THOGO: Consider the tax impact of rescue plans

Last week, a colleague hurriedly ambushed me by asking me to accompany him to a meeting that he had with the CFO of an agri-business company. We decided to carpool so that she could brief me on the agenda for the meeting on the way there.

It turned out the CFO had found himself between a rock and a hard place and like many in his position in these hard times, he was like a duck on water calm and graceful on the surface but below the surface he was paddling like his life depended on it.

The meeting was to brainstorm on how best to restructure the entity’s balance sheet and improve its financial position.

This year, Kenya’s corporate scene has had mixed fortunes with a number of entities setting records on both ends of the scale. There are a couple of entities that have hit it out of the park based on the good results they have reported.

On the other hand, some entities have found themselves in the unenviable position of having to announce profit warnings. The poor results have been attributed to a myriad of factors some self-inflicted while others have been as a result of force majeure.

One common outcome from these reasons is that these entities have found themselves treading on water as far as meeting their working capital obligations is concerned.

The typical symptoms that an entity is in a hole include challenges in meeting its monthly payroll obligations, asking for extended credit periods from suppliers, falling back on tax obligations and incessant calls from your banker “to have a chat about rescheduling your loan.”

Fortunately, it hadn’t yet come to any of these with our CFO. It turns out that he had just reviewed his cash flow forecast and it did not paint a reassuring picture for the foreseeable future. He needed to do something.

The first step in getting out of such a predicament involves a review of the besieged entity’s financial statements and making tough decisions which in some cases could involve chopping off an arm to save the patient.

Sadly, the meeting with the CFO revolved around these tough decisions and my colleague’s brief was to suggest the most effective and painless remedy.

All the possible escape routes were aimed at improving his entity’s financial condition, particularly its cash flow position. Sadly, though, all of them come with tax implications on all the parties involved the entity, its employees, the shareholders and its creditors.

These measures can be considered first-aid immediate steps taken to forestall cash haemorrhage. The impact of all these is that when someone puts numbers to the different scenarios, there is the need to plan for and budget for what is due to the taxman.

You could come up with an elaborate plan to improve cash flow only for you to receive a tax demand that you had not anticipated a few months down the line.

Entities in triage will typically put a freeze on new employment and will consider the painful process of culling staff numbers. This move has personal income tax implications for the terminal benefits will be paid to the staff who have been let go.

Others who are equity-rich but cash-poor will consider liquidating some of their assets to release much needed cash and could consider leasing back these assets.

Depending on the nature of the assets, this could trigger capital gains tax, corporate tax, withholding tax and VAT. Equity, which can be described as the residual interest in an entity’s assets after deducting all its liabilities, is one of the three elements used to portray an entity’s financial position, along with assets and liabilities.

Improving an entity’s equity position often times casts the entity in good light. For example, very few banks will be unwilling to lend money to an adequately capitalised business.

Therefore, entities may also decide to recapitalise their businesses by dipping into an entity’s earnings and profits pool or by asking shareholders to inject new money into the business (an option could have both capital gains tax and corporate income tax implications).

There is also the option of approaching lenders and asking them to convert their existing debt into equity to improve the entity’s balance sheet. If the lenders agrees to this, they will often opt for preferred shares.

The conversion of debt into shares could potentially trigger both capital gains tax and corporate tax.

I should point out that we also talked about long-term solutions that go beyond the first-aid stage and which revolve around restructuring the agri-business operations by considering both toll and contract manufacturing.

To give credit where it is due, some of the suggestions were not new. The CFO had been toying with some of these options and had considered the potential tax implications that could arise from each. It is not surprising therefore that during the meeting I ended up doing most of the talking.

On the way back to the office my colleague teased me about hijacking her meeting and stealing her thunder. I am not expecting any meeting invitations from her any time soon.

Mr Thogo works with Deloitte East Africa. jthogo@deloitte.com

SOURCE: BUSINESS DAILY