Up Again Kenya: Government Relief and Tax

Restructuring

1. Legislative changes: are there any additional processes or support which have been introduced as a response to the pandemic which I may not have considered previously?

On 28 September 2020, the president announced that the National Treasury will expedite the rollout of the credit guarantee scheme, which will give enterprises access to credit by an additional KES100 billion. This is an additional measure to the economic stimulus package announced on 23 May 2020 aimed at assisting businesses hard-hit by COVID-19, as follows:

  • The government intends to rehabilitate access roads, footbridges and other public infrastructure and set aside KES5 billion to hire local labour to undertake the works.
  • The allocation of KES10 billion to fast-track payment of outstanding VAT refunds and other pending bills. The president noted that the National Treasury has so far released KES30 billion towards payment of pending bills in the roads sector.
  • The injection of KES3 billion as seed capital for the SME Credit Guarantee Scheme with the aim of providing affordable credit to small and micro enterprises.
  • The prioritization of KES3 billion for the supply of farm inputs through e-vouchers, targeting 200,000 small-scale farmers.
  • The allocation of KES1.5 billion to assist flower and horticultural producers to access international markets, in a period of shortage of flights into and out of the country.
  • The provision of soft loans to hotels and related establishments through the Tourism Finance Corporation. A total of KES2 billion will be set aside to support the renovation of facilities and the restructuring of business operations by actors in this industry.
  • KES1 billion support made available to approximately 160 community conservancies.

With the exception of the reduction to VAT and personal income tax (which were implemented immediately by businesses and employers), as at September 2020, how these packages will be distributed and implemented remains to be seen. On a more general note, we have observed a greater willingness of most government departments to conduct meetings by electronic means, as opposed to the typical requirement for physical attendance. Many offices are also accepting electronic filing of documents (e.g. the Competition Authority) and the courts are making ongoing changes to reduce the need for people to attend in person.

2. Is there anything else I should look out for?

Yes. We suggest a review of the tax segment of this questionnaire which sets out particular changes to applicable taxes for individuals, business and projects.

Tax

3. What is the position with respect to the applicability of emergency tax measures , including

a. what they are and apply to;

b. when they are expected to be phased out on or following a return to business; and

c. whether any transitional periods are likely to apply.

The government has introduced several tax measures aimed at stimulating businesses and protecting individuals from the impact of COVID-19. These measures include:

  • the release of KES10 billion to ensure VAT refunds are promptly paid out by the Kenya Revenue Authority to businesses to increase liquidity to businesses; and
  • reduction of the standard rate of VAT in Kenya from 16% to 14%.

Through the Tax Laws Amendment Act the following tax amendments were introduced:

  • granting of 100% tax relief from income tax for persons earning up to KES24,000 per month;
  • reducing personal and corporate income tax rates from 30% to 25% to enhance personal earnings and purchasing power and provide incentives to businesses to retain staff and maintain operations;
  • reducing the turnover tax rate from 3% to 1%; increasing the threshold for TOT from a turnover of KES1 Million to KES50 Million; and TOT to begin applying to incorporated companies. Businesses that charge rental, management, professional, training or interest fees will continue to be excluded from applying TOT and income from these sources will be subject to tax at the income tax rate of 25%

The indication at the time of introduction of the amendments in April 2020 was that these would be permanent., Shortly after, the Cabinet Secretary for National Treasury and Planning indicated that, upon the end of COVID-19, the tax breaks may be reviewed to reduce the budget deficit.

The president confirmed this in his national address on 28 September 2020, where he directed the National Treasury to retain the reduced personal and corporate income tax rates until 1 January 2021 and the reduced VAT rate until 1 July 2021.

The president further directed that to cushion low-income earners and micro, small- and medium-sized enterprises the 100% tax relief for persons earning gross monthly income of up to Kshs. 24,000 be retained beyond the sunset date of 31st December 2020.

The reduced turnover tax rate for micro, small- and medium-sized enterprises at 1% would also be retained.

4. Are there specific steps that businesses should take to prepare for these tax measures being phased out – for example new timing of

a. payment obligations (and therefore likely pressure on cash flow); and/or

b. filing of returns?

No. Businesses can only prepare for phasing out of the tax measures once a bill proposing to further amend the tax laws is introduced in parliament.

There have been no amendments to the due dates for tax payments and returns in Kenya.

5. Should the impact of emergency tax measures be reconsidered by businesses – e.g. are there certain legal transactions (such as sales or reorganisations) that parties should preferably postpone or accelerate?

