Corporate firms likely to exploit tax exemptions
A tax expert has warned that corporate firms may change group structures to align themselves with the revised Income Tax Act and benefit from its exemptions.
The Ministry of Finance and Economic Development has published the much-anticipated relaxation of provisions of the Income Tax Act that restricted 100 percent deductions of interest expenses for companies.
The proposed amendment, published on 26 August through the Income Tax Amendment Bill 2019, came after rigorous lobbying by businesses following the thin capitalisation law that was enacted on 31 December 2018.
The effect of the law was to effectively limit interest expenses incurred by corporates as from 1 July 2019 as tax deductions. Previously, every company could claim 100 percent of its interest expense but the law limited it to 30 percent of what is known as Tax EBITDA, effectively increasing corporate tax.
Tax experts say this was one of the most fiercely opposed tax laws in the past decade, which businesses argued would dampen the investment mood, constrain economic growth, hamper infrastructural development, restrict employment creation and lead to a spike in taxes. Many saw the recent proposed amendment as a clear sign that tax authorities treated the concerns and fears of business regarding the negative effects of the law seriously.
The proposed amendment seek to exempt variable rate loan stock companies (huge corporates which usually build malls) and micro, small or medium enterprises (SMMEs) from the provisions of the interest deduction limiting law. Jonathan Hore, a tax expert at Aupracon Tax Specialists, says the interest expense for such businesses will not increase their tax costs as it will not be limited.
VRLSCs are companies specifically set-up to build massive properties such as Airport Junction, Riverwalk and Game City and by nature, incur excessive interest. On the other hand, SMMEs are defined in the new law as companies which do not own 20 percent shares or more in another company or have another company owning at least 20 percent of their shares.
In other words, says Hore, SMMEs are companies which do not belong to a group of companies and their interest expenses will also not be limited. “However, those companies which belong to groups will have the interest limited,” he points out. “There will not be any interest limitation for those which do not breach the 20 percent shareholding, i.e. for shareholding which is below 20 percent.”
Since SMMEs are no longer affected by the law and any group company will still be required to limit interest deductions, Hore argues that it is likely that corporates will reconsider their group arrangements, “if the tax bills bite”. He says some may have to sell off their shareholding to qualify as SMMEs so that their tax bills remain in check.
“The new amendment, while welcome, may mean that within the same group, some group entities will have their interest expenses limited while some will not, depending on the shareholding structure,” he says, adding that this calls for careful consideration of the impact of the laws on the group companies for businesses belonging to groups.
It is well known that SMMEs play a pivotal role in any economy as they are known to be the largest employers, absorbing more people than large enterprises. Therefore, Hore says, the amendment of the law recognises this critical role that SMMEs play in employment and wealth creation. If the law was not amended to exclude SMMEs from the interest limitation, that would have compounded their operational challenges, which include access to finance.
For Hore, it is also possible that some who still feel that their businesses require significant financing, such as mines and property developers other than VRLSCs, may still lobby for their inclusion as exempt entities. “This would also bring about positive growth prospects for them,” he points out.
Without a doubt the new law generally increases tax costs for heavily borrowed companies which are not included under the exemptions list. This will effectively result in more tax bills and reduced dividends to shareholders, according to observers. “Those listed on the BSE may find their shares losing value as tax costs spike,” says Hore. “It is also undeniable that the taxman will pocket more taxes as a result of the limitation of the interest deductions.”
The amendment to the law allays fears that there was going to be a slowdown in property development. Or, as some of the affected companies had hinted, that they could possibly only embark on expansions outside the country, which could stifle economic growth in Botwsana.
Further, exempting VRLSCs, most of which are registered on the BSE, may mean that they remain as profitable as they were before the introduction of the December 2018 law, preserving their share value. If the law had been maintained as it was, Hore says their shareholding, technically called linked units, could crumble due to excessive tax costs, which could potentially affect their trading on the bourse. “This could also negatively affect further property development as such companies would fail to attract investors.”