Joint Venture Development of Property in Kenya

Joint Venture Development of Property in Kenya

The prices of property in major cities and especially in Nairobi and Mombasa have sky-rocked in the last few years.  Besides, the cost of borrowing has been generally been high and at most unpredictable. Taking these factors and others into consideration, it is becoming increasingly difficult for both land owners and property developers in develop or implement real estate projects. For instances, in light of high land prices, a developer who chooses to buy land may not be left with adequate resources to develop it after the purchase. For land owners, lack of  affordable capital is a great hindrance to property development.

To bridge this gap, it is advisable for land owners and owner of capital or real estate developers to come together and devise ways of polling their respective resources together in order to achieve meaningful results. Indeed, it the recent development in anything to go by, the future of real estate development is in joint venture real estate projects.   For real estate joint ventures to work, it is important to consider salient features of such an arrangement and get a good lawyer to prepare relevent documents which will protect the parties' interest and address their concerns.

For a land owner, the greatest challange is lack of technical know-how on how to negotiate a good deal.  Besides, many a land owners may not have witnessed such arrangement in the past. Other fears to be conned by unscruplous developers.  Moreover, they is a danger that the developer may not keep part of his bargain after the commencement of the project and thus exposing the land owner to financial loss and unnecessary disputes.

For a real estate developer, his major concern is to ensure that he gets a good title on which he canbimplement the project and recoup his value with minumum risk.  A real estate developers in also interested to have some liberties like being able to advertise the proposed project and make 0ff-plan sales. Moreover, upon commencement of the project implementation of the project, the developers want to be sure that he can start selling the units and implement the project without unnecessary interferances from the land owner.

In light of the foregoing factors, a good joint venture agreement that caters for and adequatelyaddresses parties interests and concerns cannot be gainsaid.  A good joint venture agreement, should at a minumum address the folllowing factors, amongst others:-

1. Tranfer of land to the development company- If the title to the land is in the name of an individual, it is prefarable for it to be transferred to a development company. This the vehicle through which the project will be implemented.  Initially, such company should only be formed with the land owner and his family member(s) as the first  shareholders and directors. The real estate developer should only be incorporated into the company after he has invested some funds into the project.
2. Share capital of the development company and management issues- The initial share capital of the companyu is determined by the value of the land as determined by the project valuer. This is normally the market value of the land.  This value belongs to the land owner alone.  The project quantity surveyor should then try to quantify the full costs of proposed project. This portion of the share capital should be allocated to the real estate developer at various phases of the project implementation milestones. 
3. The change of user and development approvals- The parties should ensure that the change of user of the property is processed by the relevent local authority and the lands office. Moreover, requisite environmental and development permits and permissions should be processed.  The types of permits or approvals to be procured is dependant upon the type of development intended to be implemented by the parties.
4. Selection of the requisite consultants- It is advisable for the parties to agree on the relevent consultants to be involved in the projects. These consultants should include the project architect, the project contractors, the quantity surveyors, the structural engineer, the project surveyor, the project physical planner, the project valuers, project accountant and the project lawyer.  The party to bear the consultants' fees and the contracting terms of each consultants, amongst others, should also be agreed upon.
5. The Types of project and quality of finishings- Preferably, since both parties are equally interested in the type of the project to be implemented on the property, they should jointly agree on this with the help on the project achitect. This will also be influenced by the zoning regulations, the permitted user of the land and the costs implications. The agreed and approved project plans should be registered at the lands office, and copy attached to the JV agreement. Besides, the parties should agree on the qualities of the finishing and these can be attached in a schedule to the agreement.
6. Project milestones and timetable- The parties should agree on various timelines including the hiring of consultants,  the ground breaking date, the construction phase and expected project completion date. The project manager, the project achitect and the contractors can assist the parties to come up with practical timelines.
7. The roles and obligations of the parties - The respective roles and obligations of the parties should be set out in the  joint venture agreement and consequences of default or breach also defined.
8.  Shareholders' Agreement- The parties need to agree on the project management issues in the development  company, and should preferably execute some form of a shareholders' agreement. Amongst other things, such a shareholders' agreement should cover issues like, the company chairpeson, directors and the management structure, the decision making fora and rights, meetings, reserved matters which require unanimity or special majority vote, the dividend policy, keeping of books of account and audit and disputes resolution mechanisms.   Such an agreement should also provide for pre-emption rights on transfer of shares and methodology of admission of new shareholders (if a need arises).
9. The sharing of the project value or profits- The parties may agree on sharing of profits after catering for all project costs including the costs of land which is refunded to the land owner or share the units developed proportionate to their respective contributions or as may be agreed. 
10. Decision Making and Parties Representatives-The parties should agree of the modes of making decions concerning their joint venture projects. The day-to-day management issues can be delegated to the project manager or architect assisted by at least two representatives; one from the developers and the other from the land owner. Major decisions can be taken in stakeholders monthly or quaterly review meetings.
11. Project financing-In some joint venture arrangements, the developer is able to finance the costs of the development on his own or from off-plan sales. This might be from savings or external financing. Some developers may also seek to borrow funds from commercial banks and other financial institutions using the land owner's property as collateral.  In the latter case, this should be agreed upon between the parties since it exposes the property to attachment or forced sale in the event of project failure or lack of cashflow to finance the loan repayment. should be able to raise capital to implement the project.
12. Force Majeure-  These are unforseen factors or circumstances, ansd normally outside the control of either party, which might affect the implementation of the project or delay its completion.  The VJ agreement should anticipate and make provision for force majeure events.
13. Breach, termination and dispute resolution- The JV agreement should cover the consequences of breach by either parties, consequences of breach ,  the grounds of termination (if any), and mode of resolution of disputes.  It is also important to provide that parties would be at liberty to invite additional investors in the event of lack resources to complete the project on their own.
14. Taxation- Lack of compliance with the tax laws can expose the parties to huge financial penalties which might wipe out expected profits or value of the project.  Thus, parties should comply with the tax requirements including payment of withholding tax on consultants fees as well as corporate tax on profits.
15. Insurance - to mitigate against various risks, the parties should ensure that the project is insured at all times during the project implementation phase.Sales and Marketing- In order to realize their gains, the parties should come up witn an elaborate marketing plan for their projects. The should also appoint the project selling agents who will be involved on the sale of the developed units.  The project lawyers should also be able to prepare requisite sale agreements and other documentation and handle the stamping and registration formalities in a timely manner.