There were a number of amendments which would have affected ongoing transactions. The key amendments were:

  • the change of the VAT status of a transfer of a business as a going concern from one registered person to another which was previously exempt but is now subject to VAT at 14% – this had an immediate impact on businesses and on transactions; and
  • the repeal of the Second Schedule to the Income Tax Act and replacement with a new Second Schedule with new rates of capital allowances.

The above amendments by the Tax Laws Amendment Act, 2020 were quickly enacted into law and there was little time to make the decision to postpone or accelerate ongoing transactions. The laws have been in effect for a couple of months now and businesses will have had the opportunity to consider their impact on later transactions.

6. Are there any additional measures proposed, in particular any that are targeted at particular sectors (e.g. aviation)?

Yes. We highlight amendments that were introduced to the aviation sector, and the energy sector.

Aviation: The Finance Act, 2020 subjects VAT at 14% to the following supplies, which were previously exempt

  • helicopters of an unladen weight not exceeding 2,000 kg;
  • helicopters of an unladen weight exceeding 2,000 kg;
  • aeroplanes and other aircraft of unladen weight not exceeding 2,000 kg;other parts of aeroplanes helicopters;
  • air combat simulators and parts thereof;
  • aircraft launching gear and parts thereof; deck arrestor or similar gear and parts thereof; and
  • other ground flying trainers and parts thereof.

The Finance Act further imposes import declaration fees of 3.5% of the value on all aircraft excluding aircraft whose unladen weight does not exceed 2,000 kg and certain helicopters.

These amendments will come into force on 1 July 2021.

Energy: The Tax Laws Amendment Act deleted the VAT exemption on the following supplies:

  • taxable supplies procured locally or imported for the construction of liquefied petroleum gas storage facilities with a minimum capital investment of KES4 billion shillings and a minimum storage capacity of 15,000 metric tonnes
  • taxable services procured locally or imported for the construction of liquefied petroleum gas storage facilities with a minimum capital investment of KES4 billion and a minimum storage capacity of 15,000 metric tonnes.

These amendments took effect from 25 April 2020

The Tax Laws Amendment Act also withdrew exemptions from Import Declaration Fees and Railway Development Levy on goods imported for the construction of liquefied petroleum gas storage facilities as approved by the Cabinet Secretary responsible for liquefied petroleum gas. This amendment took effect from 25 April 2020.

The Finance Act 2020 deleted the VAT exemption for specialised equipment for the development and generation of solar and wind energy, including deep cycle batteries which use or store solar power. This amendment took effect from 30 June 2020.

The Finance Act 2020 introduced VAT on the supply of liquefied petroleum gas, including propane which was previously zero-rated. This amendment will take effect from 1 July 2021.

Agriculture: The Finance Act 2020 deleted the VAT exemption for tractors other than road tractors for semitrailers.

This amendment will come into force on 1 July 2021.

7. Are there any sectors or interest groups that are now putting forward, or may in the near future request, special tax measures?

None that we are aware, but we expect the energy and aviator sectors to seek to reverse the amendments introduced. Sectors that have been most impacted by the pandemic will likely seek tax reliefs and measures that will spur their businesses.

8. Which taxes might be increased to address the financial burden caused by the crisis, for example,

a. are there political commitments or policy trends that might indicate the likely focus of any tax increase in the future (e.g. to maintain low corporation tax, but to increases taxes on personal wealth)
b. measures to broaden the tax base, such as digital services taxation and a pre-emptive response to the OECD/ G20 Inclusive Framework on BEPS (“BEPS 2.0”)

To cover the budget deficit and the implication of the reduced tax rates available to businesses and individuals, the government has already taken, or will take, the following measures

  • withdrawing many tax exemptions available to taxpayers;
  • introducing a digital service tax of 1.5% on income from provision of services in Kenya through a digital marketplace, which will take effect from 1 January 2021; and
  • introducing a minimum tax of 1% on gross turnover of businesses who due to the nature of their operations and/or tax losses, pay little or no tax; this measure will take effect from 1 January 2021.

The draft Value Added Tax (Digital Marketplace Supply) Regulations, 2020 have been circulated for public comment, and will provide clarity and a framework for charging VAT on supplies made over digital platforms.

The regulations will provide for a detailed framework for the imposition of digital service tax (DST) by outlining the specific digital services that DST will apply to, defining the tax base for DST and determining who has the onus to account for and remit DST.

