Neutral Tax Effect on Transfer of Assets

Neutral Tax Effect on Transfer of Assets Between Associates as Governed by Section 44 of the Income Tax Act 2004

Introduction

When an individual or entity relinquishes ownership of an asset through selling, exchanging, transferring, distributing, canceling, redeeming, destroying, losing, expiring, or surrendering, they are considered to have “realized” that asset. This applies to various types of assets, including business, depreciable, investment, and trading assets, as defined in the Income Tax Act 2004.

Determining whether there is a gain or loss from the realization of an asset is essential.

Gain from Realization: If the sum of the proceeds (incomings) from the disposal of an asset or liability exceeds its cost at the time of realization, the difference constitutes a gain. This gain is included in the individual’s taxable income.
Loss from Realization: Conversely, if the cost of an asset or liability exceeds the sum of the proceeds at the time of realization, it results in a loss, which is considered an allowable deduction for taxation purposes.

Interpretation of Section 44 of the Income Tax Act 2004

Realizing assets can have significant tax implications. In cases where the gain is related to the realization of an interest in land, petroleum, mineral rights, or buildings within the United Republic, whether through a license or concessional right on reserved land, or shares or securities held in a resident entity, the income tax is payable in a single installment as per Section 90 of the Income Tax Act 2004.

Section 44 of the Income Tax Act 2004 governs the realization of assets through transfers between associates. If the conditions for preferential treatment on such transfers, as specified under this section, are met, the event will have a neutral tax effect, and no tax will be imposed.

When an individual realizes an asset by transferring it to an associate under these conditions, the transaction is treated as having been conducted at an amount equal to the asset’s net cost immediately before the realization. This net cost is deemed the realization value, which is also considered the acquisition cost for the associate.

Conditions for Neutral Tax Effect on the Transfer of Assets Between Associates

To qualify for the neutral tax effect on asset transfers between associates, the following conditions, as outlined in Section 44(4) of the Income Tax Act 2004, must be met:

Entity Requirement: Either the transferor (person) or the transferee (associate) must be an entity.
Asset Type: The assets involved must be business assets, depreciable assets, or trading stock of the associate immediately after the transfer.
Residency Requirement: Both the transferor and the transferee must be residents at the time of realization. Additionally, the associate (or in the case of an associate partnership, none of its partners) should not be exempt from Income Tax.
Continuity of Ownership: There must be continuity of underlying ownership of at least 50% of the asset.
Written Election: The transferor and the associate must elect in writing for the preferential treatment to apply to the intended asset transfer.

It is crucial to understand that preferential treatment for asset transfers between associates is not automatic. Taxpayers (the transferor and its associate) must request this treatment and submit evidence of eligibility to the Commissioner General of the Tanzania Revenue Authority (TRA). Per Section 44(4)(e), any transfers that do not meet these conditions will not receive neutral tax effects.