BY JOB KABOCHI AND LORNA ONDUU
In financing the huge infrastructural projects, the government ought to involve both the private and public entities as well as local and foreign investors
According to Kenya Vision 2030, Kenya as a country aspires to transform from a lower middle-income country to an upper middle-income country by the year 2030. This aspiration is valid and attainable as most of the economic fundamentals are largely in place to enable the country take off. In this regard, the Government’s development policies are driven by its desire to achieve Vision 2030.
Investment in infrastructure is expected to drive this growth as it generates the fundamental facilities, services and systems needed for economic growth. The 2018/19 national budget broadly gave a picture of a government focused on investments that will stimulate economic growth, create jobs, transform lives and reduce poverty and inequality. The focus on the big four agenda creates a roadmap for Kenya’s social and economic transformation as embedded in Vision 2030. Whereas KSh460 billion was allocated to the big four, a further KSh992 million was allocated to key enablers like infrastructure, security and education.
Infrastructure is made up of interrelated sectors as diverse as water treatment plants to airports, electrical grids, gas lines or broadband/ telecommunication networks, which work in an intertwined spirit for the operations of a society.
Tax policies fail infrastructural growth
Unfortunately, the focus on infrastructure in the abstract leads to unrealistic silver-bullet policy solutions that fail to capture the unique and economically critical attributes of each area of infrastructure.
Each infrastructure sector involves fundamentally different design-frameworks and market attributes that are owned, regulated, governed and operated by different public and private entities. It is also an acknowledged fact that infrastructural projects that play a significant role in the growth of an economy require massive capital investment. The question then lingers, what have we put on the table in support of the infrastructural fantasies we aspire to make reality? As tax practitioners, the conversation on financing these gigantic infrastructural projects will be naturally biased towards tax incentives and other tax policies aimed at enticing potential developers as well as the Government’s ability to generate revenues.
To accelerate realisation of the big four agenda and ultimately Vision 2030, it is our view that the Government must acknowledge the need for increased public private partnerships (PPPs) in the financing and development of infrastructural projects. The scale of the capital requirements on these projects is such that there tends to be heavy reliance on foreign debt capital to finance the project costs, typically 70-80 per cent of the total investment. What this means is that most of the special purpose vehicles (SPV) set up for the PPP projects will have very high levels of debt. Accordingly, it is our view that Government should consider tax initiatives that entice and lock both foreign and local investors.
Deterrent tax legislation
Unfortunately, some of our tax legislation and regulations don’t render themselves to encouraging investment in the country. For instance, under the current Income Tax legislation, a company is thinly capitalised if it is foreign controlled and its interest-bearing loans exceed 3 times the aggregate of issued and paid up share capital of all classes and revenue reserves. Therefore, if an SPV finances a project using 80 per cent debt finance (including shareholder loans) and 20 per cent pure equity contribution, then it will be thinly capitalised as its debt will be four times the amount of equity (assuming no revenue reserves) breaching the 3:1 debt to equity ratio. The implications of this capitalisation is the disallowance of interest incurred on foreign debt in the determination of income tax liability. This has a direct impact on the returns that the investor receives for their investment. What thin capitalisation creates is an uneven playing field between foreign and local participants in Kenya’s PPP programme, which given the need to mobilise foreign capital would seem inappropriate and indeed counter-productive to Kenya’s infrastructure development ambitions.
What Government should do
If the government were to exempt PPP parties in the infrastructure niche from the thin capitalisation provision or alternatively broaden the allowable ratio of debt to equity, such actions would directly reduce the cost of investment and hence attract more foreign capital.
Such a change is likely to make the process of awarding contracts more competitive ensuring that the benefits are passed on to Government or the users in the form of lower charges. Additionally, the Government will also benefit from revenue generated from withholding tax on interest payments on foreign debt capital.
Another action that the Government could consider in support of infrastructural development is amendment of the Value Added Tax (VAT) law to exempt equipment imported for the purposes of infrastructure projects as was provided for under the repealed VAT Act, Cap 476. Under the repealed legislation, The Minister of Finance had power to grant VAT remissions to qualifying projects. However, this remission was scrapped upon enactment of the VAT Act in 2013 – while the new legislation provided a transitional period of five years for utilization of remission granted under the repealed law, this period lapsed on 31 August 2018. The Government should consider re-introducing this remission scheme to be in line with the government’s plan to encourage development of infrastructural facilities through the PPP model.
Job Kabochi is a Partner and Lorna Onduu is a Senior Associate with PwC Kenya’s tax practice. Email: firstname.lastname@example.org, email@example.com