In this Article, I analyze provisions of the Income Tax Act Cap 340 as amended by the Income Tax (Amendment Act) 2014, on rental tax and break down in simple terms how to compute rental tax. I demonstrate the advantage that companies as landlords have over individuals as landlords.
In the recent period, URA has been aggressive in trying to recover taxes on rental income. Several landlords and landladies have received unwanted calls from URA officials and agents demanding and reminding them to register for taxes, file returns and pay taxes on income derived from their rental property. For many this came as a shock considering for a while now, many landlords and landladies have enjoyed the proceeds of their properties without the intervention or ‘inconvenience’ from URA.
This article seeks to ease this pressure, by enlightening the reader on how rental tax assessments are done. Once equipped with this information, compliance will be easier, and you will learn how to take advantage of the tax system especially on treatment of the different taxpayers. By complying you will avoid potential hefty penalties that may arise from your default. The point is that once you know you can plan and structure yourself better.
1.0 Imposition of Rental Tax.
Rental Tax is imposed under Section 5 of the Income Tax Act (The Act) which provides that a tax shall be charged for each year of income and is imposed on every person who has rental income for the year of income. Unlike other forms of income, rental income is classified and taxed separately under the Act. In other words, it is not added to the gross income of the tax payer from other sources. (See Section 5(3) of the Act.
1.1 Definition of a person
Person is defined under Section 2(yy) of the Act to include;
‘an individual, a partnership, a trust, a company, a retirement fund, a government, a political subdivision of a government and a listed institution.’’
1.2 What is Rental Income?
Rental income is defined under Section 2(ddd) of the Act to mean;
‘‘the total amount of rent derived by the person for the year of income from the lease of immovable property in Uganda with the deduction of any expenditures and losses incurred in respect of the property’’ [Emphasis added].
2.0 How to compute rental tax for Individuals
To compute the rental tax for individuals, you apply the prescribed rate to the chargeable income.
i) The Rate of Tax for Individuals
The rate of tax for resident individuals is prescribed under Part IV of the Third Schedule to the Act which provides that;
‘The rate of tax applicable to an individual for purposes of Section 6(2) is 20% of the chargeable income in excess of 2,820,000/=.’’
ii) Chargeable Income for individuals
Chargeable Income is the gross income of the individual for the year less allowable deductions (See Section 15, Income Tax Act).
As noted earlier, Rental Tax is computed separately and the gross income considered is only Rental Income.
Section 5(3), of Act, further provides that expenditures and losses incurred by the individual in the production of rent shall be allowed as a deduction for the year of income only as provided for under Section 22(1)(c).
iii) Allowable Deductions
Section 22(1)(c) provides that a person shall be allowed as deductions in any year of income;
‘‘…In the case of rental income, 20% of the rental income as expenditures and losses incurred by the individual in the production of such income’’.
For the taxpayer, depending on the expenses, the above provision has the unfortunate effect of capping the allowable deductions. Expenses incurred in the production of rent including interest payments for any loans secured to construct the rentals are immaterial.
The law assumes that your expenses shall represent only 20% of rental income. This therefore, calls for diligent and prudent management of expenses in any given year, otherwise, your rental business may never break even. This awareness should also guide your pricing for the rental units. The income derived should reasonably settle your expenses and enable you to meet your tax obligations.
This awareness is further important because;
1. Section 5(3)(c) further provides that the tax payable shall not be reduced by any tax credits ordinarily allowed under the Act.
2. Under Section 5(6), the Minister is empowered to prescribe estimates of rent based on the rating of the rental property in a specific location. This means that the rent charged needs to be reflective of the market rate of the location. Otherwise, you might end up assessed a tax at a rental rate higher than you are actually receiving which may significantly affect your income.
iv) Summary on computation of rental tax for individuals
To compute rental tax therefore, for an individual, the following steps should be followed;
a) Determine gross rental income. For example’s sake, let’s assume, total earnings in rent to be Ushs. 30,000,000/=.
b) Determine chargeable income; Gross Income- Allowable deductions; 30,000,000-(20%x 30,000,000) =24,000,000/=.
d) Reduce amount in (c)above by 2,820,000/=(Minimum threshold) to find tax payable ; 4,800,000-2,820,000=1,980,000/=
In the above example therefore, someone earning 30,000,000/= would be required to pay rental tax of 1,980,000/=
3.0 How to compute rental tax for Partnerships
The computations for partnerships are similar to computations of an individual. The main difference though is that you divide the tax payable by the number of partners. (See Section 5(1)(d) of the Act).
Using the example above, if Partnership X has two partners then the tax payable by each one of them would be 50% of the total rental tax payable. Accordingly, if the rental tax is 4,236,000/=, the tax payable by each partner would be 2,118,000/=.
4.0 How to compute rental tax for Companies
To compute the rental tax payable by a Company, you apply the prescribed rate to the rental income derived by the company for the year.
i) The Rate of Tax for Companies
According to Section 7(2) of the Act, the rate of tax for Companies is prescribed under Part II of the Third Schedule to the Act which provides that;
‘The rate of tax applicable to companies…. for the purposes of Section 7 is 30% .
ii) Chargeable Income for Companies
Chargeable income for companies is also determined under Section 15 of the Act by finding the gross income of the Company for the year less allowable deductions.
Like individuals, the rental income of a company must be separated from other income of the company. (See Section 5(4) (a) of the Act).
However, unlike individuals, expenditures and losses incurred by a company in the production of rent shall be allowed as a deduction under this Act for any year of income. (See Section 5(4)(c) of the Act).
This means that a simple act of structuring the character of a taxpayer can have a profound tax advantage for the tax payer. Whilst the individual’s allowable expenses are capped at only 20%, a company can have all legally recognized expenses which when applied may substantially reduce the rental tax due.
5.0 How to compute rental tax for a Trustee/Retirement Fund
5.1 To compute the rental tax payable by a trustee or retirement fund, you apply the prescribed rate to the rental income derived for the year. (See Section 5(1) (c) of the Act).
5.2 The conclusion upon reading Section 8(5) of the Act, is that rental income of these persons is determined in a manner similar to companies. You apply the rate of 30% to its chargeable income. The chargeable income is gross income less allowable deductions in the year of income. (See Part III of the Third Schedule to the Act).
5.3 The main distinction between companies and trustees arises when dealing with trustees to estates of deceased person. The law requires that Part I of the Third Schedule which sets out income tax rates for individuals is applied in the first year of death and the following year. (See Section 8(6) of the Act).This treatment is also given to a trustee of an incapacitated person’s trust.
In conclusion, the rental tax payable is dependent on the nature of the person. Where the tax payer is classified as an individual, the deductions allowed are capped at 20% notwithstanding a seemingly low rate of 20%. Although the other kinds of taxpayers have a much higher rate of 30%, the fact that they can claim more deductions enables them to set off their expenses from the income before determining the tax due hence are in a more advantageous position than an individual incurring huge expenses which may not be adjusted in the tax computations.
This article provides general information only. It is not intended to provide advice with respect to any specific set of facts, nor is it intended to advise on all developments in the law.
About the Author;
The author is a commercial law practitioner and founder of M/s Tibugwisa and Co. Advocates. For comments and inquiries contact her at firstname.lastname@example.org or +256787461139.