THE INCOME TAX ACT, CAP. 332 PRACTICE NOTE TAXATION OF GAINS FROM THE REALISATION OF INTEREST IN LAND OR BUILDINGS

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1 ISO 9001:2008 CERTIFIED THE INCOME TAX ACT, CAP. 332 PRACTICE NOTE TAXATION OF GAINS FROM THE REALISATION OF INTEREST IN LAND OR BUILDINGS PRACTICE NOTES NO. 03/2013. DATE OF ISSUE 1 ST NOVEMBER,

2 TAXATION OF GAINS FROM REALISATION OF INTEREST IN LAND OR BUILDINGS Practice Note No. 03. /2013 Date of Issue 1 st November, 2013 Contents Pages 1.0 TAX LAW INTERPRETATION THE PURPOSE OF THIS PRACTICE NOTE HOW THE LAW APPLIES REVOCATION TAX LAW. This Practice Note applies in respect of the taxation of gains or profits derived in conducting an investment from the realisation of an interest in land or buildings situated in the United Republic. 2.0 INTERPRETATION. 2.1 In this Practice Note, unless the context requires otherwise - Act means the Income Tax Act, Cap Definitions and expressions used in this Practice Note that are used in the Act have, unless the context requires otherwise, the same meaning in this Note as they have in the Act. 3.0 THE PURPOSE OF THIS PRACTICE NOTE An interest in land or building is essentially an investment asset. Realisation of interest in land or building is therefore realisation of an investment asset, except where it is provided for otherwise in the Act, and gains or profits derived are taxed in accordance with section 9(2)(b) of the Act. This Practice Note considers: 3.1 Important features in determining whether or not a transaction is considered as realisation of an interest in land or building in conducting an investment and taxation of gains, if any, which arise from such transactions. 2

3 3.2 Gain from the realisation; 3.3 Conducting an investment from the realisation 3.4 Realisation not carried out in conducting an investment. 3.5 Apportionment of costs and incomings. 3.6 Mode of calculation of gains in conducting an investment from the realisation of interest in land or building; 3.7 Mode of Payment of the tax. 4.0 HOW THE LAW APPLIES. 4.1 Gains from realisation of an asset General rule A person s gain from the realisation of an asset is the amount by which the sum of the incomings for the asset exceeds the cost of the asset at the time of realisation Incomings for an asset of a person means amounts derived or to be derived by a person in respect of realising the asset including:- (a) Amounts derived by the person in altering or decreasing the value of the asset; and derived while owning the asset including by way of convenant to repair or otherwise. (b) Amounts derived or to be derived by the person in realising the asset The cost of an asset is the sum of (a) expenditure incurred by the person in acquiring the asset; (b) expenditure incurred by the person in altering, improving, maintaining and repairing the asset; (c) expenditure incurred by the person in realising the asset; (d) incidental expenditure incurred by the person in acquiring and realising the asset; (e) any amount required to be added in calculating income from the investment under the Act Loss from the realisation of an asset. A person s loss from the realisation of an asset is the amount by which the cost of the asset exceeds the sum of the incomings for the asset at the time of realisation. 3

4 4.2 Conducting an investment from the realisation of an interest in land or building. A person who owns an interest in land or building (the asset) shall be treated as realising the asset; When the person parts with ownership of the asset When a person parts with ownership of the asset including when the asset is sold, exchanged, transferred, distributed, cancelled, redeemed, destroyed or surrendered, the asset shall be treated as realised. Realisation in this case is more than selling of an interest in land or building. Realisation also occurs where the interest is exchanged or is transferred, distributed, destroyed, cancelled, redeemed or surrendered. In the case of a person who ceases to exist, excluding a deceased individual, the asset shall be treated as realised immediately before the person ceases to exist. Therefore a deceased person who parts with ownership of an asset consequent to death is not treated as realising the asset Realisation of an interest in land or building by an entity due to change in underlying ownership of the entity At the moment the underlying ownership i.e. membership interest owned in the entity directly or indirectly, changes by more than fifty percent as compared with that ownership at any time during the previous three years, the entity shall be treated as realising any asset owned immediately before the change. Illustration Entities ACo Limited and BCo Limited own 70 percent and 30 percent membership interest respectively in the entity DarCo Limited which conducts investment by leasing its two buildings situated in Dodoma and Mwanza. A local investor InCo Limited purchases 40 percent of ACo s holding and 15 percent BCo s holding in DarCo. The new underlying ownership of DarCo Limited is now InCo Limited 55 percent, ACo Limited, 30 percent and BCo Limited holds. 15 percent interest. DarCo Limited underlying ownership has changed by 55( ) percent. Pursuant to the provisions of section 56(1) as amended, DarCo Limited is treated as having realised its buildings immediately before the change. 4

