Resurrection of Capital Gains Tax (CGT) in Kenya

Government's position

In June 2013, Henry Rotich, cabinet secretary for Kenya’s National Treasury, informed the Budget and Appropriations Committee of the National Assembly that the government had initiated a review of the capital gains tax under the Income Tax Act as part of a plan to reintroduce the CGT, which had been suspended more than 25 years earlier.

The cabinet secretary recently disclosed that the government has firmly committed to the international financial institutions to reintroduce CGT, at least on real estate. 

CGT suspended in 1985

While the charging section for the CGT (section 3(2)(f) of the ITA) is still in force, the operation of the eighth schedule to the ITA, under which capital gains are computed, was suspended in 1985 to spur investment in the capital markets and the real estate sector.

The easiest way to reintroduce the CGT would be to lift the suspension on the eighth schedule to the ITA. Alternatively, the government might introduce new regulations that are in line with current policy but incorporate recent trends in taxation.

Following is an outline of the provisions of the suspended legislation.

Rates of CGT

CGT is levied at the rate of 10 percent of net gains. However, capital gains from marketable securities held by individuals and listed on the securities exchange are taxed at 7.5 percent.

Subsection 3(2)(f) (capital gains) of the ITA is a fallback provision. Income is taxed under subsection 3(2)(f) only if it is not taxable under any other provision of the ITA. 

For example, if a taxpayer is engaged in the trade of buying and selling property, the resulting gains are taxed as business profits under subsection 3(2)(a). Depreciable capital machinery subject to balancing charges or deductions is not subject to CGT.

Who pays CGT?

Corporate and non-corporate persons (individuals and partnerships) both are subject to CGT, as are membership clubs and trade associations. 

The scope for CGT is wider for corporate organizations than individuals, however. For corporate entities, the CGT applies to real property, movable property, goods, money, and rights to property, whether the property is part of the business assets or is held for investment purposes. 

Individuals pay the tax only on gains from real property and marketable securities.

If property is held by trustees, nominees, or liquidators, they have the obligation to account for tax on any gains arising from the transfer of the property.

Subject matter

Land is defined widely to include buildings, standing timber, trees, crops, and land covered by water.

Capital gains are taxed at source. Marketable securities issued by the government, a municipal authority, or government authority are deemed to be situated in the country in which the authority is situated. 

Other marketable securities are deemed to be situated in the country where they are registered or where the principal register is located.

The taxable value for CGT purposes is the transfer value less the adjusted cost. The gain or loss is deemed to be realized at the time of the transfer even if the consideration is paid in installments.

The adjusted cost includes acquisition and construction costs, the cost of enhancing or preserving the value of the property, incidental costs, and the cost of defending title to the property. Incidental costs include legal fees; stamp duty; mortgage costs; and sales, advertising, and valuation costs.

Bad debts incurred in connection with the transfer of property can be deducted against trading income. 

CGT trigger 

A transfer occurs when a property is sold, exchanged, lost, abandoned, surrendered, or given as a gift, whether for consideration or not. There is no transfer if property is used to secure a debt, a company issues its own shares/debentures, or property is transmitted to heirs or is vested by a trustee to the beneficiary.

The tax authority may adjust the transfer price if it is not at arm’s length, if no consideration was paid, or if the consideration cannot be valued. In those cases, the market value is deemed to be the transfer price.

Transfers involving the exchange of properties necessitated by corporate restructuring and reorganizations are exempt from CGT subject to government approval.

Implications

The reintroduction of the CGT will undoubtedly cause investors to look for tax planning alternatives, including the recently introduced real estate investment trust regime and succession planning.

by Starlings Muchiri

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Kenya at 50 years – evolution of the tax system

Kenya celebrated 50 years of independence from British colonial rule on 12 December 2013.

We look at the history of tax developments in the five decades from independence and highlight the areas for further reform.

The independence 60s

At independence, Kenya adopted the colonial legislation, international treaties and agreements that the British Crown had undertaken on behalf of the colony. The tax system comprised of income tax and consumption taxes.

Income tax was administered by the East African Tax Department under the East African High Commission which was formed in 1948.

The East African Income Tax (Management) Act 1952 combined three ordinances governing income tax in the East African countries and laid the basis for administration of income tax. Separate Income Tax Acts for the three East African countries were subsequently enacted in   1953. 

