Tanzania - a more taxing jurisdiction for venture capital?

Today, the East African Venture Capital Association (EAVCA) will hold a Private Capital conference in Dar es Salaam, a particularly timely event given renewed investor interest in Tanzania. Taxation is always a topic of interest for venture capitalists, not just in terms of taxation of ongoing operations, but more importantly its impact when they seek to realise their returns through disposal of their investments. EAVCA participants will therefore have a keen interest to understand how investment disposals are taxed in Tanzania and how this compares to other East African Community (“EAC”) countries.

Ordinarily, where countries tax capital gains, the legislation makes some accommodation to recognise that the nominal value of a gain on disposal (being the difference between sales proceeds and original cost) will not represent the real value given the impact of inflation.  Typically therefore, there is either a lower rate of tax for capital gains or provision for indexation of the original cost of acquisition to adjust for inflation (or currency depreciation).

EAC countries with low capital gains tax rates include Kenya (5% (15% to apply from 1 January 2023)) and Rwanda 5%. A similar approach is taken in Sub-Saharan Africa’s largest capital markets namely Nigeria (10%) and South Africa (22.4%).

Tanzania’s predecessor income tax legislation (Income Tax Act (“ITA”) 1973) provided for a lower rate of 10% and indexation - but by contrast the current legislation, ITA 2004, only maintains this 10% rate for a disposal by a resident individual.  Otherwise, the applicable rate is 30% or 20% for disposal by a resident company or by a non-resident respectively.

Tanzania is not the only country in the EAC to apply a high rate of tax to capital gains.  For example, Uganda subjects capital gains to the normal income tax rate (30%) but importantly it provides for indexation of the cost of acquisition.  While Tanzania’s ITA 1973 used to provide for indexation, the ITA 2004 does not provide for any such adjustment.

So what is the challenge?  Well, as things stand, if you had invested USD 1m when the exchange rate was TZS 1,500: USD 1 and sold some years later at the same USD amount but when the rate was 2,300, you would be in a no gain no loss position from a USD perspective but have a TZS 800m gain (and a tax liability thereon of TZS 240m (USD0.1m)). In this illustration, you will note that due to lack of indexation, taxation in the eyes of the investor is on a nominal TZS “gain”, but in hard currency terms there is no gain; indeed, the tax liability actually then creates a negative USD return for the investor (who rather than getting back the original investment of USD1m instead remains with approximately USD0.9m once tax has been deducted).

Another frequent challenge following an initial investment is that the investor may wish to reorganise the group structure for efficiency, however, the Tanzanian laws do not provide an exemption in such a case despite there being no change in the ultimate ownership of shares. In contrast, Kenya and Rwanda provide for some exemption on group restructuring.

Lastly, a major current area of concern for investors is the “change in control” (CiC) legislation, which applies where more than 50% of the ultimate (underlying) ownership changes by more than 50%.  Following an amendment in 2012, where there is such a change all the assets and liabilities of the Tanzanian company are automatically deemed to be realised for tax purposes and if this results in a gain, then such a gain is taxable. 

Although the CiC amendment was well intentioned - namely to counter tax avoidance - its effect is much wider than originally intended. Concerns include: the potential to treat transactions to raise new funds as triggering a tax liability, the possibility of the disposal being subject to taxation twice, minority shareholders being impacted by an indirect disposal they have no part in, no exclusion for listed companies and uncertainty of how the tax is calculated.

In general, jurisdictions with CiC provisions institute certain restrictions as to the applicability of the provisions such as: (i) applicability only where the value in country is primarily attributable to a particular class of assets (for example “taxable property” (China)) as opposed to any trading business; (ii) applicability where a de minimis threshold for underlying value of the transaction is attributable to the country - for example 50% in India; (iii) applicability only where there is a tax avoidance motive – China; and (iv) exclusion for transactions on stock exchanges - China. Tanzania’s CiC legislation does not have such boundaries.

To attract more foreign investment (including investments by venture capitalists) and promote competitiveness, there is a need for Tanzania to revisit its capital gains tax provisions so as to better align with international best practice and with other countries in the region.