Following an amendment in the 2014 Finance Act, Kenya reinstated capital gains tax (CGT) with effect from 1 January 2015. CGT was originally introduced in 1975 in the Eighth Schedule to the Income Tax Act, but suspended in 1985 as an incentive to attract investment in mining, real estate and the stock exchange.
With the Nairobi Securities Exchange ranked as the second best performing stock exchange in Africa in 2013, a booming property market and the recent discovery of mineral, oil and gas deposits, the government concluded that these industries no longer require incentivising. It is estimated that CGT could raise up to USD85 million per year, which would contribute to subsidising ever increasing recurrent and development expenditure (Kenya reported a USD2 billion budget deficit in 2014).
CGT is to be levied at the rate of 5% on gains accruing to a company or individual on or after 1 January 2015 on the transfer of property situated in Kenya. ‘Property’ is widely defined and includes land, buildings and marketable securities (listed and unlisted shares).
A transfer is deemed to take 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.
The tax is calculated on the amount by which the transfer value (the value of the consideration or market value in the case of related party transactions) exceeds the ‘adjusted cost’ of property, which is defined as acquisition costs and costs subsequently incurred to enhance or preserve the property, provided such costs had not been deductible for tax purposes previously.
Incidental costs (including stamp duty, legal fees, advertising cost and 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) are deductible in determining the transfer value of property.
Capital losses are deductible against capital gains in the year the losses are made and any excess loss may be carried forward for a period of four years.
Although the CGT rate is one of the lowest in the region – Uganda levies capital gains tax at a rate of 30% and Tanzania at 20% on foreigners and 10% on residents – some uncertainty surrounds the introduction of the tax.
While the Finance Act 2014 provides for a CGT rate of 5%, the Eighth Schedule in Part II provides for a 7.5% rate on gains from investment shares (shares listed on the Nairobi stock exchange). The KRA has been referring to the 5% in recent public notices, which seems to be the accepted rate.
The transferor has the responsibility of proving the acquisition cost of property, which may be problematic where property has been owned for an extended period (in terms of the Income Tax Act, records are required to be retained only for a period of 10 years). In instances where this information is not available, the amount of the consideration for acquiring the property shall be deemed to be equal to the market value of the property at the time of the acquisition or to the amount of consideration used in computing stamp duty payable on the transfer by which the property was acquired, whichever is the lesser.
No general provision is made for the indexing of adjusted costs, which means that a significant gain may arise purely as a result of inflation. The adjusted cost of shares was originally defined as the market price at which the shares could have been purchased at arm’s length for shares acquired before 13 June 1975 and the value of consideration for shares acquired on or after 13 June 1975. However, the CGT Guidelines issued by the KRA as a public notice in January 2015, indicates that, where shares were acquired during the period until 2004, the acquisition cost of shares shall be the highest price of those shares in the year they were acquired, as obtained from the Nairobi Securities Exchange and for securities acquired from 2005, the acquisition cost will be the actual cost as per the Central Depository System (CDS) account statement. Where a pool of securities acquired at different dates and at different prices are sold, the adjusted cost will be computed on a first-in-first-out (FIFO) basis. PwC Kenya has expressed uncertainty regarding the legal enforceability of the public notice, as such substantive amendments to legislation must typically be passed through an Act of Parliament.
Although the KRA Guidelines confirm that CGT is a transaction-based tax payable by the transferor upon the transfer of property by no later than the 20th of the month following the transfer, for investment shares the responsibility to collect and account for the tax will be on stockbrokers, who should ensure that CGT is withheld/collected before releasing the sale proceeds to their clients. This places a significant compliance burden on stockbrokers, which may require system upgrades and result in significant administration costs, especially where historical documents are required to determine the acquisition cost. The Eighth Schedule onerously provides that a stockbroker who fails to collect and remit the tax shall be jointly and severally liable with the transferor for the payment of tax.
The Kenya Association of Stockbrokers and Investment Banks (KASIB) raised concerns that the tax will be discouraging to existing and potential investors and that the Nairobi Securities Exchange will lose its competitive edge as a result, while others are of the view that the relatively low tax rate will ensure a minimal effect. The longer term implications of the reintroduction of CGT on the Kenyan economy will only be revealed in due course.