How you’ll gain in the Common Market

This is the headline for the Daily Monitor Newspaper dated July 2, 2010. ‘Ground is leveled but you must brace for competition’, Dorothy Nakaweesi titles her article. She writes: If you are a teacher looking for a job, a trader ready to do business or a citizen looking for residence, you can freely enter any of the five East African countries because the ground rules have been leveled, at least on paper.

Yesterday, the five EAC member countries; Uganda, Kenya, Tanzania, Rwanda and Burundi concurrently ushered in the long-awaited single market trading bloc the Common Market.

To an ordinary Ugandan, this means accessing a job, providing a service, moving freely, and accessing a market of about 140 million people in the region.

It is interesting to note that on Wednesday June 23 2010, Kenya’s parliament passed a Bill allowing the country to return to price controls of essential food and fuel goods, after the policy was abandoned in the 1990s in favour of economic liberalization.

And the International Monetary Fund estimated that Tanzania’s economy is expected to grow by 6.7% in 2011 compared with an estimated 6.2% in 2010. The IMF said it expected inflation to ease to 5.0% by the end of June 2011, helped by declining food prices thanks to increased production.

To quote Dorothy, “the ground rules have been leveled, at least on paper’.The transition to the Common Market was a normal routine driven Thursday just like any other. It is the adoption of the different tax regimes to the Common Market that we are waiting for. Income Tax, Value Added Tax and Stamp and other duties and levies differ from country to country. The only unified law and procedure of taxation is under the Customs Management Act.

Import duty and Value Added Tax paid on importation have previously yielded high revenues for the East African Governments even if the final consumers of the goods ultimately paid the taxes. As the various tax consultants and tax policy departments deliberate on the best way forward, we wait for their recommendations and hope that Pay as You Earn will not be increased to fill the lacuna left by the scrapped taxes.

Or, maybe Stamp duty?

East African Common Market begins today

The commencement of the East African Common Market is today 1st July 2010, as was read in the East African budgets’ readings on June 10, 2010. The East African member states now enjoy free movement of goods, labour, capital, services and their citizens enjoy the rights of residence and establishment in the East African Community.

Under the common market, goods from partner states (i.e. East Africa) pay a 0% rate on import duty, Value Added Tax (VAT), excise duty and withholding tax in other partner states. The zero percent rates are subject to proof that the goods are produced in one of the partner states.

There is a list of Ugandan industrial products that the East African Community has decided to exempt from the zero tariffs pending further discussions with member states.

But the question remains, with the removal of these taxes, is this a level playing field?

Who wins, who loses?

Taxation of Petroleum Operations. This Oil is Hot!

We all would like to have a good tax avoidance plan. And respect a very good one and the person who made it when we come across it, until the plan treads the waters of uncertainty. Has Heritage Oil waded into the waters of uncertainty?

Below are some excerpts from the story ‘Oil extraction hits a snag’ covered by Ibrahim Kasiita in the New Vision Newspaper dated June 19 2010. The most eye-catching issue for the rest of us, who are not directly involved in the negotiations, was the large amounts of money involved.

“A plan to start extracting and refining Uganda’s oil has hit a snag due to tax disagreements between an exploration company and the Government. Heritage Oil and Gas Company Ltd has to sell its interests to a richer company that has the resources to extract and refine the oil but does not want to pay taxes on the sale. The Government on the other hand, insists Heritage has to pay the capital gain tax amounting to over 800b. Heritage is now seeking arbitration with the London based United Nations Commission for International Trade Law (UNCITRAL), a process that usually takes years…

Heritage wants to sell its interest in oil blocks 1 and 3A to either Italian giant ENI spa or Tullow Oil and is supposed to earn $1.5b from the sale. The transaction requires that a prospective buyer immediately pays $1.35b and a further $150m or surrender a stake in a producing oil field of a similar value within two years. But after negotiations with Government collapsed, Heritage on Thursday, issued a statement saying the sale could not start immediately.