Also as mentioned above, the Cabinet Secretary for National Treasury and Planning had indicated that, upon the end of the pandemic, the tax breaks may be reviewed to reduce the budget deficit.

9. Are there other actions that ought to be considered by businesses in your country e.g.

a. revisit past tax filings to claim carry back of losses;

b. revise or update preliminary tax assessments;

c. claim bad debt relief for VAT output tax

  • Businesses with tax losses about to expire and which cannot be extinguished should consider applying for extension of time to expend the losses to the National Treasury.
  • Businesses accounting for instalment tax and whose operations have been affected by COVID-19 should consider accounting for instalment taxes on the current year basis;
  • The Finance Act introduced a voluntary tax disclosure programme, which will run for three years with effect from 1 January 2021, to allow persons to disclose their tax liabilities by making a voluntary application in prescribed form to the Commissioner for the purpose of being granted relief of penalties and interest on the tax disclosed. The relief granted should apply to tax liabilities accrued within five years prior to 1 July 2020
  • The period within which bad debt relief for VAT output tax can be claimed was reduced by one year. Companies must therefore ensure they claim bad debt relief for VAT output within four years so as not to lose the opportunity to claim relief.

Finance

10. What do you need to consider in terms of your funding requirements for returning to business and are there any return to business financial assistance packages being made available by government?

It is critical for the business to begin by assessing its current financial position. This involves an analysis of the liquidity position of the business currently and a projection for the coming months. Given the massive impact of COVID-19 on business operations, a business would need to re-assess its expenditure to ensure it is maintained at a manageable level. This may require businesses to cut back on unimportant expenses and to take advantage of the various business financial support measures introduced by the government to curb the negative impact of COVID-19 on businesses and the economy at large including: tax reductions and lowering the Central Bank rate, which was designed to lower the commercial bank lending rates.

Unfortunately, the government of Kenya has yet to develop any return to business financial assistance packages for businesses. However, other entities, including professional bodies such as the Kenya Bankers Association, have stepped in to facilitate financial reliefs to businesses particularly for SMEs.

Another important exercise is to re-assess the business’ existing borrowing portfolio to map out and identify any defaults (especially on payment) which occurred because of COVID-19, upcoming payment dates (noting instances of likely default), and noting potential issues for renegotiation with the lenders for purposes of restructure of the loans based on the terms of the finance agreements. Key provisions to analyse in finance agreements include:

  • payment obligations – key dates and amount payable;
  • events of default;
  • penalty provisions for defaults (and remedial action);
  • force majeure clause and definition of a force majeure event;
  • material adverse change clause;
  • notice requirements; and
  • amendment of contract provisions (e.g. waivers, moratoriums).

Current financial status and existing borrowings should be based on a critical analysis of the business’ financial positions following the exercise above.

Section 25 of the Pandemic Bill proposes that the Cabinet Secretary (Finance), may with approval of parliament, introduce measures to cushion affected persons for the duration of the pandemic.

11. How will funding a return to business, including taking on additional indebtedness, impact on your financial or other covenants?

Businesses should only take on additional funding if, following the assessment set out above, a determination is made that the business is able to incur additional indebtedness. Nevertheless, in securing additional funding, some key considerations to be take into account in negotiating with the lender are as follows:

  • Payment schedule – businesses should negotiate for a convenient schedule bearing in mind the existing debts.
  • Force majeure – the business should require that COVID-19 be identified as a force majeure event. Lenders may be resistant to this. The compromise is to have a material adverse effect clause.
  • Remedial action – businesses should be keen to negotiate favourable remedial measures in the event of default. This could include payment moratoriums.
  • Interest rates – to reduce expenditure, opt for lenders with better rates. Alternatively, if taking on an additional loan from an existing lender, you are likely in a better position to negotiate for better rates than the standard commercial rates offered by the lender.
  • Foreign exchange – with COVID-19 spreading each day, economies worldwide are taking a hit and currency values will fluctuate considerably. This should be a key consideration in taking loans in any currency.

In essence, businesses should practice smart borrowing, otherwise the business could suffer negative effects including shutdowns if they are rendered insolvent.

12. Are there any remedies such as equity cure or margin ratchets that you should be checking on to provide liquidity to prevent a default or improve their financial position?

The remedies available to a borrower are as prescribed in the financial documents. A keen analysis of the remedial and mitigative remedies needs to be undertaken in assessing the financial position of the business. Further, it is important to be aware of the processes involved in activating the available remedies, including notice requirements and timelines involved. Further, there may be a requirement to submit reports such as information memorandums and financial reports to the lender.

