Tax break for infrastructure bond investors hits Sh25bn

Infrastructure bonds (IFBs) have been tax-free since they were first issued in February 2009.

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Infrastructure bond holders are enjoying a tax break of Sh25.8 billion per year, courtesy of being shielded from withholding tax on interest earned from similar securities at a rate of between 10 percent and 15 percent depending on duration.

Latest data from the Nairobi Securities Exchange (NSE) shows that there are 24 infrastructure bonds (IFBs) currently trading in the market, with tenors of between six and 25 years and a combined value of Sh1.803 trillion.

The tax free papers account for 37 percent of total outstanding bonds in the market.

Ordinary bonds of a tenor of more than five years are normally levied a withholding tax of 10 percent on interest, meaning that if the IFBs were to be given the same tax treatment they would be raising about Sh25.8 billion annually for the exchequer.

The Treasury recently tried to introduce a five percent tax on interest on new IFB’s for local investors and 15 percent for foreigners through the Tax Laws (Amendment) Bill, 2024, but the proposal was shot down in Parliament before the Bill was signed into law on December 11.

MPs cited a need to keep the bonds attractive to investors as the reason for the continued exemption from withholding tax.

The government has also taken advantage of the high investor appetite for the bonds to raise a large share of its domestic borrowing target, from the project bonds in the past two years. Incidentally, the bonds have also been sold at higher interest rates relative to other securities.

An 8.5 year IFB issued in February 2024, which has an outstanding value of Sh240.3 billion, pays interest at 18.46 percent, making it both the largest and the most lucrative government security currently in the market.

It is followed in returns by a Sh186.9 billion, 6.5-year paper floated in November 2023, at 17.93 percent.

In comparison, a 10-year ordinary bond sold in March 2024 carries a coupon of 16 percent, which is equivalent to a return of 14.4 percent net of tax.

The Treasury is currently selling two re-opened IFBs that have tenors of 14 and 17-years, and which carry coupons of 13.94 and 14.39 percent respectively. The target amount from the reopened papers is Sh70 billion.

Infrastructure bonds were initially structured to finance specific development projects within the budget, hence their tax exemption status.

The proceeds of recent issuances have however not been ring-fenced to any specific project, unlike the earlier cases where the government would specify the amounts allocated to each sector targeted for funding.

The Treasury sold its first IFB in February 2009, seeking Sh18.5 billion with a 12-year tenor. Out of these proceeds, the Treasury earmarked Sh4.15 billion for water, sewerage and irrigation projects, Sh6.44 billion for roads projects and Sh7.91 billion for energy projects.

A second IFB was sold December 2009 —also targeting Sh18.5 billion with a 12 year tenor— with its prospectus showing that 186 districts would share Sh1.49 billion for construction of water supplies, water conservation and construction of dams (57 districts/Sh2.9 billion) and construction of sewerage in 29 districts at Sh78 million.

A further Sh5 billion was lined up for construction of new roads in 23 districts, and Sh4 billion towards refurbishment and overhaul of civil works in 44 districts.

In the energy sector, geothermal exploration was allocated Sh3.5 billion, while Sh1.53 billion went into rural electrification in 130 districts.

The prospectus for the pair of bonds currently on sale states that the proceeds will be used to fund infrastructure projects in the 2024/2025 fiscal year, without offering a breakdown of sector allocations.

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Note: The results are not exact but very close to the actual.