Defer capital gains tax on stocks

In what can only be described as a bad move for the capital market, the Jubilee administration recently reintroduced Capital Gains Tax (CGT), which will come into effect in three weeks’ time.

There is nowhere the impact of this tax would be felt more than the local stock market.

The new tax will make the Nairobi Securities Exchange (NSE) uncompetitive within other jurisdictions it competes for global portfolio investment.

It would also impact the future performance of the capital markets adversely and negatively affect the market's liquidity.

A CGT on shares will naturally discourage trading and lead to low volumes and reduced liquidity in the stock market.

It will harm transaction operations in the local bourse, and drive domestic and local investments away from the country.

Simply put, taxes on exchange will lead to a gradual decline in trading volumes because any new tax means an increase in the cost of investing in the market.

That is why such an irresponsible policy will allow other countries such as Mauritius, where stocks are exempted from CGT, to become centres for commerce and services in the region.

With better policies and business-friendly environment, the centre for commerce title should be reserved for Kenya, which enjoys better geographical location and a huge base of human resources.

Incidentally, this same administration has been whining about high bank lending rates and the need to bring down the same.

The irony is that one of the obstacles to lower lending rates is the lack of depth in the financial system and too much reliance on banks for financing.

The absence of a robust capital market means there is little competition with the banks coming from outside of the banking sector for credit.

Yet this decision to tax capital market activities is only likely to worsen the current position.

I heard some say that this is essentially a super-rich man’s tax and therefore ordinary Kenyans shouldn’t bother. Nothing could be further from the truth.

The capital gains tax has the potential to hurt millions of ordinary Kenyan households.

Other than the 1 million or so individuals who invest in the stock market directly for wealth-building and many more who prefer to save through mutual funds, the introduction of CGT will hurt insurance companies.

 

It will also harm pension funds and other institutional and foreign investors that park their assets in listed companies.

Also, a CGT on our domestic capital market activities will move foreign investments to other more competitive markets. Foreign currency inflows play a major role in balancing the trade deficit and keeping the exchange rate stable.

So, any flight of capital will cause a depreciation of the shilling which means it will become more expensive for us to import essential commodities and in the process, increase inflation. This will reduce our GDP growth rate.

So, this bad policy will effectively affect all of us negatively.

No one is saying that we should never have a CGT. We have revenue shortfalls and we definitely need a cure for this. But if we look at this tax as doctors prescribing medicine to cure a problem, the Government has made two mistakes.

First, the medication is too heavy for a baby stock market such as ours.

The local stock market is doing well but it is not yet mature. The proposed tax is unquestionably akin to administering adult medication to a child, thus hurting, rather than curing, the patient.

Second, like a good physician, the administration should know when to apply the medicine so that any side effects can be avoided.

Even medication should be applied at proper times or it would be ineffective and even potentially harmful. The Government is applying the medicine at the wrong time.

Before any capital gains tax comes into effect, we will have to sustain the impact of developed nations gradually moving away from their unprecedented accommodative policies and the heightened risk of capital outflows as a result of any market reversals.

The administration has thus placed the local stock market under a two-pronged attack. The stock market is a low depth and breadth one facing potential capital outflows due to the expected hikes in global interest rates next year.

These circumstances should have made it clear that the implementation of any tax on gains would have a big impact on the local bourse. This should have been a warning for caution, but instead the National Treasury and CS Henry Rotich, chose to resolutely push for the tax.

Imposing taxes on the stock market now will just increase the burdens placed on it and reduce its competitiveness.

Rather than imposing capital gains taxes on capital markets activities, the Jubilee administration should be helping to revive investment and growth by helping put in place more investor-friendly policies.

The actual revenue received from a capital gains tax on stocks and other capital market activities is disproportionate to the burden imposed and as such the Government should exempt stock market activities from the CGT.

It is not too late to defer this badly timed tax!