Introduction
Capital Gains Tax (CGT) is a critical consideration when transferring ownership of assets such as property, stocks, or investments. In Kenya, CGT is levied at 15% on the profit (capital gain) earned from the disposal of an asset. Understanding how to accurately compute this tax ensures compliance and avoids disputes with the Kenya Revenue Authority (KRA). This guide provides a clear breakdown of CGT calculations, supported by a recent legal case, and offers actionable recommendations for taxpayers.
Key Concepts in Capital Gains Tax
- Capital Gain vs. Transfer Value
- Capital Gain: The profit realized when the transfer value (sale price) of an asset exceeds its adjusted cost (acquisition cost plus allowable expenses).
- Transfer Value: The consideration received for the asset upon disposal.
- Adjusted Cost: The original purchase price plus any additional costs incurred to acquire, improve, or sell the asset (e.g., legal fees, valuation costs).
- CGT Rate in Kenya
- Fixed at 15% of the net gain, as per the Eighth Schedule of the Income Tax Act.
- Determining Gain or Loss
- Gain: Transfer Value > Adjusted Cost → Taxable at 15%.
- Loss: Adjusted Cost > Transfer Value → No CGT liability.
- Computation of CGT in Kenya
Capital Gains Tax= 15%*(Transfer Value – Adjusted Cost)
Case Study: Commissioner of Domestic Taxes v Shah & 2 others (Income Tax Appeal 054 of 2023)
- Shah & 2 others are beneficiaries of inherited properties.
- Shah & 2 others disposed of the properties by way of sale and filed a loss made on the disposal hence not qualified to pay capital gains tax.
- KRA disagreed with the capital gains tax return filed by Shah and the two others. They asked them to revise it, arguing that the claimed loss on the property sale was incorrect and that the allowable costs used to calculate the tax were inaccurate.
- KRA made an additional assessment on the adjustment costs incurred by Shah & 2 others that resulted in a gain in the disposal of the properties.
- The Tax Appeals Tribunal (TAT) ruled that KRA was wrong to reject the acquisition costs when calculating the capital gains tax and also made a mistake by approving the extra tax demand.
- The TAT found that Shah & 2 others correctly applied the fair market value of the Properties as at the time of the acquisition by the legatees as the cost basis of applying the adjustment of costs for the determination of the CGT payable.
- Dissatisfied with the entire decision by the Tribunal’s, KRA appealed the matter to the High Court.
KRA’s Argument
- The Tribunal erred in law by failing to exhaustively consider the provisions of the Eighth Schedule of the Income Tax Act which defines what a transfer constitutes for tax purposes;
- The Tribunal erred in interpreting the provisions of the Eighth Schedule of the Income Tax Act by finding that the transaction squarely fell within its ambit;
- The Tribunal erred by misconstruing the interpretation of ‘related persons’ as used in the Eighth Schedule of the Income Tax Act;
- The Tribunal erred in law when adopting the market value as determined by the independent valuer for purposes of determining the cost of acquisition; and
- The Tribunal erred in faulting KRA for disallowing the acquisition cost which was a book entry and not an actual expense incurred in the adjustment of costs for determination of CGT.
Shah & 2 Others’ Argument
- The first transaction where the property was transferred to by assent was exempt from CGT.
- The second transfer having resulted in a loss was also exempt as no gain was realised.
- That a loss of Kshs.99,485,087/= was realised on the second transfer taking into account the purchase price and the adjusted costs on the two properties in question.
- The Tribunal’s decision was proper and founded in law.
High Court’s Decision
- The High Court agreed with the findings of the Tribunal.
- The High Court found that KRA was erroneous in disallowing the acquisition costs in the adjustment of costs for determination of CGT and fell in error in confirming the additional assessment thereby issuing an erroneous objection.
- The High Court found that the adjustment costs applied by the Shah & 2 others to determine the CGT payable are allowable.
- The High Court upheld the decision issued by the Tribunal.
Conclusion
- It is imperative and in the best interests of taxpayers to gain an understanding of relevant taxes they are liable to when carrying out various transactions.
- When calculating capital gains tax in the transfer of assets, taxpayers need to consult professionals that will aid in ascertaining the correct value they are liable to if any.
- Taxpayers need to be careful with amendments to capital gain returns made by KRA that tend to dispute the return filed.
Common Pitfalls & How to Avoid Them
- Underreporting Costs: Ensure all allowable expenses are documented.
- Overlooking Exemptions: Transfers like inheritance may be exempt; verify with the Income Tax Act.
- Disputes with KRA:
- Retain valuation reports and legal agreements.
- Object to disputed assessments within 30 days.
- Document Everything: Keep receipts, contracts, and valuation reports for at least 5 years.
- Challenge Unfair Assessments: If KRA amends your return, provide evidence to support your filing.
Recommendation
- When filing capital gain returns, taxpayers need to include all relevant costs incurred and revenues gained in the transfer of the asset.
- In the event where the CGT return is amended by tax authorities, taxpayers need to back the CGT return filed with the necessary documentation.
- Reach out to us on info@intelpointconsulting.com for any tax issues you may be having.