Tanzania – a more fiscal jurisdiction for venture capital?

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Today, the East African Venture Capital Association (EAVCA) is hosting a private equity conference in Dar es Salaam, a particularly timely event given renewed investor interest in Tanzania. Taxation is always a topic of interest for venture capitalists, not only in terms of the taxation of ongoing transactions, but more importantly its impact when seeking to realize their returns through the disposal of their investments. EAVCA participants will therefore have a keen interest in understanding how investment disposals are taxed in Tanzania and how this compares to other East African Community (“EAC”) countries.

Usually, when countries tax capital gains, the law accommodates itself to recognize that the face value of a gain on disposal (i.e. the difference between the sale proceeds and the original cost) will not represent the value real given the impact of inflation. Therefore, there is usually either a lower tax rate for capital gains or a provision for indexing the initial cost of acquisition to account for inflation (or currency depreciation).

EAC countries with low capital gains tax rates include Kenya (5% (15% to be applied from 1 January 2023)) and Rwanda 5%. A similar approach is taken in the largest capital markets in Sub-Saharan Africa, namely Nigeria (10%) and South Africa (22.4%).

Tanzania’s previous income tax legislation (the Income Tax (“ITA”) Act of 1973) provided for a 10% lower rate and indexation – but in contrast, the current legislation, ITA 2004, maintains this rate of 10% only for an assignment by a resident individual. Otherwise, the applicable rate is 30% or 20% for a transfer by a resident company or by a non-resident respectively.

Tanzania is not the only EAC country to impose a high rate of capital gains tax. For example, Uganda subjects capital gains to the normal rate of income tax (30%) but more importantly, it provides for indexation of the cost of acquisition. While Tanzania’s 1973 ITA provided for indexation, the 2004 ITA does not provide for such an adjustment.

So what is the challenge? Well, as it stands, if you had invested $1 million when the exchange rate was 1500 TZS:$1 and sold a few years later for the same amount of USD but when the rate was 2300, you would be in a position with no gain or loss of a USD prospect but have a gain of TZS 800 million (and tax payable on it of TZS 240 million (USD 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 a nominal “gain” in TZS, but in hard currency terms there is no gain ; in effect, the tax liability then creates a negative return in USD for the investor (who, rather than recouping the initial investment of $1 million, is left with around $0.9 million after tax is deducted ).

Another common challenge after an initial investment is that the investor may wish to rearrange 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. In contrast, Kenya and Rwanda provide some exemption on group restructuring.

Finally, a major current concern for investors is “change of control” (CiC) legislation, which applies when more than 50% of ultimate (underlying) ownership changes by more than 50%. Following an amendment in 2012, when there is such a change, all assets and liabilities of the Tanzanian company are automatically deemed to be realized for tax purposes and if this results in a gain, then such gain is taxable.

Although the CiC amendment was well-intentioned – namely to counter tax avoidance – its effect is much broader than originally intended. Concerns include: the possibility of treating transactions aimed at raising new funds as triggering a tax liability, the possibility that the disposal could be subject to double taxation, minority shareholders affected by an indirect disposal in which they have no , the lack of exclusion for listed companies and the uncertainty of the tax calculation method.

In general, jurisdictions with CiC provisions institute 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 class of assets (e.g. ” taxable property” (China)) as opposed to any commercial enterprise; (ii) applicability where a de minimis threshold for the underlying value of the transaction is country attributable – eg 50% in India; (iii) applicability only in case of tax evasion motive – China; and (iv) Exclusion for Exchange Transactions – China. Tanzanian CiC legislation has no such limitations.

To attract more foreign investment (including venture capital investment) and promote competitiveness, Tanzania needs to review its capital gains tax provisions to better align with international best practices and on other countries in the region.

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