UGANDA - Taxation of indirect transfers in Uganda
On 10 September 2014 the Court of Appeal in Uganda ruled in favour of the Uganda Revenue Authority (URA) in the Commissioner General and URA v Zain International BV case, overturning the High Court decision in favour of Zain International BV.
Zain International BV disposed of its 100% shareholding in Zain Africa BV to Bharti Airtel International, both resident in the Netherlands. Zain Africa BV, the subject of the disposal, had a 100% shareholding in Celtel Uganda Holdings BV which owned 99.99% of Celtel Uganda Limited. Celtel Uganda Ltd’s shares in Uganda were not transferred, and its property was not disposed of. The transfer of the shares in Zain Africa BV took place in the Netherlands. The Commissioner General of the URA raised a Capital Gains Tax assessment of USD 85 million on Zain International BV on the gain realised from the disposal of shares.
The ruling and its consequences
Unlike related cases like the Vodafone case in India and the Petrotech case in Peru, the Court of Appeal ruled in favour of the URA, saying that the URA had jurisdiction to raise a proper tax assessment against Zain International BV. This issue is currently unresolved and is under the Mutual Agreement procedure (MAP) as prescribed by the Double Tax Treaty.
The Governments of India, Peru and Uganda subsequently changed their domestic laws to allow taxation of offshore indirect sales. Uganda also introduced a provision in its domestic laws to tax the local entity once there is a direct or indirect change of ownership (of the local entity) by 50% or more.
Change in control of companies
Under the Income Tax Amendment Act of July 2018, income is sourced in Uganda if there is a direct or indirect change of ownership by 50% or more of a person other than an individual, government, political subdivision of a government or a listed institution located in Uganda. If this change in ownership happens within a period of three years, there will be a deemed sale of assets owned by the local Ugandan entity.
A change in control is determined by reference to direct or indirect ownership, which enables the tracing through of intermediate holding entities between the asset owning local entity and the ultimate holder of the shares which are subject to the actual sale. In other words, this will curb tax avoidance propagated by a transfer of shares.
The Income Tax Act provides that where direct or indirect ownership of a local Ugandan entity changes by 50% or more, the local entity will be treated as:
- Realising all its assets and liabilities immediately before the change;
- Having parted with ownership of each asset and deriving an amount in respect of the realisation equal to the market value of the asset at the time of the realisation;
- Reacquiring the asset and incurring expenditure of the amount referred to in paragraph (b) for the acquisition;
- Realising each liability, and is deemed to have spent the spent the amount equal to the market value of that liability at the time of the realisation; and
- Re-stating the liability for the amount referred to in paragraph (d).
The purpose of introducing this provision is based on the fact that although direct ownership of the local entity does not change as in the case of Zain Uganda, the shares sold derive part of their value from assets located in Uganda. The URA can tax the local entity on the unrealised gain on both source and residence since it is deemed that the assets of the local entity are disposed of. The asset owning entity is treated as disposing of and re-acquiring its assets at their market value.
A sale of the assets at their market value will be deemed to occur, and the difference between the original cost (carrying cost) of the assets and the market value gives rise to a taxable capital gain in Uganda.
Double taxation aspects
In order to protect the local entity against double taxation in case of a change in control in future, this model treats the local asset owning entity as re-acquiring the assets for their market value. This means that in case of a future sale, since the assets in the balance sheet are stated at the market value and there is intent to dispose of them at the current market value, the gain on disposal could be minimal or zero, depending on the time between the current deemed disposal and the next sale.
Under the model, liabilities are also restated to market value and the balance sheet is restated at market value.
The other advantage is that it eases enforcement and collection of the tax liability by the URA because it combats the difficulties in collecting the tax where transactions take place between two non-residents like Zain International BV and Bharti Airtel International.
On the other hand, In the case of Zain International, a possibility of double non taxation could have occurred because Netherlands exempts capital gains realised on disposal of shares qualifying for a participation exemption. However, introduction of the provision may lead to double taxation whereby tax may be imposed in the jurisdiction where the actual sale occurs and in the jurisdiction where the deemed sale occurs.
Additionally, since the local entity does not receive the proceeds of the disposal, it may be difficult to collect the taxes payable.
Further, there may be practical difficulties in determining market values of the assets at the time of the deemed disposal that are acceptable to URA.
The question arises as to what the tax point will be in this case, especially where an indirect transfer between two non-resident entities is involved.
Should the local entity track changes in its shareholding and account for capital gains tax as soon as a change in ownership that meets the threshold established by law is registered?
Yvette Nakibuule Wakabi