THOGO: Offshore deals have local tax implications

Globalisation has meant that property ownership across geographical boundaries and taxation is possible and countries have to manage their appetite for tax revenue while at the same time creating an enabling business environment.

Taxation across borders, however, has always posed challenges with countries often seeking to address these challenges painlessly through double tax agreements and the taxation of permanent establishments.

However, the ever evolving commercial world has meant that these traditional solutions have hardly been the panacea to resolving cross-border property ownership and taxation.

Indirect transfers

One area that has posed always posed a challenge and which has been receiving increased attention particularly in developing countries is indirect transfers. Typically, multinationals organograms will have a number of separate legal entities operating in different countries across the world.

To leverage on different aantages that double tax agreements or regional economic blocs present, these entities will in turn incorporate other subsidiaries or register branches offices at the lower levels of the structure.

Such structures have been adopted by entities the world over and it is not uncommon to find that somewhere in any particular organogram there is a country with a lower tax rate.

Indirect transfers in this context occur when assets owned by legal entities at the lower levels of the organogram (often in developing countries)hange hands through the disposal of a holding entity higher up the structure, which has an interest in the subsidiary or registered entity that owns the assets.

Such a disposal means that once the entity higher up the organogram changes hands, then all what that entity owns down the organogram through to the assets owned by its subsidiaries and branches changes hands as well.

Let me illustrate using an example of such a transfer. Say a UK entity, A, has a 100 per cent shareholding in a subsidiary, B and C, which have mining operations in Kenya and Tanzania. A’s shareholders in the UK decide to sell their shares in A to a third party who is also based in the UK.

After dust has settled from the transaction it means that the new shareholders of A in the UK indirectly own the mines in Kenya and Tanzania through their shareholding in B and C.

The disposal of A’s shares by its shareholders would be subject to tax in the UK. However, the separate legal entity argument means that Kenya and Tanzania would not be able to tax the transaction in their country since a tax triggering event has not taken place in their countries.

There is the view that such a transaction is an offshore sale of the foreign holding company and its ownership of assets in the developing countries directly or through entities is incidental. Through the concept of separate legal entity the claim is then made that the developing countries lack the jurisdiction under their domestic law to tax such an “extraterritorial” event not involving their tax residents.

This has meant that gains and profits from offshore commercial transactions that primarily involve assets located in developing countries go untaxed in these developing countries. The opposing view is that the actual substance of such a transaction is the assets located in the developing countries, which would ordinarily be subject to tax in those countries if disposed.

Using the argument that the substance of such a disposal are the assets and not the shares in the holding entity higher up organogram, developing countries have in the recent past introduced amendments to their tax laws to bring such offshore transactions into their tax nets.

Tanzania introduced legislative changes in 2014 which now provide that where such a transaction takes place, then the Tanzania entity will be construed to have disposed of its assets and reacquired them immediately thereafter at their fair market value.

This means that the Tanzanian entity will be required to pay 30 per cent capital gains tax on the difference between the value of its assets in its books and their fair market value.

Capital gains tax

In Kenya, which recently re-introduced capital gains tax, the indirect transfers appear confined to the petroleum extractive industry where any gain from such offshore transactions will be taxed in Kenya if the offshore shares derive at least 20 per cent of their value from the assets located in Kenya.

The change in Kenya was introduced when prospects for the oil and gas industry looked very promising with the widespread perception that a transfer of large scale extractive facilities should bring a return to the government, especially as profits are often seen as unpredictable or uncertain and may not materialise due to economic circumstances.

Since the current indirect transfer rules do not provide a safe-harbour for reorganisations, amalgamations and separations within groups, cross-border mergers and acquisitions transactions and intragroup reorganisations could trigger taxes , especially where developing countries are in organogram.

Mr Thogo works with Deloitte East Africa. Email: