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Income Tax Act Amendment alters IFSC Regime

Tumelo Rannau

International Financial Service Centre (IFSC) is one of the most common tax regimes used in the world to promote investment. Botswana, like other countries, also has this regime as one of the incentives available to investors who have interest in doing business in Botswana.

Tax benefits available for IFSC companies in Botswana include a corporate tax rate of 15% (compared to the normal 22%) for dealings with non-residents and no tax on capital gains on shares in an IFSC company. Other tax benefits are in relation to exemption of IFSC companies from the obligation to deduct withholding tax on management and consultancy fees, commercial royalties, interest and dividends paid to non-residents.

All these benefits are geared towards encouraging meaningful investment in the country with the hope of creating employment and diversifying the economy. The IFSC tax regime has recently been amended by the new Income Tax Amendment Act 2018 as it was considered harmful to the Botswana economy.

What was harmful about IFSC?

The ever rising pressure on countries to protect revenue against Base Erosion and Profit Shifting (BEPS) has led to Organization of Economic Cooperation and Development (OECD) developing some action steps and a framework on transparency. Action 5 of the OECD BEPS Action steps deals with harmful tax practices and through the Forum on Harmful Tax Practices (FHTP), our IFSC regime was identified among those that may have potentially harmful features.

It should be noted that being potentially harmful means that there are no risks yet identified thus far but in the future, the country may be exposed to tax loss risks if the features that are identified as being potentially harmful are not attended to. Other tax jurisdictions were outright identified as having harmful practices. To address the harmful practices, the Income Tax Act (The Act) was recently amended to remove the, ‘exploitation of intellectual property,’ and, ‘development and supply of computer software for use in the provision of other approved financial operations,’ as approved financial operations.

Further, the IFSC operations have been restricted to those in which the Botswana IFSC trades with its related or associated entities. Effectively, this minimizes the expenses that local entities incur by dealing with non-residents such as management fees, interest and commercial royalties. These repealed operations stated above normally give rise to fees such as royalties and management and consultancy fees and therefore entities supplying these services were exempt from withholding tax on royalties and consultancy fees when paying them to non-residents.

Additionally, such entities could also be provided with loans and have to pay huge interest bills on those loans but still, no tax would be deducted as long as they traded with non-residents. This therefore meant that all these transactions exempted from withholding tax would reduce tax collections for BURS.  Additionally, the IFSC entities could claim the expenses paid to non-residents as tax deductions, reducing the tax base, not mentioning that they would also probably be taxed at 15% instead of 22%. The concern of the FHTP is not the benefit arising to local entities from the IFSC regime but the tax losses that the country was experiencing.

Other concerns regarding the IFSC were in relation to ring-fencing of income by only sourcing financing from foreign investors and that would entail local entities having to incur significant interest bills, which could only be taxed in other countries, given that the payments were exempt from tax in Botswana.  In simple terms the benefits above only benefited foreign investors and excluded local investors who may have a larger impact on development of the economy.

As mentioned above, the Act has restricted IFSC status to trading between IFSC entities with its associated or related parties only, that is, companies in which the IFSC has at least 20% of the shareholding, as per the Act. The old regime allowed for IFSC companies to trade with third parties outside the country and other IFSC companies.

Effects of the amendment on local economy

The full utilization of the IFSC regime has been a challenge in Botswana especially due to infrastructural issues such as water and electricity and permit issues. Though some developments such as restricting trading to related parties is a welcome development as it is aligned to international practice, the new amendment may result in the country being less competitive compared to countries that we have been competing with such as Seychelles and Mauritius.

This may lead to loss in revenue in terms of directors’ fees, company secretary fees, legal fees, audit fees, and general business expenses to those that provided support services.  Income that would otherwise be earned through spending on transport and accommodation by foreign investors visiting the country is also likely to be lost. Though it is always good to get accolades from organizations such as OECD, it is important to consider the country’s needs and strive towards ensuring that unemployment is reduced.

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Business

New study reveals why youth entrepreneurs are failing

21st July 2022
Youth

The recent study on youth entrepreneurship in Botswana has identified difficult access to funding, land, machinery, lack of entrepreneurial mindset and proper training as serious challenges that continue to hamper youth entrepreneurship development in this country.

