# The Impact of the Kenya Finance Act, 2023 on An African Fintech Startup: Challenges and Opportunities

💡 **Summary**

The Kenya Finance Act, 2023, which was recently assented to by the President, introduces various changes to the tax landscape in the country. This article aims to critically analyze how these changes will affect an African startup. Our case study is Black Star Ltd, a fictional African Fintech Startup owned by the fictional character, Bella. In this article, we provide insights into potential challenges and opportunities arising from the act signed into law.

🔑 TLDR; **Impact of the Act**

1. The Act introduces a 3% tax on income from digital asset transfers, directly impacting Black Star Ltd., increasing costs for users, and adding administrative compliance.

2. Non-resident suppliers like Yellow Fingers Ltd. are now required to register for VAT, causing an administrative burden and affecting competitiveness.

3. Foreign companies' branches enjoy a reduced tax rate, but a new 15% tax on repatriated income may lead to increased effective tax rates or incentives for foreign competitors to set up in Kenya.

4. ESOPs of eligible startups benefit from a preferential tax regime under the Act, offering Bella an opportunity to issue ESOPs to her employees.

5. The Act introduces new thin capitalisation rules and limits deferral of foreign exchange losses to five years, impacting Black Star Ltd.'s capital raising and accounting practices.

6. The Act introduces two new tax bands and an affordable housing levy, potentially leading to demands for increased employee salaries and affecting Black Star Ltd.'s workforce management.

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Image source: Reuters

- **Let’s meet Bella and Black Star Ltd.**

Before delving into the impact of the Finance Act, let's briefly outline Black Star Ltd. and its current status in the fintech industry.

Black Star Ltd. is a fintech startup founded in 2020, offering an online platform for the exchange of digital assets. The company operates in Kenya, which is renowned as a leading fintech hub in Africa and globally. Her capital city, Nairobi, has even been dubbed the Silicon Savannah by among others [the FinTech Times](https://thefintechtimes.com/kenya-and-its-fintech-ecosystem-in-2022/). Bella's goal is to use Kenya as a launchpad to expand further into the African market. Bella;

- has read in the press that the Finance Act, 2023 was assented to by the President (which is the last step of the legislative process) on 26th June 2023 and that the Act amends a number of laws by introducing new taxes and changing existing tax rates.

- has read that the Act has faced stiff opposition from some quarters who posit that the Act increases the tax burden on a people and economy that is still recovering from the effects of the COVID-19 pandemic, facing the effects of a global recession, and inflation brought on in part by the rapid rise of the United States Dollar against the Kenya Shilling.

- is aware that some people opposed to the implementation of the Act have challenged it in Court and have been granted an order staying the implementation of the Act.

Bella is confused about all this and wants to know how the Act will affect her business. This article aims to provide answers to this question. That regulation and more so taxation has the ability to impact business and cannot be gainsaid.

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According to the [World Bank](https://subnational.doingbusiness.org/en/data/exploretopics/paying-taxes/why-matters):

> *“The amount of the tax cost for businesses matters for investment and growth. Where taxes are high, businesses are more inclined to opt out of the formal sector. A study shows that higher tax rates are associated with fewer formal businesses and lower private investment.”*

>

The problem for Black Star Ltd. is even more acute, especially in a country like Kenya where but for a few incentives, there is no specialised regime for startups like Black Star Ltd.

[Forbes](https://www.forbes.com/sites/williamdunkelberg/2021/10/06/impact-of-taxes-on-small-business/?sh=6382627b3250) also quoted:

> *“For small businesses, taxes are a financial and administrative burden that directly impacts their ability to invest their business, their employees and compete in the broader economy…. Taxes reduce profits, and profits are the primary source of financing for small businesses financing owners use to increase wages, for capital investment, and expansion opportunities.”*

>

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## **The Finance Act, 2023: Overview and Constitutional Challenge**

The Finance Act introduces new taxes and amends existing tax rates. However, it has faced stiff opposition from various quarters, leading to constitutional challenges. While conservatory orders were initially granted to stay the implementation of the Act, a copy of the ruling is available [here](https://drive.google.com/file/d/1FhAZFefj49r8C4XmLhMFasZskGZwKp3e/view). The Court of Appeal lifted these orders, leading to taxpayers having to pay the new taxes while the challenge is pending. See the developing story [here](https://www.businessdailyafrica.com/bd/economy/state-to-backdate-new-taxes-should-court-lift-freeze-order--4317168).

