Payment of Capital Gains Tax in Bank Forced Sale Transactions in Kenya
The statutory power of sale (granted to lenders under Section 96 of the Land Act) allows a lender/charge (usually a bank) to, where the charger (borrower) is in default, sell charged property. This is referred to as a forced-sale. At the time of sale, the lender (who at that time becomes a seller) is required to obtain the best price reasonably possible in the circumstances.
Payment of Capital Gains Tax
Like any other transfer of property in Kenya, sale of charged property is subject to payment of capital gains tax (‘CGT’), unless the particular property or the transfer in question is exempted from taxation generally or Capital Gains Tax in particular.
The current rate of Capital Gains Tax is 5% and it is charged on the capital gain – the amount by which the sale value of the property exceeds the adjusted cost of acquisition of the property. Adjusted costs include the cost of purchasing and/or constructing the property, enhancing or preserving its value at the time of the transfer, incidental costs to the transferor of acquiring the property, and any post-acquisition costs of establishing, preserving or defending the title to, or a right over, the property. The incidental costs used in computation are limited to those directly related to acquisition of the property by the borrower and its sale by the lender. Additionally, the adjusted cost is reduced by any amounts that have been previously allowed as deductions under section 15(2) of ITA. Banks are advised to obtain further advice from tax experts on the issue of computation.
It is worth noting that most of the information that would assist the lender in computing the net gain for purposes of Capital Gains Tax is usually in the possession of the borrower. While it is in the borrower’s interest to disclose information relating to adjusted cost (since it is an allowable deduction which would lower its tax liability) this being a forced sale the borrower’s co-operation is likely to nonetheless be at its minimum. From our enquiries at the KRA offices, we understand that where the borrower fails to cooperate, the bank is allowed to write to KRA requesting for their assistance in obtaining information. KRA will in turn get in touch with the relevant government agencies such as the Ministry of Lands to obtain relevant information.
However, to avoid delays and unnecessary costs, it is recommended that banks need to pre-empt the borrower’s potential non-cooperation by enhancing their KYC due diligence during loan approval to account for additional information needed in the event there is need for enforcement. We would be happy to advice further on this.
Information on the costs incidental to the sale can be provided by the auctioneer charged with the sale.
Where the value of acquisition is not ascertainable, the ITA (under Paragraph 9 of the 8th Schedule) provides that, the transfer value of the property shall be the market value of the property at the time of the acquisition or equal to the amount of consideration used in computing stamp duty payable at the point of acquisition, whichever is the lesser.
Who is liable to pay Capital Gains Tax in a forced sale?
Capital Gains Tax is payable on or before presenting an application for registration of the transfer at the Lands office. Parties to a transfer in a forced sale are the bank and a purchaser (who may, subject to certain conditions, be the bank itself).
Paragraph 5 of the 8th Schedule to the Income Tax Act (‘ITA’) provides that where a person sells property for the purpose of enforcing or giving effect to a charge or other security on the property, that person’s dealings shall be treated as if they were the acts of the owner of the property, for purposes of Capital Gains Tax. The bank therefore bears the responsibility to pay CGT.
Besides, KRA requires that, from an administration perspective, stamp duty must be paid either at the same time with or before Capital Gains Tax. This means that, since the Lands registry will not register a transfer before stamp duty has been paid before, the bank will need to source for funds to pay Capital Gains Tax.
This is problematic, given that the bank does not make a gain from the sale, since the bank must recover only those amounts that are actually owed by the borrower and pass any surplus to the borrower.
KRA recently acknowledged in our enquiry that administration of Capital Gains Tax in a forced sale is still a grey area and that they are still looking into the matter with a view to giving guidance on the same. Further, we understand that there is currently an ongoing court case regarding this. Notably, the court has previously ruled that the requirement by KRA that Captal Gains Tax should be paid either simultaneously with or before stamp duty is in breach of the ITA. We therefore foresee that the court will, in the current case, uphold its previous ruling and provide some relief to banks by ordering that Capital Gains Tax should be paid upon successful registration of the transfer instrument and by the person making the gain (if any), namely the borrower.
Article by: Patience Laki and Judy Marindany.
Please note that this publication is meant for general information only and does not create an advocate-client relationship between any reader and Mboya Wangong’u & Waiyaki Advocates. Readers are advised in all circumstances to seek particular advice on any issue dealt with herein.