Compelling case for reduction in tax rate on capital gains

Tanzania is going through an unprecedented period of rapid development and growth, particularly in its major cities. This has led to a significant increase in the value of land which is required to build new factories, expand current cultivation areas and build housing for the increasing population in the major cities and town.

Interestingly, Dar es Salaam was ranked with the highest “opportunity indicator” in a recent PwC report “Into Africa - the continent’s Cities of Opportunity “(http://www.pwc.com/intoafrica). Tanzanian private companies are also the subject of significant interest with investors willing to provide the resources for these companies to expand and grow provided that they can earn an adequate return.

Although the picture looks attractive from an economic perspective, one factor which could deter investment is the current tax treatment of capital gains. Tanzania does not have a separate tax regime for capital gains tax – instead, gains on the disposal of investment assets are taxed by way of income tax. Taxable investment assets include shares and securities in a company, a beneficial interest in a non-resident trust and an interest in land and buildings. However, there are some exemptions such as for shares listed on the Dar es Salaam Stock Exchange.

The income tax rate applicable on the disposal of investments (i.e. the “capital gains tax rate”) is as follows: 30 per cent for disposals made by a company, and 10 per cent and 20 per cent for disposals made by resident and non-resident individuals respectively. Although the original cost of the asset can be deducted in calculating the gain, the Income Tax Act 2004 does not provide indexation allowance (i.e. to adjust for inflation) and therefore a piece of land acquired in 2005 would be deemed to have the same Tanzania shilling value for cost purposes in 2015!

By contrast the predecessor Income Tax Act 1973 provided for an adjustment of the original cost to reflect either inflation or indexation – in practice, the normal approach was to take the US$ value at the time of acquisition and retranslate this based on the exchange rate at the time of disposal so as to arrive at the indexed cost.

The predecessor Income Tax Act 1973 also applied one uniform tax rate in relation to capital gains – namely, 10 per cent whether company or individual, resident or non-resident.

Globally, there is recognition that a high capital gains tax rate can act as a deterrent to transactions, investments and entrepreneurship and thereby indirectly affect growth. Against this background the concern is that a rate of 30 per cent might unduly disadvantage us, particularly in this modern interconnected world where barriers to investment have disappeared and countries compete for investment.

Against this background, we decided at PwC to compare the capital gains tax regimes of the East African member countries (excluding Burundi) as well as with Sub-Sahara Africa’s two largest economies, Nigeria and South Africa, as well as Ghana (an economy with some similarities with us in relation to the extractive sector). Of the six countries compared, four levy a lower capital gains tax rate than the standard corporate and individual income tax rate. Kenya re-introduced capital gains tax this year but at 5 per cent compared to the income tax rate of 30 per cent. Ghana and Nigeria also have lower capital gains tax rates of 15 per cent and 10 per cent respectively (and incidentally a lower income tax rate of 25 per cent and 24 per cent respectively). South Africa taxes capital gains at the same tax rate of income tax, but only 66.6 per cent of the gain is taxable for companies and 33.3 per cent for individuals thereby, in effect applying a lower rate to capital gains.

Only Uganda and Rwanda subject capital gains to the same tax rate as corporate income tax rate but Rwanda is actually considering reducing the rate to 5 per cent. Therefore, unless there is a change made in this year’sBudget, it appears that Tanzania and Uganda will be the only countries in the region to subject capital gains to the same tax rates as corporate income tax. In addition, Tanzania is also the only country that applies different tax rates for individuals and corporations when taxing capital gains.

Arguments from a policy perspective to support a lower rate include ensuring a more equitable tax system. In particular, a lower rate would provide compensation for lack of indexation of the base cost – a particularly pertinent point given the recent significant devaluation of the shilling. In addition, a lower tax rate also recognises that to some extent capital gains tax can have a double taxation impact – for example, profits derived and distributed by a company are already subject to tax by way of corporate tax and dividend withholding tax. Ultimately the key argument must be that the tax system should encourage entrepreneurship, investment and development.

Although this sounds counterintuitive, a lower rate might actually increase tax revenues – in particular, if it results in more transactions being undertaken, then more taxes will be paid. A lower tax rate would also reduce the incentive for non-compliance.

Transactions tend to reflect the health and competitiveness of an economy and ensure that funds are allocated to more beneficial use resulting in economic growth. A lower rate would also improve the investment climate and may attract international capital from venture capitalists and businesses to invest in Tanzania.

Against this background, one matter which could be considered in this year’s Budget is lowering the rate of income tax on capital gains.

Tax Senior Manager, PwC (www.pwc.com/tz) The views expressed do not necessarily represent those of PwC ([email protected])