Kenya Court of Appeal declares the Finance Act, 2023 unconstitutional one year later

On 31 July 2024, the Court of Appeal in Kenya declared the Finance Act, 2023 (the Act) unconstitutional, having found that the process leading to the enactment of the Act was fundamentally flawed and in violation of several key Articles of the Constitution of Kenya.

Detailed discussion

Background

The Court of Appeal has issued a landmark judgement in an appeal challenging the constitutionality of the Act. This was the appeal of a decision issued by the High Court on 28 November 2023, which had declared the Act constitutional in response to consolidated petitions filed by various human rights groups.

Signed into law on 26 June 2023, the Act amended various pieces of tax legislation including the Income Tax Act, Value Added Tax Act, Excise Duty Act and the Tax Procedures Act, as well as various non-tax acts such as the Kenya Roads Board Act, the Employment Act, 2007 and the Unclaimed Financial Assets Act. However, various human rights groups faulted the constitutionality of the enactment process for the Act, citing poor public participation processes and failure to follow legal provisions as the main concerns. A petition was filed in the High Court seeking a declaration of the unconstitutionality of the Act, where the High Court subsequently ruled that the Finance Act was not unconstitutional. Still aggrieved, the parties proceeded to appeal the decision at the Court of Appeal, citing erroneous interpretation of the law by the trial court. The appellate court has now issued its decision, which this Tax Alert summarizes.

Issues for determination and the Court of Appeal's decision

Some of the key issues singled out by the Court of Appeal included:

1. Whether there was sufficient public participation in the enactment of the Act and whether Parliament is obligated to give reasons for adopting and rejecting views given by members of the public during public participation
   The Court of Appeal has ruled that although the actual public participation process was conducted in accordance with the constitutional requirements, the enactment process for the Finance Act, 2023 was flawed because the National Assembly did not give the public written reasons for passing or rejecting the various amendments, many of which were contrary to the feedback received during the public participation process. It disagreed with the High Court, which had opined that providing these written reasons is merely "desirable," rather than mandatory. The Court of Appeal noted that public participation is not an inconsequential process or a mere formality. The process must be meaningful, where the collected views are taken into account.
   
   
2. Whether the Act included provisions that were not in the Finance Bill, 2023, which was subjected to public participation
   This issue stemmed from the fact that there were several amendments introduced in the Act that had not been subjected to public participation, as the amendments were made after the public participation report was submitted to the National Assembly. The Court of Appeal held that the decision to bypass public participation, contrary to the provisions of the Constitution of Kenya, constitutes a serious assault on the Constitution and a "grave" error. The affected amendments were therefore declared null and void for being unconstitutional.
   
   
3. Whether the Senate ought to have been involved in the enactment of the Act to provide concurrence
   The Court's response to this issue was that the Senate did not need to have been involved because money Bills had been removed from the enactment processes to which national government or Bills concerning counties are subjected under the Constitution. Consequently, the lack of concurrence prior to the introduction of the Finance Bill, 2023 in the National Assembly did not vitiate the Act. (A money Bill is a Bill that contains provisions dealing with taxes, the imposition of charges on a public fund or the modification or repeal of any of those charges and the appropriation, receipt, custody, investment or issue of public money.)

For the above reasons, and others, the Court of Appeal concluded that the process leading to the enactment of the Finance Act 2023 was in violation of the constitution of Kenya and therefore, the Finance Act, 2023 is null and void.

Impact of the declaration of unconstitutionality

This decision has the potential to annul the following key tax changes introduced in the Finance Act, 2023 (and currently in force):

1. Non-deductibility of expenses not supported by electronic invoices (under the Tax Invoice Management System, known as TIMS or e-TIMS)
   
   
2. Exclusion of local debt from earnings before interest, taxes, depreciation and amortization (EBITDA) computations when calculating interest restrictions
   
   
3. Reduced corporation income tax of branch companies from 37.5% to 30% and introduction of the 15% repatriation tax imposed on branches
   
   
4. Introduction of capital gains tax on indirect transfers
   
   
5. Higher employment tax bands (32.5% and 35%) for employees earning more than 500,000 Kenyan shillings (KES 500,000) per month
   
   
6. Introduction of tax exemptions granted to various taxpayers, including companies undertaking manufacture of human vaccines, special economic zone (SEZ) enterprises, SEZ developers and persons engaging in implementation of projects that are 100% grant financed under an agreement between the Government and the person
   
   
7. Increase of value-added tax (VAT) on petroleum products from 8% to16%
   
   
8. Zero-rating of VAT on liquified petroleum gas, which was being taxed at 8%
   
   
9. Zero-rating of VAT on exportation of taxable services, which were previously exempt from VAT
   
   
10. Provisions restricting the Commissioner from adjusting specific excise duty rates annually for inflation
    
    
11. Amendments to excise duty tax rates for various products and services
    
    
12. Reduction of Import Declaration Fee from 3.5% to 2.5%
    
    
13. Removal of the provisions on remission of penalty and interest
     

For more on the changes brought about by the Finance Act, 2023, see EY Global Tax Alert, Kenya enacts tax changes under Finance Act, 2023, dated 20 July 2023.

Note that the Affordable Housing Levy is not affected by the Court of Appeal's judgment because the Levy was re-introduced under the recently enacted Affordable Housing Act, 2024. Contributions of the levy will continue as-is.

The decision of the Court of Appeal is quite historic and will have significant implications for tax administration in Kenya, having been delivered slightly more than one year after the Finance Act, 2023 was enacted. The decision comes at a time when the country is experiencing increased demand from the youth for the government to provide fiscal prudence, transparency and accountability.

Next steps

Since legislative enactments enjoy presumption of constitutionality up to the moment they are found to be unconstitutional, the Court of Appeal has instructed that actions taken under the Finance Act, 2023 up to the date of delivery of their judgment remains valid.

The National Treasury has expressed intentions to appeal the decision of the Court of Appeal to the Supreme Court, which is the final appellate court in Kenya. It has cited the significant impact that the decision will have on the economy and stakeholders involved as its motivation. Therefore, taxpayers should wait for further directions from the Supreme Court in the appeals being filed.