“Heritage’s position based on comprehensive advice from leading tax experts in Uganda, the United Kingdom and North America, is that the disposal of the assets is not taxable in Uganda,” the company said. Heritage argues that they are not under obligation to pay tax. But it has also offered to deposit $108 with the Uganda Revenue Authority (URA) on receipt of the payment from its transaction, which would be refunded to Heritage if it is ultimately determined that no tax is payable. The United Kingdom-based company claimed that the offer of $108m was based on Uganda’s Income Tax Act, which requires a taxpayer to deposit 30% of the disputed amount of tax with the URA pending final resolution of the dispute.

So far, there is no reference to the double taxation agreement between Uganda and the United Kingdom or the source and residence rules that govern International tax matters. And there is also no mention of a tax waiver under any incentive scheme to promote economic development under which Heritage would benefit.

Heritage Oil is willing to remit 30% of the disputed tax to the URA as stipulated under section 103 (2) of the Income Tax Act Cap 340 (ITA) which it will be refunded if heritage is found to be exempt from tax. But this percentage is supported under section 100 of the ITA only if the appeal is to the Uganda Tax Appeals tribunal which is under the jurisdiction of the Constitution of the Republic of Uganda. The question raised is why is Heritage Oil is bothering with the 30% of the tax assessed if it is seeking arbitration with UNCITRAL?

It is interesting to note that in all the articles availed to the Ugandan public, maybe by omission, Heritage Oil has not yet quoted any sections of the Law under which they are not obliged to pay tax. In the Uganda Income Tax Act Cap 340, sections 49 to 54 are clear on the laws governing the gains and losses on disposal of assets, and capital gains tax would arise on the sale of Heritage’s interest in Oil blocks 1 and 3A.

However, there is PART IXA on special provisions for the taxation of petroleum operations, which was inserted into the Income Tax Act in 2008 and its section 89G stipulates that no gain or loss is taken into account on the transfer of interest in a petroleum agreement. These special provisions for the taxation of petroleum operations were inserted in the year 2008 and back dated to the effective date of 1st July 1997.

Whereas the Financial Times quoted Energy Minister Hilary Onek as saying Uganda “would not budge” and that, like any company in Uganda, Heritage was liable for the tax, section 89B of the ITA clearly states that were there is inconsistency between the other parts if the ITA and the special provisions for taxation of petroleum, the special provisions and the petroleum agreement will prevail. So there is a possibility that section 89G rendered capital gains tax on petroleum operations under sections 49 to 54 of the ITA obsolete.

The relevant sections of the ITA and the petroleum agreement, that has not been publicised, are still up for interpretation hence Heritage opting for arbitration.

But it is difficult to understand why such provisions for the taxation of petroleum were backdated to the year 1997 when the controversial issue of the transfer of interest in petroleum agreements was yet to arise. Whatever happened to ‘law grows with growth in society’?

East African Countries budgets 2010/2011 : Tax 101

Uganda budget tax highlights

In financial year 2010/11 there will be no increases in duty and tax rates, as a measure to stimulate the economy.

Registration fee for motorcycles has been reduced from Ushs 222,800 to 100, 400 and the Uganda Revenue Authority is to decentralize registration to ease public access. Hopefully, it will reduce bodaboda fares. Or maybe the fares will stay high because of the dust and potholes. So far, no change.

Computer software licenses are now VAT exempt. Computers have been exempt from VAT since 2002 and the supply of computer software has been exempt from VAT since 2003. It’s been a long time coming.

The Income Tax amendment bill contains new provisions for the assessment and collection of petroleum revenues. For those investing in the petroleum mining and processing sector, the objective of the new laws is to ensure adequate provisions within the tax law to handle petroleum revenue streams.

Kenya budget

Businesses with genuine outstanding Value added tax claims will be paid refunds by the end of July. The processing of refunds will be speeded up. And from July 2010, all new claims that meet the low risk criteria will be paid within 120 days. So, the refund claims will now be processed within 4 months. Is there a penalty to the Kenya Revenue Authority for failure to process genuine refunds within the 120 days?

Import duty on wheat and rice were lowered by 10%, stamp duty penalties by 5%, mortgages by 0.1% and land rates by 1%.

Import duty on iron and steel, paint dryers and LED lamps and bulbs was removed.

Withholding tax on leases was removed.

Excise duty on beer went up from Ksh45 to Ksh55 and that of malt beer up from Ksh54 to Ksh65.

