Enoch Barata and Cephas K Birungyi of Birungyi Barata & Associates discuss what the East African Community Double Taxation Agreement means for raising capital and investment in the region
The East African Community Double Taxation Agreement (EAC DTA) is a multilateral treaty for the avoidance of double taxation and prevention of fiscal evasion with respect to taxes on income. The parties to the treaty are the Republics of Kenya, Uganda, Burundi, Rwanda and the United Republic of Tanzania. The treaty seeks to eliminate double taxation among the states by imposing an obligation on the resident state to give credit for the source state tax against the resident state tax on income or exempt the income from tax. However, only the Republic of Rwanda has to date ratified the treaty despite the fact that the East Africa Community council of ministers approved the treaty in 2010. The main avenues of raising capital in East Africa are mortgaging, creating charges and issuing of bonds, on one hand, and rights issues listing and private placements, on the other. The cost of borrowing differs from country to country. Statistics from the respective central banks put the apparent commercial bank interest rates at 23% in Uganda and Tanzania; 17% in Rwanda; 16% in Kenya; and 16% in Burundi. The EAC DTA has an implication on the raising of capital and investment in East Africa. Here are its key financial aspects.
The agreement provides that profits of an enterprise are only taxable in the country of residence and so are profits from permanent establishments. However while determining profits of a permanent establishment, amounts charged by the permanent establishment to the head office of the enterprise or any of its offices by way of royalties or fees are not taken into account save for banking enterprises.
The East African partner states have the same rates of corporation tax (30%) and as such the EAC DTA maintains the status quo in regard to the rates. This limits tax competition among the East African Community states while the decision to invest in any of the states would be based on other factors such as the return on capital employed (ROCE), residual income (RI), gross domestic product (GDP) and so on.
Dividends paid by a resident company to a resident of any other East African state may be taxed in that state or in the state in which the company paying dividends is resident. However, when such dividends are taxed in the state in which the company paying the dividends is resident, the rate is capped at five percent of the gross amount of the dividends provided that the recipient of the dividends is the beneficial owner of the same.
The DTA defines the term dividends to mean income from shares or other rights, not being debt claims, participating in profits, as well as income from other corporate rights which is subjected to the same taxation treatment as income from the shares by the laws of the contracting state of which the company making a distribution is a resident. The definition is therefore limited to distributions made in cash and is similar to the definition under the tax regime in Rwanda.
On the contrary, the definitions under the tax regimes in Kenya, Tanzania and Uganda include the issue of bonus shares to shareholders although, in Kenya, any other property distributed by a company to its shareholders with respect to their equity interest in the company is considered a distribution of a dividend. Unlike Kenya and Tanzania, in Uganda the payment of tax on a dividend in respect of bonus shares is deferred until the disposal of the shares. The disparities in the definition and treatment of dividends may breed disputes such as the applicability of the EAC DTA to distributions which are made in kind or whether the said distributions fall within the phrase 'participating in profits' as used in the agreement.
In Uganda dividends to non-resident individuals are charged at a rate of 15% of the gross amount payable and the same rate is applicable in Rwanda and Burundi while in Kenya and Tanzania the rate of tax stands at 10%. However, in Rwanda and Kenya a rate of five percent is applicable to dividends paid to residents of any of the partner states. In the tax perspective and all factors constant, Kenya and Tanzania would appear to be the better countries for foreign firms to hold equity while in regard to interstate investment, Rwanda and Kenya would appear to be the better states to hold equity.
Although the agreement impliedly covers dividends distributed by listed corporations, some states such as Kenya, Tanzania and Rwanda treat such dividends separately. In these states dividend payments made by companies listed on their respective stock exchanges are taxed at a rate of five percent of the gross amount. This encourages the raising of capital from the public by encouraging the acquisition of shares of listed companies.
It is worth noting that gains from trading in venture capital enterprise shares are treated as dividends in Kenya, although no tax is payable against the said gains, while in Rwanda venture capital companies registered with the Capital Markets Authority of Rwanda are exempt from tax for the first five years of trading.
The tax administration systems in the East African partner states are in such a way that tax on dividends is withheld by the companies at the time of payment dividends. Consequently, dividends are more likely to be taxed in the state in which the company paying the dividends is resident and credit sought for the source state tax against the resident State tax.
Similar to dividends, interest paid by a resident company to a resident of any other East African state may be taxed in that state or in the state in which the company paying the interest is resident. When such interest is taxed in the state in which the company paying the interest is resident, the rate is fixed at 10% of the gross amount of the interest paid. However, interest derived and beneficially owned by the government, political subdivision or local authority of an East African state or institution, body/board which is wholly owned by the aforesaid is exempt from tax.
The term interest is defined to mean income from debt claims of every kind whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profit, and in particular, income from government securities and income from bonds or debentures including premiums and prizes attaching to such securities, bonds and debentures. This definition is in line with the domestic legislations of the states while the variations in the definition by the states are minor.
In states such as Uganda, Rwanda and Burundi interest payable to non-residents is taxed at a rate of 15% while in Kenya and Tanzania it is charged at a rate of 10%. In the context of taxation, the cost of capital is higher in Uganda and Burundi compared to Kenya, Tanzania and Rwanda. However, it is intended by the EAC DTA that governments and government institutions borrow within the Community at no cost.
The tax regime in Rwanda encourages short term borrowing from capital markets by reducing interest arising from investments in listed bonds with a maturity of three years to five percent when the listed company is a resident taxpayer of Rwanda or of the East African Community. This hoped to encourage cross listing on the capital market in the respective East African partner states.
Tax on interest from government securities is often higher since the risk in such investments is low. In Uganda interest for payments on government securities to a non-resident person is 20% while in Kenya interest arising from a government bearer bond of at least two years is taxed at 15%. The implication of the ratification of the EAC DTA by Uganda and Kenya, is that residents of respective states would pay higher tax on interest from government securities compared to their counterparts in the Community.
