New incentives needed to draw more investors into real estate

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By Rachel Muiru

In the recent past, Kenya has witnessed an upsurge in real estate development. This has been driven by a number of factors notably the quest for Kenyans to own homes, rural urban migration, increased diaspora remittances etc. As a result, property prices in the urban areas have taken an upward trend. The expansion of Mombasa road and the construction of Thika super highway have also contributed to the rise of property prices in the adjacent areas. It is now a reality that people can live in Kitengela or Thika towns and commute every day to Nairobi courtesy of the improved road network. Many multinationals have chosen Nairobi as their preferred destination for setting up regional offices. This has also contributed to the high demand for residential and commercial buildings. The question that therefore begs an answer is whether our tax laws have kept in pace with the current developments in real estate and to what extent they enhance this.

The Income Tax Act herein after referred to as ‘ITA’ offers various incentives to real estate developers. Key among them is the allowance of 50% on the cost of investing in a building for use as a hostel or education building. The introduction of this incentive was a welcome move as the education facilities constructed in the 1980s and 1990s were no longer sufficient to cater for our increased population and the demand for tertiary education in Kenya. Indeed, provision of quality education is no longer the responsibility of the Government alone. The introduction of free primary education saw an upsurge in the enrolment levels of pupils in primary schools whereas the facilities were not upgraded to cope with the increased numbers. Many private developers took advantage of this fact and established academies to provide options to parents who view the public schools as being too congested.

An investor in rental residential building in a planned developed area is entitled to an annual allowance of 5% of the cost of the investment. Rental residential buildings constitute the biggest percentage of investment in real estate due to the rising demand for residential houses. The allowance of 5% is low and does not offer an incentive for investments in this sector. Moreover, it will take 20 years for the investor to recoup his investment. Further, the approval process is time consuming and the requisite conditions very restrictive rendering the scheme unattractive. Iam not aware of any investor who has benefited from this allowance despite the existence of the incentive in our legislation since 2008.  It is expected that during the budget for 2012/2013, the Minister for Finance will increase this allowance and stream line the approval process to make it attractive to investors. The ITA has not specified the materials to be used for construction of the buildings for investments to qualify for the allowances. The choice of the material is left to the investor and the building qualifies as long as the usage meets the requisite criteria mentioned above.

A building in use as an industrial building qualifies for industrial building allowance at 10% of the cost of the investment. Further, civil works or structures on the premises of the building are deemed to be part of the building for purposes of the allowance.

A building in use for purposes of manufacture qualifies for investment deduction at the rate of 100% of the cost of the investment. Where the investment is more than Kshs.200 Million and the building is constructed outside the three main cities, the investor qualifies for an investment deduction at 150% of the cost of the investment!. This allowance comes in handy as it reduces the tax payable in the first years of operation.

Kenya is a favorite tourist destination for tourists from all over the world. This is due to a number of factors notably the geographical features and tropical climate.  Tourism has spurred investments in hotels. A hotel building qualifies for investment deduction at 100% of the cost of expenditure. In addition, the investor is entitled to remission of VAT and custom duties on capital goods imported or purchased locally for use in the hotel. The remission is granted on application basis.

Through the 2009 Finance Act, the Minister introduced a commercial building allowance of 25% of the cost of the investment where roads and other social infrastructure have been provided. This change was warmly welcomed as investors in this sector had felt left out. The joy was short lived as the 2010 Finance Act brought amendments to the effect that for anyone to qualify for the allowance, they must have invested in the social infrastructure. The amendment essentially locked out almost all of the would-be beneficiaries. This is because most of the infrastructures are provided by the Government or the local authorities. The investor is only required to make connections to access the infrastructures. To retain the objective and the value of the allowance, the Minister should disregard the new amendment and retain the provision as it was. This will go a long way in attracting investments in commercial buildings. In addition, the Minister should consider granting a higher allowance for investments made outside the three main cities as is the case for investment deduction.

Rachel Muiru is a Tax Manager with EY. Views expressed in the article are personal and may not represent the firm’s