Income Tax Act (Financial Derivatives) Regulations, 2022
The Nairobi Securities Exchange derivatives market (NEXT), was launched on 4th July 2019, with the aim of facilitating the trading of the futures contract on the Kenyan Market and is regulated by the Capital Markets Authority.
The Finance Act, 2022 amended Section 3(2) of the Income Tax Act, to introduce income tax on gains accrued in or derived from Kenya by a non-resident person from financial derivatives. This amendment will take effect from 1st January, 2023. This effectively brings to tax
the gains made by a non-resident person who enters into a financial derivate contract. The gains are to be subjected to withholding tax at the rate of 15%.
The Finance Act required the enactment of Regulations to further govern the taxation of the financial derivatives. The Kenya Revenue Authority on behalf on the Cabinet Secretary of the National Treasury and Planning have published the Income Tax Act (Financial Derivatives) Regulations, 2022.
The Income Tax Act (Financial Derivatives) Regulations, outline that the gains, on a financial derivative transaction accruing to a non-resident person, other than a non-resident person having a permanent establishment in Kenya shall be chargeable to a final tax. However, gains accruing to a non-resident person from financial derivatives traded at the Nairobi Securities Exchange are exempt from the tax.
The financial derivatives that the regulations refer to include:
- Futures Contract: This is a financial contract between two parties where both parties agree to buy/sell a particular asset at a predetermined price at a specific date. These contracts can be traded on a centralized exchange or an Over-the-Counter (OTC) market as standardized contracts.
- Forward Contract: This is a financial contract that can be customized to a specific commodity, a specific quantity of the commodity and agreed-upon delivery date at a future point in time.
- Options Contract: This type of derivative gives the holder of the option contract the right but not the obligation to buy/sell the underlying asset at a specified price (strike price), at a set time in the future.
- Swap Contract: This is a financial contract where two parties agree to exchange the cash flows from two different financial instruments. For instance, two parties may agree to exchange cash flows where one party makes payment in one currency while the other makes a payment in another currency.
The Regulations also provide that a gain or a loss from a financial derivative shall be deemed realized when the underlying asset changes hands, or on settlement of the contract, or on the payment of option premium, or on the expiry of the financial derivative contract.
It requires people involved in financial derivatives transactions to keep records of all contracts and financial activities resulting from such contracts and all incomes arising from financial derivative activities shall be characterized as “other income” (financial derivative gains/losses) in the tax returns.
The aim of the amendment is to expand the tax base and spread the burden of tax across the tax-paying public; both residents and non-residents who derive or accrue income from Kenya. However, the issue of the existing double taxation agreements will definitely be a debatable issue as the country progresses towards implementation of the new regulations.