The legal framework prevents mergers and acquisitions

Uganda, like many other developing countries, has difficulty taxing overseas disposals that derive value from assets and businesses located in its jurisdiction.

As a result, the tax office resorts to amending Art. 75 and 79 of the Income Tax Act (ITA) 2018, which – as many law firms point out – “inadvertently lead to double taxation”. This is especially true for companies whose owners have already paid capital gains tax in another jurisdiction on the sale of their shares or mergers with local companies.

Uganda amended sections 75 and 79(a). ga) the ITA to decisively address the taxation of disposals of shares in offshore companies that derive value from locally owned assets or enterprises in 2018, following the example of other developing countries such as Tanzania, Ghana and Nepal.

“This move was necessitated by the prevailing international tax situation, which considers the sale of shares abroad as extraterritorial and considers the ownership of assets in developing countries as incidental,” Denis Yekoyasi Kakembo, managing partner of Cristal Advocates, states in a corporate notice.

Better safe than sorry
This is because many multinational corporations have a common practice of selling off subsidiaries at the group or parent company level, which allows them to avoid local taxes, intentionally or unintentionally. However, those transactions that occur at higher levels of the corporate structure involve a change in ownership at the subsidiary level.

In such cases, the Uganda Revenue Authority (URA) loses significant amounts of tax. For example, in the 2010 deal in which Airtel Uganda acquired assets from Celtel Uganda Ltd, URA claims to have lost over Shs140 billion in capital gains tax.

“This transaction was not entered into in Uganda because we (URA) did not tax capital gains. At that time, there was no law in Uganda imposing tax on such a transaction. Here we had a dilemma because the negotiators stated that the transaction was to be taxed in the Netherlands, and yet after research we realized that it was tax exempt in the Netherlands, which now ensures so-called non-double taxation” – Robert Luvuma, Tax Manager international at URA, he told a reporter last year, a month after Cipla Quality Chemicals was acquired by a private equity firm.

URA notes that it has managed to overcome this loop by adding certain clauses to its tax policy that now enable it to tax transactions involving more than 51% of shares.

“This cannot happen again unless someone sells significant shares. “Uganda is negotiating with countries that have joint DTAs (double taxation agreements) so that we can withdraw some of the tax rights that we have given up in these agreements,” Luvuma said.

However, some of these policies that the tax authorities use have caused damage to private companies to some extent. One example is the recently completed sale of Hima Cement, which the company said resulted in a loss of $2.9 million (Shs10.7 billion) last year due to one-off tax and regulatory expenses.

Mergers and acquisitions may seem like a one-sided deal, but they make strategic, financial and organizational sense for all parties. They consolidate market share, increase competitiveness, save costs and sometimes facilitate talent acquisition.

Data tracked by private equity and venture capital trackers shows that the volume of these deals has declined over time. They dropped to 15 last year from 32 in 2022, according to data from the East Africa Venture Capital Association.

The decline is attributed to various factors, including a tax system imposing a 30 percent capital gains tax, value added tax and a stamp duty of one percent of the transaction value.

Moreover, it was found that a contributing factor to this situation is the cyclical nature of the investment industry, characterized by periods of record harvests followed by market declines. This is especially true when private equity funds have delays in raising funds for new funds.

Amendment to Art. 75
In 2018, changes were introduced to Art. 75 section 2 and art. 79 lit. ga) of the ITA to bring such transactions under Uganda’s tax radar. Pursuant to Art. 75 section 2 ITA, an entity is deemed to have realized all its assets and liabilities immediately before the change if it changes its ownership by at least 50 percent within three years.

In this case, he is deemed to have relinquished ownership of each asset and received a redemption amount that corresponded to the market value of the asset at the time of realization.

Moreover, it is assumed that each liability has been fulfilled by the entity and the expenses related to each liability at the time of fulfillment are equal to its market value.

However, a simple interpretation of the text of this amendment may inadvertently expand its scope, potentially leading to unintended consequences, in particular double taxation of a single transaction, Cristal Advocates tax lawyers note in a corporate notice on the taxation of transactions deemed to be disposals.

Paradox
Lawyers argue that the key issue is whether the amendment to Art. 75 The ITA was intended to apply to transfers of shares at the level of a direct holding in Uganda. And if so, such transactions would trigger Section 75 of the ITA on direct and indirect share sale transactions at the Uganda level involving at least a 50% change in ownership.

“In the case of a local sale of shares visible to the Ugandan tax authorities, a simple interpretation of Art. 75 means that selling shareholders would be subject to capital gains tax, just as an entity is deemed to have realized its assets and liabilities in connection with a change in its ownership by more than 50 percent,” they claim.

“Although not documented in law, it can be assumed that Sections 75(1) 2 and art. 79 lit. ga) The ITAs were intended to capture overseas share sales involving non-resident shareholders on the one hand and local Ugandan entities on the other, they further explain.

They add that in such cases selling shareholders would normally be exempt from local taxes in Uganda but would be subject to share sale transaction taxes applicable in their respective jurisdictions.

“Any different interpretation would result in double taxation of a similar economic event,” they quote.

Quotation
In the event of a change of owner in accordance with Art. 75 UIT, the entity is obliged to realize all its liabilities and assets at book value, as well as sell them at market value.

“If we interpret the law strictly, will other valuation approaches, such as asset-based and income-based methods, suffice?” – Cristal Advocates asks rhetorically.

They add: “The market value of individual items of assets and liabilities is determined based on prevailing market conditions and transactions reflecting the amount that 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 pricing issue is easier read than implemented.”

Cristal Advocates further notes: “To reassure markets and strengthen the confidence that is essential for mergers and acquisitions through which foreign direct investment may flow, it is important that the government aligns the law with its political position.”

They add: “Such discrepancies create uncertainty and undermine investor confidence. Clear and consistent tax rules are essential to creating a favorable business climate.

Appetite for private equity
The prevailing uncertainty comes amid Uganda’s efforts to expand the use of private equity (PE) financing as a substitute source of capital for the private sector.

From the 2024/2025 tax year onwards, income received from or by venture capital or private equity funds subject to the Capital Markets Authorities Act, ch. 84, will be tax-free. The government introduced this exemption “to increase the supply of capital available to Uganda’s private sector.”

As regional equity markets struggle to attract new listings, recent research, such as one by the African Private Capital Association (AVCA), shows that companies in East Africa are raising more money through private equity deals than through initial public offerings , which are expensive and require full disclosure of their financial and management position.

According to new data from AVCA, East African companies completed 205 private capital deals in 2022 and 2023, enabling them to raise almost $2.26 billion in new financing from private equity investors. The uncertainty is how these deals will deal with Uganda’s tax rules if they are close to that country.