Tanzania budget

Agricultural implements are now VAT exempt. Suppliers of goods and services used in building farm infrastructure are exempt from VAT.

Machines and equipment used in the collection, transportation and processing of milk products in Tanzania, are now VAT exempt. The supply of machinery used for the processing of agricultural or dairy products has been VAT exempt in Uganda since 2001.

Tax holidays have been reinstated to investors on importation of some capital goods in the hospitality sector after having been scrapped last year.

There is a 1% reduction in the income tax rate from 15% to 14% and an increase in the minimum wage which will be announced soon by the minister of state for the president’s office and public service management.

Excise duty has been increased by 8% on non-petroleum products including wines and spirits, cigarettes, beers and soda. Oh, the high cost of luxuries.

Rwanda budget

Taxes on mobile phone handsets and SIM cards have been scrapped but taxes on airtime have increased from 5% to 8%.

East African Community pre budget consultations of the Ministers of Finance

( in the Uganda budget speech on page 64 of the New Vision newspaper dated 11 June 2010).

It was agreed that Common External Tariff (CET) rate of 25% for buses and trucks for Tanzania, Uganda and Rwanda not be applied for 1 year to ease the transport of persons and goods.

Duty remission for the list of Uganda industrial inputs has been extended for 1 year to enable manufacturers to remain competitive.

The CET of 0%, 10% and 25% has been maintained.

The ministers agreed to establish an East African Infrastructure Fund which will be domesticated within the East African Development Bank,

To develop a coordinated framework of engagement with the multi lateral agencies e.g. World Bank, IMF, ADB and others,

To convene a meeting of Ministers for Finance, Permanent Secretaries and Governors to agree on the Road map for the 45 Monetary Union including Macro- economic convergence criteria immediately after conclusion of the budget sessions of partner states; and

To review the sensitive list within five years with a view to reduce the list and preserve the current tariff structure of 0%, 10% and 25%.

God speed.

STAMP DUTY AND DERIVATIVES IN UGANDA

  1. INTRODUCTION

Definition – “Stamp duty is a tax raised by requiring stamps sold by the government to be affixed to designated documents, thus forming part of the perpetual revenue, “Blacks law Dictionary Eighth Edition at page 1441.

“A fifth branch of the perpetual revenue consists in the stamp duties, which are tax imposed upon all parchment and paper whereon any legal proceedings, or private instruments of almost any nature whatsoever are written; and also upon licenses…. and pamphlets containing less than six sheets of paper. These imposts are very various, according to the nature of the thing stamped, rising gradually from a penny to ten pounds.” 1 William Blackstone, Commentaries on the Laws of England 312-13 (1765)

Stamp Duty is governed by the Stamps Act Cap 342 of 2002 and the Stamps Amendment Act No 12 of 2002.

An Instrument is defined as a written document that defines rights, duties, entitlements or liabilities, such as a contract, will, promissory note, or share certificate.

“An ‘instrument’ seems to embrace contracts, deeds, statutes, wills, orders in Council, orders, warrants, schemes, letters patent, rules, regulations, bye-laws, whether in writing or in print, or partly in both; in fact, any written or printed document that may have to be interpreted by the Courts.” Edward Beal, Cardinal Rules of Legal Interpretation 55 (A.E. Randall ed…, 3d. 1924)

Instruments chargeable with Duty

  • Under section 2 of the Act, instruments chargeable with duty as per the schedule to the Act include every instruments executed in Uganda after commencement of the Act that relate to property situate or any matter or thing done or to be done in Uganda, or to be done, in Uganda and is received in Uganda.
  • Every bill of exchange, cheque or promissory note drawn or made out of Uganda after the commencement of this Act and accepted or paid, or presented for acceptance or payment, or endorsed, transferred or otherwise negotiated in Uganda, and
  • Every instrument (other than a bill of exchange, cheque or promissory note) mentioned in that schedule, which, not having been previously executed by any person, is executed out of Uganda after the commencement of this Act, relates to any property situate, or to any matter or thing done.

No duty is chargeable in respect to instruments executed by or on behalf of government of Uganda.

