Taxation affects how much developers and home purchasers borrow for real estate projects.
Kenyan tax laws are amended almost every financial year contrary to the country’s draft National Tax Policy, which stipulates that a comprehensive review of such regulations should be done after every five years.
Keen on netting more revenue to pay off the country’s ballooning domestic and foreign debt, as well as finance ambitious projects, both the current and previous regimes have been revising these laws to widen tax bases.
Key private sector actors including the Kenya Property Developers Association (KPDA), Kenya Association of Manufacturers (KAM) and the Kenya Private Sector Alliance (KEPSA), have long held that these frequent revisions affect investment decisions.
“Taxation affects where investors locate their projects, with investors often preferring to stake their money in jurisdictions that guarantee recovery within a given timeline,” says Fredrick Ogutu, a senior associate at Bowmans a legal services firm.
Similarly, taxation affects how much developers and home purchasers borrow for real estate projects, as well as how much financial institutions lend towards real estate projects.
“Due to the tax implications, it has become very unattractive to lend to real estate, with the sector leading in non-performing loans according to Central Bank of Kenya data,” says Ogutu.
As an alternative source of capital, many developers have turned to foreign investors, who lend either in the form of debt, where loans are repaid with interest, or equity, where they acquire shares in projects.
This capital is subjected to taxation when it is recovered, thus the success of this form of financing too is tied to how favourable tax policies are, as this is something investors will always consider prior to making decisions.
“If the capital is recovered via dividends, the implication is on withholding tax on dividends, if it is via loans, there is the issue of interest expense restriction, that affects the operating entity in Kenya, who can only deduct interest expenses of up to 30 per cent when paying interest to a non-resident lender,” says Ogutu.
According to the lawyer, frequent revision of tax laws not only stalls investment decisions, but also makes tax compliance harder, ultimately affecting government revenues and thus inhibiting economic growth.
For instance, when the Capital Gains Tax (CGT) was increased from five per cent to 15 per cent in the Finance Act, 2022, tax revenues from real estate and private share transactions fell from Sh3.76 billion in the first quarter of 2022, to Sh3.28 billion in the first quarter of 2023, according to data from the National Treasury.
CGT is a tax charged on profits made after someone sells or transfers property such as land or shares. Between 1985 to 2014, property sales were not subject to Capital Gains tax in Kenya.
This was done deliberately to spur investments from both local and international investors in the country’s real estate sector, as well as the capital markets.
As the government sought to widen the tax base in order to meet growing expenditure, the CGT tax was reintroduced in Kenya through the Finance Act, 2014 at the rate of five per cent. The tax was later increased to 15 per cent in the Finance Act, 2022, amid protestats from industry stakeholders such as KPDA, who claimed that the marked rise would cause a decline in the sale of property, ultimately resulting in stagnation of the real estate market.
The KPDA urged the government to consider increasing it gradually to 10 per cent, basing their argument on the absence of a mechanism in Kenya to address inflation adjustment in relation to the increased CGT rate.
Additionally, the KPDA expressed concerns that the higher CGT rate would negatively affect Kenya’s competitiveness as an economic hub and as a desirable investment destination.
“The justification the government gave for increasing the CGT was that we needed to be at par with the other East African jurisdictions, but what they did not bear in mind was the issue of indexation and inflation over the period that the property has been held,” says Ogutu.
Veronicah Ndegwa, a senior research analyst on Policy and Public Debt at the Institute of Public Finance, says if tax laws are to be revised, then a periodic review should only be in response to emerging trends such as emergencies, pandemics, or natural disasters.
At the same time, the government should set a definite timeline for a new tax provision to be operational before it is reviewed, especially for tax incentives targeted at promoting investments as proposed in the draft National Tax Policy. “While one might argue that this may lock-in ‘bad’ tax policies, the chances of having a bad tax policy will be significantly reduced if the government conducts thorough impact analysis before proposing tax changes,” says Ndegwa.
There should also be citizen engagement before any amendment of tax laws, to identify the impact that proposed changes could have on revenue collection, investment, employment and economic growth.
“The government should adopt a collaborative approach to tax policy design involving the Finance ministry, tax authority, and external stakeholders,” says Ndegwa.
Wangoi Karuga, a partner at MAK and Partners Advocates, adds that considering the views of stakeholders in formation of tax policies will reduce incessant court battles that have been witnessed over the past two years, costing the parties involved time and money.
“No one wants a situation where because of protracted court disputes, developments get stalled, property loses value, money remains locked in investments and nobody in the transaction gets anything,” says Wangoi.
