Nairobi Grapples with Tax Policy Fallout

NAIROBI - A controversial decision to triple Kenya's Capital Gains Tax (CGT) rate from 5% to 15%, effective from Tuesday, January 1, 2023, has failed to deliver the anticipated revenue windfall for the government. Instead, official data reveals a subsequent decline in both transaction volumes and tax receipts, fueling a robust debate among economists, investors, and professional bodies about the policy's detrimental impact on the nation's investment climate.

Provisional statistics from the National Treasury indicated a notable downturn following the tax hike. In the first quarter of 2023 (January to March), CGT collections from real estate and private share transactions fell to KES 3.28 billion, a 12.92% decrease from the KES 3.76 billion collected during the same period in 2022. This decline suggests a cooling of investment activity as sellers hesitated in the face of significantly higher tax liabilities.

The Core Grievance: Taxation Without Inflation Adjustment

The central argument from critics is the law's failure to account for inflation through indexation. Without adjusting the initial purchase price of an asset for inflation, the tax is levied on nominal gains, effectively penalizing long-term investors who are taxed on wealth eroded by currency devaluation over time. This concern was a primary objection raised by numerous stakeholders during the assessment of the Finance Bill 2022.

For instance, an individual who bought land for KES 1 million in 2005 and sold it for KES 2.5 million in 2025 would have a nominal gain of KES 1.5 million. However, accounting for an average annual inflation rate of 6% over 20 years, the real gain would be closer to KES 300,000. Under the current law, the seller pays 15% tax on the full KES 1.5 million, a situation many experts deem punitive.

Professional bodies like the Institute of Certified Public Accountants of Kenya (ICPAK) and consulting firms including Crowe LLP, Ernst & Young (EY), and KPMG had warned against the steep increase without an accompanying inflation adjustment. During parliamentary committee hearings, stakeholders proposed a more moderate rate of 10% as a compromise, a recommendation that was ultimately rejected in favor of the 15% rate to meet ambitious revenue targets amid rising public debt.

Regional Competitiveness and Capital Flight Risk

While the government justified the increase as a move to align with regional peers, the argument faces scrutiny. Although Kenya's 15% rate is lower than Uganda's 30% and Rwanda's 30%, the 200% hike was abrupt. Economists argue that unpredictable and steep tax policy changes create an unstable environment that can deter foreign direct investment and encourage capital flight.

Malkesh Shah, a Senior Audit Manager at PKF, warned on Monday, June 10, 2024, that Kenya risks losing investors to neighboring countries with more predictable tax regimes. While concrete data directly linking the 15% CGT to a surge in capital flight remains under investigation, the principle is a significant concern for the business community. The recent trend of institutional investors exiting the Nairobi Securities Exchange, though influenced by multiple factors, highlights the sensitivity of capital to perceived risks. The lack of a stable, long-term national tax policy is a recurring concern for private sector bodies like the Kenya Private Sector Alliance (KEPSA).

A Historical Perspective on Capital Gains Tax

Capital Gains Tax is not new to Kenya. It was first introduced in 1975 but was suspended in 1985 in a strategic move to stimulate growth in the real estate and capital markets. The tax was reintroduced on Tuesday, January 1, 2015, at a rate of 5% through the Finance Act of 2014, with the government aiming to widen its tax base. The tax applies to the net gain on the transfer of property, including land, buildings, and unlisted shares. Certain transactions are exempt, such as the transfer of agricultural land under 50 acres and the sale of a private residence occupied for at least three years, provided the transfer value is not more than KES 3 million.

The Path to Reform: A Call for Balanced Policy

The current debate centers on finding a sustainable path forward. The data from the Kenya National Bureau of Statistics (KNBS) showed a 1.73% decrease in property income tax collected in the 2023/2024 period compared to the previous year, reinforcing arguments that the rate hike was counterproductive. Analysts and professional bodies are advocating for a comprehensive review of the CGT framework.

The primary recommendation is the introduction of indexation to ensure only real gains are taxed, which would promote fairness and encourage long-term holding of assets. A reconsideration of the rate, possibly to the 10% compromise originally proposed, is also on the table. Striking this balance, experts argue, is crucial not just for revenue collection, but for fostering a competitive and predictable investment landscape that can drive sustainable economic growth for Kenya and the East Africa region. As the government prepares for future finance bills, the pressure to reform the capital gains tax will undoubtedly continue to mount from all corners of the economy.