Every bill of exchange, cheque or promissory note previously stamped in Kenya or Tanzania and presented in Uganda for acceptance or payment or endorsed, transferred or otherwise negotiated in Uganda.

There is no stamp duty on cheques.

2. DERIVATIVES

Definition of a derivative

A derivative is a financial instrument or other contract with all three of the following characteristics;

  1. Its value changes in response to the change in:
    • a specified interest rate
    • financial instrument price
    • commodity price
    • foreign exchange rate
    • index of prices rates
    • credit rating or credit index, or
    • other variable (sometimes called the “underlying”)
  2. Requires no initial net investment
  3. Settled of future date

A specialized security or contract that has no intrinsic overall value, but whose value is based on an underlying security.

A derivative is a financial instrument that derives its value from the value of other financial instruments or an underlying asset such as a future, forward, commodity, futures contract, stock, bond, currency, index or interest rate. It is a financial contract between two or more parties and it is derived from the future value of an underlying asset.

The most common types of derivatives are futures, options, warrants and convertible bonds. Others include Interest Rate Swaps, Forward Rate Agreements, Caps, Floors and Swap options. Beyond this, the derivatives range is only limited by the imagination of investment banks.

It should be noted that not all securities are derivatives and this discussion is targeted towards derivatives, which by their nature and definition, attract stamp duty.

3. OPTIONS

An option contract differs from other sorts of derivatives because it gives the holder a choice. Any option agreement gives the holder the right, but not the obligation, to buy or sell a specified underlying asset, on or before a particular date.

A call option confers the right (but not the obligation) to buy the underlying.

A put option contract will always include an expiry date. You may come across the following terms relating to when, in relation to the expiry date, the option can be exercised: Does that mean that if the option expires before stamp duty is paid, the 5,000/= duty should not be paid?

The rights acquired by the holder of an option have a value. Someone who enters into an option contract will almost always have to pay a premium to do so. The premium is normally payable at the start of the contract, although you may sometimes see option arrangements where the premium is paid in installments over the life of the contract, or even rolled up and paid at the expiry date.

Stamp duty is paid in a lump sum and not in installments.

Options are by their nature difficult to classify. But they are still contracts/agreements, where the duty is 5,000/=. In the event that there is an actual transfer of the option, then the Act has to be revisited to determine whether there are other duties due to the actual transfer for example conveyances (not being transfer) of total value where the duty is 1% of the total value.

Many types of standardized option contracts are exchange-traded in relation to interest rates, currency, shares, bonds or commodities. Companies may also use over the counter (OTC) options. (OTC refers to trading in a security that is not listed and traded on an organized exchange. Any option that is not standardized and not traded on an exchange and for which the buyer and the seller negotiate all the terms of the contract is an OTC option). Trading in OTCs that are not listed is dutiable. There is no duty on options in the act but Agreements of memorandum of agreements have a duty of 5,000/=.

4. WARRANTS

A warrant is similar to an option. The term is normally used to mean an option to subscribe for shares, corporate bonds or other debt instruments. When someone exercises a warrant, the exercise normally results in new financial instruments being created – unlike an ordinary call option, which generally confers the right to buy an existing asset. This means that the exercise of a warrant to subscribe for shares in a company will result in the dilution of existing investors’ shareholdings. Warrants have stamp duty of 1% of the total value on share warrants. Bonds have stamp duty of 5,000/=. All warrants have to be examined individually as the rated of duty differ from transaction (this is for example; in case the contract is in relation to a warrant, which has different duty from a bond as seen above).

You will often come across warrants attached to fixed-rate bonds. A company may issue bonds with an equity warrant attached – a right to subscribe for shares in the issuing company. These bonds are similar to convertible bonds, except that the warrant element can be separately traded. This means that an investor will be prepared to accept a lower interest return on the bond. So a company can often borrow more cheaply by issuing bonds with equity warrants attached than by issuing straight forward corporate bonds. Here the issue of referring to the instrument as a bond or a warrant arises as there is a very big difference in the dutiable rate as seen above. Corporate Bonds at 5,000/= and equity warrants have a listed dutiable rate of 1% of the total value in the Act (shares are equity and share warrants have a dutiable rate of 1% of the total value).