The study conducted by Alliance for African Partnership (AAP) in collaboration with University of Botswana has confirmed that despite the government and private sector multi-billion pula entrepreneurship development initiatives, many young people in Botswana continue to fail to grow their businesses into sustainable and successful companies that can help reduce unemployment.

University of Botswana researchers Gaofetege Ganamotse and Rudolph Boy who compiled findings in the 2022 study report for Botswana stated that as part of the study interviews were conducted with successful youth entrepreneurs to understand their critical success factors.

According to the researchers other participants were community leaders, business mentors, Ministry of Trade and Industry, Ministry of Youth, Gender, Sport and Culture, financial institutions, higher education institutions, non-governmental institutions, policymakers, private organizations, and support structures such as legal and technical experts and accountants who were interviewed to understand how they facilitate successful youth entrepreneurship.

The researchers said they found that although Botswana government is perceived as the most supportive to businesses when compared to other governments in sub-Saharan Africa, youth entrepreneurs still face challenges when accessing government funding. “Several finance-related challenges were identified by youth entrepreneurs. Some respondents lamented the lack of access to start-up finance, whereas others mentioned lack of access to infrastructure.”

The researchers stated that in Botswana entrepreneurship is not yet perceived as a field or career of choice by many youth “Participants in the study emphasized that the many youth are more of necessity entrepreneurs, seeing business venturing as a “fall back. Other facilitators mentioned that some youth do not display creativity, mind-blowing innovative solutions, and business management skills. Some youth entrepreneurs like to take shortcuts like selling sweets or muffins.”

According to the researchers, some of the youth do not display perseverance when they are faced with adversity in business. “Young people lack of an entrepreneurial mindset is a common challenge among youth in business. Some have a mindset focused on free services, handouts, and rapid gains. They want overnight success. As such, they give up easily when faced with challenges. On the other hand, some participants argue that they may opt for quick wins because they do not have access to any land, machinery, offices, and vehicles.”

The researchers stated that most youth involved in business ventures do not have the necessary training or skills to maintain a business. “Poor financial management has also been cited as one of the challenges for youth entrepreneurs, such as using profit for personal reasons rather than investing in the business. Also some are not being able to separate their livelihood from their businesses.

Lastly, youth entrepreneurs reported a lack of experience as one of the challenges. For example, the experience of running a business with projections, sticking to the projections, having an accounting system, maintaining a clean and clear billing system, and sound administration system.”

According to the researchers, the participants in the study emphasized that there is fragmentation within the entrepreneurial ecosystem, whereby there is replication of business activities without any differentiation. “There is no integration of the ecosystem players. As such, they end up with duplicate programs targeting the same objectives. The financial sector recommended that there is a need for an intermediary body that will bring all the ecosystem actors together and serve as a “one-stop shop” for entrepreneurs and build mentorship programs that accommodate the business lifecycle from inception to growth.”

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Business

BHC yearend financial results impressive

18th July 2022
BHC

Botswana Housing Corporation (BHC) is said to have recorded an operating surplus of P61 Million, an improvement compared to the previous year. The housing, office and other building needs giant met with stakeholders recently to share how the business has been.

The P61 million is a significant increase against the P6 million operating loss realized in the prior year. Profit before income tax also increased significantly from P2 million in the prior year to P72 million which resulted in an overall increase in surplus after tax from P1 million prior year to P64 million for the year under review.

Chief of Finance Officer, Diratsagae Kgamanyane disclosed; “This growth in surplus was driven mainly by rental revenue that increased by 15% from P209 million to P240 million and reduction in expenditure from P272 million to P214 million on the back of cost containment.”
He further stated that sales of high margin investment properties also contributed significantly to the growth in surplus as well as impairment reversals on receivables amounting to P25 million.

It is said that the Corporation recorded a total revenue of P702 million, an 8% decrease when compared to the P760 million recorded in the prior year. “Sales revenue which is one of the major revenue streams returned impressive margins, contributing to the overall growth in the gross margin,” added Kgamanyane.

He further stated professional fees revenue line declined significantly by 64% to P5 million from P14 million in the prior year which attributed to suspension of planned projects by their clients due to Covid-19 pandemic. “Facilities Management revenue decreased by P 24 million from P69 million recorded in prior year to P45 million due to reduction in projects,” Kgamanyane said.

