Support for tax grows amidst investors’ jitters

To tax or not to tax; debate on the question taxing capital gains grows even as experts argue the move is long overdue, writes FRANCIS AYIEKO

A few days after Finance Cabinet Secretary Henry Rotich announced that the Government was planning to re-introduce capital gains tax, shares at the Nairobi Securities Exchange dropped to a 14-week low as investors reportedly worried that the tax plans might dim the appeal of equities.

Rotich had told lawmakers in his budget speech on June 13, that there would be a review of the tax, suspended in 1985, to allow the wealthy to make a token contribution to the development of the country.

“The Government has initiated a review of the capital gains tax, under the Income Tax Act, with a view to formulating modalities for its effective enforcement. This will allow wealthier members of our society to also make a token contribution toward our national development agenda,” he said.

Whereas Government officials say it will take sometime for the tax to be implemented, the proposal is causing ripples among developers and other property investors.

They claim it could stifle growth of the real estate sector, which has registered major price increases over the last few years as the country struggles to deal with acute housing shortage in the face of high demand.

Capital gains tax is charged on the profit realised from the sale of an asset that was purchased at a lower price and mainly affects sale of stocks, bonds, precious metals and property.

Suspended in 1985

After suspending capital gains tax in 1985, Kenya tried to re-introduce it in 2006, but the proposal, contained in the 2006/2007, was shot down in Parliament.

The then Finance minister Amos Kimunya, had proposed that property owners be charged a ten per cent tax on the gain arising from the sale of property and buyers are charged three per cent of property value. Stocks were not covered in the Kimunya proposal.

It is still not clear which asset groups will be affected by the tax if introduced.

Tax experts and economists have, since the announcement, come out to support its re-introduction, saying its implementation was in the interest of tax equity and fairness.

“There is absolutely no reason why people who have the capacity to own property should not pay tax, when the poor are actually being taxed through Value Added Tax,” says Michael Mburugu, the director of PKF Taxation Services Ltd.

He added: “I think it is only fair — in fact, it is a moral issue — that those who have property should pay taxes on the profit they make when they sell it. You cannot tax the poor and leave out the rich. The basic principle of taxation is that those who have more should pay taxes and support the poor. It is rich people who own property that are going to be affected by the capital gains tax, not those who live in slums.”

Mburugu says that most countries in the world, including Kenya’s East African neighbours, have capital gains tax. He notes that there is no known economic impact those countries have suffered because of this tax. In fact, he says, they are stable economies because their tax system is very efficient.

South Africa levies a 40 per cent capital gains tax, Uganda 30 per cent, Botswana 25 per cent, Tanzania 20 per cent, Nigeria and Ghana charge ten per cent.

Ashif Kassam, the Group Chief Executive and Managing Partner at audit firm RSM Ashvir, says capital gains is in every country that is developing, and Kenya should be no exception.

“Capital gains tax is in Uganda, Tanzania, South Africa, Rwanda, United Kingdom, Japan…Why not Kenya? More so, the proposal has come at a time when transactions in Kenya are leaning towards capital gains, and so we should introduce it,” he argues.

“We cannot do without capital gains tax because if you look at the oil and gas industries, they are pretty much foreign owned and if they make huge profits in Kenya, why should those gains not be taxed?” he asks.

He says it is important for the Government to be clear on what assets it wants to be subjected to capital gains tax: Is it oil and mining assets, property assets or transaction in shares on the stock exchange?

He explains that the capital gains tax suspended in 1985 was badly written and not workable. In those days, he says, the oil and mining industries were not there; huge property developments were also lacking.

“But now things have changed and it is the right time to introduce it — we need money; where is Kenya going to get Sh1.6 trillion from to fund the budget if you do not tax people?” he wonders.

Fairness

John Mutua, an economist with the Institute of Economic Affairs, says re-introducing capital gains tax would achieve a key taxation principle, which is fairness or equity. “It is unfair to have people making so much money, yet they are not paying taxes on it,” he says.

But why is capital gains tax a major concern in the real estate sector? An argument for capital gains tax is that it helps tame run-away property prices usually driven by speculation.

There appears to be consensus between tax experts and property experts on the validity of this argument.

“The people who really need to worry about capital gains tax are those who buy property to keep for a long time before selling,” says Mburugu of PKF.

Daniel Cheruiyot, Head of Property Valuation at Regent Management Ltd, says capital gains tax, which he describes as “a tax on profits earned from sale of a capital asset that is attributed to price appreciation”, has lately become an important tool used by fast growing cities to encourage land owners to add value to land before sale.

Regulates property prices

“It is also used to mitigate excessive increases in property prices. This is done by ensuring that land that is bought and resold without putting site infrastructure or any form of development is taxed highly,” says Cheruiyot.

He adds: “Land or property bought and resold is taxed in a reducing rate the longer the holding period. This reduces windfall gain from sale of vacant land, discourages speculation, and as a result, property prices increase moderately and more people are able to afford housing.”

In an attempt to encourage home ownership, he notes, some governments tax gains are attributable to land only even when the property is developed. Others exempt owner occupied homes and small parcels of land sold by investment groups or pension funds to members for home development.

“Gains from speculative land transactions should be taxed because it is unfair to tax earned income (wages, rent and business profits), and leave out profits from a resource whose existence and capital gain is not attributed to the ‘investor’ but to God, economic growth and government investments in infrastructure funded by those being taxed. It should be taxed to avoid diversion of a lot of resources from productive investments that create employment to idle land,” he says.

However, he notes that the Government should formulate a tax structure that will not suppress the whole sector. “If capital gains tax is to be reintroduced, it should be done after extensive consultation, public education, and allowance of adequate implementation timelines,” he advises.

Kassam of RSM Ashvir agrees: “Introduce it, but at a “palatable” rate. Do not introduce high rates that lead to disinvestment; it should be below 15 per cent, which is lower than corporation tax.”

He says that unlike before when the tax was introduced with “no consultations”, the Government must this time around consult and come up with a workable solution.

He says the Government will have to consult on how to deal with exploration assets, property and shares.

While announcing that capital gains tax was going to be re-introduced, the Finance Cabinet Secretary noted that there was going to be wide consultations to take into account every aspect or sector of the economy.

“The Government is keen to have it not objected to… they should borrow a leaf from the best system from other countries that have implemented it,” says Mburugu, noting that the hope is that the rates are not going to be very high — less than 30 per cent.

Chinese scenario

Early this year, the Chinese Government announced new 20 per cent tax on profits from housing sales (capital gains tax) in a move aimed at curbing property prices that have for years been spiralling out of control.

Interestingly, this saw divorce filings shoot up in big cities across China, at least on paper, as a way of avoiding the tax. Spouses formed long lines at property bureaus to register to sell their homes before the restrictions went into effect.

According to a study conducted in 2011 at the University of Michigan, the United States, asset price bubble was one of the most important causes of the recent global financial crisis and is still now one of the most serious economic problems faced by some countries such as China.

Study

Titled, Speculative Bubbles and Tax Policy, the study says that in order to curb asset price bubbles, many governments adopted higher capital gains tax and other land related taxes. 

In the early 1990s, for example, Japanese government raised land taxes against speculative bubble in land prices. China, on the other hand, is trying to discourage land bubbles by its land policy including the more extensive usage of existing land related taxes and the introduction of property tax in Shanghai and Chongqing. 

Both of Hong Kong and Singapore introduced new types of stamp duty on residential property transactions (“special stamp duty” and “seller’s stamp duty” respectively) to discourage their land price bubbles. Taiwan also introduced vacant land tax to deal with real estate price bubbles.