5 4.2.3 Special Rules of realisation (a) Realisation with retention of asset; Where an interest in land or building has been realised by a person by parting with ownerships in any of the manners described in Sections 39(d) to (g) or for an entity due to changes in its underlying ownership, under section 39(h): (i) the person or entity shall be treated as having parted with the ownership of the asset and deriving an amount in respect of the realisation equal to the market value of the asset at the time of realization; and (ii) the person shall be treated as reacquiring the asset and incurring expenditure of the amount referred to in paragraph (i) above in the acquisition. (b) (c) Transfer of asset to spouse or former spouse Where an an interest in land or building is transferred to a spouse or former spouse on divorce settlement or bona fide separation agreement and the spouse elect for application of this provision to apply by written notice; (i) the individual is treated as deriving an amount in respect of the realisation equal to the net cost of the asset immediately before the realisation; and (ii) the spouse or former spouse is treated as incurring expenditure of the amount referred to in paragraph (i) in acquiring the asset. Transfer of interest in land or building to an associate or for no consideration Where a person realises an interest in land or building by way of transfer of ownership of the asset to an associate of the person or by way of transfer to any other person by way of gift- (i) the person shall be treated as deriving an amount in respect of the realisation equal to the greater of the market value of the asset or the net cost of the asset immediately before the realisation; and (ii) the person who acquires ownership of the asset shall be treated as incurring expenditure of the amount referred to in paragraph (i) in acquiring the asset. 5

6 Where a person realises an asset, being a business asset, depreciable asset or trading stock by way of transfer of ownership of the asset to an associate of the person and the requirements of section 44(4) are met (i) the person shall be treated as deriving an amount in respect of the realisation equal to the net cost of the asset immediately before the realisation; and (ii) the associate shall be treated as incurring expenditure of the amount equal to the net cost of the asset referred to number (a) above. The requirements to be met under Section 44(4) are:- (i) either the person or the associate is an entity; (ii) the asset or assets are business assets, depreciable assets or trading stock of the associates immediately after transfer by the person; (iii) at the time of the transfer (i) the person and the associates are residents; and (ii) the associate or in the case of an associate partnership none of its partners is exempt from income tax (iv) there is continuity of underlying ownership in the asset of at least 50 percent; and (v) an election for the roll over relief is made by both the person and associate. The provisions of section 44(2), 44(3) and 44(4) with respect to transfer of business assets, depreciable assets or trading stock shall not apply to realisation of investment assets. (d) Involuntary realisation of an interest in land or building with replacement Where a person involuntarily realises an interest in land or building in conducting an investment as provided for in section 39(a) and within one year of the realisation acquires a replacement asset and elects in writing for application of section 45 of the Act, the person shall be treated as:- (a) deriving an amount in respect of the realisation equal to (i) the net cost of the assets immediately before the realisation; plus (ii) the amount, if any, by which amounts derived in respect of the realisation exceed expenditure. (b) incurring expenditure in acquiring the replacement equal to 6

