Business Daily
Date: 30.08.2016
Page 12
Article size: 272 cm2
ColumnCM: 60.44
AVE: 114844.44
KRA shouldn't tax interest­free loans
non­resident to a thinly capitalised Kenyan
entity. The deemed interest rate is pegged to
the average 91 day Treasury Bill rate. There
was uncertainty about the government's in­
tention when this change was introduced
and there was speculation that its intention
was to collect 15 per cent withholding tax
JOSEPH TH0G0
on the deemed interest.
This intention was confirmed in 2012
Corporate tax provisions cannot be
properly applied until one first iden­
tifies the instrument at issue as debt
or equity, at heart being a concern whether
payments with a particular instrument will
qualify as a deductible interest expense for
when the government issued rules on cal­
culating the deemed interest and amended
the withholding tax provisions. The long
unsettled question about the legitimacy of
this provision and whether it can withstand
a litmus test before a court. Withholding
tax is merely a mechanism for collecting
tax from one's income.
Through this mechanism, the govern­
ment makes different people statutory tax
agents who are required to collect tax on its
behalf. If withholding applies, the source
or payer of income is designated a "with­
holding agent" and, as such, he must with­
hold tax from the income of the recipient
and short of this is that the taxman does not
at the time of payment and remit it to the
recognise interest free loans. The provision
means that if a Kenyan entity receives a
government.
rate capital. From an economic perspective,
mand Kenyan tax on the notional interest
whether an entity is financed in the form of
that would have been applicable on the loan
With regard to the deeming provision for
interest­free loans, the lender does not have
income, least of all Kenyan sourced income.
In addition, the Income Tax Act requires a
person making a payment to deduct tax at
an appropriate rate and provides guidance
debt or equity does not really make a differ­
ence from a finance perspective.
at the 91 day Treasury Bill rate.
on how the deduction is to be made.
income tax purposes.
Corporate issues of shares and debt are
simply alternative methods of raising corpo­
Why, then, should there be any differ­
ence in the tax treatment of debt and equity?
Why does it matter?
The tax advantage of debt over equity
from the corporation's perspective is the de­
ductibility of corporate interest payments
loan from a non­resident related entity, the
Kenya Revenue Authority will not recognise
the interest free nature of the loan and de­
Creates problems
This assumption, which it would seem was
geared solely towards getting the 15 per
cent tax, creates all sorts problems for the
borrower. The 15 per cent tax is meant to be
a tax that is withheld from income that is
on debt in contrast to the non­deductibil­
sourced from Kenya. However, in this case
ity of corporate dividend payments on
the lender does not have income which
shares. Thus, in balancing corporate capi­
means that the borrower has no amount
tal structure corporations often include a
substantial proportion of debt issue, which
provides them with regular interest deduc­
to withholding the tax from and therefore
has to pay the tax from his own pocket,
consequently increasing his costs.
tions. However, there are the thin capitali­
One would naturally assume that the
sation rules which are designed to prevent
taxman recognises that there should be
an interest element­due on the loan, he
excessive deduction of interest arising from
related party loans.
On the other hand, no interest arises
from interest free loans which means there
is no deductible expense. In 2010 the govern­
ment introduced deeming interest provi­
sions for interest­free loans provided by a
should allow the borrower to deduct the
corresponding amount as a cost against
his income, right? Well, that is the argu­
ment that taxpayers have advanced since
this provision was introduced but the tax­
man has a different view. There is also the
Deduction implies subtracting from
what is due and being paid to another per­
son and therefore these provisions negate
any intention of the Legislature to ascribe
a meaning other that the plain and obvious
meaning to "paid" and "upon payment".
In Republic v KRA ex­parte Fintel Ltd,
the court said that the word "paid" in "the
Income Tax Act assumes its ordinary mean­
ing and the use of the words "include" is
merely illustrative of the kinds of activities
that constitute payment and therefore the
words "distributes, credited, dealt with or
deemed to have been paid in the interest
or on behalf of a person" should not be con­
strued to mean payment. Therefore, the
deeming provision for interest­free loans
does not amount to payment for withhold­
ing tax purposes.
Thogo works with Deloitte East Africa.
[email protected].
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