Demystifying Capital Gains Tax in real estate

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Kenya’s local and foreign investors in real estate and property transactions may obtain legal advice on the eligibility of their investments to Capital Gains Tax (CGT) charge from advocates who are tax law practitioners, advocates’ firms, real estate and financial consultants, banks, investment and financial institutions with legal and tax departments.

However, creation of public legal awareness on tax legislation, taxpayers’ rights and obligations is solely the duty of Kenya Revenue Authority (KRA). In this regard, KRA has set up a website which provides detailed, updated information on Real Estate and Landlords’ Legislation, court rulings, notices, news and publications, which include information relating to CGT. Despite all these, the taxman has been accused of insufficient stakeholder engagements at the time of re-introduction of CGT, which resulted in administrative challenges of its implementation. The Authority could put more efforts into legal education by organising and holding tax legal literacy events, camps, lectures, interactive workshops or crash programs, distributing brochures and pamphlets that impart essential and elementary knowledge of tax laws. Victor Adar spoke to Ekaterina Handa, an expert on Capital Gains Tax, an Advocate of the High Court of Kenya, and a Lecturer at Kenyatta University School of Law, Nairobi.

Is CGT helping or hurting the real estate sector in the country?

The CGT was re-introduced after nearly 30 years of suspension by the Kenyan Parliament as an incentive to grow real estate sector and capital markets. The provisions of Income Tax Act (Cap. 470 of the Laws of Kenya) on CGT were ‘operationalised’ in January last year. Whereas there was vigorous manifest resistance to its reintroduction emanating from different stakeholders, it is still too early to assess its impact on the real estate sector, particularly in terms of revenue production and Kenya’s housing and home ownership markets. This is because, first, there is no accurate empirical data, reflecting sector’s performance for the last one year. Second, CGT was reintroduced at a rate of 5%, which is lower than the rate initially contemplated in 1985 and lower than the withholding corporate tax rate. Third, there are a number of transactions, which comprise statutory exemptions from CGT. The exemptions include transfers of private residences continually occupied by the home-owners for a three year period immediately prior to the transfer, transfers of land by individuals where the value of the land does not exceed Sh30, 000, transfers of agricultural property of less than one hundred acres situated outside a municipality, a gazetted township or an area declared to be an urban area. Last, judging from the KRA’s own admissions, the Authority has been experiencing challenges in implementation of the legislative provision on CGT.

What can be done about this?

Those who resisted the re-introduction of CGT into our taxation system argued that it will discourage and eventually cause exodus of local and foreign investors from Kenya’s real estate market, slow the sector’s growth and impact negatively on investor confidence and trading, jeopardise the country’s position as an attractive investment destination in Africa. Interestingly, the CGT was resisted not only by the directly affected stakeholders such as Kenya Association of Stockbrokers and Investment Banks (KASIB) and medium income earners but also by low income earners, people unlikely to pay it, but who thought that if someday they might need to, then they’d rather not support its introduction. One of the strongest arguments against the reintroduction of CGT was that it will affect the ‘first time’ and ‘young’ home-buyers on the decisions to resell their homes in order to buy bigger and better ones, particularly when such buyers have to take out mortgages to support the new purchase. The argument was also stretched even to the decisions of the ‘older’ homeowners from trading down their big houses and purchasing smaller properties.

What then is its impact to the economy?

The proponents of such notions belonged to the school of thought that property-related taxation plays a huge if not major role in house and home price volatility and sector’s performance. However, inadequate housing supply, absence of government and institutional housing, are partly the underlying causes of both the pricing out of younger households from home ownership and market volatility. This is not taking into consideration changes in financial credit accessibility, credit cost and conditions as well as the impact of inflation on the rising cost and prices of property, all of which factors have to be taken into account when assessing the impact of CGT on Kenya’s real estate sector.

Why are there still unmet needs?

Important to mention that the assessment of performance of CGT and its overall impact, ought not to be done in isolation, observing its impact on the real estate sector alone. There is need to consider the general purposes of tax policies in the country. One of such purposes is income and wealth redistribution, which is achieved through broadening of the tax base. The development and/ or sale of real estate properties (land and buildings) is an economic activity that falls within the purview of rich, wealthy and ultra-wealthy individuals and corporations, whose income, before the reintroduction of CGT was ordinarily subjected to income tax charges albeit without inclusion of huge profits made from real estate transactions. Part of the their income comprising of gains or profits realised upon sale of a capital asset for a price higher than the purchase price or higher than the cost of development was not taxable before reintroduction of CGT in Kenya.

