In a 2010 transaction where Airtel Uganda purchased assets from Celtel Uganda Ltd, URA claims it lost more than Shs140 billion in capital gains tax. PHOTO/FILE
Uganda’s tax laws have become “so detrimental”, experts say, to merger and acquisition (M&A) transactions that firms now only conduct such transactions when they have no other option for asset disposal that generates significant value.
The legal and regulatory frameworks that these companies must navigate to have deals through hold tax laws that may have unintended consequences like double taxation, which several tax experts worry deprives the frequency of such deals. They now firmly believe this is at least partially the reason no investment bank has come up to facilitate such deals.
Uganda, like many other developing countries, is finding difficulties in taxing offshore share disposal transactions that derive value from assets and businesses within its jurisdiction.
As a result, the taxman is moving to exploit the 2018 amendment to sections 75 and 79 of the Income Tax Act (ITA), which numerous legal firms point out that “inadvertently lead to double taxation.” This is particularly true for firms where the owners have already paid capital gains tax in another jurisdiction on the sale of their shares or mergers with local firms.
Uganda revised sections 75 and 79(ga) of the ITA to firmly address the taxation of offshore share disposal transactions that derive value from locally owned assets or businesses in 2018, following the lead of other developing nations such as Tanzania, Ghana, and Nepal.
“This move was pressed by the prevailing international tax position that considers offshore share sales as extraterritorial, with ownership of assets in developing countries considered incidental,” Denis Yekoyasi Kakembo, the managing partner of Cristal Advocates, states in a corporate notice.
Once bitten, twice shy
This is so because many multinational corporations have a common practice of selling off subsidiaries at the group or parent level, something that allows them to avoid local taxes either intentionally or unintentionally. And yet these transactions, which occur at higher levels within the corporate structure, entail a change in ownership at the subsidiary level.
The Uganda Revenue Authority (URA) has lost significant amounts of tax in such instances. For example, in a 2010 transaction where Airtel Uganda purchased assets from Celtel Uganda Ltd, URA claims it lost more than Shs140 billion in capital gains tax.
“That transaction was not concluded in Uganda because we [URA] did not tax the capital gains. At the time Uganda did not have a law to tax such a deal. Here we were juggled because the negotiators said the deal is supposed to be taxed in the Netherlands and yet when we researched, we realised that it is tax-exempt in the Netherlands, which brings now what we call non-double taxation,” Robert Luvuma, manager of International Taxation at URA, told this reporter last year, a month after Cipla Quality Chemicals had just been acquired by a private equity firm.
URA notes that it has managed to overcome this loop by adding some clauses in its taxation policies that now allow it to tax such deals which involve more than 51 percent shareholding.
“It can’t happen again unless someone does not sell a substantial stake. Uganda is negotiating with countries where there are shared DTAs (Double Tax Agreements) so that we can pull back some of the tax rights we gave up in these treaties,” Mr Luvuma said.
But some of these policies the taxman is leveraging have to some extent been detrimental to the private firms. One example is the recently completed Hima Cement sale that the company says made it lose $2.9 million (Shs10.7b) last year on account of one-off taxation costs and legal settlement expenses.
M&As may appear one-sided in the transactions involved, but they provide strategic, financial, and organisational sense for all parties. They consolidate market share, enhance competitiveness, save costs and at times, enhance talent acquisition.
Data tracked by private equity and venture capital trackers players shows that the volume of these deals has slumped overtime. According to data from the East Africa Venture Capital Association, they decreased to 15 last year from 32 in 2022.
The decline is ascribed to various factors, including the tax regime that levies a 30 percent capital gains tax, value-added tax, and stamp duty equivalent to one percent of the deal value.
Additionally, the cyclical nature of the investment industry, which is marked by periods of bumper harvests followed by down markets, has been found to be a contributing factor. This is especially true when private equity funds get a lag in fundraising for new funds.
Section 75 amendment
The year 2018 saw modifications to sections 75(2) and 79 (ga) of the ITA to bring such transactions under Uganda’s tax radar. As per Section 75(2) of the ITA, an entity is deemed to have realised all of its assets and liabilities immediately prior to the change if it modifies its ownership by 50 percent or more in a span of three years.
Here, it is thought to have relinquished ownership of each asset and derived an amount related to the realisation that matched the asset’s market value at the time of realisation.
In addition, each liability is presumed to have been realised by the entity, and the expenditure associated with each liability at the time of realisation is presumed to have been equal to its market value.
But a plain interpretation of the text of that amendment may inadvertently broaden its scope, potentially leading to unintended consequences, especially double taxation on a single transaction, Cristal Advocates tax lawyers note in a corporate notice about taxing deemed disposal transactions.
The paradox
The lawyers argue that a key issue is whether the amendment to Section 75 of the ITA was intended to apply to share disposals at the immediate shareholding level in Uganda. And if so, such transactions would activate Section 75 of the ITA for direct and indirect share-sale transactions at the Uganda level involving a 50 percent or more change in ownership.
“For a local share sale visible to the Ugandan tax authorities, a plain interpretation of Section 75 implies that selling shareholders would be subject to capital gains tax, just as the entity would be deemed to have realised its assets and liabilities due to the change in its ownership by more than 50 percent,” they proffer.
“Though not documented in the law, it is plausible to consider that sections 75(2) and 79(ga) of the ITA were intended to capture offshore share sales involving non-resident shareholders on one side and local Ugandan entities on the other,” they further explain.
In such cases, they add, selling shareholders would normally be exempt from local taxes in Uganda but subject to share-sale transactions taxes in their respective jurisdictions.
“Any interpretation to the contrary would risk double taxation of a similar economic event,” they cite.
Valuation
In the event that ownership changes in accordance with Section 75 of the ITA, the entity is required to realise all of its liabilities and assets at book value in addition to disposing of them at market value.
“If we strictly interpret the law, would other approaches to valuation such as those based on asset and income methods suffice?” Cristal Advocates asks rhetorically.
They add: “The market value of individual items of assets and liabilities is determined by reference to the prevailing market conditions and transactions reflecting what an investor or buyer would be willing to pay for the assets or assume the liabilities in an open and competitive market.
In practice, this particular issue about valuation is easier to read than implement.”
Cristal Advocates proceed to note thus: “To reassure markets and bolster confidence that is vital for merger and acquisition transactions avenues through which foreign direct investment can flow, it’s crucial for the government to align legal provisions with its policy stance.”
They add: “Such disparities breed uncertainty, eroding investor trust. Clear, consistent tax regulations are essential for fostering a favourable business climate.”
Private equity appetite
The prevailing uncertainty arises amid Uganda’s efforts to increase the adoption of private equity (PE) financing as a substitute source of capital for the private sector.
Beginning the 2024/2025 fiscal year, income derived from or by venture capital or private equity funds subject to the Capital Markets Authority Act, Cap. 84, will be free from taxation. The government has put up this exemption “to enhance the supply of capital available to Uganda’s private sector.”
As regional stock markets struggle to draw new listings, recent surveys such as one from the African Private Capital Association (AVCA), reveal that businesses in East Africa are raising more money through private equity deals than initial public offerings, which are expensive and require full disclosure of their financial and governance positions.
According to the new AVCA data, East African companies closed 205 private capital deals in 2022 and 2023, which enabled them to raise nearly $2.26 billion in new funding from private equity investors. Uncertainty surrounds how these deals will handle Uganda’s tax code should they come close to the country.
