The Income Tax (Financial Derivatives) Regulations, 2022 came into force on January 1, 2023, following the amendment of Section 3(2) of the Income Tax Act, Cap 470.
While the new law targets users of traditional hedging instruments — options, swaps, futures and forwards, among others — if the definition was not interpreted narrowly, almost all other derivatives would be affected.
This means that Contracts-for-Difference (CFDs), popular with the retail market, will also be affected by the new 15 percent capital gains taxes (CGT).
If this is the case, traders will have to ask themselves whether they still want to trade such products in the future. Will this decrease speculative trading?
Will the law incentivise the use of other assets that require fewer taxes? It’s wait-and-see but a few implications are sure.
Obviously, CGT on trading will be a heavy burden, especially if we take into account the fact that traders are charged with various trading fees - brokers have spread markups, commissions, transaction fees, inactivity fees and swap fees or overnight financing.
And given the nature of speculative trading, CGT will affect returns. Trading strategies will be touched too as CGT becomes due when contracts settle or when they expire — note CFD trades do not own the underlying asset.
Besides, the added primary responsibility for reporting their taxable income takes away focus from the market.
Further, the new tax gives no grounds as to why the “deduction in respect of realised losses” principle does not apply when derivatives trading forms an integral part of one’s investment activity. Knowing the ins and outs of trading tax implications will ensure you are not caught at the last hurdle.
In light of this, some may seek alternatives. Budget investing, commonly known as fractional investing — a scheme that lets you buy slices of shares at an equivalent fraction of the price — is a cost-effective, readily available alternative.
This pathway gives access to almost similar names and markets, both local and international, as found in CFD platforms albeit in a tax-efficient wrapper.
Derivatives at the Nairobi Securities Exchange NEXT’s platform is another alternative — although restricted to a few names.
What’s critical is that the most important goal is trading cost-effectively. But if modifications were to be made to the new law, this would be the ideal scenario; traders would not have to make tax calculations after closing every single winning trade.
Instead, by the end of the tax year, the online FX brokerage company issues the document, which shows the total amount of gains or losses for the year.
Consequently, the trader uses this number to file their tax returns.
From the CFD corner of derivatives, tax revenue may be negligible — 80 percent of CFD traders lose money and brokers know it well.
Hobby traders and gamblers (no big difference between them) will normally show losses, rather than profits, as is the case with most gambling activity. How much this will affect the CFD business is hard to estimate.