This meant that, unlike employees and corporations, whose entire income is assessable and chargeable to withholding tax, investors’ and real estate developers’ gains on capital assets sales were exempt from tax or fell outside the brackets of Kenya’s taxation system despite their ability to pay and contribute to the country’s revenue generation. This is not to mention that they have an option of computing the CGT then including it into the assets’ price and passing it over to the purchasers as part of the new cost of a capital asset.

Therefore, developers would not be directly affected by the reintroduction of CGT, while the purchasers would because there will be expected general increase in the prices of houses, discouraging some of the potential purchasers from concluding the transactions, and acting as a disincentive to savings. Such situation was perceived not only to be unfair but also inequitable and resulted in speculation activities, which re-introduction of CGT was targeting to curb.

Kenya, for example, abolished taxes on profit that is made from sale of bonds and shares through the NSE late last year.

Has Capital gains tax worked in other countries?

Globally, most asset sales and disposals are liable to CGT. This includes real estate properties and assets sold on the Stock Exchange. In fact Kenya is one of the few jurisdictions that have not been imposing CGT. In comparison with other countries, Kenya’ CGT is not quite a heavy burden. The CGT rate is one of the lowest in the region – Uganda levies capital gains tax at a rate of 30%, South Africa at 40% and Tanzania at 20% on foreigners and 10% on residents. Other low Capital Gains Tax jurisdictions in Africa are Mauritius and Seychelles.

In the UK CGT could range from 18% to 28% for individuals depending on the total amount of taxable income and gains, 28% for trustees or personal representatives and 10% for gains qualifying for entrepreneurs’ relief. In Australia, net gains are taxed at 30% for corporate taxpayers. In India, short term capital gain from assets held for less than 36 months, is taxed at the normal income tax slab rates, while long term capital gain, for assets held for more than 36 months, is taxed at 20%.

What are the advantages of engaging services of a registered company during transactions?

One cannot, strictly speaking, refer to any specific benefits in engaging the services of a registered company in sale of real estate transaction. Unless, perhaps, incorporating a company with capital asset holding, such that when an incorporated entity, a holder of one or more of capital assets, is being sold, acquired or merged with another company together with all assets and liabilities, then the transfer of assets owned by such an entity will not subjected to Capital Gains Tax. This is because incorporated entities or companies fall outside the definition of a capital asset for purposes of income tax law in Kenya Such transactions are referred to as indirect transfers. Individuals sometime incorporate companies and vest asset ownership into such companies, then later on when the assets appreciate, they offer for sale such entities together with all the assets. In addition, in practical terms, inventories such as land or property purchased by corporate entities for business purposes for example premises or land and disposing of the same in one years’ time will accrue no CGT.  This is because inventories do not fall within the definition of a capital asset. One more consideration is that investors’ in real estate and developers’ core business is building houses and selling them. The units they build are reflected in their books of records as stock for sale and not capital assets.  Any gains in the value of houses or stock for sale is captured as part of the income and taxed like any other business income not subject to CGT.

Are buyers and sellers willing to submit the tax to KRA?

In recent years, KRA has done a remarkable job in blocking the legal loopholes open for tax avoidance or evasion. However, enhancement of voluntary taxpayers’ compliance with tax legislations has continued to be a challenge that KRA still experiences. This is based on a number of factors, which include taxpayers’ lack of confidence in taxation system, failure to appreciate the benefits accrued from payment of taxes, lack of transparency on government’s expenditure from collected revenues, high levels of corruption in the country, poor governance systems and arbitrariness of tax imposition amongst other factors.

Therefore, unless the above concerns are addressed, collection of CGT may pose a challenge, mainly because similar to other taxes, it is based on taxpayers’ assessment of gains. Profits on disposal of capital assets are generated in the course of contractual transactions. There is no law that can penetrate privity of contract and by so doing prevent parties to a transaction from taking advantage of contractual privity and ‘under declaring’ realised profits when it comes to keeping of records. Taxpayers’ honesty largely depends on their civic consciousness, which is fed by the factors mentioned above.

And finally please, where do you see the property industry in the next two or three years from now. Is it a hot market?

Real estate has numerous opportunities, while remaining vibrant and relatively strong. Despite challenges such as high cost of credit, inflation, inadequate commuter infrastructure amongst others, the industry will remain stable due to steady growth of Kenya’s middle class and its improved buying capacity, growing expatriate and tourist communities, high housing deficit accompanied by the high demand, no shortage of land as a resource, investment in and expansion of infrastructure  such as transport and telecommunication.

Note! piece is not a formal legal opinion.

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