Aligning with Innovation Agenda
The Kenyan government is proposing a special tax regime on startups’ Employee Share Ownership Plans (ESOPs), as part of its plan to spur innovation. The finance bill 2023 proposes the deferment of taxes on employee-allocated shares, recommending that they apply after the expiry of five years from the time of share-award or when an employee sells them or leaves the company.
How it Works
The taxable benefit will be based on the fair market value of the startup’s shares at the end of the five years or at the time of the disposal. In cases where this information is unavailable, the tax commissioner will make a determination based on the startup’s financial statements.
Impact on Startups
If the changes are adopted, the special tax regime will come into effect on July 1. Currently, employees pay taxes immediately on the gains accrued between the dates they became eligible and when they exercised the share option.
"The way our (Kenyan) Income Tax Act works is that anything that an employee derives as a consequence of the employment is a taxable benefit," said Daniel Ngumy, corporate law expert and partner at Anjarwalla & Khanna. "One of the benefits is also being given shares in a company [and] under the current Income Tax Act, that benefit becomes taxable immediately. Now, what they’re proposing to do is to delay the payment of that."
Why it Matters
Startups offer employees equity as a way to retain talent, reward teams, and inculcate a culture of ownership. This ensures that the prospects of the shareholders are aligned with those of the staff.
The special tax regime will be applicable to startups incorporated in Kenya, with an annual turnover of less than Sh100 million ($731,255), have been in existence for less than five years, and are not formed as a result of splitting or restructuring of another or existing business. Startups in management, professional, or training businesses are excluded.
Government’s Plan
The proposal follows remarks by Kenya’s President William Ruto during the American Chamber of Commerce regional business summit earlier in March, where he hinted at the change saying that he had received complaints over the imposition of benefit tax ‘even before any value is realized.’
"The shift, he said, is part of its government’s plan to make Kenya an attractive business destination, and Africa’s top innovation center," said Ngumy.
Potential Pitfalls
However, Ngumy says that while the intention is to incentivize employees and innovation in Kenya, the taxes might end up being too high. "The drafting of the provision, in my view, generally almost captures the rationale, with an exception of provision three and four (refer to paragraph three) because the fair market value of the taxable benefit in five years could be high… I think it does not give them any real benefit, and will likely be amended because it gives them a worse outcome," said Ngumy.
Impact on Kenya’s Economy
Kenya remains one of the top four market destinations in Africa in terms of VC investment. The special tax regime may provide an attractive environment for startups to operate in, potentially leading to increased innovation and growth.
Conclusion
The Kenyan government’s proposal of a special tax regime for startups’ Employee Share Ownership Plans is a step towards making Kenya an attractive business destination and Africa’s top innovation center. While the intention is to incentivize employees and innovation, there may be potential pitfalls in the implementation of the policy. The impact on Kenya’s economy remains to be seen.
Related Topics
- Africa: As one of the top four market destinations in Africa for VC investment, Kenya’s economic growth and stability are crucial.
- Government & Policy: The proposal is part of the government’s plan to make Kenya an attractive business destination and Africa’s top innovation center.
- Startups: Startups offer employees equity as a way to retain talent, reward teams, and inculcate a culture of ownership.