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Delicate balancing act in tax exempt projects and growth for Kenya

By Beatrice Nyabira

In recent years, Kenya’s development trajectory has greatly been propelled by a slew of ambitious infrastructure projects. These projects have been made possible, in part, by foreign lenders who have been incentivized by, among other things, a tax exemption on interest income earned from infrastructure loans. If recent media reports are to be believed, however, this tax exemption may be in jeopardy should the newly introduced measures under the Finance Act of 2023 fail to yield sufficient revenue.

The position on tax exemptions is already uncertain, following the recent High Court judgment in Constitutional Petition No. E280 of 2021, which declared tax waivers extended through Gazette Notices, as unconstitutional. The exemption above, was granted under Gazette Notice in 2015, leaving questions unanswered regarding the implications of the Court’s decision on loans already extended on the strength of the exemption. It shall be interesting to see how this plays out, and this should be good fodder for another article.

Gazette Notices aside, investors, both domestic and international, prioritize the stability and predictability of a country's tax regime when making financial and investment decisions. A tax landscape marred by frequent changes and unpredictability can deter investments, introduce volatility to financial planning, and ultimately impede economic growth. Coming hot on the heels of several tax changes under the Finance Act of 2023, Kenya risks losing its competitive edge in the global market if it lifts the tax exemption. Not only will the tax environment be deemed to be highly fluid due to the piecemeal tax changes, but lenders may also be tempted to channel their funds to jurisdictions with more favorable tax policies.

Many infrastructure loans have already been disbursed under the existing tax exemption. The million-dollar question is the impact on these loans if the tax exemption is lifted. In most cases, lenders' contracts will insulate them from mid-stream tax changes, compelling the developers to gross up payments so as to leave the lenders in the same financial position as before.  The developers will, in turn, invoke tax stabilisation clauses to demand compensation from the offtaker/ government for the additional financing charges.  Therefore, reintroducing this tax could inadvertently shift the burden of higher finance costs to the government and taxpayers. This could exacerbate the government's financial strain, potentially leading to a reduction in the number and scale of infrastructure projects, which is far from desirable.

One often overlooked aspect of infrastructure development is its role in job creation and the development of technical skills. A multitude of Kenyan citizens rely on these projects for their livelihoods, spanning from construction workers to service providers. Eliminating the tax exemption could result in fewer projects, directly impacting job opportunities and upskilling of Kenyan labour.

Overall, Kenya has worked hard to establish itself as a stable and predictable environment for investment, gaining traction and a strong reputation in the global market. To maintain this position, it is imperative that the potential consequences of reintroducing taxes on interest income are carefully considered. While short-term financial gains may seem tempting, they must be balanced against the long-term implications for infrastructure development, economic growth, and job creation, as these may outweigh any immediate benefits. The path forward requires a prudent evaluation of the nation's economic priorities and the well-being of its citizens.

The article was featured in the Business Daily on 18 October 2023 and can be accessed here.