Taxpayers are broadly financed in two ways, namely use of equity and debt. The returns on equity capital and debt capital are treated differently for tax purposes.
Interest payments incurred in the production of income by a person carrying on a trade are, subject to certain conditions and restrictions, deductible in determining taxable income while distributions of profits (whether in the form of dividends or returns of capital) is not deductible.
The way in which a taxpayer is financed has an impact on the calculation of the taxpayer’s taxable income. This raised tax concerns regarding the balance between the amount of equity and debt capital. A taxpayer which is considered to have too little equity when considered against the amount of its debt is said to be thinly capitalised for tax purposes.
Thin capitalisation typically becomes an issue in cases where a Botswana taxpayer is funded either directly or indirectly funded by a non-resident connected person. The funding of a Botswana taxpayer with excessive intra-group, back-to-back or intra group guaranteed debt may result in excessive interest deductions, thereby eroding Botswana’s tax base.
The general principle of thin capitalisation rules is that if the Commissioner considers the funding to the Botswana taxpayer to be excessive in proportion to its fixed capital; the interest, finance charges and other consideration relating to the excessive financial assistance would be disallowed.
Prior to 2019, these rules applied only to mining companies and IFSC companies. Now, after an amendment to the tax legislation, they apply to all persons engaged in a transaction with a connected person. In terms of the amendment, every transaction with a connected person will be assessed on an arm’s length principle. In applying the principle, the Commissioner will assess if the conditions of the funding transaction do not differ from the conditions that would have applied between independent persons in similar transactions carried out under comparable circumstances.
While we expect the government going forward to continue to cast the net wider to achieve its policy objective of ensuring that non-resident connected persons pay tax on their Botswana investments, we are also of the view that this creates the platform for the creation of innovative funding structures.
The AJA Corporate and Commercial team has the necessary skills to guide and assist clients through the process of creating innovative funding structures.
*Topiwa Chilume, a Partner in the Corporate and Commercial Department, has 22 years post-qualification experience. His vast experience ranges from corporate and commercial law to intellectual property gained from working both for large corporates and in private practice. His areas of expertise include transactional law, competition law, corporate restructures, private equity, capital markets, project finance, mergers and acquisitions, mining & energy, public-private partnerships and infrastructure, telecommunications and intellectual property. Email; firstname.lastname@example.org