Tanzania's finance minister, Dr. Philip Mpango, is set to present the annual budget in Parliament this week on Thursday, 11 June for fiscal year 2020/21 that starts on July 1. All eyes and ears will be on Dr. Mpango as he presents the new budget ahead of the October 2020 general elections and amid strong turbulence as COVID-19 ravages the global economy.
The tax treatment of capital gains could unlock domestic and foreign investment. Tanzania has a no stand-alone, specific capital gains tax regime, instead the country charges to tax any taxable profit arising on a gain from disposal of investment assets. Under current tax law, investment assets include shares and securities in a corporation, a beneficial interest in a non-resident trust, and an interest in land and buildings.
Pursuant to the Income Tax Act, 2004 ("ITA-2004"), the applicable income tax rates on gains from disposal of investment assets are follows: resident individual (10 percent on a Tanzanian asset and 30 percent on an overseas asset); resident corporate entity (30 percent on a Tanzanian asset and on an overseas asset); non-resident individual (30 percent on a Tanzanian asset); and non-resident corporate entity (30 percent on a Tanzanian asset). Thus, it is visible that Tanzania applies different rates for individuals and companies and for non-residents and non-residents.
However, Tanzania does not levy capital gains tax on disposal of an overseas asset by a non-resident individual or corporation. Furthermore, gains arising from disposal of shares listed on the Dar es Salaam Stock Exchange (DSE) and held by a resident as well as gains arising from disposal of shares held by a non-resident with shareholding of less than 25 percent are exempted from income tax. Gains from disposal of agricultural land with a market value of less than Shs 10 million are also exempted.
Higher rates on capital gains would deter investments as investors hold on to assets in preference to realising them and, consequently, triggering a slump in capital gains tax revenues. But low rates would boost investment from venture capital and private equity investors as many potential projects get approved. Moreover, when exiting investments, investors would be enticed to use their after-tax returns to finance more business start-ups.
Given the high mobility of capital across countries in the eternal quest for higher returns, there is an overall trend towards slashing capital gains tax rates. Tanzania's tax administration and policymakers may frown upon individuals and entities that move as much of their investments and profits outside Tanzania, but in reality, international capital mobility is the 'new normal'.
In this new normal, capital gains taxation in Tanzania needs to be guided by African and global competitiveness.
Under the ITA-2004, the original cost of the investment asset disposed can be deducted when calculating the gain, but this extant Act does not provide for "indexing" of capital gains to adjust for inflation over the years of holding of the asset. Under the 1973 Income Tax Act, capital gains taxation allowed adjustment of the original cost for inflation, in effect increasing one's cost base and lowering the capital gains, which effectively meant a lower tax. This old legislation also provided for a standard lower rate of 10 percent on capital gains, regardless of whether the disposal was made by an individual or a company or, by a resident or non-resident.
In an effort to beat the ongoing slowdown, will finance minister Dr. Mpango announce in his 2020/21 budget speech a return to capital gains indexation? That's an interesting question, but does it make sense to index capital gains for inflation? Some businesspeople surveyed believe that the taxation of inflationary capital gains is tantamount to seizing investment assets. A come-back to adjusting the taxation of capital gains for inflation would encourage entrepreneurship, investment and economic growth.
On the contrary, there is a belief that indexing capital gains would lead to a weakening of otherwise much needed tax revenues, an increase in Tanzania's long-term deficits and debt, and truncated readiness to tackle challenges in the fiscal and other policy domains. The finance minister needs to balance budget 2020/21; each shilling of reduced tax revenues results in reduced government spending on education and health and little public investment in the form of infrastructure outlays.
It's a tough balancing act against the backdrop of the COVID-19 pandemic, and the general elections slated for October this year. I wish the finance minister Godspeed in this endeavour. The government needs to deliver on the high expectations for several measures to ride out the ongoing slowdown by boosting liquidity, creating demand and incentivising corporate Tanzania to invest more.