Indexation in capital gains tax is necessary


The tripling of taxes on the transfer of real estate and shares in privately-held firms failed to lift government collections. PHOTO | SHUTTERSTOCK

The Treasury’s move to triple the capital gains tax without excluding the impact of inflation is punitive to investors.

Kenya will from January 1 increase the capital gains tax on the sale of land, houses and unquoted shares to 15 percent from five percent, hitting real estate investments and private equity deals.

This will lead to reduced income by people selling land, buildings and company shares outside the Nairobi Securities Exchange as well as intangible assets such as software and business goodwill.

We understand that the property levy is supposed to help widen the tax base, and help the Treasury cut its appetite for debts in the middle of the push to cut expenditures.

The tax is paid on the gain – or profit – investors make after excluding costs associated with the property such as upgrade, legal fees and mortgage interests and not the value of the asset itself.

But the low side of the capital gains tax is the lack of indexation allowance to take care of gains due to inflation.

Often, the market value of an asset increases over time such that when disposed of, a capital gain is realised.

However, the reality is that when the value of an asset increases, only a fraction of the increase is due to actual appreciation of the asset.

The rest of the increase is attributable to inflation.

A tax on the entire gain without isolating the two sources of increase in the property value means that the taxman imposes tax on inflation, which is punitive on the investor. The Treasury should have considered adopting an indexation adjustment as a methodology in determining the fair value to tax in line with global practice.