Changes in business ownership will usually take one of two forms; one could sell the shares in a company together with its underlying assets and liabilities or simply sell the underlying assets and liabilities of the company. There are many commercial and legal reasons that inform why a potential investor would opt to purchase the shares of a company instead of the underlying the assets and liabilities of the company or vice-versa. One of the reasons could be the tax impact each option would have.
The transfer of shares is exempt from VAT whereas the transfer of the underlying assets and liabilities of a company is, subject to VAT at the standard rate of 16%. When one considers VAT alone, the acquisition of shares is significantly lower than the latter option.
In previous iterations of the VAT Act, the transfer of the underlying assets and liabilities (net assets) of a company that constitute the whole or an independent part of a business such that the person receiving the assets can continue with the business was referred to as a Transfer of Business as a Going Concern (“TOGC”).
The VAT status of a TOGC in Kenya has in recent years changed significantly:
- Prior to 1st July 2018, a TOGC was classified as a zero-rated supply. During this period no VAT was added to the TOGC value and the seller could recover any VAT credits it was carrying;
- From 1st July 2018 to 25th April 2020, the VAT status of a TOGC was changed from zero rated to exempt. VAT was also not included in the TOGC value but in this instance the seller lost the opportunity to recover some if not all of the VAT credits it was carrying;
- By an amendment to the VAT Act, 2013 by the Tax Laws Amendment Act (2020), effective 25th April 2020, all reference to a TOGC was deleted from the VAT Act which meant that such transfers became subject to VAT at 16%. VAT must now be added to the TOGC value and the VAT remitted to the Kenya Revenue Authority.
Subjecting VAT to a TOGC transaction may have a temporary cashflow implication or a real cost implication. At the time of acquiring the business, the buyer must not only fund the agreed price but the VAT cost as well which at 16% represents a significant portion of the purchase price. It could be argued that the buyer can claim the VAT incurred from the taxable supplies it makes but the reality is that the buyer can only recover a small portion of the VAT monthly depending on how the business is performing. The recovery of the VAT could therefore take years meaning that cash will be tied up in the VAT credit in the purchaser’s books. The VAT may eventually be recovered in full but if recovered at a slow rate, it will invariably hamper the buyer’s operations.
There could also be real cost implications where the net assets being transferred are for use in a business that is exempt from VAT such as a school or a hospital. In such a case the purchaser will not be able to claim the VAT on the transaction. This means that the VAT paid to KRA is a cost to the purchaser, which cannot be recovered and could discourage a prospective buyer.
Parliament seems to misunderstand the issue and in response to several submissions to the parliamentary finance committee seeking to exempt or zero rate such transactions, the Finance Committee has often responded saying that the purchaser should be able to re-claim the VAT paid and therefore there is no need to exempt such transactions from VAT. This position does not however consider the cash-flow impact of charging VAT on TOGC transactions to commerce.
Jurisdictions such as the United Kingdom, India, South Africa recognise these challenges and treat transfers of businesses as a going concern are exempted from VAT. Prior to the most recent amendment, Kenya had also adopted a similar practice. The VAT status of transfers of business as going concern should be reviewed to facilitate such transactions, foster commerce and to align with the global position on VAT on transfers of businesses.
The article was featured in the Business Daily and can be accessed here.