For Bella, this means that she must start paying the new taxes and prepare to be hit with a demand from KRA in the event she was not paying the new taxes while the conservatory orders were in place. While in theory, the sums she pays towards the new taxes will be recoverable should the challenge against the Act be successful, practically, it is unlikely that she will ever be able to recover those sums.

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# 💡Relevant Changes

### A. Digital Assets Tax

- Digital Assets are defined broadly as:

“(i) anything of value that is not tangible and cryptocurrencies, token code, number held in digital form and generated through cryptographic means or otherwise, by whatever name called, providing a digital representation of value exchanged with or without consideration that can be transferred, stored or exchanged electronically; and

(ii) a non-fungible token or any other token of similar nature, by whatever name called.” (Emphasis Added)

- By using the terms ‘anything of value that is not tangible’ and ‘by whatever name called’, this definition captures all digital assets that can be exchanged, transferred and stored electronically.

The Act also provides a formula for how the ‘income derived from transfer or exchange of digital assets’ is to be calculated. The term is defined as:

“…the gross fair market value consideration received or receivable at the point of exchange or transfer of a digital asset”.

Simply, put if person A transfers $ 100 worth of digital assets to person B using Black Star, Black Star Ltd. is required to deduct $ 3 and remit this to KRA within 5 days of the deduction. This means that person B would receive $ 97 and not $ 100.

The Act introduced a digital asset tax of 3% of the income derived from the transfer or exchange of digital assets. This new tax specifically targets businesses like Black Star Ltd. The tax is imposed on the owners of the platforms that facilitate the transfer or exchange of digital assets and requires them to remit the tax to the Kenya Revenue Authority (“KRA”) within 5 days of making the deduction.

**Impact on Bella**

1. The tax will increase the costs of transfers or exchange of digital assets to the users of Black Star and users will have to consider the tax when making transfers. It will also increase the administrative and compliance costs of Black Star Ltd. which will have to calculate the ‘gross fair market value’ of each transaction and also remit the tax to KRA within a short period of only 5 days.

2. Non-resident owners of platforms, such as Yellow Fingers Ltd., will be required to register for tax purposes and also make a distinction between users of their platform who are residents of Kenya and those who are not for purposes of applying the tax. This creates an almost impractical administrative task for such persons that they will be forced to comply with.

3. While ordinarily what is taxed is the gain on the transfer of an asset, for example, capital gains tax on the sale of property, for digital assets what is taxed is the gross fair market value. It is arguable that this is inequitable as it treats digital assets differently from other asset classes. The flip side of the argument, however, is that the volatility of digital assets is in fact the reason why the tax is imposed on the gross value and not the gain which would be more difficult to determine.

### B. **Expansion of VAT Obligations**

The Act requires non-resident suppliers of services to Kenyans without a place of business in Kenya to register for VAT effectively bringing them under Kenyan VAT law. This tax affects non-resident players in the fintech industry that serve Kenyans. Although, Black Star Ltd., will not be directly affected by this expansion as it is already required to be registered for VAT, Yellow Fingers Ltd. as a non-resident that supplies services to Kenyans will be affected.

In a nutshell, Yellow Fingers Ltd. will now be captured by the deeming provisions of the VAT Act that provide that a supply of services shall be deemed to have been made in Kenya if:

1. The services are physically performed in Kenya by a person who is in Kenya at the time of supply;

2. The services are directly related to immovable property in Kenya;

3. The services are radio or television broadcasting services received at an address in Kenya;

4. The services are electronic services delivered to a person in Kenya at the time of supply; or

5. The supply is a transfer or assignment or, or grant of a right to use, a copyright, patent, trademark, or similar right in Kenya.

