Income Tax bill pitches for equity against debt

Companies borrowing for projects from banks will face a bigger cost of business in terms of tax under a proposed new law seeking to drive firms toward equity financing.

The new provision discourages companies from borrowing heavily for expansion and encourage them to take more capital from shareholders.

If a company has total capital of Sh100 million, it can take loans that allow it to deduct up to two times of this or Sh200 million in interest so that only amounts of interest above is subject to tax.

Previously the provision was more generous allowing a firm to deduct three times of this amount, meaning it could pay interest without tax of up to Sh300 million.

According to the Income Tax Bill, a tighter restriction has been imposed on the multiple of capital that should be in the form of interest and for which a firm is allowed to deduct for purposes of income tax.

“When you put this restriction, then you are increasing costs for the business. You are making it expensive to borrow for expansion.

Equity financing

A company can go for equity financing, but this goes through a more complex process,” said Titus Mukora, a partner and director for tax at PricewaterhouseCoopers.

He said that equity financing that the new bill is trying to encourage by discouraging borrowing, has to take account of issues such as dilution of minority shareholders and has also to go through several steps such as regulators before it is approved.

“For borrowing, a company can have a quick turnaround time, but equity can take a lot of time. An investment can take a while to be effected.

"Loans are an easier bet when you are looking at complexity issues,” said Mr Mukora in an interview.

20pc shareholding

Section 24 of the bill says that firms in which foreigners have at least 20 per cent shareholding – regardless of the stake owned by locals – will be considered to be controlled by non-residents and therefore subject to the restrictions on income tax deduction.

Many companies, some of which are listed on the Nairobi Securities Exchange have foreign ownership well in excess of 20 per cent.

In effect, the provision applies to both companies that are borrowing locally from banking institutions, but also to those borrowing from associated companies, say parent firms, based overseas.