How rental tax Bill will discourage investment in real estate sector

What you need to know:

Government through the proposed tax amendments is giving with one hand and taking away with the other hand.

Rental tax is always a pertinent issue to many people and has invoked a lot of discussions. Just like any other form of tax, it is one that is particularly close to the heart for many people, mostly for landlords and tenants. For the landlords, it affects how quickly they can recoup cashflows from their high capital investments in rental property. For tenants, it affects the rental prices charged since they are looking for affordable comfortable housing.

Well, it is that time of the year again when proposed tax amendments bills have been presented and the public have ears on the ground to find out which of the amendments will directly affect their disposable income.

When it comes to rental income taxation, government through the proposed tax amendments is giving with one hand and taking away with the other hand. On one hand, they are reducing the tax rate from 30 percent to 12 percent which may cause premature celebrations.

Eliminating tax benefits

On the other hand, they are removing tax benefits such as not deducting mortgage interest and all other property expenses when calculating taxable income. The net result is a higher effective tax payable by individual landlords.

The Bill proposes that interest on mortgages obtained to acquire and construct rental property is not deducted when computing rental taxable income. Acquisition and construction costs of rental property are very capital intensive and very few people can afford to construct these properties with their own cash savings. Eliminating the interest on mortgages as a deduction when calculating rental tax would discourage investment in the real estate business and investors would not be able to recover the high investment cost within a reasonable period.

The Bill also proposes that individuals would not be allowed to deduct expenses that could have been incurred when generating rental income. Just like any other business, investors inevitably incur expenses when generating rental income and it is only fair that they are deducted when computing rental income. Some of these expenses are also incurred to attract more tenants or make the living conditions for tenants much better. Some of these expenses include house repairs, painting, cleaning among others.

This Tax Amendment Bill would result into a higher tax liability for landlords which would lead to slower recovery of the capital invested in the acquisition or construction of the rental property. Accordingly, there is a likelihood of increase in the rental charges as the landlords would like to recover the costs that they incurred in constructing these properties.

Discouraging investment

The Bill ignores the fact that investment in real estate is very capital intensive with running costs that are clear and easily ascertainable. This disadvantage is concealed by the reduced tax rate which looks low but results into a higher effective tax rate.

There will be very little motivation of potential investors in this sector as the one big incentive where interest on mortgages is deducted is removed. This law is counter intuitive to the drive to provide affordable housing in the country.

It is paramount that investors assess their property portfolio to understand their tax obligations to avoid penalties and unplanned cash outflows. It is also important to reach out to tax experts for guidance on the applicability of the proposed amendments and advise on proper tax planning.

The writer Esther Achieng is a tax manager with KPMG Uganda.