Determination of the Acquisition cost in the sale of inherited properties for Capital Gains Tax purposes

Case Study: Dhanjal v Commissioner of Domestic Taxes (Appeal E619 of 2023) [2024] KETAT 1259 (KLR) (23 August 2024) (Judgment)

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Dhanjal declared in its self-assessment Capital Gains Tax return for the period of December 2022 sales proceeds of Kshs. 177,915,900.00 from the sale of land, and claimed incidental costs of Kshs. 6,913,814.00 comprising agent’s commission of Kshs. 6,191,474.00 and legal fees of Kshs. 722,340.00 and acquisition cost of Kshs. 150,000,000.00 on the land.

Following an additional assessment by KRA, Dhanjal lodged a late notice of objection on 22nd June 2023 which KRA accepted on 5th July 2023.

Dhanjal provided documents in support of the objection on 10th July 2023.

KRA issued its objection decision on 10th August 2023, which Dhanjal appealed against at the Tax Appeals Tribunal after filing a Notice of Appeal on 8th September 2023.

The appeal was premised on the following grounds:

• That KRA erred in law in disallowing the adjusted cost of the property and as such KRA’s assessment is erroneous and lacks legal basis.
• That KRA’s conduct is unfair and infringes on the taxpayer’s rights and freedoms under the Constitution.

Dhanjal argued that:

• the property was transferred to him by way of transmission in the year 2014 from the Estate of his deceased father.
• he received an offer from Omicron Resources Limited which offered to purchase the property for the sum of Kshs. 30,000,000 per acre, aggregating to the total sum of Kshs. 177,915,900.00.
• Dhanjal and Omicron Resources Limited reached a consensus and entered into a sale agreement, after which Dhanjal received a deposit of 10% of the purchase price in December 2022.
• he self-assessed Capital Gains Tax (CGT) liability of Kshs. 1,050,105.00 ,computed and paid to KRA on 30th December 2022 in compliance with his tax obligations as set out in Section 3(2)(f) of the Income Tax Act as read together with the Eighth Schedule to the Income Tax Act.
• ?he received a demand dated 16th May 2023 that demanded him to settle Kshs. 25,338,215.00 (comprising principal tax of Kshs. 24,600,208.00 and penalty of Kshs. 738,007.00) within 14 days from the date of the demand. Dhanjal further averred that
• ?he ?acquired the property in question by way of transmission after the demise of his father. Dhanjal argued that in circumstances like Dhanjal’s, where one inherits land and therefore does not pay actual cash for the property, Paragraph 9(1)(d)(ii) of the Eighth Schedule to the Income Tax Act provides that the applicable adjusted cost of the property is the market value.
• prior to Dhanjal acquiring the land in 2014, Dhanjal and his brothers had sought to acquire a finance facility with Diamond Trust Bank (DTB) and charge the land in question. That DTB procured the services of DK Real Estates Limited, a real estate valuer to value the land before advancing the facility. That DK Real Estate Limited established that the property had an open market value of Kshs 150,000,000.00 in its report dated 15th August 2014

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KRA Responded that:

• CGT is chargeable on gains or profits made on the transfer of land and buildings, and that the rationale for computation of CGT is set out in Paragraph 4(1), Part I of the Eighth Schedule to the Income Tax Act which provides that:- “The gain which accrues to a person on the transfer of any property is the amount by which the transfer value of the property exceeds the adjusted cost of the property.”
• for adjusted cost to be allowed under Paragraph 8 of Part I of the Eighth Schedule to the Income Tax Act it ought to consist of the following: - “(a) the amount of or value of the consideration for the acquisition or construction of the property; (b) the amount of expenditure wholly and exclusively incurred on the property at any time after its acquisition by or on behalf of the transferor for the purpose of enhancing or preserving the value of the property at the time of the transfer; (c) the amount of expenditure wholly and exclusively incurred at any time after the acquisition of the property by the transferor establishing, preserving or defending the title to, or a right over, the property, and (d) the incidental costs to the transferor of acquiring the property.”

KRA argued that from a reading of the above provisions, it is evident that Dhanjal’s purported cost of acquisition does not fall within this category by dint of the fact that the properties were transferred to Dhanjal through transmission. That Dhanjal, therefore, never incurred any cost in the acquisition of the property for the market value to qualify for inclusion under adjusted cost.

• Dhanjal incurred nil consideration cost at the time that the property was acquired or inherited was correct.

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In its ruling on 23/08/2024, the TAT observed that:

• Dhanjal attached as evidence a completed form R.L 7 ‘Transfer by Personal Representative to Person Entitled Under a Will or an Intestacy’ dated 17th September 2014, which transferred the interest in the title to land ?to Dhanjal, being a beneficiary to the Estate of his deceased father. Dhanjal likewise attached as evidence the title deed of the said property which confirmed that Dhanjal was the registered owner of the land effective from 2nd October 2014. In addition to the property transfer documents and title to property, Dhanjal attached a valuation report dated 15th August 2014 prepared by DK Real Estates Limited on the instruction of Diamond Trust Bank Kenya Limited on behalf of Dhanjal
• Paragraph 6(2) of the Eighth Schedule to the Income Tax Act provides as follows: “(2) There is no transfer of property for the purposes of this Schedule– (a) … (b) … (c) … (d) by the transfer by a personal representative of any property to a person as legatee in the course of the administration of the estate of a deceased person. For this purpose, "legatee" includes a person taking under a devise or other testamentary disposition or on an intestacy or partial intestacy whether he takes beneficially or as a trustee; (e)… (f)… (g)… (h)…”

?The Tribunal noted that Paragraph 6(2)(d) of the Eighth Schedule to the Income Tax Act provides what does not constitute a transfer of property, however, contrary to KRA’s assertion, the provision does not negate that Dhanjal indeed acquired the property by transmission in the testamentary disposition pursuant to him being a beneficiary of his deceased father’s Estate. In which case, the Tribunal found that Paragraph 6(2)(d) does not preclude Dhanjal from applying Paragraph 9 to ascertain the amount of the deemed consideration for the acquisition of the property for purposes of Paragraph 8 of the Eighth Schedule to the Income Tax Act.

• The Tribunal reiterated its decision in Shah & 2 Others v Commissioner of Domestic Taxes TAT Appeal No. 587 of 2021 wherein the Tribunal held as follows in circumstances similar to the present case: - “59. The Appelant herein acquired the properties known as LR 1871/11/404 and LR 1871/11/406 through a transfer on 30th September, 2015, upon the confirmation of a grant of probate, as legatees of the deceased owner, who was their father. The transfer therefore falls within the four corners of Paragraph 9 of the Eighth Schedule, as a property acquired and transferred by way of a gift, and between persons who are related. The cost basis for purposes of adjusting costs for determining CGT is therefore the fair market value as at the date of transfer, or the consideration applied to determine stamp duty for the transaction whichever is the lesser, as provided for in the aforesaid paragraph
• Dhanjal correctly applied the fair market value of the Properties as at the time of the acquisition by the legatees as the cost basis of applying the adjustment of costs

As such Dhanjal won

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