The Corporation’s strength is on its investment properties portfolio that stood at P1.4 billion at the end of the reporting period. “The Corporation continues its strategy to diversify revenue streams despite both facilities management income and professional fees being challenged by the prevailing economic conditions that have seen its major clients curtailing spending,” added the CEO.

On the one hand, the Corporation’s Strategic Performance which intended to build 12 300 houses by 2023 has so far managed to build 4 830 houses under their SHHA funding scheme, 1 240 houses for commercial or external use which includes use by government and 1 970 houses to rent to individuals.

BHC Acting CEO Pascaline Sefawe noted that; BHC’s planned projects are said to include building 336 flat units in Gaborone Block 7 at approximately P224 million, 100 units in Maun at approximately P78 million, 13 units in Phakalane at approximately P26 million, 212 units in Kazungula at approximately P160 million, 96 units at approximately P42 million in Francistown and 84 units at approximately P61 million in Letlhakane. Emphasing; “People tend to accuse us of only building houses in Gaborone, so here we are, including other areas in our planned projects.”

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Business

Commercial banks to cash big on high interest rates on loans

18th July 2022
Commercial-banks

Researchers from some government owned regulatory institutions in the financial sector have projected that the banking sector’s profitability could increase, following Bank of Botswana Monetary Policy Committee recent decision to increase monetary policy rate.

In its bid to manage inflation, Bank of Botswana Monetary Policy Committee last month increased monetary policy rate by 0.50 percent from 1.65 percent to 2.15 percent, a development which resulted with commercial banking sector increasing interest rate in lending to household and companies. As a result of BoB adjustment of Monetary Policy Rate, from 1.65 percent to 2.15 percent commercial banks increased prime lending rate from 5.76 percent to 6.26 percent.

Researchers from Bank of Botswana, the Non-Bank Financial Institutions Regulatory Authority, the Financial Intelligence Agency and the Botswana Stock Exchange indicated that due to prospects of high inflation during the second half of 2022, there is a possibility that the Monetary Policy Committee could further increase monetary policy rate in the next meeting in August 25 2022.

Inflation rose from 9.6 percent in April 2022 to 11.9 percent in May 2022, remaining above the Bank of Botswana medium-term objective range of 3 – 6 percent. According to the researchers inflation could increase further and remain high due to factors that include: the potential increase in international commodity prices beyond current forecasts, logistical constraints due to lags in production, the economic and price effects of the ongoing Russia- Ukraine conflict, uncertain COVID-19 profile, domestic risk factors relating to possible regular annual administered price adjustments, short-term unintended consequences of import restrictions resulting with shortages in supplies leading to price increases, as well as second-round effects of the recent increases in administered prices “Furthermore, the likelihood of further increases in domestic fuel prices in response to persistent high international oil prices could add upward pressure to inflation,” said the researchers.

The researchers indicated that Bank of Botswana could be forced to further increase monetary policy rate from the current 2.15 percent if inflation rises persistently. “Should inflation rise persistently this could necessitate an upward adjustment in the policy rate. It is against this background that the interest rate scenario assumes a 1.5 percentage points (moderate scenario) and 2.25 percentage points (severe scenario) upward adjustment in the policy rate,” said the researchers.

The researchers indicated that while any upward adjustment on BoB monetary policy rate and commercial banks prime lending rate result with increase in the cost of borrowing for household and compnies, it increase profitability for the banking sector. “Increases in the policy rate are associated with an overall increase in bank profitability, with resultant increases in the capital adequacy ratio of 0.1 percentage points and 0.2 percentage points for the moderate and severe scenarios, respectively,” said the researchers who added that upward adjustment in monetary policy rate would raise extra capital for the banking sector.

“The increase in profit generally reflects the banking industry’s positive interest rate gap, where interest earning assets exceed interest earning liabilities maturing in the next twelve months. Therefore, an increase of 1.5 percentage points in the policy rate would result in industry gains of P71.7 million (4.1 percent increase), while a 2.25 percentage points increase would lead to a gain of P173.9 million (6.1 percent increase), dominated by large banks,” said the researchers.

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