The tax administration systems in the East African partner states are also in such a way that tax on interest is withheld by the payer at the time of payment (interest to financial institutions is exempted). Consequently, interest is more likely to be taxed in the state in which the company paying the dividends is resident and credit sought for the source state tax against the resident state tax.
Gains from the disposal of shares are taxable only in the contracting state which the person disposing of shares is resident. The tax regimes in the respective East African Community states do not have distinct capital gains tax systems. In Uganda capital gains tax is charged on the disposal of an asset where the gain is included in the gross income or the loss is deductible, including a gain on disposal of shares in a private limited liability company. The gain is included in the gross income and taxed as part of the gross income.
Similarly, in Rwanda capital gains from business are taxable under the provisions of the Income Tax Act. However, capital gain on the secondary market transaction on listed securities is exempted from capital gains tax and in case of reorganisation of companies, the transferring company is exempt from tax in respect of capital gains and losses realised on reorganisation. Reorganisation is defined in the Rwanda Income Tax Act to include takeovers, mergers and acquisitions. The tax treatment of takeovers, mergers and acquisitions in Burundi is similar to that of Rwanda as capital gains tax is not charged on company restructuring. It follows that Rwanda and Burundi are favourable for equity financing by means of takeovers, mergers and acquisitions.
Tanzania does not seem to have a capital gains tax system while in Kenya capital gains tax was suspended with effect from June 14 1985. Tanzania and Kenya are equally favourable for equity financing by means of takeovers, mergers and acquisitions.
Pensions, annuities and social security payments
Pensions, annuities and social security payments arising in an East African Community state and paid in consideration of past employment to a resident of any other state within the East African Community is taxable only in the state which the payment arises. In circumstances where the payment is made by a resident of any of the other East African Community state or a permanent establishment situated therein, it may be taxed in any of the other states save for national/state contributions which are only taxable in the state which they are made. Consequently, the EAC DTA seeks to maintain the status quo in regard to distributions.
In Uganda amounts from a pension, lump sum payment made by a resident retirement fund to a member of the fund or dependent of a member of the fund and proceeds of a life insurance policy paid by a person carrying on a life insurance business are exempt from tax. The tax treatment of pensions in Burundi and Rwanda is similar to that in Uganda but (in Rwanda) in order for retirement contributions made by the employer on behalf of the employee and or contributions made by the employee to a qualified pension fund to be exempted, they must amount to a maximum of 10% of the employee's employment income or 1,200,000 Rwandan francs per year, whichever is the lowest. The exemption of pension income from tax encourages saving and accumulation of savings which are invested in various sectors of the economy.
On the contrary, in Kenya pensions or retirement annuity is taxed at the rate of five percent for residents and non-residents but the tax rates range from 10% to 30% in respect of a payment of a pension made after the expiry of 15 years from the date of joining the fund, or on the attainment of the age of 50 years, or upon earlier retirement on the grounds of ill health or infirmity of body and mind, from a registered pension fund, registered provident fund, the National Social Security Fund of Kenya or a registered individual retirement fund, in excess of the tax-free amounts. In Tanzania commuted pensions are taxed at a rate of 10% of the payments but pensions or gratuities granted in respect of wounds or disabilities caused in war and suffered by the recipients of such pensions or gratuities are exempted from tax.
The East Africa Community Double Taxation Agreement recognises the sovereignty of the partner states by leaving the taxation of business profits, pension and capital gains to the states where the amounts arise. The agreement puts in place anti-tax abuse measures which aim at avoiding the improper use of the treaty. For instance the beneficial ownership provisions regarding dividends and interest have the effect of limiting the reduction of tax on the said passive income to the beneficial owners of the said income. The coming into force of the EA DTA is premised on the ratification of the treaty by all the partner states. However this is being hindered by factors such as: fear of loss of revenue; red tape; and potential abuse of the treaty attributable to weaknesses in tax administration.
Since the failure to ratify the EAC DTA is seen as a non-tariff barrier to growing cross-border trade and investment, the partner states should develop their tax administration capacity, ratify the treaty, align their domestic legislations with the treaty and make use of their comparative advantages.
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Birungyi Barata & Associates
About the author
Enoch Barata is the head of the firm's banking, corporate and commercial and litigation departments. He has trained as a lawyer and advocate of the courts of judicature and has received specialised training in finance and financial law from the center for finance and management studies at the University of London. As a founding partner and with over ten years' experience, he has gained repute as an astute professional lawyer, corporate consultant and general commercial transactions lawyer. He has represented various clients in complex corporate transactions, finance and lending, due diligence, insurance and litigation. Barata advises top and reputable companies, banks, insurance companies, government ministries, public agencies and multinational corporations both in Uganda and sub-Saharan Africa.
He is a member of local and regional professional bodies, the IBA and the Institute of Corporate Governance of Uganda.
Cephas K Birungyi
Birungyi Barata & Associates
About the author
Cephas K Birungyi is a highly qualified and distinguished tax expert, easily recognised as a leading tax advisor in Uganda, and in the East African Community. A highly experienced tax lawyer, Birungyi has previously worked for the Ugandan government in various capacities including as deputy commissioner of domestic direct taxes in the Uganda Revenue Authority. He has represented the country in the negotiations and drafting of several double taxation treaties with over five countries. He is the head of the tax department of the firm and regularly advises, consults for and represents major local and international corporations, governments, international agencies and financial institution in Uganda, Africa and all around the world.
He is thoroughly trained and holds various specialist qualifications from the UK and South Africa. He is a member of local and regional professional bodies, the IBA, the Institute of Taxation and the Institute of Corporate Governance of Uganda.