Note: This is just a summary of some of the issues to be considered when dealing with joint venture project involving real estate development. It does not in any way obviated the need to seek specific legal advice.  If you require further information or legal advice on  joint ventures covered in this write-up, please do not hesitate to contact the writer on mainacy@gmail.com

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Taxation of Rental Income in Kenya

Taxation of Rental Income under Kenya Laws

(A) Income Tax

For purposes of Kenyan income tax, rental income, premium or similar consideration is regarded as taxable income pursuant to section 3(2) (a) (iii) of the Income Tax Act, Chapter 470 of the Laws of Kenya.   Such other consideration aforesaid include rent realized from sub-leases.

It is also important to note that rent on commercial buildings is also subject to VAT at the rate of 16% , and this is pursuant to sections 5 a and 6 of the of the Value Added Tax Act, Chapter 476 of the Laws of Kenya.

Such a tax payer must register for VAT under the 6^th Schedule of the VAT Act.  Registration is online and is done by choosing the VAT obligation.  Further details on VAT on rental income are provided for in Part B below.

All persons should pay income tax on rental income except if exempted. For instance, charitable organizations can be exempted to pay income tax on rental income pursuant to paragraph 10 of the First Schedule to the Income Tax Act

Section (2) (a) (iii) of the Income Tax Act state that income tax shall be chargeable for each year of income upon all income of a person, whether resident or non-resident, which accrue in or is derived from Kenya.  Under section 6 of the Income Tax Act, gains or profits from trade or business which are taxable under the Act includes a royalty, rent, premium or similar consideration received for the use or occupation of the property.

Resident Tax Payer

Resident taxes payable are supposed to declare the gross rent income but pay tax on net income. Pursuant to section 16 the Income Tax, such net income is arrived at after deducting all expenses which are ‘wholly and exclusively incurred in the production of the income’.  Deductible expenses in respect of rental income are covered under section 15 (1) of the Act and include repairs and maintenance, caretaker costs, legal expenses for preparation of leases, land rents and rates, insurance, agency fees, ground men etc.   In certain cases, some capital expenditures are also deductible and these include costs incurred for the alternation of the premises in order to maintain the existing rent (section 15(2) (f) of the Act).  Under section 15(3) (a) of the Act interest on money borrowed and used to put up rental premises is also a deductible expense.

