By Joseph O. Okuja
There’s a lot of discussion around the merits and implications of the judgement in the HAM vs DTB case. I have had the benefit of reading the judgement but I must confess I failed to appreciate the full facts and sequence of events in order to offer any meaningful opinion. One would need to review the original suit and the prior arguments made (That’s for another day). However, I have taken time to read the relevant provisions of the law touching on the business of financial Institutions and analysed it against the decision on DTB’s ‘syndicated loan’ that has rattled the banking industry. I will say this – based on the face of the record, I have my reservations on whether the appointment of a licensed financial institution in Uganda as an agent, by a foreign bank (not “financial institution as defined in FIA”), to receive/collect loan repayments on its behalf, amounts to establishing a representative office in Uganda and therefore conducting financial institution business in Uganda! I believe the appeal will resolve this, subject to the facts of the transaction between Ham & DTB Uganda or Kenya, as the case may be.
There’s also talk about the tax that may have been lost over the years through syndicated loans by the banks in Uganda. Staying on my lane, let me provide #AlternativeFacts and some general guidance on the tax implications that may arise from the judgement and the issues that the taxman may pick an interest in.
Deemed Taxable Gains
Many businesses are still struggling to emerge from the effects of the lock-down attributed to COVID-19. Where loans are involved, there is a substantial increase in debt restructuring activity since borrowers with liquidity issues cannot generate enough cash to service their debt. Many of these borrowers are now relying on debt restructuring in the form of debt modifications, to help them meet their obligations. Debt restructuring of an old debt instrument for a new debt instrument can result in a deemed taxable gain and trigger tax consequences. This is because a modification of a debt may result in a taxable gain on account of a satisfaction or cancellation of a business debt. In the Ham case, whatever amount that ultimately qualifies as being satisfied or cancelled by virtue of the court decision (assuming a debt existed), will constitute income or a gain that is taxable as business income.
Loan syndications are not anything new in the banking industry. They are an important part of the financial landscape. In this context, a syndicate is a group of banks probably with registered offices in various countries, making a loan jointly to a single borrower. In other words, a syndicated loan agreement allows lenders often from different jurisdictions to finance the borrower and the projects for which the loan is granted. Several factors are responsible for the desire of banks to share a large loan among several lenders, the main one being a banks’ need to achieve diversification in their loan portfolios. Capital constraints also promote loan syndications. Banks that find themselves with capital-asset ratios below or close to regulatory minimums may not want to increase assets by adding large loans to their balance sheets and may choose, instead, to share them with other banks by syndicating them. Furthermore, banks are limited in the size of the loan they can make to any one borrower. In a structure of a syndicated loan, one of the banks usually takes up the role of syndicate agent. All repayments, interest payments and other fees must be payed to the syndicate agent who is then responsible to distribute collected funds to other lenders in the syndicate.
Without a doubt, the funds granted to the borrower by the lenders are subject to tax law and what needs to be determined is under what tax rules the funds should be regarded. In my view, the income tax and VAT rules on imported services must be considered while analysing under what rules the funds are or can be potentially taxed. The syndicate loan in particular must be considered in the context of the different jurisdictions that syndicate banks and borrower originate.
A crucial tax question that arises in connection with the payments received or collected by the syndicate agent is who is responsible for withholding tax (where it is due), on interest payments on the loan? In the first instance, for the purpose of determining whether withholding tax should be applied to interest payments made under the loan agreement to the syndicate agent, the tax residency of the lead syndicate bank is critical. Secondly it should also be established if the payments made to the syndicate agent should be considered to be its income in totality, or whether only the part corresponding to its involvement in the total financing by the syndicate lenders should be considered.
Our current income tax law on interest payments provides thus:
- Interest paid by a resident individual to any resident person (individual or non-individual) is not subject to withholding tax.
- Interest paid by a resident company to a resident financial institution is not subject to withholding tax.
- Interest paid by a resident company to an associated resident company is not subject to withholding tax.
- Interest paid by a resident company to a resident individual is subject to 15% withholding tax.
- Interest paid to a non-resident person from sources in Uganda is subject to 15% withholding tax on the gross amount of the interest. However, interest paid by a resident company to a non-resident person outside Uganda in respect of debentures (i.e. any debenture stock, mortgage, mortgage stock, loan, loan stock or any similar instrument acknowledging indebtedness, whether secured or unsecured), is exempt from tax if all the following conditions are met:
- The debentures were issued outside Uganda for the purpose of raising a loan from outside Uganda.
- The debentures were widely issued (at arm’s length) for the purpose of raising funds for use in a business carried on in Uganda;
- The interest on the debentures is paid to a financial institution of a public character outside Uganda.
- The interest is paid to a person outside Uganda.
Joseph O. Okuja is Director | Team Lead, Tax & Regulatory Services at Libra Advocates and Consultants