Prior to the introduction of income tax, Africans were subjected to hut and poll tax from 1901 while non-natives resident in Kenya were subjected to graduated personal taxation from 1933.

At independence, the Customs tariff ordinance, 1958 was in force. The colonial government had started charging customs tariff at the port of Mombasa under an agreement between Sultan Mazrui and the British in 1824. The tariff was slightly modified in 1922 to charge Duty at 30% on spirits, tobacco & perfumes, 10% duty on industrial commodities and 20% on other products. 

Excise Duty was collected under the Excise duty Agreements Ordinance. Duty was first introduced on beer in 1923 and on sugar, tea, cigarettes and tobacco in 1931. 

The mixed fortune 70s

In the decade after independence, the Kenyan economy boomed due in part to the green revolution and generous aid and grants from donors. 

The country was however affected by the oil shocks of 1973 and 1979. The government responded with tax changes to reduce the resulting fiscal deficits.

In response to the first oil shock, Kenya replaced the existing consumption taxes with a sales tax in the 1972/3.

The rate of corporate taxes was increased in 1973/4 from 40% to 45% for local companies and from 47.5% to 52 % for foreign companies.

The government introduced Capital Gains Tax on property and marketable securities in 1975 to increase tax revenue.

In addition to the oil shocks, the East African Community (EAC) collapsed in 1977, requiring public money to form corporations and buy out others.

The government responded to the collapse of the EAC and the 1979 oil shock by increasing sales taxes from 10 to 15 per cent and excise duties from 50% to 59%. Personal Income Tax was however decreased from 36% to 29% per cent in response to increasing tax competi­tion in East Africa.

The reformative 80s

In the early 1980s the Kenya economy was still reeling from the economic shocks of the 1970s.

Capital Gains Tax was suspended in 1985 to encourage foreign direct investment and development of the stock exchange.

In the second half of the decade, the country embarked on tax reform, which was part of the Structural Adjustment Programmes   in economic restructuring agreement between the Government of Kenya and the international financial institutions. The government adopted the Tax Modernization Programme (TMP) in 1986 and the Budget Rationalization Programme in 1987.

In the 1980s the personal tax rates were still high. For instance, the top marginal rate of taxation in 1986 and 1989 was 65% and 45%, respectively.

Excise Duty was specific and charged on domestically produced goods.

The dramatic 90s

Early 1990s was politically turbulent, characterised by the clamour for multi-party democracy in Kenya. 

The Berlin wall had fallen on 9 November 1989, signalling the demise of communism and end of the cold war. This marked the end of unconditional aid and grants from donors. In fact bilateral and multilateral donors suspended aid in 1991 to pressure the government to meet its commitments.

Despite the political intrigue, a number of administrative reforms were instituted in the 1990s.

VAT was introduced in 1990 to replace sales tax. VAT had a wider scope and included tax on services. On introduction of VAT, there were 9 rates of ranging from 0% to 150%, with a standard rate of 18%.

At the end of the decade, the VAT rates had been reduced to 4, ranging from 0% to 15%, with a standard rate of 15%.

The EPZs Act was enacted in 1990. The Act gave generous incentives to export oriented manufacturers. Among the incentives available to EPZs were Exemptions from VAT, WHT, Stamp Duties, Import Duties and a 10 year corporation tax holiday followed by CIT at a reduced rate of 25%.

The EPZs Act also provided for manufacture under bond. Manufacturers under bond were exempted from Duty and VAT on imported plant, equipment and raw materials. They were also entitled to 100% investment allowance on PPE. 

In 1991/2 Excise was changed from specific to ad valorem. The scope of excise was expanded to included imports, effectively turning Excise from a tax on domestic production to a tax on consumption.

In 1993, the economy was liberalised. Import licencing requirements and foreign exchange controls were abolished and export compensation was suspended.

The government tried, without much success to reform taxation of the agricultural and informal sectors. Presumptive tax was introduced in 1990, abolished in 1993, reintroduced in 1995 and abolished again in 2000.

A semi-autonomous Kenya Revenue Authority was incorporated in 1995.  KRA amalgamated 5 departments in Ministry of Finance namely: Customs Duty, Excise Duty, Sales Tax, Income Tax and Corporate Tax. Two years later KRA established a special station for large taxpayers (LTO). 

The transition 00s

The first decade of the 21^st century was a transition period. President Moi handed over power to President Kibaki’s NARC team in 2003, after 24 years in power.

