (Judgment), delivered its judgment in favour of the Decree-Holder/Applicant and awarded of Kshs 2,284,101,000.00 (together with interest at court rates until payment in full), for what the Court found to be an irregular and wrongful sale of the Applicant’s parcel land, known as LR No. 5865/2.
4. The Court of Appeal further issued a mandatory injunction compelling the 1st Judgment debtor (NBK) to pay to the Decree holder the sum of Kshs. 35,000,000.00, being the surplus realized from the sale of the Suit Property.
5. Pursuant to the Judgment by the Court of Appeal, the parties concluded a Settlement Agreement dated 27th July 2023, under which NBK was to pay the judgment debt in 60 equal monthly installments of Kshs. 52,248,445, each comprising part of the principal sum owing plus interest computed at a rate of 14 per cent per annum on a reducing balance.
6. In making the monthly payments as per the Settlement Agreement, NBK has been withholding tax (WHT) of 15 per cent on the interest payable and remitting the same to the Kenya Revenue Authority (KRA) to credit on the Applicant’s account.
7. By a letter dated 4th March 2024, the Applicant’s advocates sent a demand letter to NBK advocates demanding that the bank immediately stop the unlawful deduction of the 15 per cent WHT. According to the Applicant, the payment was being made as a result of a decree of the court and therefore ought not to have been subjected to WHT since the same does not constitute income under Section 3 of the Income Tax Act.
8. That despite the demand by the Applicant, the NBK did not stop subjecting the payments to WHT. As of 14th May 2024, the amounts that had been withheld by NBK and remitted to KRA stood at Kshs. 33,679, 654.06/-.
9. Aggrieved by the NBK’s action of subjecting the payments to WHT, the Applicant filed the instant application, seeking orders that NBK be restrained from making any further deductions on the decretal sum at the rate of 15 per cent on account of WHT and that NBK be directed to refund to the Applicant, with interest, any monies so far withheld in the past.
10. The Application is opposed. The Judgment Debtor filed a replying Affidavit sworn by Samuel Mundia on 31st October 2024. The Garnishee did not file any response to the application.
11. Directions were given by this Court on the filing of submissions and both parties duly complied. The Applicant filed his submissions dated 25th October 2024, and a further (supplementary) submission dated 7th November 2024. The 1st Respondent’s submissions are dated 31st October 2024. Parties highlighted their respective submissions in court virtually on 12th November 2024.
Decree Holder’s/Applicant's Submissions
12. The Applicant submitted that the payments by NBK to the Applicant are made pursuant to a decree of the court and that a decree is not subject to taxation. According to the Applicant, a Decree is not one of the sources identified to be subject to tax under Section 3 of the Income Tax Act. The Applicant cited, among others, the case of AM Bahaji & Company Limited v Kenya Ports Authority [2020] eKLR in support of this argument.
13. Referring to the decision in the case of Muema Kitulu t/a Muema Kitulu & Co Advocates v County Secretary, County Government of Kitui [2020] eKLR the Applicant further submitted that there is no known law that subjects the decree of the court to taxation and that the income tax is silent on the taxation of a decree.
14. In his supplementary submissions dated 7th November 2024, the Applicant maintained that the element of interest at court rates was part of the judgment of the Court of Appeal and that the interest forms an integral and inseparable part of the decree.
15. While admitting that section 3(2) of the Income Tax Act imposes income tax on ‘dividends and interest’, the Applicant submitted that the ‘interest’ referred to under that provision of the law does not include interest payable under a decree by the court.
16. The Applicant asserted that under Section 3 (1) of the Income Tax Act, income tax can only be lawfully levied on ‘income’. According to the Applicant, ‘a decree’ of the court and the interest arising thereof, is not an income for Income Tax Act purposes.
17. Consequently, the Applicant urged this court to allow his Notice of Motion Application as prayed.
Judgment Debtor’s/1st Respondent’s Submissions
18. The 1st Respondent on its part opposed the application and asserted that the law (Income Tax Act) tax imposes tax on all income, except those specifically exempted under Sections 13 and 14 of the Act. That, this is in line with Article 210 of the Constitution provides for taxation unless one is expressly exempted by law.
