Why capital gains tax doesn’t bode well for unquoted market
Taxes collected from financial deals arising from the transfer of real estate and shares in privately-held firms posted a double-digit fall in the third quarter of the current financial year. FILE PHOTO | SHUTTERSTOCK
Some things don’t work well together; water and oil, Arsenal and trophies, Slay queens and a tight budget, politicians and answering questions, markets and, of course, taxes.
On the latter, it is the recent hike in capital gains tax (CGT) which is most unwelcome.
The Finance Act 2022, which increased the CGT from five percent to 15 percent and has been in effect since the 1st of January 2023, does not bode well for the unquoted market.
To add unnecessary friction to this moribund market only steepens the illiquidity discount. But why is CGT easily the most hated tax?
First off, the overriding issue is tax capitalisation - in which the cost of capital for companies increases if the capital gains tax rate increases - comes from the blow that tax hikes deal to investors’ cash flows.
Simply, when CGT goes up, a larger portion of investors profits is diverted to the government, which decreases the investors expected cash flows.
To compensate for this decrease, investors demand a higher expected rate of return from firms.
In addition, as these companies may still face CGT in the normal course of the business, investors take a hit twice albeit indirectly.
Under the new Act, the rate of CGT for the transfer of real property (land and buildings) is applicable to the net gain made on such transfers and is accounted for by the transferor.
Moreover, being a transaction based tax, investors will have the additional task of paying CGT not later than the 20th day of the month following that in which the transfer was made.
Considering the above, I would suggest investors using the unquoted platform qualify for capital gains tax relief under some scheme as a way to spur investment in small and medium enterprises.
Why? A simple reason is that unlisted companies are not obliged to pay dividends to shareholders or if they do, they may be infrequent.
Instead, many are likely to choose to reinvest profits in the business to facilitate further growth. This means, for the length of their investment, investors have only capital gains to monetise their investment.
To “eat into” this vital cash flow is, therefore, a major disincentive. Hence, my traditional view stands that raising CGT hurts unquoted firms more than it benefits the government.
The bottom-line; the unquoted platform, which targets mainly small companies but with ambitious plans for rapid growth, cannot bear the CGT burden.
Conversely, it needs all the support it can get now to take it to the next level.
As companies on it are likely to be considered high-risk by traditional financial institutions, having a favourable tax treatment will be essential to attract (and keep) investors.
For the average investor has a simple goal: to maximise his/her returns. Any more hurdles erected towards this goal will not mix well with the market.
PAYE Tax Calculator
Note: The results are not exact but very close to the actual.
