A proper reason for sale, save for profits can negate corporation tax assessment. FILE PHOTO | NMG
l gains and trading gains for tax
purposes has been a bone of contention between tax payers and the Kenya
Revenue Authority (KRA).
The importance of
distinguishing between the two is the underlying tax rate. Capital gains
attract tax at the rate of five per cent while trading gains attract
corporate tax at a higher rate of 30 per cent.
Due to
the higher tax yield resulting from corporate tax, the KRA is often
inclined towards making corporation tax assessments whenever a tax
payer, especially a company, has sold property.
In the
recent past, the KRA has made numerous erroneous assessments relating to
sale of real estate property by companies. However, most of these have
been successfully challenged at the Tax Appeals Tribunal by the
aggrieved tax payers.
The line between capital gains and trading gains is thin. It is
determined by the type of gains accrued on disposal of property, which
is more of a question of fact than law.
The subsisting
legal provisions do not draw the line between trading and capital gains
and the classification is heavily dependent on analogous interpretation
of the relevant provisions of the law as well as accounting standards
and international best practices.
Over time, judicial
precedents and practice has led to evolution of a criteria for
classification of gains accruing from the sale of property. This
criteria, dubbed badges of trade, can be traced back to the Common Law
and its application has gained universal acceptance in many
jurisdictions.
The badges of trade provide a
multifaceted approach based on the inherent characteristics of the
transaction and the circumstances surrounding it.
The
first issue to look at is whether there was a profit motive in disposing
the property. If the intention of the sale was to make a profit, then
the gains realised are considered to be trading gains as opposed to
capital gains.
The motive can be inferred from the
reasons for the sale. A proper reason for sale, save for profits can
negate corporation tax assessment.
Secondly, the
frequency of similar transactions determines if the sale is a habitual
exercise. If the person has made other similar transactions in the past
then the trend is perceived to be of a trading nature, hence a trading
gain.
Thirdly,
the nature of financing in acquisition of the property helps in
determining the intention of the tax payer. The general assumption is
that if the asset was acquired though long-term financing, then the
intention was not to resale it for profit. However, short-term financing
connotes intention to dispose the property due to the associated costs.
Fourthly,
modification of tangible property before the sale indicates a trading
motive. If modification is done to the asset with the intention to make
the asset salable or fetch better value in the market, then it is deemed
to be a trading gain.
Fifthly, the length of ownership
of the property is also considered. The shorter the duration of
ownership, the more likely its sale would be deemed to be of a trading
nature. Disposal of property held for a long duration of time is likely
to be deemed a capital disposal.
Lastly, the principal
activities of the company are also paramount in determining the nature
of the sale. For investment holding companies, gains from sale of a
property are deemed as capital while for investment dealing companies,
the gains accrued are considered trading gains.
In
conclusion, one has to consider all the factors surrounding the sale
transaction to be able to correctly classify the gains realised.
Even so, this criteria is heavily subjective and is largely dependent on the supporting documentation and evidence.
Samuel Kioko is Senior tax associate at KN Law LLP.
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