19. According to the 1st Respondent, Section 3(2) (b) of the Income Tax imposes income tax on “dividends or interest”. The Respondent submitted that the term ‘interest’ is defined under section 2 of the Income Tax Act to mean interest “payable in any manner in respect of a loan, deposit, debt, claim or other right or obligation...”
20. The 1st Respondent argued that the definition of “interest” per the Income Tax Act is wide enough to encompass the form of interest paid in court decrees, to the extent that such payments would constitute “a debt, claim, other right or obligation” as stipulated under the Act.
21. Further the 1st Respondent submitted that Section 10 of the Income Tax Act obligates a resident person, making a payment to any other person, to withhold tax (WHT) on such payments and remit the same to KRA. The 1st Respondent submitted that payments on account of “interest” are specifically listed under section 10(1) (c) of the Act.
22. Referring to the case of Mount Kenya Bottlers Limited & 3 Others v Attorney General & 3 Others [2019] eKLR, the 1st Respondent submitted that since tax statutes are to be strictly construed, the interest payable to the Applicant/Decree Holder in this case was taxable.
23. The 1st Respondent therefore urged this court to dismiss the Applicant’s application and find that the interest payable to the Decree holder is subject to WHT under Sections 3, 10, and 35 of the Income Tax Act.
Analysis and Determination
24. I have carefully considered the Decree Holder’s Notice of Motion application and the submissions by both parties in support of their respective positions as well as the cited authorities. I find that the only issue for determination is whether the interest paid pursuant to a court decree is taxable for Income Tax purposes.
25. The foundation for all taxation in Kenya is derived from Article 210 of the Constitution which provides that no tax is to be imposed, waived, or varied except as provided by legislation. The Article provides that; -
“210. Imposition of tax
(1) No tax or licensing fee may be imposed, waived or varied except as provided by legislation.
(2) If legislation permits the waiver of any tax or licensing fee –
a) a public record of each waiver shall be maintained together with the reason for the waiver; and
b) each waiver, and the reason for it, shall be reported to the Auditor General.”
26. For income tax purposes, the applicable legislation for the charging, assessment, and collection of income tax in Kenya is the Income Tax Act (Chapter 470), Laws of Kenya. The preamble to the Act stipulates that the statute is; -
“An Act of Parliament to make provision for the charge, assessment and collection of income tax; for the ascertainment of the income to be charged; for the administrative and general provisions relating thereto; and for matters incidental to and connected with the foregoing” [emphasis added].
27. In line with Article 210 (1) of the Constitution, Section 3 of the Income Tax Act which is the charging provision of the Act, identifies the following thirteen (13) sources of income upon which income tax is to be levied in Kenya; -
“3. Charge to 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) any business, for whatever period of time carried on;
(ii) any employment or services rendered;
(iii) any right granted to any other person for use or occupation of property
(b) dividends or interest
(c) (i). a pension, charge or annuity; and
(ii). any withdrawals 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 a registered home ownership savings plan
(ca) income accruing from a business carried out over the internet or an electronic network including through a digital marketplace
(d) deleted by Act No. 14 of 1982, s. 17
(e) an amount deemed to be the income of any 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;
(g) subject to section 15(5A), the net gain derived on the disposal of an interest in a person, if the interest derives twenty per cent or more of its value, directly or indirectly, from immovable property in Kenya
(h) a natural resource income; and
(i) gains from financial derivatives, excluding financial derivatives traded at the Nairobi Securities Exchange [Emphasis added].
28. From the above, it is evident that “interest” is specifically identified under Section 3(2) (b) of the Income Tax Act as a source from which income tax is to be levied.
29. It is not in dispute in this case that the Court of Appeal issued a decree in favour of the Applicant and warded him damages in the sum of Kshs.2,284,101,000 for the irregular and unlawful sale of his property, being LR No. 5865/2. The Court also directed that the said decretal sum was to attract interest at court rates (14 per cent) until payment in full.
30. It is also not in dispute that following the delivery of the judgment by the Court of Appeal in favour of the Applicant, parties entered into a Settlement Agreement dated 27th July 2023, under which NBK (the Respondent/Judgment debtor) was to pay the judgment debt in 60 equal monthly installments of Kshs. 52,248,445, each comprising part of the principal sum owing, plus interest computed at a rate of 14 per cent per annum on a reducing balance.