Non Resident Tax Payer

It should be noted that non-resident tax payer are not allowed to deduct any expenses heighted above from rental income.

Rates of Taxation

There are different rates of income tax which are dependent on whether the tax payer is a corporate or individual or is resident or non-resident for income tax purposes.

(a)  For individuals, the entire income include net rental income is taxed at the current graduated rate, which is as follow:-

For the first KShs.121, 968………………..…10%

               For the next KShs. 114, 912 ………………..15%

For the next KShs. 114,912………………….20%

               For the next KShs., 114,912………………..25%

For the next KShs. 466, 704………………..30%

(b)  For a resident corporate tax payer the entire taxable income including net rental income is taxable at the flat rate of 30%.

(c)   For a non-resident tax payer, there is only a 30% withholding tax on gross rent, which is the final tax.  As stated above such tax payers are not allowed to deduct any expenses on gross rent income.

(d)  For partnership, only a single rent declaration is submitted but individual partners will be taxed on their respective share of rental income.

(e)  For the estate of a deceased landlord, the net rental income is taxable at resident corporate rate of 30%.  Such tax should be paid by, and assessed on, the estate administrator or legal personal representative of the deceased.

(f)   VAT on rent from commercial building is at the rate of 16% since it is not exempted under the Third Schedule of the VAT Act.

Incentives offered to the landlords under the income tax include the following:-

• For industrial buildings-Industrial Buildings Allowance on the cost of the construction as per the paragraph 1(1) of the Second Schedule to the Act. The applicable rate is dependent on the nature, use or location in which the  is constructed.  The rates are provided in the aforesaid provision as read together with paragraph (5) of the said schedule.
• Wear and Tear Deduction on the machinery and equipment on the building as per Schedule 2 of the Act.
• Income of Real Estate Investment Trusts (REITs) is not taxable under section 20C of the Act.  The mode of taxation is the same as that of unit trusts which are not taxed on investment income.
• Personal and insurance reliefs as per sections 30 and 31 of the Act.
• Home Ownership Saving Plans for individuals per section 15 of the Act.
• Mortgage Relief for owner occupied income as per section 15 of the Act.
• The Finance Act of 2008 also amended the VAT to introduce certain incentives for low income housing projects.  (L.N. No. 115 of 5^th September, 2008). A low cost earner is defined a person with monthly gross income of KShs. 35,000 or less. A  Low cost house is defined as a house put up at construction costs of not more than KShs. 1.6 Million and of plinth area not less than 30 square meters. A low income housing project means a project of not less than 20 houses intended of low cost earners.

For non-resident individuals Kenyan who have rental properties in Kenya, they must pay withholding tax on gross rental income at the resident corporate rate of 30%. No expenses are allowable or deductible from such gross income.

Taxation of Real Estate Developers

The real estate developers construct housing or office units for sale to third parties (buyers).  Such developers should pay tax on the net profits of their business. Pursuant to section 15 of the Act, they are allowed to deduct expenses incurred wholly and exclusively in the production of such income. These include cost of land, professional fees payable to various consultants and professionals, materials costs, labour costs, marketing and advertising and other administrative costs. 

Such tax payers should also deduct and pay withholding tax payable on contractual, agency, management and professional fees payable to the contractors and other consultants.

Residence for Kenyan Tax Payer

For purposes of income tax, resident is defined in section 3 of the Act to mean the following:-

• One has a permanent home in Kenya;
• Has been in Kenyan for a aggregate 183 days in any year of income; or
• Hass been in Kenyan for a maximum of 121 days in that year and two preceding years of income.

A corporate person is considered resident if:-

• It was registered or incorporated in Kenya; or 
• Its management or control of the company is exercised substantially in Kenya.

(B) VAT on Rent payable on non-residential Buildings

With effect from 1^st January, 2008 supply of non-residential building is a taxable supply.  

Any person who makes taxable supplies, or is expected to make taxable supplies, the value of which is Kshs.5million or more per annum is required to register. Where a person makes other taxable supplies, taxable rental income will be added to the other taxable supplies to determine the taxable turnover. A person who is already registered for VAT will not be required to register afresh for rental income but will charge tax on rental income even if rental income does not exceed KShs 5m.

Thus, VAT is chargeable on rent payable on letting, renting, hiring or leasing of non-residential buildings or premises. The building owner is required to register for VAT it he meet the threshold set out in the VAT Act and charge VAT on rental payable and remit it to KRA on or before 20^th of every month.  However, a non-residential property owner may apply to the Commissioner of VAT for the registration of an estate agent who should be responsible for the imposition and collection of the tax on his behalf.

