12 April 2018

Tanzania: Tax Reforms Could Help Attract Venture Capital to Tanzania

A Venture Capital and Private Equity Conference took place recently in Dar es Salaam, and one topic discussed was whether the current tax regime is conducive to investment in Tanzania by venture capitalists.

As a starting point we need to understand the nature of venture capital, and why it might be important. In broad terms, "venture capital" can be described as a type of private equity, a form of financing that is provided by firms or funds to small, early-stage, emerging firms that are deemed to have high growth potential, or which have demonstrated high growth.

The potential relevance of venture capital to Tanzania is that, whilst it has been among the fastest growing economies in sub-Saharan Africa and is projected to continue growing over the years, the ability to raise capital has become more difficult in an environment of tighter liquidity - manifested for example in the reduction in credit growth to the private sector. This scenario creates an opportunity for venture capitalists in Tanzania as on the one hand the projected growth indicates opportunities for new investors and the liquidity issue presents a funding gap that Venture Capitalists could perhaps fill.

Venture capitalists' returns (share of business profits or sale of shares) are obtained after tax, hence a venture capitalists would be interested in understanding taxes applicable to them before making an investment. The income taxes that a company's profits are subject to are not unreasonable, with an overall effective rate of 37 per cent (once account is taken of 30 per cent corporate income tax and then 10 per cent withholding tax on dividends). The challenge however arises with the tax treatment of disposals and in particular three aspects: (i) the tax rate applicable, (ii) the lack of indexation of the original TZS cost for inflation/devaluation and (iii) the tax treatment of indirect disposals of shares.

The concern with the tax rate on a gain on disposal of shares is that the rate in Tanzania is relatively high (30 per cent) when compared to rates in other jurisdictions (a few examples Kenya (5 per cent), and South Africa (22.4 per cent). Indeed, there is a school of thought that it is economically more efficient not to tax capital gains, but instead simply tax the profits from the entities in which the shares are held - the logic being that any price paid for shares is effectively paid in anticipation of future profits, which in any case will be taxed (with no relief at the level of the business for the cost incurred for the shares). By way of illustration, Nigeria, Mauritius and Zambia do not tax capital gains. Of interest is that Tanzania's predecessor income tax legislation (Income Tax Act 1973) provided for a lower rate of 10 per cent which I believe is reasonable.

Where countries do tax capital gains, it is a common feature to provide for indexation of the cost of acquisition - particularly so, if the tax rate is relatively higher (for example, Ethiopia's tax law provides for indexation). However, Tanzania, in addition to having the high tax rate, does not provide for indexation. As such, even where a gain arises as a result of inflation/currency depreciation, it would be subject to tax at 30 per cent. By way of example, if someone had invested USD 1 when the USD: TZS exchange rate was say 1,500 and sold the investment later at the same amount (i.e. USD 1) but when the exchange rate is 2,000, they would be considered as realizing a gain (subject to 30 per cent tax) of TZS 500, but in USD terms there would not be a gain. This illustrates the risks for outside investors who may realise no gain in hard currency terms, or even possibly a loss, but nevertheless end up being taxed on a TZS "gain" driven by local currency depreciation. Given this concern, it is important that an indexation provision is included in our law. Again, the Income Tax Act 1973 was more attractive in this regard as it had a provision for indexation.

Last but not least, is the indirect disposal/change in control provision which is probably the greatest concern for investors, and which will be the subject of a separate article.

In my view, in order to continue growing the Tanzania economy, investments including venture capital investments should be encouraged. A priority is to change how gains from disposal of shares are taxed (perhaps by reverting to a taxation of gains more similar to the Income Tax Act 1973) and amend the scope of indirect disposal provisions. These changes would be compensated by the increase in taxes as a result of business growth/increased profits.

Jonia Kashalaba (jonia.k@pwc.com) is a Tax Manager at PwC Tanzania, who has also worked for a number of years on secondment in PwC Ghana and PwC Dubai. The views expressed do not necessarily represent those of PwC.

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