How Capital Gains Tax will affect your shares

As Kenyans celebrate the New Year on 1 January, 2015, the Nairobi Securities Exchange will be taking yet another step in its long journey to the peak of world capital markets. GRAPHIC | NATION 

In Summary

• Starting Friday, 2 January, investors at the bourse will begin to pay 5 per cent tax when they sell shares and make a profit.
• According to the Kenya Association of Stockbrokers and Investment Banks (KASIB), the tax will be discouraging to existing and potential investors. Prominent among KASIB’s worries is that the Nairobi Securities Exchange will lose its competitive edge.
• The Treasury and KRA are yet to come up with a schedule on how the re-introduced tax will be calculated.

By KINUTHIA MBURU
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As Kenyans celebrate the New Year on 1 January, 2015, the Nairobi Securities Exchange will be taking yet another step in its long journey to the peak of world capital markets.

Starting midnight on that Thursday, the NSE is to implement the newly assented capital gains tax. Consequently, starting Friday, 2 January, investors at the bourse will begin to pay 5 per cent tax when they sell shares and make a profit.

This new tax will be in addition to the transaction fees usually charged by stockbrokers to buy and sell shares at the stock market. Why? you may ask. Well, the new levy, dubbed capital gains tax (CGT), was approved in the Finance Bill 2014 in late August this year and assented to by President Uhuru Kenyatta on 14 September. It is estimated that the tax will earn the Kenya Revenue Authority (KRA) Sh7.5 billion annually.

CAPITAL GAINS

It is not only investors at the NSE who will be affected. According to the Act, a firm acquiring more than 50 per cent stake in mineral blocks will pay a premium tax. 

Value of the transaction

“This tax is technically referred to as net gain tax and will be paid on the value of the transaction after deducting attendant charges,” explains Mr Ndindi Nyoro, the executive director of Investax Capital, a Standard Bank Group affiliate.

The law states further: “Subject to this schedule, income in respect of which tax is chargeable under section 3(2) (f) is the whole of a gain which accrues to a company or an individual on or after 1 January, 2015, on the transfer of property situated in Kenya, whether or not the property was acquired before January 1, 2015.”

The Capital Gains Tax is making a comeback after its suspension in 1985. According to Mr Eric Munywoki, a research analyst at Old Mutual Securities, the tax was suspended in an effort to spur growth in the real estate market and deepen local participation in the capital markets.

The effect the tax law could have on the Nairobi Securities Exchange was first felt last year when plans for its reintroduction were announced in the June 2013 budget. Investors’ wealth depreciated as share prices at the local bourse marched south due to fears that the tax would erode the NSE’s general profitability stature.

The Kenyan shilling also took a nosedive amid concerns that the effects on the NSE would trickle down to the general economy.

Although the goals that led to the suspension of the law in 1985 may appear to have been realised with the NSE now ranked among the top five bourses in Africa and the country climbing to middle income status, its reintroduction have begged the question whether it was necessary.

According to Aly Khan Satchu, the chief executive officer at Rich Management, “It was not necessary. As a country, I think we have gone a little stir crazy on the taxation side.”

According to an Old Mutual Securities paper titled Reintroduction of ‘Red hot’ Capital Gains Tax prepared by Mr Munywoki, the tax should have been much lower. 

MORE INCENTIVES

“Given the need to grow our economy in the long term, the long-term capital gains need to be taxed at a lower rate than short-term gains in order to provide more incentive to invest in firms that build the economy, rather than trying to make quick profits by speculating on stocks,” says the paper.

Evidently, although all investment analysts agree that the new tax will scare investors from the NSE, there have been differences on whether the tax is a mere scarecrow, or the effects will be majorly felt.

According to the Kenya Association of Stockbrokers and Investment Banks (KASIB), the tax will be discouraging to existing and potential investors. Prominent among KASIB’s worries is that the Nairobi Securities Exchange will lose its competitive edge.

