Image Credit: 99acres.com

LAST WEEK, WE saw the peculiar case of John (and, possibly, other landlords) who runs the risk of reducing his rental income when he increases the monthly rent. He collects Sh800,000 per month and incurs Sh80,000 in taxes plus Sh120,000 in operating costs, leaving him with a monthly net profit of Sh600,000.

If he increases the rent to Sh880,000, the taxes will go up to Sh217,724 and the operating costs to Sh132,000. Thus his new monthly income will be Sh530,276. This is almost Sh70,000 less than what he was getting when the rent was lower.

The reason is that the way taxes are calculated for the lower rent is very different from the method used on the higher one.

After reading my analysis, John was quick to inform me that his properties are registered in the name of his family business which is a limited company. In that case, the taxes are going to be even higher because such companies are taxed a flat rate of 30 per cent of the profit for rent greater than Sh10m per year. In addition, they are not allowed the personal tax relief.

For the limited company, the tax on the Sh748,000 profit (Sh880,000 – Sh132,000) will be Sh224,400 and so the net income will come down to Sh523,600. So now we go back to John’s question: how can he avoid this predicament?

The law says that if rent from residential properties is Sh10 million or higher, then the special 10 per cent tax cannot be applied. In other words, only Sh833,332 or less per month is allowed. If John was to charge this amount, then his net income would be calculated as follows:

The 10 per cent special residential rent tax comes to Sh83,333; the 15 per cent operating costs comes to Sh125,000. Therefore, John’s net profit is Sh833,332 – Sh83,333 – Sh125,000 = Sh625,000. This is what he would earn if he charged the amount.

We have seen that if he goes above that threshold, his final income reduces. So, the question to be answered is: what rent should John charge to make sure that after normal 30 per cent tax, his net profit doesn’t go below the current Sh600,000?

Let’s work backwards from Sh600,000. If this is the net income after 30 per cent tax, what was the profit before tax? The answer is Sh625,000 divided by 70 per cent; that is, Sh857,143.

Next; we work backwards from Sh857,143: if this is the profit after 15 per cent operating costs, what was the gross rent charged? The answer is Sh892,857 divided by 85 per cent; that is, Sh1,008,403.

Therefore, my advice to John is to avoid charging anything between Sh833,332 and Sh1,008,403. Within that range, there is a likelihood that he will end up with lower net income.

So, John should first raise it to Sh830,000 per month for some time; perhaps one year. Then increase it again to Sh1,010,000. Even though his tenants will be paying more, John’s net income will remain constant!

This article was first published on Daily Nation by www.figures.co.ke; Twitter: @mungaikihanya

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