Insights into new changes of Uganda’s capital gains tax regimeAhabwe says although the proposals are an attempt to simplify the capital gains tax regime in Uganda, they potentially invalidate double taxation treaties that envisage capital gains as per the current tax regime. This may result in taxing losses on sale of assets and disregard the carry forward of tax losses on assets.
The recent Income Tax (Amendment) Bill, 2023 proposed a raft of changes regarding taxation of capital gains in Uganda and if passed into law and assented to by the President of the Republic of Uganda they would come into force on July 1, 2023 writes Prosper Ahabwe.
Capital gains arise when you sell an asset for more than you originally bought it. There are two kinds of assets in the Income Tax Act; a depreciable asset and a business asset.
Depreciable assets are plant or machinery, or any implement, utensil or similar article, which is wholly or partly used or held ready for use, by a person in the production of income and which is likely to lose value because of wear and tear, or obsolescence. Common examples include computers, furniture and fittings, motor vehicles, plant and machinery.
A business asset is one that is used or held ready for use in a business and includes any asset held for sale in a business and any asset of a partnership. Business assets generally include land, commercial buildings, shares, net assets of a business, financial assets such as trade receivables, loans, treasury bills and bonds etc.
Depreciable assets are included in any of the three pool classes for wear and tear purposes and upon their disposal, the proceeds received by the seller are included as a reduction to the tax written-down values of the pool of assets which is treated as a single asset. When all assets in the pool are disposed of, a taxpayer gets a capital gain (if the proceeds exceed the written-down value of the pool) or capital loss (if the proceeds are less than the written-down value of the pool).
The disposal of a business asset on the other hand is dealt with under part VI of the Income Tax Act (ITA) which deals with gains and losses based on a comparison of the consideration received upon disposal of an asset and the cost base of the asset. The cost base of an asset is generally the amount paid to acquire or construct the asset.
In the current capital gains taxation regime, capital gains are part of business income and would be derived by deducting the cost base of an asset from the consideration received by the seller of the asset. The cost base is however indexed using the ratio of the Consumer Price Index published for the month of the sale (CPID) to the Consumer Price Index published for the month immediately prior to the date on which the relevant item of cost or expense was incurred (CPIA).
As Inflation affects the purchasing power of a currency occasioned by the general increase in prices of goods and services in a country’s economy, indexing the cost base helps to consider the effect of inflation on the cost of the asset and eliminate taxation of inflationary gains as capital gains of the seller. Assuming a company sold land for UGX 100 million on 31 December 2022 which has been purchased at a cost of UGX 15m in March 2010. The capital gain made on the sale of land would be UGX82.7m determined by consideration received 100m less UGX17.3m (i.e., UGX15m * 126.4/109.3 (CPID/CPIA). If the seller has no tax losses to offset against the capital gain, the seller would be liable to pay capital gains tax of 30% of UGX 82.7m i.e., UGX 24.8M as income tax.
The key amendments and their implications are explained below:
- Section 18 which defines business income has been proposed to eliminate capital gains on business assets from being classified as business income. Effectively restricting business income gains to only those that arise from cancellation or satisfaction of a business debt. Capital gains derived from business assets would not be part of business income or gross income of a taxpayer.
- Section 22 has been proposed to exclude a deduction for capital or revenue losses on the disposal of business assets during a year of income. Thus, no deductions for the costs of acquiring or purchasing a business asset would be allowable against the proceeds received by a disposer of a business asset.
- Sections 49, 50 and 54 of the ITA have been proposed to be repealed, these sections deal with gains that were part of gross income or losses that were deductible on the disposal of an asset. This repeal would eliminate the mode of determining gains and loss on disposed assets which is based on the consideration received less the cost base of the asset along with indexation of the cost base. This could result in taxation of inflationary gains that are not the actual gains from the disposal of an asset.
- Instead, the bill proposes to introduce a simplified taxation regime based on withholding tax system under Section 118B by imposing the obligation to withhold tax 5% of the gross payment for an asset situated in Uganda on the purchaser of an asset except for a) transfer of an asset between spouses, b) transfers between a former spouses as part of a settlement of bona fide separation agreement c) an involuntary disposal of an asset if reinvested in like kind within 1 year of the disposal d) transmission of an asset forming the estate of a decease tax payer to a trustee or beneficiary on the death of a tax payer e) the sale of investment interest of a registered venture capital fund if at least 50% of the proceeds on the sale are reinvested within the year of income. The tax withheld will be a final tax thus no further tax can be levied on the income, deduction claimed or withholding tax credited by the seller. It must be noted that the wording of Section 118B is broad and would obligate any person whether natural or corporate, resident or non-resident who purchases an asset situated in Uganda to withhold tax. Although the proposal aims at simplifying the capital gains taxation regime, it could result in taxation of losses made on the disposal of an asset as the 5% is applied on the sales proceeds and does not consider any deductions or whether gain or loss was made on the disposal. Such taxation would not be aligned with the commercial realities arising from the disposal of the capital asset.
- The proposed amendment also defines an asset to mean a resource with economic value that is expected to provided future benefit to its holder but does not include trading stock. This implies that purchasers would have to consider whether they are purchasing an asset or trading stock, but it is not clear from whose perspective this would be looked at to determine whether the item being purchased is an asset or trading stock. Would it be from the seller’s or buyer’s perspective? An item may be an asset to the purchaser but the trading stock of the seller. If not clarified, the administration of the withholding tax may be complicated.
- Lastly, the proposed amendment to Section 118B eliminated withholding tax obligation on the cancellation of transferee shares in a liquidated company. Whereas this is a welcome proposal it is only limited to the cancellation of shares in a liquidation situation. It is still unclear how the transfer of assets happening as part of a business reorganisation would interact with the withholding tax obligation for other forms of business reorganizations that do not involve the cancellation of shares. It would be advisable to exclude all forms of disposal as part of a business reorganisation from the ambit of Section 118B.
Whereas the above proposals are an attempt to simplify the capital gains tax regime in Uganda, they potentially invalidate double taxation treaties that envisage capital gains as per the current tax regime, they potentially result in taxing losses on sale of assets and disregard the carry forward of tax losses on assets. These tax measures could discourage investment in real estate and the development of intellectual property in Uganda. Government should therefore reconsider maintaining the current capital gains taxation regime as it is more aligned with the commercial realities of transactions involving the disposal of business assets.
Prosper Ahabwe is an Associate Director, Tax at Ernst & Young Uganda