Clarification on taxation of real estate

“A friend was selling a house on a 60-decimals plot of land in Bugolobi. The price was $500,000 (Shs1.8 billion). He had been renting it and paying rental income tax to URA. Here are the taxes he would pay if he sold the house. First would be 18 per cent VAT i.e. Shs275m. He had bought the house in 1997 at Shs 300m. Therefore, he had to pay capital gains tax of Shs450m. The buyer would have to deduct 6 per cent as withholding tax i.e. Shs108m. The total tax liability would come to Shs 833m.”

Mr Mwenda’s friend resorted to a rudimentary form of “tax planning” by demolishing his house and selling the plot as empty land at the same price and thus only paid withholding tax.

This illustration is inaccurate in a number of aspects:
a) There is no Value Added Tax (VAT) charged on the sale of residential properties. Paragraph 1(f) of the Second Schedule to the VAT Act exempts a supply by way of sale, leasing or letting of immovable property, other than a sale, lease or letting of commercial premises and service apartments. 
Furthermore, VAT is only chargeable by a person registered for VAT and making taxable supplies.

b) The writer assumes that the withholding tax of six per cent on sale of a business asset under Section 118B(2) of the Income Tax Act is a final tax and separate from capital gains tax. Withholding tax is merely a means of collecting income tax in advance. 

Mr Mwenda’s friend would therefore be able to reduce his capital gains tax liability by the withholding tax already remitted. The capital gains due would therefore be Shs450m – Shs108m which is Shs342m. 
Moreover, he need not consider the cost base upon which to calculate capital gains at just Shs300m. 

Any improvements made to the house over the years (purchased in 1997) should be added to the cost base. Assuming he made improvements valued at Shs200m over the years, the capital gains liability becomes Shs390m – Shs108m which is Shs282m. 
Thus the true tax liability upon sale of his 60 decimal plot of land would be about Shs282m. 

Further, he ought to be advised that his “tax planning” may not be beneficial. Destroying the building does not change the tax liability and comes with heavy demolition costs. 

The second example; “Imagine a Ugandan who has made Shs400m and decides to purchase an apartment in Bugolobi to earn some income. Let us assume that he registers with URA for rental tax and that three years later, he had a tenant for only four months but the price of his apartment has appreciated to Shs600m, giving him or her capital gain of Shs200m. If he sold the apartment, he would have to pay VAT of Shs92m, Shs 60m as capital gains and the buyer would have to withhold Shs36m as withholding tax, a total of Shs188m. Three years later he would have gained only Shs12m from the investment. But this is before we deduct the cost of inflation. His net return is most likely close to zero.”

As explained, unless the apartment described above is a service apartment, there will be no VAT charged. 

Similarly, the withholding tax is an advance collection of the capital gains tax therefore the final tax liability would be Shs24m after offsetting withholding tax of Shs36m if there was no improvement on the apartment in the three years. 

 Mr John R. Musinguzi, Commissioner General URA