An investor monitors trading at the Nairobi Securities Exchange. PHOTO | FILE
By JOSEPH THOGO, jthogo@deloitte.com
In Summary
- Even though the taxman ranks as an unsecured creditor, it does not apply for all taxes. The hierarchical order does not apply to transactional and agency taxes such as VAT, excise duty, PAYE and withholding tax.
- An argument can be made that changes in a firm’s capital structure do not change the corporation’s overall value. Indeed, from an economic point of view it should make little difference whether the corporation raises funds through debt or equity.
To say that corporate Kenya has in the recent past taken a beating would perhaps be an understatement.
With listed companies issuing profit warnings, a number of
entities reporting record losses and some going into administration,
the prognosis has not been very been positive.
A while back, the print media was also inundated
with a number of publicised bailouts of listed companies by their
shareholders and even by the government.
Corporate issues of shares and debt are simply
alternative methods of raising corporate capital. Equity arises where
shareholders fund the company in exchange for shares while loans come
about where the company borrows against its assets. Whether these have
been in the form of debt or equity would not really matter from a
finance perspective.
An argument can be made that changes in a firm’s
capital structure do not change the corporation’s overall value. Indeed,
from an economic point of view it should make little difference
whether the corporation raises funds through debt or equity.
Why, then, should there be any difference in the
tax treatment of debt and equity? Why does it matter? The unintended
consequences of all these are losses that impact all those involved from
a tax perspective—the entity, its shareholders and those who lent it
money.
When a company goes into administration, the
administrator is required to operate under certain guidelines provided
under the recently enacted Insolvency Act.
The objectives of administration are to maintain
the company as a going concern, to achieve a better outcome for the
company’s creditors as a whole than would likely to be the case if the
company were liquidated and to realise the property of the company in
order to make a distribution to one or more secured or preferential
creditors.
Whereas previously a company could be wound up
immediately it became insolvent, the Insolvency Act now gives the
company an opportunity to operate as a going concern and not
necessarily engage in the sale and realisation of its assets as a
primary option.
During this phase, the entity’s tax obligations do
not extinguish and it is the responsibility of the administrator to
ensure compliance.
Taxman
The hierarchical order of payments that the
administrator should adhere to starts with the insolvency costs (fees
for overseeing the process) followed by secured creditors (lenders to
whom the company granted security, which includes banks, asset based
lenders, finance and agreement providers), then comes the preferential
creditors (employee claims), followed by unsecured creditors (all
remaining creditors such as the taxman, suppliers, contractors) and
lastly the shareholders (who get paid if all the above creditors are
paid in full).
Even though the taxman ranks as an unsecured
creditor, it does not apply for all taxes. The hierarchical order does
not apply to transactional and agency taxes such as VAT, excise duty,
PAYE and withholding tax.
Since the entity collects these taxes on behalf of
the taxman, its obligations as a tax agent are not affected by the
hierarchy of payments. The hierarchy of payments will impact the
entity’s income tax its normal trading and the taxman has to join the
queue.
However, if the administrator is able to
resuscitate the business and the entity comes out of administration, the
taxman adopts his usual role.
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