Computing capital gains tax is not as straightforward as it seems

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

10 November 2024

On paper, the calculation of Capital Gains Tax (CGT) is simple and straightforward. You start with the selling price of the property, then subtract the following: the purchase price, cost of any improvements made, interest charged by financier and transaction costs. Whatever remains is the net capital gain and is charged 15 per cent tax. Easy!

Thus, if you bought a plot of land for one million shillings, then built a house on it costing Sh2 million and later you sold the house for Sh5 million, the CGT would be calculated as follows: Sh5M – Sh1M – Sh2M = Sh2M. You then subtract transactions costs like, 2.5 per cent of selling price (Sh125,000) for brokers charges and 1.5 percent (Sh75,000) legal fees. This brings the net gain to Sh1.8M. Applying 15 per cent tax rate to this brings the CGT payable to Sh270,000. Simple. Straightforward.

Unfortunately, there are many properties in Kenya whose initial purchase price is not known! The reason being that the people selling are children and grandchildren of the original owners. So, the question is, what value should be used in such a case?

One way of establishing this initial cost is to depreciate the selling price backwards to the purchase date. But what percentage rate is to be applied? Its not a simple problem because vacant land appreciates at different rate from built-up property. However, if it is a building that is on sale, the average for buildings may be applied.

A good and independent indicator is the Kenya Bankers Association Housing Price Index. It is published every three months (since 2013) and the most recent one shows an average appreciation rate of about 2.4 per cent over the last 11 years. Thus, if a property was bought, 20 years ago and it is sold today for Sh10 million, we can estimate its initial purchase price as about Sh6.2 million. The gross capital gain comes to Sh3.8M.

Clearly, these calculations can get rather complicated, in fact, we have just scratched the surface. So, it makes one wonder if there is a way of simplifying it. I think there is: we can do away with CGT altogether and replace it with an enhanced stamp duty. I estimate that increasing the stamp duty rate from the current 4 per cent to 7.5 per cent would be more than enough to recover the revenue lost by abolishing CGT.