The NARC administration put more emphasis in financing the budget through internally collected tax revenues.

The NARC administration accelerated the Tax Modernisation Programme, introducing new tax administration measures, including use of IT. 

The NARC government started with a “gift” of a tax amnesty in 2004. Taxpayers were allowed to declare and pay past taxes without suffering penalties and interest.

The government then introduced Electronic Tax Registers (ETR) in 2005 to enhance VAT Compliance. This move was met with countrywide opposition by traders before gradual acceptance. The SIMBA 2005 system for Customs declaration was also introduced in 2005.

The government gazetted Transfer Pricing regulations in 2006 to prescribe the methods of determining transfer prices between resident companies and related non-resident entities.

The reforms at KRA were largely successful. KRA was awarded the ISO 9001:2001 certification in 2007 and the ISO 9001:2008 certification in 2011.

To keep up with developments in the IT sector, the government introduced provisions for taxation of non-resident providers of bandwidth, satellite and radio communications. The government also prescribed new capital allowances on fibre optic cable and computer software.

Once again in 2006 the government sought to bring the informal sector into the tax net through Turnover Tax (ToT) and Advance Tax.

The government reverted to specific rates of Excise Duty in 2003/4. A hybrid system was adopted for cigarettes.

Regional integration proceeded fast in the decade. The EAC Treaty came into force in 2000. The Customs Union was launched in 2004 and the Common Market in 2010.

VAT standard rate was reduced from 18% at the turn of the decade to 16%. The 16% rate prevailed till the end of the decade. A special rate of 12% was charged on electricity and HFO.

Personal Income Tax brackets were reduced to 5 in number.

The new dawn 10s

The adoption of a new constitution in 2010 was a watershed in public finance management. The 2010 constitution laid down an elaborate framework for public finance management as well as entrenched the right to fair administrative process as a fundamental right.

Section 47 of the constitution entitles a taxpayer to an expeditious, efficient, lawful, reasonable and procedural fair administrative process. Taxpayers have a right to be given written reasons for actions that may affect their tax liabilities adversely.   

The constitution devolved some powers of taxation from the national government to the county governments. The national government was granted a monopoly in imposing income tax, value-added tax, customs duties and other duties on import and export goods and excise tax. The county governments may impose property rates, entertainment taxes and any other tax that may be authorized to impose by Parliament.

The new constitution abolished tax exemptions for public officers. The Income Tax Act, Customs and Excise Act and VAT Acts were amended to remove tax exemptions for the president and other public officers.

A new broad based VAT Act was enacted in 2013 to improve VAT administration and improve VAT tax yields.

In the present decade, the government has identified new sources of tax revenue including excise on mobile money transfer and tax on transfer of rights to oil prospecting blocks.  

KRA has continued with Tax Modernisation measures. The Medium Taxpayers Office (MTO) station, modelled along the lines of the LTO was introduced in 2010 to manage taxpayers making a turnover of KES 350-750 Million. 

KRA is rolling out an integrated system of the registration, filing of returns and payment of tax (iTax).

The government introduced the legal framework to enable KRA to co-operate with other revenue authorities and exchange information on tax revenue matters in 2012.

On tax dispute resolution, the government has introduced a single tribunal to replace the multiple tribunals for income tax and VAT. 

The future

In the 50 years since independence, Kenya has made progressive steps to reform public finance management and the tax system.  There have been notable improvements in the policy framework and tax administration processes.

Going forward, KRA should continue improving tax administration processes and aim at adopting international best practices.

The county governments have been granted taxing powers by the constitution. Most of the counties lack the capacity and expertise to administer tax systems. The national government should assist the county governments to develop capacity to administer taxes at the county level.

The government has largely failed at bringing the informal sector to taxation. Large taxpayers and people in formal employment account for most of the tax collections.  The country should explore economically efficient means of bringing the gray market to taxation.

Substantive taxation of land and wealth has been elusive since the colonial government tried to tax land by enacting the 1908 Crown Land Bill. There is a huge potential for tax revenue collection from property. The government should explore ways and means of taxing the sector.
    

Finally research suggests that tax incentive schemes introduced in the 1990s through the EPZs Act may be harming rather than helping tax collections. The government should reassess the incentives and if possible enact the Special Economic Zones Bill as soon as is practically possible.

by Starlings Muchiri

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