Just recently, in a ruling delivered on 31 July 2024, the Kenyan Court of Appeal declared the Finance Act 2023 unconstitutional, on grounds that the process leading to its enactment was fundamentally flawed and in violation of the Constitution.
What this would imply is that from the day of the ruling, taxpayers would refer to the Finance Act 2022 while meeting their financial obligations to the government.
Since legislative enactments enjoy presumption of constitutionality up to the moment, they are found to be unconstitutional, the Court of Appeal instructed those actions taken under the Finance Act, 2023 up to the date of delivery of their judgment remain valid.
Taxes in the Finance Act, 2022 that would be enforceable include the Value Added Tax on transfer of business as a going concern. If one were to sell a building such as a hotel as a commercial asset, a 16 per cent VAT would be chargeable on the transaction.
“The same would, however, not apply if the sale was made through shares, as the sale of shares is exempt from VAT,” says Wangoi.
At the time of acquiring such assets, buyers will be required to not only fund the agreed price but the VAT cost as well which at 16 per cent represents a significant portion of the purchase price.
“Assuming one is buying a hotel building for Sh500 million, recovering a 16 per cent VAT on top of such an amount could take years and this could pose cash flow challenges for the buyer,” says Wangoi.
New taxes that had been introduced in the Finance Act, 2023, that would be unenforceable going forward include the indirect capital gains tax and the export promotion levy that impacted the importation of certain construction materials.
However, with the National Treasury having expressed intent to appeal the decision of the Court of Appeal at the Supreme Court, citing the impact that the decision will have on the economy, it became unclear which Act Kenyans should refer to.
“It is a tricky situation for a country to be in. If the Supreme Court overturns the Court of Appeal ruling and upholds that the finance act was constitutional, does their decision apply from the 31st which is the day the Court of Appeal ruling was made, or from the time the Supreme Court makes its ruling?” posits Wangoi.
In the past, when a higher court has overturned the decision of a lower court, the Kenya Revenue Authority’s interpretation has often been that, even in that period when there was uncertainty, the overruled Act was still in place.
This was the case when the housing levy was introduced in the Finance Act 2023. After the levy was challenged at the High Court, the court ruled that the levy was unconstitutional.
This was on the basis that it did not have a comprehensive legal framework and was discriminatory against persons in formal employment, since it excluded non-formal income earners.
However, KRA continued to implement the levy, creating a lot of confusion amongst accountants, tax auditors, lawyers and their clients as to which positions to take on it.
“We are all alive to the positions that KRA has been taking during such uncertainties. Not that they are right in taking these positions because you could actually challenge their legality,” says Alex Kanyi, a partner at Kieti Law.
But then again, depending on one’s risk appetite, Alex points out that this is something one would have to think about and in many cases, the lawyer recommends that perhaps it would be wiser to take a conservative approach.
“The penalties for failing to abide by tax laws can be severe, yet KRA has become more aggressive in trying to expand the tax bracket. It’s important for businesses to know how to deal with the taxman, be aware of tax procedures and meet their obligations,” urges Kanyi.
If for instance you as the seller of a property indicate that the selling price is inclusive of VAT, then once the buyer agrees to purchase at your price and pays the full amount, then you ought to declare that VAT to the government.
“Sometimes you may be tempted to use the inclusive of VAT phrase as a selling point, but if you fail to declare the VAT, then you will likely face some penalties,” notes Kanyi.
Similarly, if for example a contractor does some work for you and charges a contractor’s fee of a certain amount, the government will expect that when you pay this contractor, you withhold tax at the rate of five percent, if the contractor is a resident.
“When you fail to do that and pay the contractor 100 per cent, the government is right to come back to you and say that you have an obligation to actually withhold tax on this contractual fee which you have failed to do,” says Kanyi.
With uncertainties around tax laws persisting, Alex notes that developers could capitalise on instruments such as the Special Economic Zones (SEZs) that offer favourable incentives for investment.
While developers operating outside SEZs pay corporate tax at the rate of 30 per cent, under the SEZ Act, developers of more than 100 low-cost residential units pay corporate tax at 15 per cent.
Real Estate Investment Trusts (REITs) are also a viable investment option, with government incentives such as tax exemptions on dividends and reduced corporate tax rates, lowering the costs associated with property acquisitions.
“Listed REITs are exempt from income tax except for payment of withholding tax on interest income and dividends. Equally, REITs are exempt from stamp duty, value added tax and capital gains tax in some instances,” says Kanyi.
