Delicate balancing act in tax exempt projects and growth for Kenya

In recent years, Kenya’s development trajectory has greatly been propelled by a slew of ambitious infrastructure projects.

These have been made possible, in part, by foreign lenders incentivised by, among other things, tax exemption on interest income earned from infrastructure loans.

This exemption may be on the chopping board should newly introduced measures under the Finance Act of 2023 fail to yield sufficient revenue.

The position on tax exemptions is already uncertain following a recent High Court judgment, which declared tax waivers extended through Gazette Notices, as unconstitutional.

The exemption was granted under Gazette Notice in 2015, leaving questions unanswered regarding the implications of the court’s decision on loans already extended on the strength of the exemption.

Gazette notices aside, investors, both domestic and international, prioritise the stability and predictability of a country's tax regime when making financial and investment decisions.

A tax landscape marred by frequent changes and unpredictability can deter investments, introduce volatility to financial planning, and ultimately impede economic growth.

Coming hot on the heels of several tax changes under the Finance Act of 2023, Kenya risks losing its competitive edge in the global market if it lifts the tax exemption.

Not only will the environment be deemed to be highly fluid due to the piecemeal changes, but lenders may also be tempted to channel their funds to jurisdictions with more favourable regimes.

Many infrastructure loans have already been disbursed under the existing tax exemption. The million-dollar question is the impact on these loans if the tax exemption is lifted.

In most cases, lenders' contracts will insulate them from mid-stream tax changes, compelling the developers to gross up payments so as to leave financiers in the same financial position as before. Developers will, in turn, invoke tax stabilisation clauses to demand compensation from the offtaker/ government for the extra financing charges.

Therefore, reintroducing this tax could inadvertently shift the burden of higher finance costs to the government and taxpayers.

This could exacerbate the government's financial strain, potentially leading to a reduction in the number and scale of infrastructure projects, which is far from desirable.

One often overlooked aspect of infrastructure development is its role in job creation and the development of technical skills.

Many Kenyans rely on these projects for their livelihoods, spanning construction workers to service providers. Eliminating the tax exemption could result in fewer projects, directly impacting job opportunities and upskilling of Kenyan labour.

Overall, Kenya has worked hard to establish itself as a stable and predictable environment for investment, gaining traction and a strong reputation in the global market.

To maintain this position, it is imperative that the potential consequences of reintroducing taxes on interest income are carefully considered.

While short-term financial gains may seem tempting, they must be balanced against the long-term implications.

The writer is a partner and head of projects, Energy & Restructuring Practice at DLA Piper Africa, Kenya (IKM Advocates)