Proposed 5% tax on disposal of assets  is a recipe for disaster 

If the proposed amendment is passed into law, starting July 1, the capital gains provisions will be no more. Instead, a withholding tax of 5% will apply on the gross proceeds received from the sale of an asset.

Since the Finance Ministry issued Tax Amendment Bills on March 30, 2023, the media has been awash with mixed reactions from the general public. Overall, this year’s proposed tax changes seem to have garnered the greatest reaction from the general public since 2012 when the income tax rate of 40 percent was introduced for individuals earning above Shs10m per month. 

One aspect that stands out is the proposal to repeal capital gains tax and instead introduce a withholding tax of 5 percent of the gross proceeds on the disposal of assets. 

This article looks at what this proposed amendment means for you and I.

Currently, when a business asset is sold, a profit or loss may arise. A profit arises when the proceeds derived from the sale of the asset exceed the cost incurred in buying or acquiring the asset. This profit is subject to tax at 30 percent (or a maximum rate of 40 percent for individuals).

In tax language, we call this profit a capital gain and the tax imposed, capital gains tax. On the other hand, a loss arises where the cost of the asset exceeds the sale proceeds. A deduction is allowed for the capital loss against their other income. 

Currently, this tax on capital gains is generally restricted to business assets, that is, those assets that are used by a business to generate income, including shares in a private company. 

If the proposed amendment is passed into law, effective 1 July 2023, the capital gains provisions will be no more. Instead, a withholding tax of 5 percent will apply on the gross proceeds received from the sale of an asset.

This 5 percent tax will apply on the sale of assets situated in Uganda. The proposed amendment defines an asset to mean a resource with economic value that is expected to provide a future benefit to its holder but does not include trading stock. 

Accordingly, the tax will apply on the sale of any asset situated in Uganda (other than trading stock), regardless of whether the asset is for business or personal use, and regardless of whether the sale results in a profit or loss. The 5 percent tax will be withheld by the buyer and will be a final tax for the seller. This means the sales proceeds derived by the seller will not be subject to tax again in Uganda, and the tax withheld will not be credited against any other tax liability in Uganda. 

Some transactions will be exempted from this tax. These include trading stock, transfers between spouses, settlements from a divorce or separation, assets from the estate of a deceased, proceeds from an involuntary disposal if the proceeds are reinvested in a similar asset within one year, etc.  

The fact that the tax will also apply to all personal assets does not follow good taxation principles. 
This is because, if this amendment is passed, it means that if you sell your personal assets such as your house, land, bed, chairs, car, kitchenware etc., the buyer will be required to withhold 5 percent on the gross amount payable to you and remit it to Uganda Revenue Authority (URA) on your behalf. To understand this better, let’s consider the scenario below:  

Musa, an employee of Sanyuka Construction Ltd, has a personal car, a Subaru, that he purchased at Shs30m in 2015 using his salary savings which had suffered Pay as You Earn. Musa is now desperate to sell the car so that he can clear a bank loan of  Shs10m, overdue medical bills of Shs7m for his mother and school fees of Shs3m for his four children. In total, Musa needs cash of Shs20m. The market value of Musa’s car is Shs25 m but because he is desperate, he accepts an offer of Shs20m from Henry. 

Upon sale, Musa would make a loss of Shs10m (Shs20m sales proceeds – Shs30m purchase cost). Under the current law, Musa would not be subject to tax because the car is a personal asset. [Note: Musa cannot claim a deduction for this loss because the car is a personal asset. On the other hand, if the car were a business asset, Musa would have been able to claim a deduction for the capital loss].   

The proposed tax amendment, if passed, changes things. Let’s see how:

Since Musa is not in the business of selling cars, Henry, the buyer will be required to deduct withholding tax of Shs1m (5 percent x Shs20m) on the payment to Musa. This means instead of Musa receiving cash of Shs20m, Musa will receive cash of Shs19m. 
Henry will be required to file a withholding tax return and remit the tax of Shs1m to URA within 15 days after the month in which the payment is made. To comply with these requirements, Henry will need a TIN. 

Upon realising that the amount he will receive is even less than the amount he needs to settle his dues, Musa may be very unhappy. Imagine if Musa insists that he wants his Shs20m cash. He may probably tell Henry, “I don’t care what the tax is, just pay me my money or the deal is off”. 

In practice, this is very likely to happen. Either Musa will increase (by grossing up) the price of the car to cover for the additional 5 percent tax; or if desperate, Henry will be forced to take on the tax burden for the tax due. In either case, the cost to Henry will increase by 5.26 percent as indicated below: 
    Normal    With grossing up 
Cost to Henry     20,000,000        21,052,632 
WHT rate                 5%                     5% 
WHT due     (1,000,000)         (1,052,632) 
        
Cash paid to Musa       19,000,000         20,000,000
 
Grossing up for the withholding tax means that the seller will pass on the 5% withholding tax burden to the buyer, artificially inflating the cost of the commodity by 5.26%. This will make the cost of purchasing the item unnecessarily expensive.
Therefore, if passed into law, the proposal to tax asset disposal proceeds would not only erode value as it disregards the cost incurred by a person in developing or acquiring an asset, but could also have the unintended consequence of leading to artificial inflation as sellers pass on the tax burden to buyers. 

It also leaves us with a question:  How will URA enforce collection and remittance of withholding tax from every individual who buys an asset located in Uganda? 

The good news is that based on Parliament’s recent report of the Committee on Finance, Planning and Economic development on the Income Tax (Amendment) Bill, 2023, Parliament has proposed to withdraw this proposal. I welcome this move and pray that this status quo is maintained. 

Sophie Kayemba is a senior manager in tax at PwC Uganda.