31. What is in dispute, in this case, is whether or not the interest component of the decree is taxable under Section 3 (2) (b) of the Income Tax Act.
32. Section 2 of the Income Tax Act defines the term ‘interest’ in the following terms; -
"interest" (other than interest charged on tax) means interest payable in any manner in respect of a loan, deposit, debt, claim or other right or obligation, and includes any premium or discount by way of interest and any commitment or service fee paid in respect of any loan or credit or an Islamic finance return”
33. From the above definition, this court is of the considered view that interest payable on a decretal sum, as is the case herein, falls under Section 3 (2) (b) of the Act and is therefore taxable under the Act. The broad definition of the term ‘interest’ under the Income Tax Act is obviously intended to achieve neutrality in taxation by ensuring that no payment in the nature of interest escapes taxation simply because it is described differently by the parties to a transaction.
34. Further, Section 3 of the ITA is clear that income tax is to be levied only on ‘gains or profits’ and not on the capital/principal sum. Black’s Law Dictionary defines the term ‘gain’ to mean “an increase in value, profits, or winnings. It can also refer to the value increase that appears on a company's balance sheet, which is a result of a profitable sale of an asset.”
35. In the instant case, the Decree Holder was awarded damages (compensation) in the sum of Kshs.2,284,101,000/-. According to the judgment, this was the value of the Applicant’s property LR No. 5865/2, which was unlawfully sold by the Respondent. It is important to note that the principal sum (compensation for the value of the property), being, Kshs.2,284,101,000/- is not taxable since it is simply compensatory/restorative in nature and does not confer any benefit, income, or gain to the Applicant/decree-holder.
36. However, any amount payable to the Applicant over and above the value of the property would be a “gain” within the meaning of Section 3(2) of the Income Tax Act, and therefore taxable. However, for such a gain to be taxable under the Income Tax Act, the gain must have arisen or accrued in the form/nature of any of the thirteen (13) sources of income identified under Section 3 (2) of the ITA.
37. Consequently, all such “gain” is to be taxable under the Income Tax Act, unless specifically exempted under Sections 13 and 14 of the Act.
38. In the instant case, the gain was in the form of ‘interest’ on the value of the capital asset (land). This gain is therefore taxable under Section 3(2) (b) of the Act. If for instance, the gain was to be realized as a result of ‘capital gains’, then the same would have been taxable under Section 3(2) (f).
39. Further, Section 10 of the Income Tax Act provides that where a resident person or a person having a permanent establishment in Kenya makes certain payments (including interest as was the case herein) to any other person, then the amount so paid (subject to certain restrictions), shall be deemed to be income derived from Kenya. The different types of income identified under Section 10 of the Act to which withholding tax (WHT) is to be applied under Section 35 of the Act are as follows; -
“10. Income from management or professional fees, royalties, interest and rent.
(1) For the purposes of this Act, where a resident person or a person having a permanent establishment in Kenya makes a payment to any other person in respect of—
(a) a management or professional fee of training fee;
(b) a royalty or natural resource income
(c) interest and deemed interest;
(d) the use of property
(e) …………..” [Emphasis added]
40. In the present case, the Respondent, being a resident person, made payments to the Applicant (another resident person) in respect of interest. Therefore, pursuant to section 10 (1) (c) of the Income Tax Act, the amount of interest so paid shall be deemed to be income derived in Kenya, and is therefore subject to WHT under Section 35 of the ITA which imposes an obligation on the payer (in this case the NBK) to deduct and remit to the Commissioner (KRA) withholding tax at the rate of 15 per cent.
41. The Applicant argued that a decree is not to be subjected to tax since it is not one of the sources of income specifically identified under Section 3(2) of the Income Tax Act as taxable. With greatest respect, this argument by the Applicant is in my view, not merited.
