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Send  Share  RSS  Twitter  30 May 2012

BUSINESS IN AFRICA: Kenyan Tax Law Could Trap Africa Investors


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South African multinationals considering investing in Kenya and other parts of Africa stand to fall into a potential tax trap which could prove to be costly to their business operations, warns Professional Services Firm, PwC.

South African companies need to consider the overall implications of tax legislation in Kenya before rolling out their investment initiatives. Multinational companies stand to be taxed on any interest-free loan they make to their subsidiary companies in Kenya for investment purposes, according to recent amendments under the Kenya Finance Act, 2010.

Finance Minister Pravin Gordhan announced in his February budget speech this year that interest-free loans made by multinational companies to foreign African subsidiaries may be treated as additional share capital for South African tax purposes in order to avoid transfer pricing concerns and to adopt a more flexible approach to funding African operations. “However, this initiative can create negative tax consequences for multinational companies if the interest –free loans were provided to investments in Kenya,’ says Elandre Brandt, an International Tax Director and leader of the Africa Desk at PwC in Johannesburg.

South African Tax Payer Faced with Transfer Pricing Adjustment

Usually this would be viewed as a welcome development as often, new African investments do not begin to make profits until after a few years, says Brandt. Therefore, the loans from their parent companies, usually available at no or marginal interest payment provide the much needed lifeline for these new businesses on foreign soil early in the life cycle of businesses. “However, from a South African tax perspective, loans to foreign related parties are except in very exceptional circumstances required to bear interest at market related rates, failing which the South African taxpayer may be faced with transfer pricing adjustments. If the Minister’s announcement takes effect, it will mean that interest-free or low interest loans will no longer be at risk of transfer pricing adjustments.

“However, this seemingly good gesture from the South African government could prove to be a booby trap for South African firms investing into Kenya, often referred to as the gateway to East Africa.”

Controlling Interest Rates for South Afticans

The Kenya Revenue Authority in implementing this legislation deem an interest rate which is adjusted every three months on such interest-free loan. The applicable interest rate for the quarter ended 31 March 2012 is 16%. The Kenya Revenue Authority levies a withholding tax of 15% on the deemed interest which should be paid over in the month following the onset of the deemed interest. Effectively, South African firms providing interest-free loans to their Kenya investments in which they hold controlling interests risk paying at least 2.4% of the loan amount to the authorities in taxes, explains Brandt.

While most South African firms with outbound African investments would find the proposal of the Minister of Finance laudable, those with investments in Kenya may not find it exciting, he says. “A further dampener is the corporate tax effect that the interest-free loans will have,” says Steve Okello, Country Tax Leader for PwC Kenya. “The deemed interest amount computed based on the prevailing rate published by the Kenya Revenue Authority will not be tax-deductible. The effect of this is that the Kenyan company will pay corporate tax at 30% on an amount that is basically fictitious even if it is not thinly capitalised.”

Africa to Consider Both Sides of Transactions When Investing

He says that such companies will be compelled to impute an arm’s length interest charge on qualifying loans provided, therefore creating an extra cost burden on their African operations.

The deemed interest provision as it applies to the corporate tax deductibility of the deemed interest is not applicable to Kenyan–based financial institutions. Therefore South African firms investing in such firms will not suffer the adverse effect of such provision, However, the withholding tax implications of the deemed interest provision will still apply, says Okello.

“South African firms investing into the rest of Africa should take heed and always consider both sides of the transaction when considering new developments in South African tax legislation as a well intended plan may prove to be costly in other parts of Africa,” says Brandt.

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