The familiar adage “It’s not how much you make, but how much you keep” is a truism that has become even more of a reality for investors in Kenya. President Uhuru Kenyatta recently assented to the Finance Act, 2014 effectively reintroducing capital gains tax through an amendment to the Eighth Schedule of the Income Tax Act (ITA).
Not only is the reintroduction of capital gains tax expected to affect passive investment income from real estate and marketable corporate securities, it is expected to affect the country’s nascent oil, gas, mining and other extractive sectors.
The reintroduction of capital gains tax since its suspension almost 30 years ago is widely viewed as a plug in measure by the government to reduce budget deficits and raise funds for infrastructure and development projects. The move is also perhaps a reflection of the government’s intention to harmonise and align tax laws within the East African Community, since Kenya was the only state that did not levy taxes on capital gains.
A Snapshot on the Highlights:
- The new law imposes a 5% tax on net gains on the ‘transfer’ of property situated in Kenya. Kenya’s levy is at the bottom with other East African countries levy being between 10% to 30%.
- The tax is applicable on net gains on transfer of any property or stock where the transfer value is 20% or more of the original value. There is no reduction formula for chargeable gains as Part III of the Eighth Schedule of the ITA has been repealed. This will create difficulties in establishing the adjusted cost for the purposes of determining the gain. The adjusted cost formula currently applicable is the actual acquisition cost plus cost spent on developing or preserving the property.
- The 5% tax would be a final tax i.e., the net gain would not be subject to further taxes.
- The effective date for the capital gains tax is 1st January 2015 whether or not the property being transferred was acquired before the effective date.
- The new law taxes capital gains made by companies on the disposal of any of their property (excluding road vehicles), which is widely defined to include every description of property, whether movable or immovable. This imputes that intellectual property and goodwill is also subject to capital gains tax making computation of the adjusted cost difficult because there is rarely an actual acquisition cost where the transferor is the creator of the intellectual property and goodwill.
- For individuals, the tax is applicable on net gains made on land and marketable securities including investment in shares listed on the Securities Exchange. However, the law is equivocal on the rate applicable to gains on investment in shares as the rate of 7.5% set out in the Eighth Schedule seems to continue to be applicable. Nonetheless, the withholding tax to be deducted and remitted by stockbrokers on transfer of listed shares is still applicable.
- A firm acquiring more than 50% stake in a mineral block or an oil exploration block will pay capital gains tax on the net gain on the value of the transaction. This seeks to tax transfers of prospecting rights in the mining and extractive sector.
What is a ‘transfer’ for the purposes of Capital Gains Tax?
- Sale, exchange, conveyance or disposal of property in any manner including gifts.
- If property is lost or destroyed whether or not compensation is received.
- If the property is abandoned, surrendered or forfeited, including the surrender of shares or debentures on the dissolution of a company.
What is not considered to be a ‘transfer’?
- Transfer of property for the purposes of securing a debt or transfer by a creditor of property used as security.
- The issuance by a company of its own shares or debentures.
- Transfer of a deceased’s property to the personal representative;
- Transfer by a personal representative of a deceased’s property to the deceased’s heirs or beneficiaries of the estate in the course of the administration of the estate.
- Vesting of a Company’s property in the liquidator by an order of the court during winding up.
- Vesting of property in the Official Receiver or Trustee in Bankruptcy.
- Transfer of property to a beneficiary by a trustee subject to a trust.
Not All Capital Gains Are Taxable
The following transactions are exempt from Capital Gains Tax:
- Property (including investment shares) transmitted under inheritance.
- Sale of a deceased’s property for the purpose of administering the estate of the deceased provided the sale is completed within two (2) years of the death of the deceased.
- Compensation for land compulsorily acquired by the government for infrastructure development.
- Land transferred by an individual where the transfer value is less than K.Shs. 30,000/=. This value seems not to take into account adjustments for inflation.
- Agricultural property that is less than 100 acres where the property is situated outside a municipality or gazetted township or urban area.
- Residential houses that are owner occupied for a period of three years preceding disposal.
- Gains on the transfer of property under a transaction involving recapitalisation, acquisition, amalgamation, dissolution or other similar restructuring of the corporate identity of a company that is found to be in the public interest.
As a result of the reintroduction of Capital Gains Tax, the Kenya Revenue Authority will need to refine its tax assessment and collection mechanism to accommodate the new tax. It is not clear how the government intends to implement the new tax. Logistics for valuation of property for the purposes of implementing Capital Gains Tax seems to have evaded the National Assembly. Indeed, since the tax is applicable to all property whether or not acquired on the effective date, it will be onerous to determine the original cost of property since records on the acquisition, improvement and maintenance costs may be difficult to obtain for the purposes of computing the adjusted cost of property. This effectively requires investors to keep accurate and up-to-date records for effective implementation of the new law.
We anticipate that Treasury will consult with the Kenya Revenue Authority on how to implement the newly reintroduced capital gains tax prior to the effective date of January 1, 2015.
The Cabinet Secretary has indicated that the 5% tax levy could be reviewed depending on performance of the sectors to be affected and the need to create certainty in the business environment. It is likely that such revision could be on the upward scale rather than downwards. It is evident that there is need for an alignment of the new law with the entire ITA for the purposes of internal coherence and consistency as far as income tax legislation is concerned. We shall be monitoring any developments in this area and keep you updated.
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For consultation on this subject, kindly contact:
Senior Partner, Corporate & Commercial Law
Mwale & Company Advocates