The nature of some business transactions may in some cases require substantial monetary investment. Local financial institutions may not be willing to finance the business endeavor (s) and equally local business owners/entrepreneurs may shy away from local banks due to prevailing interest rates. This state of affairs creates an opportunity for foreign entities keen on venturing into a particular local market to finance business endeavor (s) by advancing interest-free loan facilities.
In Kenya, where a foreign entity advances an interest-free loan to a local entity, such a loan would be subject to the Deemed Interest provisions under the Income Tax Act, CAP 470, Laws of Kenya (the “Act”). Section 16(3) of the Act defines Deemed Interest as;
“….an amount of interest equal to the average ninety-one day Treasury Bill rate, deemed to be payable by a resident person in respect of any outstanding loan provided or secured by the non-resident, where such loans have been provided free of interest.”
Essentially, Deemed Interest applies to interest-free loans advanced to Kenyan entities by foreign entities. In deciding on the applicability of Deemed Interest, the Commissioner of the Kenya Revenue Authority ordinarily looks at the terms of the loan agreement (s) between the Kenyan and foreign entities, audited financial records and other means through which the Commissioner can access information. If it is established that the loan was advanced interest-free, then the loan amount will be subject to Deemed Interest.
Rate of Deemed Interest
The Commissioner 30th October, 2023 published a Notice fixing the prescribed rate of interest as 13% for October, November and December, 2023 and a withholding tax rate of 15% on the Deemed Interest shall be deducted and paid to the Commissioner by the 20th day of the month following the month of computation. It is instructive to note that the Deemed Interest rate and corresponding Withholding Tax is prescribed on a quarterly basis by the Commissioner.
Challenging an Assessment of Deemed Interest
Under the Tax Procedures Act, 2023 a taxpayer dissatisfied with a tax assessment by the Commissioner for Income Tax can object within 30 days of being notified of the assessment stating clearly the grounds of objection, the amendments required to be made to correct the decision, and the reasons for the amendments. The commissioner shall consider and determine the objection within 90 days.
The decision on the Commissioner (objection decision) is appealable to the Tax Appeals Tribunal and further Appeals can be lodged at the High Court and the Court of Appeal under Sections 53 & 54 of the Tax Procedures Act on matters of law.
This alert is for informational purposes only and should not be construed as a legal opinion. If you have any queries or need clarifications, please do not hesitate to contact Gregory Makambo, Partner, (gmakambo@makambolaw.com), Diana M. Kimiti, (dkimiti@makambolaw.com) or your usual contact at our firm, for legal advice.