Equity cure mechanisms are used, and a number of finance documents have incorporated the ability for the borrower to use equity contributions or proceeds of subordinated debt to cure financial covenant defaults. The ability to make use of such a mechanism assumes the availability of funds at shareholder level for such use and one should have regard to the timing as to when such cure can be made.

A business and its shareholders should therefore carefully asses the costs and benefits (to each of them) of using such mechanisms.

13. What practicalities do you need to consider in relation to audit requirements?

Depending on the entities’ financial year calendar, many businesses have until 2021 to consider the audit requirements for the COVID-19 period (2020). Concerns will include poor performance and expenditure on items not budgeted for because of the uncertainties brought about by COVID-19.

At this time, COVID-19 restrictions may lead to various challenges in meeting audit requirements including:

  • scaling down of personnel – for some organisations, the appointed auditor may have shut down or scaled down their business and will be unable to offer audit services to the business;
  • difficulties meeting deadlines – with the slowdown in operations, the requirements for social distancing, restrictions on handling physical documents, businesses may fail to meet audit deadlines;
  • reluctance to meet physically for perusal of the files and explanations of the various questions raised by the auditors; and
  • for businesses that lack technological capacity, it may be difficult or impossible to have an audit conducted remotely where a complete lockdown is instituted.

A breach of the audit requirements may lead to reporting breaches under finance agreements (especially for large or syndicated borrowings). It is important that businesses mitigate this by notifying the lenders of any anticipated breaches beforehand.

Some businesses may also be at risk of receiving qualified audit reports (particularly around its going concern status) in connection with their financial statements. This, in turn, could affect compliance with the terms of its finance documents and its disclosure obligations to shareholders and creditors.

Businesses should therefore discuss the above issues with its lenders, keep them up to date of developments and (where applicable) proactively obtain the appropriate concessions or waivers.

14. What is the process if I need any amendments made or waivers given under my loan documentation (including in respect of financial covenants)?

The process is prescribed by the loan documents, many of which have clauses such as force majeure, material adverse effect and amendment provisions that lay the foundation for renegotiation of the terms. It involves the borrower approaching the lender by submitting a written request for a waiver or for an amendment.

The lender would typically require the business to make comprehensive disclosures in respect of its operations.

Where there is a syndicate of lenders, and a representative (such as a facility agent) has been appointed by the lenders, the request should be directed to such a representative. The finance documents will usually contain voting majorities or thresholds applicable to decision-making by the lenders (including the percentages of votes required to grant waivers or agree to amendments).

All agreed changes should be put in writing and the variation documents will go through the registration formalities at the relevant registries. Some costs may be incurred (e.g. for stamp duty on the deed of variation and registration costs).

15. Dealing with creditors, including amendments and waivers – Bonds

a. If I can’t comply with the terms of my bond covenants who do I need to notify?

The bond document typically identifies the persons to be notified, the address, timelines and procedures involved in issuing notices where relevant. It is important to bear in mind the potential penalties that may accrue upon default and the remedial action that may be taken by the borrower (business).

b. If I need to ask for a waiver or amendment to the terms of bonds issued by my business what steps do I need to take?

This also depends on the terms and conditions of the bond document which prescribe events of default and remedial or mitigative actions that could be taken up by the borrower. Further, the bond document typically contains provisions on amendment/modification and waiver of the terms of the bond which sets out the various actions the business/borrower needs to take to amend or have certain terms of the bond waived. Generally, the borrower will be required to make comprehensive disclosures in respect of its operations before the lender(s) make a decision on proposed waivers or restructures. Typically, consent of the bondholder/lender is required to amend or waive a bond term particularly where such amendment or waiver seems prejudicial to the bondholder/lender.

c. What is the process for contacting bondholders and holding meetings to agree changes in the terms of my bond documents?

The bond document prescribes this process but typically this is done by the borrower issuing a notice to all bondholders or the representative of the bondholders setting out all relevant details of the proposed meeting, including the date, place, time and agenda. The borrower should take into account the relevant notice period for convening a meeting, which is typically prescribed in the bond documents.

16. Is the availability of any return to business funding or relief either (a) conditioned on the use of proceeds for green or social purposes or (b) linked to sustainability-related outcomes? If so, what are the applicable purposes or outcomes?

Unfortunately, as at 3 September 2020, the government of Kenya has yet to develop any return to funding or relief packages for businesses.

This material was prepared by DLA Piper Africa, Kenya (IKM Advocates)