After registration the tax payer is required to display a certified copy of the VAT registration Certificate in each of the buildings from which he is earning taxable rent because such a building will constitute his business premises in accordance with paragraph 10(1) of the Sixth Schedule to the VAT Act.

Other that rental, VAT is also applicable on service charge and any premium charged on top of rent like goodwill and development levy.

Where a building is used partly for residential and non-residential purposes, VAT on rentals of the non-residential portion of the building will be applicable.  Where the premises is used by the owner thereof for his own business this will be treated as making self-supplies and VAT is not chargeable.

Where a non-residential building is owned under common tenancy or joint tenancy, owners thereof will be considered to be in partnership and be required to pay VAT.

A tenant who is registered for VAT is entitled to deduct input VAT paid on rent when making monthly returns.

A person who is registered for the supply of rental services is be entitled to claim relief of tax incurred in the construction of such buildings or civil works, in accordance with section 12, but not on the purchase of the building as sale of buildings is still exempt from VAT.  However, where any person develops a non-residential building and uses it to supply rented income and then sells the same within 5 years, he will be required to refund the input tax claimed as provided under Section 11(1B).

Please also note that where a person rents a building and he further sublets the whole or part of the same building for rent, he will be treated as a supplier of rental services and shall be liable to register for VAT if the income exceeds Kshs.5million per annum.

VAT is not applicable on sale of land, building or units, and this is not considered a taxable supply for purposes of VAT Act. 

The VAT Bill, 2012 which is before Parliament mirrors the above provisions and there will not fundamental change on VAT on rent in respect of non-residential buildings.

Note: This is generalized information applicable as at the date hereof, and does not obviate the need to seek specific or detailed legal opinion depending on your circumstances. Should you require such advice or legal opinion, please do not hesitate to contact the writer via mainacy@gmail.com

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Investing Through Chamas and the Best Operational Vehicle

INVESTING THROUGH CHAMAS AND THE BEST OPERATIONAL VEHICLE

In Kenya, Chamas or investment clubs has become one of the most famous form of saving and investment amongst friends, and it involve a group of friends contributing agreed amounts of money, mostly on periodic basis, for investment purpose.

Majority of Chamas operate on good will basis and without formal agreement between the members, business plan or legal registration.  As a result , many members have lost their investment through such risky ventures, and due to lack of written agreement, they cannot enjoy any legal remedies.  Connected to this, as investment vehicles, many Chamas are faced with myriad problems including lack of clear investment goals and objectives, default amongst members in paying the agreed contributions, dishonest officials,  lack of investments skills and inadequate capital base.

I have also observed that many Chamas mix their social and investment objectives, and some may have same leadership for the two.  Undoubtedly, such motley create confusion amongst members and  is a great contributor to lack of seriousness amongst some of the members since they know that in the event of default their  friends' will treat them with leniency.  It is therefore imperative for business venture to be separated from the social interest of members like weddings ceremonies. Where members of a Chama intend to have  social component, separate  should be elected and separate bank accounts operated for such activities.

Registration of Chamas as Companies

Chamas should be registered as private limited companies. For this purpose, members should engage a  qualified lawyer to assist them in the registration process and other legal matters

Under the Companies Act, a private company should have 2-50 members  (Chamas with more than  this number can register as co-operative society). Members in a company have limited liability and in the event of liquidation, the members can only lose money invested in the company; and not individual private property.  The reason for this is that a company has a separate legal personality which is different from that of its members or directors, and can therefore own property , or sue or be sued,  in its own name.

The day-to-day affairs of the company are under the control of its directors whereas the shareholders/ members are only supposed to attend general meetings where they mix certain decisions like approval of books of accounts, remuneration of directors and appoint of directors and company's auditors.

By law, a private company can be registered with at least one director, although it is preferably to have at least 2 directors.  The articles of the association of a company will usually prescribe the  minimum and maximum numbers of directors.

After registration, the company should hold a meeting during which the first directors of the company are appointed or confirmed.  If this is not done, the subscribers would be deemed to be the first directors of the company.  After this, the directors should open a bank account where they will be signatories. When this has been done, the directors can roll out the investment plan for the company in consultation with the members.

