Beyond revenue: Why Kenya must reform its capital gains tax

Capital gains tax is a subject that impacts investors and taxpayers. It sits at the intersection of economic theory, public policy, and personal finance, sparking intense debate among lawmakers, economists, and taxpayers.

As global markets evolve and wealth generation become increasingly diverse, understanding the nuances of capital gains tax is more crucial than ever.

At its core, capital gains tax is imposed on the profits realised from the sale or transfer of property. As per the Kenyan Income Tax Act, the definition of the term property encompasses land and every description of property, shares and comparable interests among others. The gain is calculated as the difference between the property’s cost basis or adjusted cost and its sale price or transfer value. The gain is taxed at the rate of 15 per cent in Kenya and is payable by the transferor or seller.

The transfer value is the amount of consideration for the transfer of property, less the incidental costs incurred; while the adjusted cost is the amount of consideration for the acquisition of the property.

Government revenue

The due date for the tax payable in respect to the property transferred is the earlier receipt of the full purchase price by the seller or registration of the transfer.

The rationale behind capital gains tax policy is multifaceted.

On one hand, it serves as a source of government revenue, helping to fund public services and infrastructure. And on the other hand, it aims to address economic inequality by taxing wealth accumulation.

Different countries adopt varied approaches to capital gains tax, reflecting their own economic philosophies and fiscal needs. Some countries impose little to no tax on capital gains for individuals and corporates, while others like Kenya, maintain robust tax systems with defined rates and exemptions. However, policymakers must strike a careful balance.

Excessively high capital gains tax rates could discourage investment, stifle entrepreneurship, potentially slow economic growth and prompt capital flight to more tax-friendly jurisdictions. 

When capital gains tax rates are high, investors may be disinclined to sell appreciated assets, preferring to defer tax liability by holding onto investments indefinitely. This can reduce liquidity in financial markets and inhibit the natural reallocation of capital. In a welcome move for corporations or individuals navigating change, Kenya’s Income Tax Act provides key exemptions from capital gains tax during corporate restructuring to include transfer of property necessitated by a legal or regulatory requirement, internal restructuring within a group that has existed for at least 24 months among others.

In addition, transfer of private residence if the individual owner has occupied the residence continuously for the three-year period prior to the transfer of the property (being land) by an individual where the transfer value is not more than Sh3 million is exempted from tax.

The exemptions for both individuals and corporations reflect a thoughtful approach to tax policy, recognising that not all property transfers signal profit and sometimes they are simply a necessary part of keeping a business afloat, compliant, or better aligned for growth.

Long-term investors

Yet even with these exemptions, another critical issue that remains largely unaddressed in Kenya’s capital gains tax framework is the question of indexation.

This refers to the adjustment of the original cost of an asset for inflation before calculating the taxable gain.

Without indexation, taxpayers may find themselves paying tax on gains that are not real, but simply the result of inflation eroding the value of money over time.

This can lead to unfair outcomes, especially for long-term investors.

Take for example, assuming a person bought a plot of land in the year 2005 for Sh1 million and sold it in the year 2025 for Sh2.5 million. On paper, the gain is Sh1.5 million. However, if the inflation averaged approximately 6 per cent annually over those 20 years, the real value of the original investment would be closer to Sh2.2 million. Meaning the real gain is Sh300,000. Yet, under the current law, the seller would still owe 15 per cent tax on the nominal Sh1.5 million gain.

Thus, capital gains tax is a complex and evolving component of fiscal policy, shaping the behavior of investors, businesses, and governments alike.

Its future will be determined by ongoing debates over fairness, efficiency, and economic growth issues. As the world continues to change, the conversation around capital gains tax will remain as dynamic as the markets it seeks to regulate.

The increasing mobility of capital in a globalised world challenges the ability of individual nations to tax gains effectively. As such, international cooperation, information sharing, and harmonisation of tax standards become increasingly important.

-The writers are consultants within PwC’s tax line of service