“Nigeria has a 10 per cent Capital Gains Tax, but the capital markets are excluded,” said Mr Willie Njoroge, the chief executive officer at KASIB.

But, according to Dyer and Blair Investment Bank, the tax is going to be non-consequential.

“We maintain that, from a private investors point of view, the five per cent rate is fairly competitive and unlikely to ward off would-be investors from the Kenyan market,” the bank said in a report in September.

Further, according to Mr Nyoro, the tax will be way lower than what is charged in other markets in Africa. “Zambia has a high rate of 35 per cent, Uganda has a rate of 30 per cent, Tanzania has a rate of 20 per cent, while South Africa and Nigeria are at par with 10 per cent CGT,” he says.

“Given the need to grow our economy, the long-term capital gains need to be taxed at a lower rate than short-term gains in order to provide more incentive to invest in the companies that build the economy rather than trying to make quick profits by speculating on stocks,” says the paper.

Evidently, although all investment analysts agree that the new tax will scare away investors from the NSE, they are divided on whether the tax is a mere scarecrow or if its effects will be significant. According to the Kenya Association of Stockbrokers and Investment Banks (KASIB), the tax will be discouraging to existing and potential investors.

Prominent among KASIB’s worries is that the Nairobi Securities Exchange will lose its competitive edge. “Nigeria has a 10 per cent capital gains tax, but the capital markets are excluded,” said Mr Willie Njoroge, the chief executive officer at KASIB.

However, Dyer and Blair Investment Bank thinks the tax will be inconsequential. “We maintain that from a private investor point of view, the five per cent rate is fairly competitive and unlikely to ward off would-be investors from the Kenyan market,” said a report it released in September.

Further, according to Mr Nyoro, the tax is much lower than what is charged in other markets in Africa. “Currently, Zambia has a high rate of 35 per cent, Uganda 30 per cent, Tanzania 20 per cent, while South Africa and Nigeria are at par with 10 per cent CGT,” he says.

FOREIGN PORTFOLIOS

Mr Munywoki explains: For instance, if you buy 25,000 shares at Sh4 per share, you will need Sh100,000 for the shares and Sh1,800 transaction fees.

If the share price rises to Sh5 and you sell, your gross proceeds will be 125,000. After deducting your transaction fees, your net profit today will be Sh22,750. On 2 January, after paying the five per cent tax, your profit will reduce to Sh.21,612.50.”

He is quick to point out that with higher returns, the effect may not be so hard-hitting. “Looking at higher returns derived from frontier markets, we still expect increased foreign portfolio flows driven by the recent discoveries in oil and gas,” he says.

“This could lead to introduction of new products at the bourse such as day-trading margin calls, which may not be subject to CGT.”

Although investors who sell their stakes at a loss will not be affected by the CGT, Mr. Munywoki notes that the law is quiet on what will happen in case you make losses on investments outside shares and whether you can net off your losses from your gains in order to pay lower taxes.

Interestingly, Mr Munywoki points out that the CGT will be applicable where the gross gain exceeds 20 per cent.

“This means that small investors can cash in their 19 per cent gains without paying the tax,” he says. “However, this will not be a rational move to make. An investor who makes 30 per cent gross profit and pays the 5 per cent tax will still make more money than the investor who exited at 19 per cent without the tax.”

The Treasury and KRA are yet to come up with a schedule on how the re-introduced tax will be calculated.

Subsequently, before 1 January, 2015, KRA and the National Treasury are mandated with the task of formulating guidelines on how much is to be paid and under what circumstances.

According to Mr Satchu, the current proposed formula where stockbrokers are to levy the CGT is not tenable.  Mr Munywoki concurs, adding that in future, the taxman may want to integrate the charge with other market levies through the broker back office, making it the responsibility of the market players to remit the tax.

It remains to be seen whether the tax will affect foreign investors, who account for most of the trading at the NSE.