42. As rightly pointed out by the Applicant, the term ‘decree’ is used in civil proceedings as a formal expression of a determination of any question by a court of law. Section 2 of the Civil Procedure Act defines the term ‘decree’ as follows; -
“decree" means the formal expression of an adjudication which, so far as regards the court expressing it, conclusively determines the rights of the parties with regard to all or any of the matters in controversy in the suit and may be either preliminary or final; it includes the striking out of a plaint and the determination of any question within section 34 or section 91, but does not include—
(a) any adjudication from which an appeal lies as an appeal from an order; or
(b) any order of dismissal for default: 1 Provided that, for the purposes of appeal, "decree" includes judgment, and a judgment shall be appealable notwithstanding the fact that a formal decree in pursuance of such judgment may not have been drawn up or may not be capable of being drawn up;”
43. From the above, it is evident that a decree is simply a formal expression of the court, which conclusively determines the rights of the parties with regard to all, or any of the matters in controversy in the suit. A decree may be for payment of money or otherwise. Where a decree is for payment of money, then the nature of the underlying payment will determine whether or not the payment (decree) will be taxable.
44. From the design of the Income Tax Act, a court decree for the payment of awards that are compensatory in nature (such as damages for defamation, personal injury claims, loss of asset, etc.) are not taxable since such payments represent no real gain to the payee/decree holder. However, payments under a court decree that are of the nature identified under Section 3(2) are generally of revenue in nature and are therefore taxable under the Act.
45. For instance, where a decree of a court is for the payment of any rent, employment benefits, loss of business, dividends, interest, pension, charge, or annuity to a decree-holder, then such payments are taxable in the hands of the decree-holder since the payments (which are generally revenue in nature) relate to the sources specifically identified under section S. 3(2) of the Income Tax Act to be taxable.
46. I have carefully read and reviewed the following cases cited by the Applicant in support of his case; -
i. AM Bahaji & Company Limited v Kenya Ports Authority [2020] KEHC 918 (KLR); - D.O. Chepkwony J – which dealt with the question of whether a decree may be subjected to tax under the Income Tax Act.
ii. Twiga Construction Co Ltd v Isiche & another (Both suing as administrators of the Estate of the Late Shadrack Elly Isiche) (Civil Appeal 515 of 2012) [2023] KEHC 27413 (KLR) (Civ) (15 June 2023) (Ruling); W.A. Okwany J – which dealt with the question of who between the decree-holder and the judgment debtor was to bear the burden of Withholding tax.
iii. Mohamed & Samnakay v General Hardware Limited (Miscellaneous Application E208 of 2019) [2022] KEHC 13317 (KLR) (Commercial and Tax) (22 September 2022); WA Okwany J – which dealt with the question of whether “withholding tax” is a specified source of income under Section 3 (2) of the Income Tax Act.
47. For the reason cited under paragraphs 38 – 41 of this judgment, I do not agree that a decree issued by a court is generally not taxable for income tax purposes. The determinant of whether a decree will or will not be taxable depends on the payment underlying the decree. If the decree is for the payment to the decree-holder, of any of the thirteen (13) items specified as sources of income under section 3(2) of the Income Tax Act, then such a payment (decree) will, accordingly be taxable for income tax purposes.
48. Before I pen off, it is critical that I mention that ‘withholding tax’ is not really a tax, neither is it a specified source of income under the Income Tax Act. Withholding tax is simply a mode of collection of income tax from the person to whom the payment is made (payee). It is a portion of the payee’s tax that is deducted in advance by the payer and remitted to the Commissioner (KRA) pursuant to Section 35 of the Income Tax Act, on behalf of the payee. The payee, when making his final tax declarations for the year, is then entitled to have/claim credit for any taxes withheld and remitted to the Commissioner on his account.
49. It is, therefore, a misnomer to argue that to the extent that ‘withholding tax’ is not specifically identified as a source of income under Section 3 of the Income Tax Act, then the same cannot be applied to payments which are subject to WHT.
50. Accordingly, I find the Decree Holder’s/Applicant’s Notice of Motion application dated 3rd September 2024 to be without merit. Consequently, I dismiss the same with costs to the Respondent/Judgment debtor.
51. It is so ordered.
SIGNED DATED and DELIVERED IN VIRTUAL COURT THIS
17TH DAY OF DECEMBER, 2024
ADO MOSES
JUDGE
In the presence of: -
C/A – Moses
Otieno h/b for Allen Gichuhi SC………...for Applicant
Kamara h/b for Chacha Odera ………for Respondent