A covered warrant is an exception to the general principle that the exercise of a warrant creates a new financial instrument. A covered equity warrant is really a long-dated call option over shares. It is issued by a third party with a substantial holding of the shares of the company in question, so that when an investor exercises the warrant, he or she will receive shares that already exist.

5. FUTURES

Futures contracts are like forwards, but they are standardized and often publicly traded on exchanges.

Futures are most often used in commodity and currency markets where both producers and buyers gain security from fixing their buying or selling prices, but have little to gain by paying the extra for an option as they are likely to have to walk away from the contract even if prices move in their favour.

As with options almost all futures traded (which can be settled physically) on exchanges are settled by payments of their value on the day they expire rather than by delivery of the underlying asset.

Futures are not classified in the Act and have no dutiable rate. In the alternative, stamp duty at a rate of 5,000/= can be paid on the contract as it is also an agreement. But as seen above with options, the duty may differ if it can take on actual delivery.

6. FORWARD CONTRACT

Forward contracts and futures are very similar. A forward contract is an agreement to buy or sell;

A given quantity of a particular asset

At a specifies future date

At a pre-agreed price

Forward contracts also have a duty rate of 5,000/=

Some securities may be issued on terms that allow the borrower, or the lender, to

  • Convert the security into shares of the issuer (convertibles), or
  • Exchange the security for the shares in another company (exchangeables), or
  • Acquire shares as a result of warrants attached to the security.

Transfer of shares or a conveyance not being a transfer has a dutiable rte of 1% of the total value.

Where the holder has an option to take cash on redemption, such securities are loan relationships. However, the reward of the lender may depend on the changes in value of the shares.

7. SWAPS

A swap is a contractual agreement to exchange (swap) cash flows denominated in different terms.

The two most widely used types of swap are interest rate and currency swaps. A company may swap a floating rate of interest for a fixed rate market, but finds it cannot do so at any reasonable rate. It might therefore take out a floating rate loan, and enter into a swap contract under which it pays amounts equivalent to floating rate interest on the same notional principal.

Under a currency swap, the parties exchange ‘interest’ payments on a principal amount denominated in one currency for ‘interest’ on a principal amount denominated in a second currency. Unlike interest rate swaps, however, the principal amounts are actually exchanged at the end of the swap period, at an exchange rate agreed in the contract.

You may come across other types of swaps, which may be used to hedge credit risk. More exotic swaps have been developed, for example swapping the rental stream from a property or portfolio of properties for an interest rate. Incidentally, there is stamp duty paid on rental agreements which most tenants do not pay. This is also 5,000/=. Each swap agreement has to be examined, depending on the transaction and the actual transfer might also give rise to further duties as previously seen above.

A swap is normally a zero cost derivative, in other words neither party has to put money up front (apart from any required payment of collateral) in order to enter into the contract. You may also see a termination payment going from one party to the other if a swap contract is terminates prematurely.

Stamp duty on agreements or memorandum of agreements is 5,000/=.

8. CONVERTIBLES

Derivatives can be bundled with other financial instruments to create structures products, a simple example of which are convertibles. Convertibles are not listed in the description of dutiable instruments in the Stamps Amendment Act. Therefore, it is important to classify the derivative accordingly in order to reduce the duty to be paid by the purchaser of the derivative. There will be the duty of 5,000/= paid for the convertible agreement and then stamp duty can arise at a later event depending on the value transferred in the financial instruments.

9. CONCLUSION

Derivative transactions are quite complicated and novel to Uganda and will raise issues on the payment of stamp duty especially in their classification. There is the option of paying duty of 5,000/= on the derivative agreement/contract or the 1% that can arise when dealing with some transactions like No.6 that deals with pledge of the total value, No.24, Conveyance not being transfer, or even equitable mortgage at the rate of 0.5% of the total value.

Derivatives can be created in so many types of transactions and the rate will not always be 5,000/= that is paid on agreements and so each transaction has to e independently examined to determine whether there is stamp duty, and if there is stamp duty, the dutiable rate for the particular instrument as per the Act.

East African and International Tax debates – Toil, Taxes, Technology, Tea (or Coffee)

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