This is important because where the services are deemed to have been supplied in Kenya, VAT will be payable.

**Impact on Bella**

It creates an administrative headache for Yellow Fingers Ltd. as they will be required to register for VAT and be brought under Kenyan VAT law and also make a distinction between its users from Kenya and those from other countries for purposes of ensuring VAT is paid where it supplies services to Kenyans.

This is not only impractical but also against international best practice that provides that the place where the supply is made is where VAT may be charged.

### C. **New Tax Regime for Foreign Companies**

Under the Act, the tax rate for branches of foreign companies has been reduced from 37.5% to 30%. However, a new tax of 15% has been introduced on income repatriated to the non-resident head offices of the branches of foreign companies.

Black Star Ltd. is registered in Kenya and is not directly affected by this new regime. However, its competitors may be incentivised to set up in Kenya as a result of the reduced tax rate.

**Impact on Bella**

While the reduction of the tax rate on branches to put them at par with local companies such as Black Star Ltd. may be a welcome move for Yellow Fingers Ltd. In practice, if Yellow Pages Ltd. wanted to benefit from the lower tax rate for local companies it would just set up a subsidiary instead of a branch or permanent establishment.

Furthermore, the introduction of the tax on repatriated income and especially the manner in which it is calculated under the Act actually increases the effective tax rate for branches to above 40% where branches repatriate their income, which they do in most cases. This is a good example of GOK giving with one hand and taking even more with the other hand.

### D. **Taxation of Employee Share Ownership Schemes/ Stock Options for Employees**

The Act introduces a preferential tax regime for employee share ownership schemes (“**ESOPs”**) of eligible startup companies. Under the preferential regime, the tax on the ESOPs will be deferred to within 30 days of the earlier:

1. The expiry of 5 years from the end of the year the shares were awarded;

2. Disposal of the shares by the employees; or

3. When the employee ceases to be an employee of the start-up.

- *Eligible startup companies are defined as: “…a business incorporated in Kenya that -*

*(a) has an annual turnover of not more than one hundred million shillings;*

*(b) does not carry on management, professional or training business;*

*(c) has not been formed as a result of splitting or restructuring of an existing entity; and*

*(d) has been in existence for a period of not more than five years.”*

This directly affects Bella as she had promised her employees shares in Black Star Ltd.

Before the Act, ESOPs would be taxed when they vested and the employee exercised the option to purchase the shares. **

**Impact on Bella**

Bella promised her employees shares in Black Star Ltd. The Company qualifies for the preferential regime as its turnover was KES. 12 million, does not carry the non-qualifying businesses, was not formed from an existing and was incorporated in 2020. It would therefore be a good time to consider setting up the ESOP to benefit from this preferential regime.

### E. **New thin capitalisation and Foreign Exchange Losses rules**

The Act introduces new thin capitalisation rules. Entities are considered thinly capitalised and subject to interest restrictions where they have a total gross interest paid or payable to related persons and third parties in excess of 30% of earnings before interest, taxes, depreciation and amortisation (“**EBITDA**”). Where they are thinly capitalised they are limited to deducting only 30% of their interest expenses before EBITDA when computing their annual income anything above 30% cannot be deducted.

This directly affects Bella as she is looking for investors for Black Star Ltd. Previously, loans from both resident and non-resident entities were included in the calculation. Under the Act, loans from resident persons are excluded, meaning only interest on loans from non-residents is considered. Furthermore, the Act allows for the restricted interest to be carried forward for three years from the time it was previously restricted. The Act further introduces a cap of 5 years for the deferral of foreign exchange losses for thinly capitalised entities. Previously there was no limit.

**Impact on Bella**

1. Should Black Star Ltd. raise capital through debt persons or entities in Kenya it will be able to escape the thin capitalisation restrictions and deduct all of the interest it pays on the debt when computing its taxable income.

