In Kenya, a company is thinly capitalised if all of the following occur:
- The company is controlled by a non-resident person alone or together with four or fewer persons.
- The company is not a bank or financial institution.
- The highest amount of all loans held by the company at any time exceeds the sum of three times the revenue reserves (including accumulated losses) and the issued and paid up share capital of all classes of shares of the company.
A company that is thinly capitalised cannot claim a deduction on the interest expense incurred by the company on loans in excess of three times the sum of revenue reserves and issued and paid up capital of all classes of shares of the company. The company also cannot claim a deduction for any foreign exchange loss realised by the company with respect to any loans from its shareholders in the period that the company remains thinly capitalised.
For companies in the extractive sector, the debt-to-equity ratio is 2:1.
Companies with projects aimed at implementing the affordable housing scheme are exempt from thin capitalisation provisions. The eligible companies can raise capital through debt without occasioning the thin capitalisation measures whose effect is to subject interest payable on the loans to CIT.
A company is considered to be “controlled” by a non-resident person where the non-resident person holds 25% or more of the issued share capital in the company. “Debt” is deemed to comprise all types of financial indebtedness while “equity” is deemed to comprise all classes of share capital (including redeemable preference shares). Where the debt to-equity ratio exceeds 3:1 such a company is said to be thinly capitalised and the interest on the loan which exceeds the ratio will be non-deductible for tax purposes. Additionally, where a company is thinly capitalised the foreign exchange losses (whether realised or unrealised) in respect of loans are deferred and hence not tax deductible until the Kenyan entity ceases to be thinly capitalised.
The interest is deemed based on the amount of interest equal to the average ninety one-day Treasury Bill Rate, as prescribed by the Commissioner on a quarterly basis. Where interest has been deemed, this attracts withholding tax at the statutory rate of 15%, unless this rate is reduced through a double tax treaty. We also wish to point out as the interest is deemed, and thus not an actual expense, it does not form part of the tax-deductible expenses of the company.