Sophia Kayemba: Insight into Proposed Tax on Disposal of Non-Business Assets

Recently, the Minister of Finance issued the Income Tax (Amendment) Bill, 2024 which proposes various changes to the Income Tax Act, Cap 340 (‘ITA’); and if passed into law, the changes will take effect from 1 July 2024.

One key proposal is the introduction of a 5% tax on gains from the disposal of non-business assets. If you recall, in 2023, Parliament tried to introduce a similar law to tax the full proceeds on the disposal of every non-business asset. This did not sit well with many of us, and fortunately, the proposal was withdrawn.

So, what differentiates the 2024 proposal? Is it fair? Is it feasible? What challenges should we expect? Let’s delve into the specifics.

The current position

Currently, except for disposals of shares in a private limited company or commercial buildings, gains from the sale of a non-business asset are exempt from income tax under Section 21(k) of the ITA.

A business asset is any asset which is used or held for use in a business, any asset held for sale in a business and any asset of a partnership or company.

The proposed amendment

The 2023 proposal sought to introduce a 5% final withholding tax on the gross disposal proceeds on virtually all assets (with some exceptions such as trading stock). In comparison, the 2024 proposed amendment will be restricted to only gains on specific non-business assets, namely:

• Shares of a private company;
• Rental property that is subject to rental tax; and
• Land in cities or municipalities except one’s principal place of residence.

Exclusions will include involuntary disposals due to auctions, court orders, mortgages, divorce settlements, separation agreements, transfers by a deceased, and divestment of a registered venture capital or private equity fund.

The 5% tax will apply to these gains as a final tax, but unfortunately, the bill lacks clarity on the term final tax in this context. Ordinarily, it implies that no other income tax should be imposed on this income. The bill should be revised to include provisions that clarify this aspect.

The bill requires a person to notify URA and to pay the tax within 15 days of disposing the non-business asset.

Ambiguities

At first glance, the proposed amendment seems straight forward, but upon a closer analysis, a number of questions and uncertainties arise.

1. Which rental properties are being targeted?

It is unclear whether the proposal aims to tax all rental properties or simply rental properties which are currently not taxed at disposal e.g., rental properties owned by non-business individuals.

2. Which type of land? Is location important? What is a principal residence?

The amendment seeks to tax disposals of non-business land in a city or municipality, except one’s principal place of residence. Questions to ponder on here include:

• Which type of land is being targeted?

Uganda has four main types of land tenure including customary land, mailo land, leasehold land, and freehold land. The proposed amendment seems to target all types of land tenure.

How about buildings and other permanent structures on the land? Does the tax apply on the sale of these structures?

Whereas the amendment explicitly mentions that the tax will apply to land, it is common to treat all permanent structures sitting on the land as part of the land. However, depending on the type of land tenure, this is not always the case. There are instances where one can sell the structure but not the land e.g., an apartment in a high rise building, and instances where one can sell the land but not the structure.

• Is the location of the land important?

The amendment does not define what qualifies as a city or municipality. According to the Minister of Local Government, as of 1 July 2020, Uganda has 146 districts of which 11 are cities and 31 municipalities.

What is Parliament’s intention in highlighting land in cities and municipalities? Does this matter? Are the demarcations of these jurisdictions clear? Is non-business land falling outside these areas outside the scope of taxation?

Principal residence

The land category will exclude one’s principal place of residence from the tax. However, this term is not defined. Can one have more than one principal place of residence if one spends equal time at each?

What about asset conversions from non-business to business use?

The bill seeks to tax gains arising out of disposals of non-business assets. One may then ask; what is a disposal? Under Section 51 of the ITA, an asset is treated as disposed if it is sold, exchanged, redeemed, or distributed by the taxpayer; transferred by way of gift; or destroyed or lost.

How about instances where one in trying to legitimatize and legalise his/her businesses transfers personal assets such as land, or buildings to a registered enterprise. Is this a disposal?

According to Section 51(3)(b), the conversion of an asset from a non-taxable use to a taxable use is deemed to be a disposal of the asset at market value.

Based on the current law, if an individual like Nasser transfers personal land to his registered business, he does not have to pay any tax on the transfer because of the prevailing exemption under Section 21(k) of the ITA.

However, under the proposed amendment, coupled with the provisions of Section 51(3)(b), Nasser will be deemed to have disposed of this land and be required to pay tax at 5% on the deemed capital gain. This is likely to burden Nasser because he now has to look for the money to pay the tax even if he did not actually ‘sell’ his land.

Dilemma of verifying the cost base

To determine the gain on disposal, one essentially takes the gross amount received from the sale and deducts the cost base (including incidental capital costs incurred to acquire, construct and/or improve the asset). There is no allowance to claim costs incurred to affect the sale.

If the land was acquired in a non-arm’s length transaction e.g., Nasser inherited the land from his father, then the cost base of the land will be the market value of the land on the date he inherited it.

The general rules on how the cost base is determined are clear. The dilemma however is on non-business assets for which one has never been legally required to obtain or maintain documentation on the costs incurred to acquire, construct, alter and improve such property. This is further exacerbated in cases where one has held the property for many years and records may have been lost. This is likely to create challenges for both taxpayers and for URA when it comes to ascertaining the gain on disposal.

The proposal impliedly excludes the ability to adjust the cost base for inflation; yet this privilege is available for disposals of business assets.

Conflict with Section 21(k) exemption 

It is worth noting that the proposed amendment conflicts with Section 21(k) of the ITA. This section currently, except for gains from the sale of shares in a private company and commercial buildings, exempts from income tax any capital gain arising from the disposal of non-business assets.

Unless Section 21(k) is simultaneously amended to exclude assets caught under the new provision e.g., land in cities and municipalities for non-business use, the proposal will conflict with the existing exemption.

According to case law, in case of such conflicts, the law should be interpreted in favour of the taxpayer.  Hence, Section 21(k) may prevail over the 5% proposed tax.

In conclusion, and in my opinion, the 2024 proposed amendment is not a bad law in theory.

Is it fair? I would think so, especially when compared to the previous amendment in 2023 which sought to tax the gross proceeds on the disposal of virtually all assets. However, to ease applicability, there is a need to refine the 2024 proposed amendment by defining some of the key terms and to also consider the wider aspects of the amendment before passing the same into law come 1 July 2024.