Abstract
Financial derivatives are key financial instruments that may be entered into to manage risk. They may also be used for investment or speculative purposes. A comprehensive framework for the taxation of financial derivatives may provide for the nature of the transaction being taxed (these may be options, futures, forwards, or notional principal contracts), rules applying to particular taxpayers such as financial institutions, and aspects of taxation being considered such as the jurisdiction to tax financial derivative gains, rules on timing and incurral of gains and rules on the nature of the income being taxed.
Through the Finance Act 2022, Kenya introduced a 15% withholding tax on derivative gains earned by a non-resident through derivative contracts entered into with Kenyan resident entities. The Income Tax (Financial Derivative) Regulations 2023 were enacted to provide more guidance on how such gains would be taxed. The reader will note that these regulations create various practical difficulties. For instance, it is noteworthy that a loss to a resident is regarded as being equivalent to a gain for a non-resident, which may not really be the case. This is shown to unnecessarily raise the cost of derivative contracts which is not good for emerging markets. In addition, differences in the characterisation of payments arising from derivative contracts may lead to double or non-taxation of derivative income. Lastly, it is noted that entities such as financial institutions deal with multiple contracts daily, it may then be difficult for them to make adjustments for tax purposes. With this in mind, while this dissertation focuses largely on cross-border aspects of derivative contracts, it also proposes approaches for the taxation of financial derivatives that deals with each of the issues highlighted above.