7 (i) the net cost of the asset immediately before the realisation; plus (ii) the amount, if any, by which expenditure incurred in acquiring the replacement exceeds the amount derived in respect of the realisation. Illustration Mr. M owned interest in a building which be rented to a parastatal institution as an office of the institution. The local authority ordered demolition of the building in order to create more space for expansion of a trading hospital used by the local university. Mr. T was paid Shs million and an alternative plot on which he constructed a similar building for renting in eight months. The following are the cost of the demolished buildings, amount derived on realisation and the expenditure for the replacement. Net cost of the asset realised Shs. 10,000, Percent derived on realisation Shs. 20,000, Expenditure incurred on the replacement Shs. 24,000, Calculation of gain (a) Amount derived in respect of the realisation net cost of the asset realised Shs. 10,000, plus excess of amount derived 20,000,000 over expenditure of opinion 14,000,000 6,000, ,000, (b) Expenditure incurred Net cost of the realised asset 10,000, Plus Excess, if any, of expenditure of replacement 24,000, exceeds amount derived 20,000, ,000, ,000, ,000, Gain derived (a) (b) 2,000, (e)realisation of interest in land or building by separation 7

8 Except for situations of instalment sales and finance leases administered under section 32 of the Act, where rights with respect to an interest in land or buildings owned by one person are created in another person, including by way of lease of an asset or part thereof, than (a) Where the rights are permanent, the person shall be treated as realising part of the asset but is not treated as acquiring a new asset, and (b) Where the rights are temporary or contingent, the person is not treated as realising part of the asset but as acquiring a new asset. 4.3 Realisation of interest in land or building not carried out in conducting investment. Realisation of interest in land or buildings which are subject to single instalment under section 90(1) are only those carried out in conducting an investment. The following transactions are considered as realisation whose gains are not subject to single instalment income tax for the basic reason that the transactions are not carried out in conducting an investment:- (a) (b) (c) the distribution by an entity of the investment asset to its shareholders on its liquidation. the distribution of the investment assets on dissolution of a body corporate, any transfer of assets in a scheme of amalgamation by the amalgamating company to the amalgamated company if the amalgamated company is a Tanzanian company. 4.4 Apportionment of costs and incomings Expenditure incurred when a person acquires one or more interest in land or buildings by way of transfer at the same time or as put of the same arrangement, the expenditure treated as incurred in acquiring each of the asset shall be apportioned between the assets according to their market values at the time of acquisition. 8

9 4.4.2 Amounts derived Where a person realises one or more interest in land or buildings by way of transfer at the same time or as part of the same arrangement, the amount derived in realising each of the assets shall be apportioned between than according to their market values of the time of realisation Realisation of a part of the asset A person who owns an interest in land or building realises part of it, the net cost of the interest or building immediately before the realisation shall be apportioned between the realised and the retained parts according to their market values immediately after the realisation Interest I land and building not investment asset The following interests in land are not investment asset by definition in the Act: Realisation of a private residence. Where a private residence of an individual is realised, the gain derived as a result of the realisation of such residence is not to be included in the gains subject to income tax provided the following conditions are fulfilled: (a) (b) The residence has been owned continuously by the individual for three years or more and lived in by the individual continuously or intermittently for a total of three years or more; and The interest was realised for a gain of not more than shillings 15,000, Realisation of interest in land used for agricultural purposes. Where the interest in land held by an individual that has market value of less than shillings 10,000,000 at the time it is realised and has been used for agricultural purposes for at least two of the three years prior to realisation, the gain, if any, which arise from the transaction is not to be included in calculating gains subject to single instalment payment under section 90(l). 9

10 Mode of calculation of gains from realisation of interest in land or building. The gain from realisation of an asset is calculated as follows: The sum of incomings of an asset from the realisation reduced by (a) the cost of acquisition of the interest (b) the expenditure incurred on any improvement to the asset (c) expenditure incurred wholly and exclusively in connection with the realisation, such as stamp duty, registration charges, legal fees, brokerage etc. The calculation of a person s gain from the realisation of interest in land or buildings: The net gain from the realisation of investment asset of a person are calculated as the sum of an all gains from realisation of investments assets of the investment during the year reduced by (a) The total of all from the realisation of investment assets of an investment during the year; (b) any unrelieved net loss of any other investment of the person for the year; and (c) any unrelieved net loss for a previous year of income of investment any other investment of the person. Where an interest in land or buildings is realised for inadequate consideration being less than the fair market value of the interest and the Commissioner has reason to believe that the realisation is effected with the object of avoiding or reducing the liability for payment of tax under gains on realisation of interest in land or building, the Commissioner may adopt the fair market value of the interest against the value declared by the Instalment payer. 4.6 Mode of payment of the tax Filing of a return Where the person derives a gain in conducting an investment from realisation of the interest in land or building is required to file a return under the Act, the gain realised is to be included in the person s gross total income for the year of income Payment of Tax (a) Where an instalment payer derives a gain in conducting an investment from the realisation of an interest in land or building situated in the United Republic, the person shall pay income tax by way of single instalment at the rates shown in Paragraph below. 10

