real estate tax administration Reginald okumu

Real Estate Tax Administration: Strangling the goose that lays golden eggs

By Reginald Okumu

Real estate is the 4th largest sector of the economy. Between 2008 and 2014 the sector grew on average by 7.2% annually. In 2016, tax revenues recorded from the sector amounted to KShs 3.1bn. According to Kenya Revenue Authority (KRA) the sector’s tax revenue contribution did not reflect the growth and expansion of the economy. At the time approximately 20,000 landlords were in the tax net and complying. An amnesty programme that waived interest and penalties netted an additional KShs 130 million in tax revenue from the sector. Given that the sector is subject to various taxes and levies which include Income tax, value added tax, capital gains tax, stamp duty, rate and ground rent, the figures quoted pointed to possibly low compliance rates. Therefore something needed to be done.

To remedy the situation, the government introduced a raft of administrative measures targeting the landlords and tenants. The measures include introduction of withholding tax on rent, appointment of tenants and estate agents as collection agents and execution of a drive to increase the number of landlords in the tax net by 20,000. This article, will focus on the administrative measures and their impact on real estate investment.

All profit making entities including corporate landlords are required to pay an installment tax calculated at 25% of 110% of previous year’s profit. Installment tax, which has been in existence for many years is actually an advance corporate tax. It is usually paid in a maximum of five (5) installments. In working out this tax, the national government assumes that an entity will record at least 10% growth in profit every year. They therefore require a corporate landlord to pay this projected profit in advance in four (4) equal installments. The fifth installment will arise if a corporate landlord records a hire profit than projected, then the balance of the tax needs to be settled before the end of the first quarter of the following financial year. This methodology assumes that real estate investment is an all-round profitable business and there is no chance that a landlord will suffer losses. However like any other business, landlord do experience losses due to unfavorable economic conditions, high operating costs and voids.

Following the introduction of valued added tax on commercial rent, the Government in 2016 introduced withholding of Value Added Tax (WHVAT). Like installment tax, WHVAT is not a new tax but a reinforcement measure to ensure all VAT due to Government is remitted. To enforce the measure KRA appointed mostly the large tenants including state corporations, public agencies, banks, insurance companies and leading retailers as withholding agents. The appointed agents are required to withhold the VAT component which is 16% of invoiced rent and remit directly to KRA by the 20th of the following month. On withholding, the agents are required to issue the landlord with a withholding certificate. The withholding certificate issued by the tenant is used by the Landlord to claim back VAT to avoid double taxation. Unfortunately landlords do not have the option of paying for goods and services less VAT and issue the vendor with a withholding certificate just like their tenants issued them with one. Withholding of VAT has the effect of denying landlords actual cash for the period when it should have been collected to when it is remitted.

This year and specifically on January, 1st 2017, withholding tax on rent (WHTR), a new administrative measure on rental income passed when the amendments to the Finance Act of 2016 came in to effect. According to this law, tenants are obligated to deduct 10% of the rent payable to the landlord and pay directly to KRA by 20th day of the month. This means that landlords will every month receive 10% less of the rent they invoice their tenants. Withholding 10% of the rent affects both individual and corporate owners of commercial and residential property. However for corporate landlords who also pay installment tax this new measure amounts to double taxation as there is no recourse to reclaim while say paying installment tax.

Collectively the three measures highlighted above, have the two positive net effects and two major negative effects. On the positive side, the Government is on one hand able to receive all tax revenue due to it and on the other hand, tenants have an improved cash position by delaying remittance of the withheld amount by between 20 and 50 days. On the negative effects, less cash flow means landlords will be unable to respond to unexpected increase in expenses or take up opportunities as they arise. Some may even exit the sector. With low investments and reduced number of landlords, tax revenue from the sector will also decline. Though not intended, the reinforcement measures being implemented may end up strangling the goose that lays the golden eggs. The adage, “cash is king and is the lifeblood of any business” holds true for real estate investments as well.

It is generally accepted that tax is a necessary obligation of the citizens of any country. Therefore before I conclude, it is important that a clarification is made about the KShs 3.1 billion tax revenue that was collected in 2016. Real estate as a sectors has different tax points and therefore contributes significantly to the overall tax revenue. Accordingly a portion of the total revenue that is VAT and corporate tax collected is from and by business in the sector. The sector is also a huge employer and so a portion of the pay as you earn (PAYE) is from employees working in the sector. In addition more is collected from capital gains tax, stamp duty, rates (by County Governments) and ground rent. Therefore the KShs 3.1 billion collected in 2016 was only from one source and that is the approximately 20,000 landlords in the KRA database. There is certainly need to address the compliance issues by bringing more landlords in to the database.

Ronald Reagan the 40th President of the United States was quoted stating that “businesses do not pay taxes, they only collect on behalf of Government”. The incentive for business to collect tax on behalf of government is that it gives them liquidity and interest free cash. Accordingly with stifling administrative tax measures, it is unlikely that landlord’s will relax and take in the reduced cash in-flow position. They are likely to institute mitigating measures which include increasing rent payable. The actual burden of these administrative measures, therefore is and will be borne by individual tenants and consumers through higher rents and prices of goods and services. It follows that if the tenants and consumers are unable to pay more, the sector will become less attractive to investors. It is therefore necessary that the government engages landlords and investors in the real estate sector and discuss how best to ensure that there is full compliance without depriving the sector of much needed cash in-flows. One such possible measure is to allow landlords to deduct the withheld 10% from installment tax.

Reginald Okumu is the Director in charge of Commercial Service at Ark Consultants Limited (www.arkconsultantsltd.com) an integrated real estate services provider. He has 20 years’ experience in valuation, sales, letting, estate management and real estate investment advisory.