Thursday, 19 March 2015
CAPITAL GAINS TAX AND HOW IT AFFECT LAND TRANSFER TRANSACTIONS IN KENYA
The Finance Act CAP 16 of 2014 was assented by the president on September 2014; section 23 of the said Act has amended the Eighth Schedule of the Income Tax Act CAP 470 to require that the sale of property be subjected to Capital gains tax. The tax which was suspended in 1985 has now been re-introduced and was effective from 1st January 2015; the tax is 5% of the net gain from the transfer of property (Section 3(2)f of the Income Tax Act). Capital Gains Tax is a tax chargeable on the whole of a gain which accrues to a company or an individual on or after 1st January, 2015 on the transfer of property situated in Kenya, whether or not the property was acquired before 1st January, 2015 . The net gain is calculated as the excess of the transfer value over the adjusted cost of the property that is being transferred. The Transfer Value provided for in section 7(1) of the Income Tax Act is the amount or value of consideration or compensation for transfer of the property less incidental costs on such transfer. The Adjusted Cost as stated in the Income Tax act section 8(1) is the sum of the cost of acquisition or construction of the property; expenditure for enhancement of value and/or preservation of the property; cost of defending title or right over property, if any; and the incidental costs of acquiring the property . The adjusted cost shall be reduced by any amounts that have been previously allowed as deductions under Section 15(2) of the Income Tax Act. That is: Capital gains Tax= (Transfer Value – Adjusted Cost) x 5% The tax is paid by the person who transfers the property, the transferor. It can be a legal person or corporate body. A transfer takes place where a property is sold, exchanged, conveyed or disposed of in any manner (including by way of gift) or on the occasion of loss, destruction or extinction of property whether or not compensation is received or on the abandonment, surrender, cancellation or forfeiture of, or the expiration of rights to property . It is considered a final tax and cannot be offset against other income taxes. Where the transfer value cannot be ascertained, the market value is used. Incidental costs are deductible in determining the transfer value of property. These costs include: a) stamp duty; b) legal fees; c) advertising cost; and d) any costs of the acquisition or transfer of property which consist of expenditure wholly and exclusively incurred by the person acquiring the property or the transferor for the purposes of the transfer. Transfers of property as provided by the Eighth Schedule paragraph 6(2) of the Income Tax Act are not considered transfers for the purpose of CGT. These includes: a) transfer through inheritance; b) transfer of property as security for a debt; c) issuance by a company of its own shares or debentures; d) transfer of an asset between spouses or former spouses, as part of a divorce settlement or bona fide separation agreement . Effects if Reintroduction of the Capital Gains Tax 1. The reintroduction of the Capital Gains Tax will increase the cost of land transactions because most investors and land owners and developers will try to pass on the costs to buyers. The process of paying this additional tax will add up to the already strenuous work of transfer of land transaction. 2. The Finance Act does not specifically provide guidelines on how the CGT relating to the transfer of property shall be paid. It is expected that the CGT will be payable in the same manner as the stamp duty such that, evidence of payment of CGT may be required for the transfer of property to be registered . Although KRA has not outlined the procedure that will be applied the Capital gains it says that plans are underway to ease the process of payment of CGT by developing a module within the iTax system that will allow taxpayers to make electronic declarations. 3. Raising tax rates on high income individuals dissuades them from doing productive things – that is to say, it causes them to cut back on working and investing . 4. It may lower Kenya’s appeal as an investment destination but this is debatable since Kenya’s CGT rate is among the lowest in Africa compared to some countries like Tanzania which charges 20% Capital Gain Tax and Uganda which charges 30%. 5. Concerns have been raised that the new tax is likely to push up the cost of housing, and that it could be difficult to administer. “The net effect will be an increase in property prices as sellers look to pass on the tax to buyers. This may result in an adjustment in the sector, particularly for individuals or small developers,” said Timothy Kamau, the head of investor relations at Home Afrika, a NSE-listed real estate company . Recent debates have suggested that the Capital Gains Tax may encourage people to hold property for longer periods and to promote better capital allocation. However inventory is not taxed: after buying land or property for your business premises and selling it after one year, it will not be taxed . This is because inventory is not considered a capital asset. Those whose land is compulsorily acquired by the State will be exempt from the tax . Taxpayers will also have to review transactions involving the transfer of property where the transaction is expected to take place on or after 1 January 2015 . The effect it will have on the real estate sector will get clear when the modalities of how the tax will be administered are released and even clearer when the same is implemented. But generally speaking, this is one additional hurdle and complication in home ownership and everyone will be affected directly or indirectly. And since the government will now get more from the industry, the cost of the industry is more likely to increase than decrease, for the simple reason that someone has to bear the additional cost. Taxing the income from capital income has the potential to reduce savings and investment incentives as well as being a disincentive to entrepreneurship. This dampens the nation's entrepreneur spirit as well as long term prospects for increased productivity and economic growth . Banks and other financial institution may exercise more caution before taking land as security for loans because of the uncertainty and controversy surrounding the reintroduction of the capital gains tax. The Income Tax of 2010 section 72D states that where any amount of tax remains unpaid after the due date a penalty of twenty percent shall immediately become due and payable. On the other hand the Kenya Revenue Authority provides that non payment where no deduction is made could attract a penalty of up to 200% or a fine or imprisonment but where a declaration is made the penalties are 20% and 2% interest per month until the amount is paid in full. In conclusion the Capital Gain Tax is only 5% at the moment and has not been fully implemented. It is therefore difficult to measure the effect it will have on land transfer transactions in the country. However, it is clear that if this percentage is raised the government risk losing income whether as stamp duty or registration costs associated with property transactions because it has real prospects of making Kenya unattractive to investors. For further clarification on tax issues, please contact us. Christine GITONGA For: Taxlex Consulting Group – a participating consultancy firm in the SLS Group of consultancies
The SLS Group is a consortium of fourteen (14) professional services firms specializing in advisories in select practice areas, namely: State Corporations laws and regulations, Banking and Corporate Finance, Conveyancing and Property Law, Tax Law, Energy Law, Intellectual Property, Policy Development and Legislative Drafting, Legal Research, and Legal Compliance Advisories, Environmental Law, Cyber Law, Mergers and Acquisitions, Corporate Law and Business Services, Tourism Research and Policy, Media Entertainment IP and Sports Law, Company Secretarial Services, Contract Negotiation Review and Preparation, Due Diligence, Development of Legal and Business Service Operation Processes, Advisories on Laws of Other Jurisdictions as well as International Law and WTO Regime, Legal Process Outsourcing, and Litigation and ADR processes. Our contacts are email@example.com, firstname.lastname@example.org or +254 715310677.