11 (b) The income tax instalment shall be paid before the title to the interest is transferred and the Registrar of Titles shall not register such a transfer without the production of a Certificate of the Commissioner certifying that the tax has been paid or that no instalment is payable. (c) The single instalment payer shall be entitled to a tax credit for a year of income equal to the amount paid by way of single instalment Tax on gains from realisation of interest in land or building in case of individuals. An individual instalment payer who derives gains on realisation of an interest in land or building shall pay income tax equal to: (a) in the case of a resident individual, ten percent of the gain, or (b) in the case of a non-resident individual, twenty percent of the gain. (c) in the case of a resident individual who derives a gain from the realisation of interest in land or building the individual shall pay tax as follows: - (aa) the greater of (i) (ii) the individual s total income less the gains; or the individual s threshold income liable to income tax currently in force. (bb) shall be taxed at the specified individual resident income tax rates as though it was the only total income of the individual; and the balance of the total income shall be taxed at the rate of 10 percent. Example 1 Mr. Y was resident during the year He sold his personal building, which was not used, for his residence for TZS. 40,000,000/=. The building was acquired for TZS. 15,000,000/= four years back on which he spent TZS. 3,000,000/= on improvement and TZS. 1,500,000/= in connection with the sale of the house. Mr. Y also had business income of TZS. 16,000,000/= during the year. 11

12 Capital gains tax computation TZS TZS Business income 16,000,000/= Gain on realisation: Sale (Incoming of...) 40,000,000/= Less: Cost Improvement 15,000,000/= 3,000,000/= Selling Expenses 1,500,000/= Gain on realisation 20,500,000 Total Income 36,500,000/= Less: Gain realised 20,500,000/= Other Income 16,000,000/= TZS. 16,000,000/= to be taxed at individual resident tax rates Gain on the realisation - TZS. 20,500,000 at 10 percent i.e. single instalment tax TZS. 2,050,000/= Example 2 Mr. M a resident individual realised gross receipt of TZS. 4,000,000/= which he acquired three years back for TZS. 1,000,000/=. Mr. M incurred no expenditure on improvement and the sale and had no other income during the year. Capital gains tax computation: TZS Receipts on realization 4,000,000 Less: Cost of acquisition 1,000,000 Gain on realisation 3,000,000 Other income NIL Total income 3,000,000 Less TZS. 720,000 (threshold) 720,000 Taxable gains 2,280,000 Tax at 10% rate 228,000 Example 3 If Mr. N was non-resident during the year the capital gains tax would be computed as follows: TZS Gross gains 4,000,000 Less cost 1,000,000 Capital gains 3,000,000 Tax at 20% 600,000 12

13 Example 4 Mr. Z realized his house for TZS 1,8000,000/=, which he acquired for TZS. 1,000,000 few years back. During the year he had incurred business loss of TZS. 1,000,000/=. Mr. Z had unrelieved loss of TZS. 10,000 emanated from realization of interest in land in the previous year. The gain on realisation will be computed as follows: - TZS TZS Business Loss for the year (1,000,000) Gain on realisation: Receipts 1,800,000 Less: Cost (1,000,000) Gain on realisation 800,000 Less: Unrelieved Capital loss (10,000) 790,000 Less: Threshold (720,000 Taxable gain 70,000 Tax on gain at 10% 7, Tax on gains on realisation of interest in land or building in case of an entity. Gains on realisation of interest in land or building of entities are charged to tax at the rates of 10 percent for residents and 20 percent for nonresidents of the gains amount. However the total income of the entity is taxed at the prevailing corporate tax rate. 5.0 REVOCATION Pursuant to the provision of section 130(2) the Practice Note Number 02/2004 issued on 15 th December, 2004 is hereby revoked. Signed... Commissioner 1 st November,