Rental income tax, a controversial area in tax policy discussion

Government’s focus on increasing domestic revenue through reform of the rental tax regime is reflected in attempts to amend the rental tax provisions in the Income Tax Act over the last three years. 

Among the proposed amendments to the Income Tax Act for Finance Year 2021/2022 (FY 21/22), is a proposal to increase the rental income tax rate for individuals currently at 20 per cent to 30 per cent to match the current one for companies. 

Secondly, there was a proposal to fix the allowable deductions at 60 per cent for expenses and losses incurred in generating revenue and then drop the annual fixed threshold of tax-free rental income which was at Shs 2,820,000 per year. This in effect proposed to tax only 40 per cent of the rental income as taxable for both individuals can companies. A reasonable trade-off given the increase in the tax rate for individuals from 20 per cent to 30 per cent.

However, following debate and the approval by Parliament, the Income Tax (Amendment) Bill 2021, now proposes to only tax 25 per cent of the rental income at a rate of 30 per cent while allowing 75 per cent  as deductible/allowable expenses and losses. We also note that according to the Parliament Hansard, the 75 per cent allowable deductions will be subject to verification/approval by URA.

While this proposal might at first glance appear to be a great/incentive from government, it is a sugar-coated poison pill.The 75 per cent deduction will only be claimable to the extent that a taxpayer can ably support the expenses in a URA verification process. The proposal will further increase the administrative responsibilities of the taxpayer in relation to rental income tax filings and tax record keeping. A landlord will have to provide all receipts and invoices totalling to 75 per cent in order to be able to claim this expense. 

Furthermore, to the individual taxpayers, we see the removable of the annual threshold of 2,820,000 which was the tax exempt rental income tax .The implication of this will be that the boda boda rider who may also be a landlord of a few small mzigo from which he earns  gross rental income of 150,000 per month will now have to file online tax returns and pay tax. Compliance for such a taxpayer will be very burdensome and tracking down and taking enforcement action against them by the tax administrator (URA) will be costly and inefficient. 

If this Amendment Act is assented to by the president in this current state, it will incentivise hitherto compliant rental income taxpayers to create fake receipts and invoices to support the verification of expenses by URA.

 This is because most rental related expenses such as repairs by plumbers, electricians and the like are not usually receipted. URA will have a costly administrative burden in attempting to distinguish between fictitious and genuine expense receipts. The exercise of verification of these expenses is likely to create opportunities to compromise the integrity of the officers. Further, many unpayable assessments, objections and Tax Appeal Tribunal disputes are likely to arise as a result of this amendment.
 
Conversely, the original proposal by Ministry of Finance of fixing the allowable deductions at 60 per cent to cover expenses and losses incurred in generating rental tax was much better. These would be automatically deductible without being evidenced through receipts. This was a better deal for both the taxpayer and the policy makers/tax administrators as it is likely to widen the tax base by encouraging compliance and thus reduce on compliance costs.

 In summary, the proposal may reduce the effective tax rate for some taxpayers by creating tax savings only to the extent that one is able to support the 75 per cent allowable deductions. The only expectation is that there will be excessive tax planning in terms of records keeping and ability to ably defend your tax numbers which is likely to create a lot of creative/fake records. 

A reconsideration of a fixed rate to either 60 per cent with no verification of expenses may be a considerable option.
What I can only say is “there is no equity about tax” as per the case of Cape Brandy Syndicate Vs Inland Revenue Commissioners (921)KB 64

The author, Sarah Muzungyo Chelangat is an Associate Director, Tax at Ernst & Young Uganda.