IPO investors set to lose big in capital gains tax

Investors who bought shares in the wave of the initial public offerings (IPOs) that started with the 2006 KenGen listing are set to be the hardest hit by the new capital gains tax due to the huge price gains the stocks have recorded, an analysis of market data shows.  

The investors who bought shares of some of the companies listed on the Nairobi Securities Exchange (NSE) over the past decade have seen the value of their stocks appreciate by up to three-fold, making them potentially the biggest losers should they decide to sell now that the five per cent capital gains tax has come into effect. 

The biggest gaining stocks in this category include Safaricom, Co-operative Bank, Britam and ScanGroup, which have risen 179 per cent, 99 per cent, 222 per cent and 330.6 per cent since their respective listing dates. 

Wednesday Treasury Secretary Henry Rotich maintained that the new tax, which is applicable on sales of shares, treasuries, property and private equity will not be suspended and instead advised stockbrokers to address challenges they are facing in collecting the levy with the Kenya Revenue Authority (KRA).

“We are still concerned that many areas have not been clarified, especially the issue of the base rate or year,” said NSE chairman Eddy Njoroge Wednesday during the listing of Uchumi rights issue shares, in an apparent reference to the investors’ fears. “This uncertainty is likely to drive many potential investors away.”

READ: Experts push for share taxes cut to boost economy

A majority of the over 2.3 million shareholders at the NSE entered the stock market through successive IPOs that transformed the face of the bourse, starting with the 2006 KenGen offer that on its own attracted 275,041 new investors.

The popularity of stock market investing peaked two years later when the government sold 25 per cent of its shares in Safaricom to the public, attracting more than one million new investors to the Nairobi bourse.

Other IPOs that attracted big numbers of investors were the 2006 Eveready and ScanGroup offers. Of the 19 companies that have listed at the NSE since 2005, 11 have recorded gains in their share value above the IPO price.

Investors whose shares have been split since listing, such as Equity Bank, will have as their reference price the cost they originally paid for the shares, given that a split also brings about a price dilution equivalent to the split ratio.

Equity Bank, which came into the market by introduction in 2006 with 90.5 million shares at a price of Sh90, split its shares tenfold in 2009. This means that Equity’s current market price of Sh50 is likely to be treated as Sh500 for purposes of the tax (a multiple of 10), or in the converse the introduction price of Sh90 is likely to be divided by 10, giving an equivalent acquisition cost of Sh9 per share.

The lender had also issued 200 million new bonus shares in 2007, and now has 3.7 billion issued shares.

“I don’t see the share splits as a problem. The price is not really the focus. We are looking at the consideration, that is the overall difference between what you paid and what you are getting on selling the shares,” said KRA commissioner-general John Njiraini Wednesday.

Safaricom, which has the largest number of investors at the NSE, has seen a gain of 179 per cent on its Sh5 IPO price, with the company providing the largest pool of investors who will be affected by the tax.

The biggest gain is by Scangroup investors, whose shares have risen 330 per cent in value from a listing price of Sh10.45 to Sh45 apiece.

This means that if an investor bought 10,000 Scangroup shares during the IPO worth Sh104,500, selling today would result in a tax of about Sh17,275 arising from the capital gain of Sh345,500.

Liberty Holdings, which listed at Sh6.15 in 2011, has a gain of 278 per cent to Sh23.25, with Britam up 222 per cent on its IPO price of Sh9 a share and CIC Insurance up 181 per cent on its IPO price of Sh3.50.

The overall investor wealth at the NSE has gone up by 220 per cent since 2006 to Sh2.3 trillion from Sh719 billion, with the market attracting inflows due to the high return potential compared to other investment classes that have seen more modest gains.

READ: NSE turnover more than triples as capital gains tax nears

Aware of the potential hit on the trading activity of the investors, the NSE has called for more dialogue on the issue of the base rate of the capital gains tax.

The bourse and stockbrokers will present their views on the tax on Monday in a stakeholders meeting called by Mr Rotich, the Treasury secretary.

READ: Why brokers want KRA to suspend capital gains tax

However, any potential changes to the law would only come through a subsequent amendment through a finance Bill.

Under the KRA guidelines for the tax, all the shares bought from January 2005 onwards will have as a reference price their actual cost recorded as per the CDSC records.

For shares bought between January 1998 and December 2004, when there was no electronic share depository at the NSE, the reference price will be taken as the highest price achieved by the share in the year of purchase.

Shares bought prior to 1998 will be referenced on the highest price the counter achieved in 1998.

Where shares acquired at different dates and at different prices are sold, the adjusted cost will be computed on a First in – First out (FIFO) basis.

One of the queries raised by analysts on the new regulations concerns the handling of IPO shares brought into the NSE by the original owners of companies, on whether they will have the listing price as a reference or based on the capital injected by the founder of the business.

KRA deputy commissioner at the policy unit James Ojee said that on such cases the KRA commissioner will give guidelines on a case by case basis.

In many new listings, especially those done through introduction, the founders carry over their previous shareholding into the market, for example the 85 per cent held by Flame Tree Group founder Heril Bangera and Longhorn’s Francis Nyammo who has a 34.89 per cent shareholding in the publisher.

“The guidelines are not detailed enough to cover all the scenarios. Other jurisdictions that have these regulations have a lot more detail on the regulations.

However, a share is an asset like any other so they may look at the initial cost of investment in such a case,” said Standard Investment Bank analyst Eric Musau.