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Reasons why capital gains enjoy low tax rates

Thursday, 22 September 2016 00:00
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The 2014 Finance Act has re-introduced the capital gains tax. Capital gains shall be subject to tax at the rate of five per cent effective from 1st January 2015.

Capital gains enjoy low tax rates compared to ordinary income in most jurisdictions. In Kenya, resident ordinary business income is taxed at the rate of 30 per cent while capital gains will be taxed at the rate of five per cent.


This is because of several reasons. First, some component of capital gains could be attributed to inflation. Some element of the appreciation in the land value can be attributed to inflation. Opponents of capital gains tax argue that the nominal value of capital gains is different from the real value.

Thus, they reason that the tax rate on the capital gains should be adjusted so that the taxes are based on the real value of the capital gains as opposed to the nominal value. To counter the inflationary effect, some jurisdictions such as the UK have introduced an indexation allowance.

Secondly, a high tax rate on capital gains could yield the lock-in-effect. Investors would refuse to dispose the assets because disposing the assets would be a taxable event which would increase their taxes.

A low tax rate thus encourages the productive use and transfer of capital assets. The productive use and transfer of capital assets in turn generates high ordinary revenues which leads to higher taxes in the long run.

Thirdly, capital gains represent a “bunch” of gains accumulated over a long period of time. Taxing the capital gains at a specific year would push individual taxpayers to higher tax brackets.

On the other hand, proponents of capital gains taxes argue that it is fiscally regressive for a government to finance government expenditure largely from indirect taxes.

They argue that the exemption of capital gains from taxes only benefits the wealthy who have the financial muscle to deal with stocks and real estate on a large scale.

The preferential tax treatment of capital gains over ordinary income has often led to disputes between taxpayers and the revenue authorities.

However, in certain cases, dealings in property could constitute a “business” under section 2(1) of the Kenyan Income Tax Act.


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