Changes in business ownership will usually take one of two forms. One could sell the shares in a company together with its underlying assets and liabilities or simply sell the underlying assets and liabilities.
There are many commercial and legal reasons that inform why a potential investor would opt to purchase the shares of a company instead of the underlying assets and liabilities or vice-versa. One of the reasons could be the tax impact each option would have.
The transfer of shares is exempt from VAT whereas the transfer of the underlying assets and liabilities of a company is subject to VAT at the standard rate of 16 percent.
When one considers VAT alone, the acquisition of shares is significantly lower than the latter option.
In previous iterations of the VAT Act, the transfer of the underlying assets and liabilities (net assets) of a company that constitute the whole or an independent part of a business such that the person receiving the assets can continue with the business was referred to as a Transfer of Business as a Going Concern (“TOGC”).
By an amendment to the VAT Act, 2013 by the Tax Laws Amendment Act (2020), effective April 25, 2020, all reference to a TOGC was deleted from the VAT Act, which meant that such transfers became subject to VAT at 16 percent.
VAT must now be added to the TOGC value and the VAT remitted to the Kenya Revenue Authority.
Subjecting VAT to a TOGC transaction may have a temporary cash-flow implication or a real cost implication.
At the time of acquiring the business, the buyer must not only fund the agreed price but the VAT cost as well, which at 16 percent represents a significant portion of the purchase price.
It could be argued that the buyer can claim the VAT incurred from the taxable supplies it makes but the reality is that the buyer can only recover a small portion of the VAT monthly depending on how the business is performing.
The recovery of the VAT could therefore take years meaning that cash will be tied up in the VAT credit in the purchaser’s books.
The VAT may eventually be recovered in full but if recovered at a slow rate, it will invariably hamper the buyer’s operations.
There could also be real cost implications where the net assets being transferred are for use in a business that is exempt from VAT such as a school or a hospital.
In such a case the purchaser will not be able to claim the VAT on the transaction. This means that the VAT paid to the KRA is a cost to the purchaser, which cannot be recovered and could discourage a prospective buyer.
Parliament seems to misunderstand the issue and in response to several submissions to the parliamentary finance committee seeking to exempt or zero rate such transactions, it has often responded by saying that the purchaser should be able to reclaim the VAT paid and therefore there is no need to exempt such transactions from VAT.
This position does not, however, consider the cash-flow impact of charging VAT on TOGC transactions to commerce.