2. Should Black Star Ltd. raise capital through debt from persons who are not resident in Kenya, although it will not be able to escape the thin capitalisation restrictions it will be able to carry forward the restricted interest for a period of 3 years and therefore may still be able to deduct the restricted interest from its taxable income in future.

3. Unfortunately, debt from third-party non-residents is still included and their exclusion would create further relief. Ideally, only loans from related parties create the base erosion problem that the thin capitalisation rules are designed to resolve.

4. Black Star Ltd. will only be able to defer foreign exchange losses for 5 years. It will therefore have to make changes to its internal accounting practices to reflect this change. This is unfair as such losses are occasioned by macroeconomic factors and Black Star Ltd has no control over these factors.

### F. **Preferential Rate for Qualifying Intellectual Property Income**

The Act introduces a preferential tax rate for qualifying intellectual property income. In what can only be described as poor legislative drafting, the Act does not provide a preferential tax rate or define “qualifying intellectual property”. The Act however provides the following formula for determining the income that would benefit from the preferential rate:


> Where -

>

>

> *I = Income receiving tax benefits*

>

> *Q = Research and development expenditures made by the taxpayer, excluding acquisition costs and related party outsourcing costs; and*

>

> *P = Intellectual property income including royalties, capital gains and any other income from the sale of an intellectual property asset including embedded intellectual property income calculated under transfer pricing principles.*

>

**Impact on Bella**

A preferential tax rate would be welcome for Black Star Ltd. which generates income based on intellectual property and spends money on research and development. However, poor legislative drafting has robbed this provision of any practical effect.

### G. **Increased Tax Burden on Employment Income**

The Act introduces two new tax bands for employees affecting employees earning at least KES 500,000 per month. Employees earning between KES 500,000 - 800,000 per month will now be taxed at 32.5% and those earning more than KES 800,000 will now be taxed at 35% both up from 30%.

The Act also introduces the affordable housing levy requiring employees to contribute 1.5% of their gross salary to the housing fund with employers required to make a matching contribution.

**Impact on Bella**

Black Star Ltd. has employees who may be affected by the new tax bands and it will be required to make a matching contribution to the housing fund.

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✅ **Conclusion**

For Bella, the Act means the following:

1. Even as the constitutionality of the Act is challenged, Bella must ensure that Black Star Ltd. is paying the new taxes with the knowledge that even if the challenge is successful, Black Star Ltd. is unlikely to recover the sums paid towards the new taxes.

2. Bella now has even more incentive to issue the ESOPs to her employees as the ESOPs will benefit from the preferential tax regime that has been introduced by the Act

3. Should Bella wish to raise capital through debt from resident persons, she no longer has to worry about the thin capitalisation rules that restrict the deduction of interest expenses. Even if captured, she can deferr the deductions for a period of 3 years. She must however be mindful of the new foreign exchange losses rules that limit the deferral of such losses to 5 years.

4. The introduction of the two new tax bands for employees, and the housing every means that Bella may be faced with demands from the employees affected to have their salaries increased to accommodate the new taxes. Black Star Ltd’d tax burden has also been increased due to the requirement to match their employee's contribution to the housing fund.

5. The introduction of the digital assets tax directly affects Black Star Ltd.’s business and Bella has to develop systems for determining when the tax is payable, collecting and remitting the tax. This means an increase in administrative costs. While in theory this tax burden can be passed down to Black Star Ltd.’s customers, the increase in the transfer costs may drive some customers to use other platforms that are not complying with the new tax.

6. Black Star Ltd.’s foreign competitors’ administrative costs will increase as they are now captured under the expanded VAT Obligations and the digital assets tax. The tax is likely to be passed down to their customers and therefore increase the cost of their services. Upwork has already notified their Kenyan users of the VAT change. More information is available [here](https://support.upwork.com/hc/en-us/articles/15139264398995-Kenya-VAT-for-Freelancers).

7. In the absence of a definition of a preferential tax rate, the preferential rate for qualifying intellectual property income is robbed of any practical effect. Bella will have to wait for the provision to be amended to determine the potential benefits of this new tax.