Why Kenya’s capital gains tax regime needs a rethink

Last week, the Kenya Revenue Authority (KRA) issued a notice informing the public that with effect from October 1, 2016 all payments for capital gains tax and stamp duty would be automated and paid through its iTax system.

In addition, the payment dates for stamp duty and capital gains tax (CGT) would be simultaneous and would be on or before the application for transfer of the property at the relevant lands office.

The KRA’s public notice seeks to implement a recent amendment to the CGT regime on the payment date which became effective on January 1, 2016.

While the payment of stamp duty and CGT through the online iTax platform is a welcome move by the KRA, there is need to carefully consider the due date for payment of CGT and administrative difficulties related to the computation and payment of CGT.

By way of background, CGT is payable in Kenya at the rate of five per cent on the gain made on disposal of property.

The gain is calculated as the difference between the historical cost at which the property was bought and the price at which the property is sold, having deducted any costs of improvement of the property and any incidental costs incurred on the transfer of the property.

The challenge with the payment date arises with respect to real property. In Kenya, most lawyers adopt and follow the Law Society of Kenya Conditions of Sale when acting on the sale or purchase of real property (with appropriate variations, depending on the circumstances of the case).

Under the said Conditions of Sale, a lawyer acting for a seller of land is required to hold the consideration of purchase price as stakeholder pending registration of the title in favour of the purchaser.

Even where the Conditions of Sale are negotiated and varied, due to the parlous state of the land registries in Kenya coupled with the risk of fake titles and double titles issued on the same property, property purchasers almost always demand that the purchase price is held by the lawyers pending registration of the transfer of the property.

If registration does not occur within a reasonable period of time, the purchaser would have the option to reverse the transaction and require the purchase price to be returned to him by the lawyer acting for the seller.

The issue therefore with the new regulations relating to the date of payment of CGT in Kenya is that a seller is required to pay CGT to the KRA as soon as the application for registration of the transfer of the property is made.

At this stage, the seller has not received the purchase price from the purchaser (since registration has not occurred yet) and would therefore be required to fund the CGT from his or her own pocket.

Difficulties would arise where a seller may not have the funds to pay the CGT and may be waiting to receive the funds from the purchaser in order to pay it.

Another issue to be considered is what happens should registration of the transfer not occur for reasons beyond the seller’s control.

There are many instances in Kenya where files go missing at the lands registry and registration cannot be completed on time.

Should a purchaser seek to reverse the transaction in such a case, what happens to the CGT paid by the seller? Is it refundable by the KRA? Within what period of time is it refundable?

A third issue to be considered is where the purchaser is seeking bank financing to acquire the property. Lending banks usually only allow drawdown of the loan after the transfer of the property and the bank’s security (legal charge) over the property is registered at the land registry.

The seller would therefore be required to fund payment of CGT from his or her own source as he or she will not have access to the sale consideration until the loan drawdown occurs, which is usually a couple of weeks after registration.   

A fourth issue to be considered is the fact the application for registration of the transfer of the property is done by the purchaser, yet the CGT is payable by the seller.

Since the new KRA system requires payment of CGT prior to lodging the documents for transfer, it will be the case that transactions may become delayed where the seller is unable to raise the CGT required.

In other words, a purchaser will have to wait until the seller pays the CGT (from his own sources) prior to lodging the documents for registration at the lands registry.

If the seller takes time in doing so, the purchaser’s registration process will be delayed, slowing down land transactions significantly.

Such delays in completion of land transactions can have a negative impact on economic cycles in the country arising from the general slowdown of property developments.

A fifth issue is that the CGT legislation in Kenya anticipates that a seller who has made a capital loss on one transaction can offset the loss against a future capital gain.

Under the new CGT regulations, it is unclear how a seller who wishes to apply a prior capital loss against a current capital gain will provide evidence through the iTax system to the satisfaction of the KRA.

The procedural difficulties of applying such a loss would delay a transaction or prevent a seller from taking advantage of such a prior loss.

Similarly, it appears impossible for a seller who anticipates making a capital gain on a sale, say in January, and a capital loss on a sale, say in April of the same year, to not pay CGT on the earlier sale on the basis of the capital loss to be suffered in the course of the same year.

This is all coupled with the fact that the CGT regime in Kenya is already quite draconian in that CGT is payable on “paper gains”. Price indexation or inflationary price adjustments which exist in other parts of the world are not provided for under Kenya’s CGT regime.

To illustrate this point, imagine if you bought a piece of house in Nairobi’s South B area in 1983 for Sh350,000.  You intend to sell the same house today for Sh23,500,000.

CGT would be computed on the gain of Sh23 million and will not take into consideration the impact of inflation over the years on the current price of the property.

In reality, the cost should be adjusted for inflation, as is the case in other countries which have an efficient CGT regime, to ensure that CGT is not paid on paper gains.

Furthermore, all amounts which a taxpayer seeks to deduct against the selling price (including the historical cost and any improvements) must be proved by documentary evidence.

A taxpayer who improved a building in the 1980s would be most unlikely to have the receipts available almost 30 years later and such costs would therefore be liable to being disallowed. 

The new system will therefore be fraught with implementation and administrative difficulties.

Perhaps the KRA should have considered a system similar to the United Kingdom where CGT is due at the end of a tax year, which allows a person to aggregate all the capital gains and capital losses made in the year and to determine the CGT position thereafter.

Alternatively, the KRA and the Treasury could consider changing the law to provide that the due date for CGT falls no more than 20 days after effective registration of the property at the lands registry.

Such a system would not interfere with the property registration arrangements currently in place in Kenya.

Of course, it is possible that the sellers will going forward insist either that purchasers bear all costs (including stamp duty and CGT) or that the purchasers bear the registration risk and release part of the consideration required by the seller to pay CGT prior to registration.

This will make the cost of property purchase in Kenya, which is already very high, increase further and lock out millions of Kenyans from the property market.

We would hope that in the coming weeks the KRA and the Treasury will consider these issues carefully and act in the best interests of Kenyans.

Ngumy and Devani are Partners with the Kenyan law firm, Anjarwalla & Khanna.