Ways of Raising Capital

A private company limited by shares must be registered with a certain share authorised capital, which is divided into shares of a certain nominal value.  For instance, a company can be registered with a registered capital of KShs. 100,000 divided into 1,000 shares of KShs. 100 each.

The authorised share capital with which the company is intended to registered is determined with its investment plan or requirement. Share capital can also be increased from time to time by members passing a special resolution and thereafter registering the increase with the registrar of companies.

The directors of an investment company of a Chama should raise capital by allotting shares to members. Members should be allotted shares of a certain value, which can be paid for in one instalment or over a certain duration through calls by directors.  The amount of capital that is paid for can be used for the intended investment. 

When the share capital has been exhausted and members have paid for all the shares allotted to them, the members should be issued with share certificate for their shares.  The share certificate issued to a member will constitute prima facie evidence of the investment made by such member in the company.  A mechanism should also be established to allow a member to sell part or all of his shares to other members.

Initially, members can agree to raise capital up to a certain threshold. Other than real estate which is the commonest form of investment for Chamas, it is prudent for a certain portion of the capital to be invested into profitable ventures which can generate regular income for the company. Such income can be used to fund day-to-day operations of the company, and the surplus ploughed back into investment ventures in order to augment the additional capital raised by members through allotment of shares and payment thereof in agreed instalments/calls.

An investment company can also raise capital for investment by borrowing from a financial institution or bank, or its rich shareholder or member.

Shareholders' Agreement in Chamas

In order to better regulate the internal affairs of their company, the members of the company should have suitable shareholders'  agreement signed and executed by all members. Such an agreement should, inter alia,  cover the following matters; the manner of making investment decisions;  the number of directors, their appointment, tenure in office, replacement and decision making powers, the types of meetings of members, their decision making power and frequency; the transfer of shares between members or in the event of withdrawal or death of a member;  the forfeiture of unpaid for shares; mode of raising capital for investment; the reserved matters that require unanimous decision of all members like sale of assets; call by directors; dividend policy; disputes resolution mechanism; and mechanism of admitting new members/shareholders.

The shareholders' agreement can also prescribed the penalty to be paid by members who do not pay for calls on shares allotted to them  within the agreed time frames. In the event of persistent default, the shareholders' agreement can also provided that a shareholder will be deemed to have sold his shares, which can be sold by the board of directors to the existing shareholders and the defaulting members refunded his contribution less a certain default penalty.

A shareholder agreement should also prescribed the manner in which a company will raise additional capital for its investment.  As stated before, a company can raise capital by borrowing from a  financial institution or bank , or a rich member  (i.e., shareholder loan). For bank loans, the shareholders' agreement should make it clear that such loan will be guaranteed by all members and  proportionate to their shareholding in the company. this is despite the fact that the bank may only require such loan to be secured only by personal directors' guarantee.  In case of a shareholder loan, the agreement should also provide that in the event of default by other members and the company, such loan can be converted into shares which will be issued to the loanee shareholder.

Chama Investment

Generally, the investment plan of the investment company should be prepared by the directors and approved by the shareholders during the annual general meeting. After this, the directors should be left alone to implement the approved business plan and come up with the ways of raising the necessary investment capital.  As explained above, the directors can do this by increasing the share capital of the company, and then allotting shares to members proportionate to their shareholding, and then requiring the members to pay  for shares allotted to them either by one instalment or by making periodical and agreed instalments payment (calls on shares).   Where a loan is taken out by the company to funds investment  by the company, this can be repaid by the instalment payments by members.

Use of Professionals

It is highly recommended for Members and officials of investments clubs to always insist on using qualified professionals including the company auditor, lawyer and company secretary.  All transactions and payments thereof must also be done in consultation with the company lawyer. Such a culture, among other things, will ensure that the interests of the members are properly safeguarded and that directors are properly advised before making critical investments decisions.

 As the saying goes, 'cheap is also expensive'; it is always prudent to use professionals

Summary

Members of a  Chama should  set solid foundation by their Chama by registering it as a private company and thereafter agree on clear rules of engagement by signing a shareholders' agreement. Thereafter, the Chama should agree on their vision, make a business plan, and actualize their collective dream.  Once they have created enough wealth for their members, they can convert it into a public company and  invite the members of the public to subscribed for shares, or even list in the Nairobi Securities Exchange, as TranCentury did in the recent past.

If you require detailed advice on who you can set up a company for your Chama or craft a suitable shareholders' agreement, please do not hesitate to contact the writer through mainacy@gmail.com

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