Today, the East African Venture Capital Association (EAVCA) will host a private capital conference in Dar es Salaam, a particularly timely event given the renewed investor interest in Tanzania . Taxation is always a subject of interest for venture capitalists, not only in terms of taxation on ongoing operations, but especially in terms of impact when they seek to realize their returns through the sale of their investments. EAVCA participants will therefore have a keen interest in understanding how investment divestments are taxed in Tanzania and how this compares to other East African Community (“EAC”) countries.
Usually, when countries tax capital gains, the legislation goes to some extent to recognize that the nominal value of a sale gain (i.e. the difference between the sale proceeds and the initial cost) will not represent the real value taking into account the impact of inflation. There is therefore generally either a lower tax rate for capital gains, or the possibility of indexing the initial acquisition cost to take into account inflation (or currency depreciation).
EAC countries with low capital gains tax rates include Kenya (5% (15% to apply from January 1, 2023)) and Rwanda 5%. A similar approach is taken in Sub-Saharan Africa’s largest capital markets, namely Nigeria (10%) and South Africa (22.4%).
Tanzania’s previous income tax legislation (Income Tax Act (“ITA”) 1973) provided for a lower rate of 10% and indexation – but in contrast, current legislation, ITA 2004, only maintains this rate of 10% for a transfer by a resident individual. . Otherwise, the applicable rate is respectively 30% or 20% for a transfer by a resident company or by a non-resident.
Tanzania is not the only EAC country to impose a high tax rate on capital gains. For example, Uganda subjects capital gains to the standard income tax rate (30%) but above all provides for indexation of the acquisition cost. While Tanzania’s 1973 ITA provided for indexation, the 2004 ITA does not provide for such adjustment.
So what is the challenge? Well, as it stands, if you had invested $1 million when the exchange rate was 1,500 TZS: 1 USD and sold it a few years later for the same dollar amount, but that when the rate was 2,300 you would be in a no win no lose position. from a US dollar perspective, but have a gain of TZS 800 million (and a related tax liability of TZS 240 million ($0.1 million)). In this illustration you will notice that due to the lack of indexation, the taxation in the eyes of the investor is based on a nominal “gain” in TZS, but in hard currency terms there is no no gain; in fact, the tax to be paid then creates a negative return in USD for the investor (who, instead of recovering the initial investment of 1 million USD, is left with around 0.9 million USD once the tax is deducted) .
Another common challenge following an initial investment is that the investor may wish to reorganize the group structure for greater efficiency. However, Tanzanian laws do not provide for an exemption in such a case, although there is no change in the ultimate ownership of the shares. On the other hand, Kenya and Rwanda provide certain exemptions for group restructuring.
Finally, a major area of concern today for investors is “change of control” (CiC) legislation, which applies when more than 50% of the ultimate (underlying) ownership changes by more than 50 %. Following an amendment in 2012, in the event of such a change, all assets and liabilities of the Tanzanian company are automatically deemed to have been realized for tax purposes and if this results in a gain, then that gain is taxable.
Although the CiC amendment was well-intentioned – namely to combat tax evasion – its effect is much broader than initially anticipated. Concerns include: the possibility of treating transactions to raise new funds as triggering a tax liability, the possibility of the disposal being subject to double taxation, with minority shareholders being impacted by an indirect disposal in which they do not participate, the absence of exclusion for listed companies and the uncertainty. how the tax is calculated.
In general, jurisdictions with CiC provisions impose certain restrictions on the applicability of the provisions, such as: (i) applicability only where the value in the country is primarily attributable to a particular category of assets (e.g. “ taxable goods” (China)) as opposed to any commercial activity; (ii) applicability where a de minimis threshold for the underlying value of the transaction is attributable to the country – for example 50% in India; (iii) applicability only in case of tax evasion motive – China; and (iv) exclusion of stock transactions – China. Tanzanian legislation on CiCs has no such limits.
To attract more foreign investment (including investment from venture capital firms) and promote competitiveness, Tanzania needs to review its capital gains tax provisions to better align with international best practices and on those of other countries in the region.