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Andrew M. Mwenda is the founding Managing Editor of The Independent, Uganda’s premier current affairs newsmagazine. One of Foreign Policy magazine 's top 100 Global Thinkers, TED Speaker and Foreign aid Critic

Monday, June 7, 2021

Anatomy of policy disaster

How Uganda’s tax policy on real estate has destroyed the once thriving sector and stifled economic growth

THE LAST WORD | ANDREW M. MWENDA | This week, the government will read the 2021/22 budget. Given the poor performance of the economy, government is proposing new taxes. For instance, it has proposed to increase rental income tax from 20% to 30%. Many have made fine arguments in opposition to this tax but I don’t think government will listen. Uganda’s tax policies towards real estate have been growing from bad to worse since 2012. This article seeks to explain this development.

A friend was selling a house on a 60-decimals plot of land (0.6 of an acre) in Bugolobi. The price was $500,000 (Shs 1.8 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% VAT i.e. Shs275m. He had bought the house in 1997 at Shs 300m. Therefore, he had to pay capital gains tax of Shs 450m. The buyer would have to deduct 6% as withholding tax i.e. Shs 108m. The total tax liability would come to Shs 833m.

To avoid paying all these taxes, my friend demolished the house and sold just the plot as empty land – actually at the same price of $500,000. This meant he would not pay VAT or capital gains tax (since he was not in the business of buying and selling land). He paid withholding tax of Shs 108m. This is how Uganda’s taxes on real estate have made the building and selling of houses a loss[1]making venture. For a country where land and house prices were appreciating on a monthly basis about ten years ago, today house prices in Kampala have been stagnant for the last eight years.

Imagine a Ugandan who has made Shs 400m and decides to purchase an apartment in Bugolobi to earn some income. Let us assume that this tax compliant Ugandan registers it with URA for rental tax. Let us assume that three years later, he has had a tenant for only four months but the price of his apartment has appreciated to Shs 600m, giving him or her capital gain of Shs 200m. If he sold, he would have to pay VAT of Shs 92m, Shs 60m as capital gains and the buyer would have to withhold Shs 36m as withholding tax, a total of Shs 188m. Three years later he would have gained only Shs 12m from the investment. But his is before we deduct the cost of inflation. His net return is most likely close to zero.

But let us even assume that this young Ugandan did not have all the Shs 400m to pay for the apartment – and that is the majority of the cases. So we assume he has worked hard and saved Shs 100m. He puts this upfront as a down payment on the apartment. He then borrows Shs 300m from the bank at an interest rate of 18% for 15 years. Let us assume it was rented for only six months in three years. Let us assume the value of the apartment appreciated to Shs 600m and he sells to realize that gain. But after three years (36 months), he would have paid interest on the mortgage amounting to Shs 160m, he would be required to pay VAT of Shs 92m, capital gains tax of Shs 12m and withholding tax of Shs 36m. His total costs would be Shs 298m i.e. he would have made a loss of Shs 98m in three years, before calculating the cost of inflation.

This is how absurd tax policy in real estate and other sectors has gotten in Uganda. Many people blame URA for these mistakes. Yet URA does not make tax policy. It only implements it. Tax policy is made by the ministry of finance. One has to ask how those tax gurus at finance really think. What drives public officials to make such absurd policies? One suspicion is that most public officials in Uganda do not make money honestly. They can get one big bribe at a time and buy a house or many other investments. Therefore, they do not understand the life of an honest citizen.

The other suspicion is that our public officials are lazy and are lacking in imagination. Whenever government wants to raise more revenue, they go for only those sectors they can easily see. This same attitude pervades URA. Whenever they need taxes, they go to those few taxpayers who have been compliant. So, both our tax laws and our tax administration focus on a very small number of compliant tax paying citizens.

But then we must ask ourselves why these citizens of Uganda who are subjected to these obnoxious taxes do not organize collectively to demand fairer tax policy through their elected representatives or civic associations? One reason is that many Ugandans are not suffering from these onerous taxes. For many, the limited reach of URA keeps them free. The tax authority has a very poor map of the real estate investments of many Ugandans. This is largely because of its limited manpower, but also because of its own internal incompetence and corruption.

On the face of it, these bad tax policies reflect a conflict between the state and productive citizens. The state seeks to squeeze the last penny out of the embattled taxpayer. The taxpayer would ideally seek to avoid such onerous taxes by shifting their investment to less taxed sectors. But the reality is much more subtle. Whereas at the level of official policy the interests of URA officials and ordinary citizens conflict, at the level of unofficial practice they are actually in consonance given the structure of incentives the official policy gives. To put it plainly, the policies create joint gains for tax official and taxpayer through corruption.

In exchange for a bribe, the URA official can help someone avoid paying the taxes. For the Ugandan taxpayer, rather than organize politically to oppose government policy, which can be individually costly, he can do better by seeking to become an individual exception to the tax. He does this by offering bribes to URA officials so that he can evade taxes. It is through these very subtle accommodations between taxpayers and tax officials that government in Uganda is able to secure individual compliance with its rules which are often collectively harmful. But this is also the mechanism that has stifled the development of collective associations among citizens to promote the common good.


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