Any business seeking to grow must source funds. This
can be from internal sources or externally. For purposes of this article, we
will concentrate on tax implication of internally sourced loans by a Limited
liability company from its directors or shareholder.
Uganda’s Income tax Act broadly defines an associate as
“…any person, not being an employee, that acts in accordance with the
directions, requests, suggestions, or wishes of another person whether or not
they are in a business relationship and whether those directions, requests,
suggestions, or wishes are communicated to the first-mentioned person, both
persons are treated as associates of each other”.
The above definition means that a director or Share
holder is treated as an associate of a limited liability company for tax
purposes.
Where companies have obtained loans from Directors or
shareholders, URA has on many occasions disallowed these loans and
re-characterized them as Income under the anti-avoidance provisions. Under Section 116 of the Income Tax Act, the
Commissioner General has powers to “…. distribute, apportion, or allocate
income, deductions, or credits between the associates…”
In the past, the above provisions were unfairly applied
by URA against the taxpayers. However, the Tax Appeals Tribunal ruling in Explorer Limited Vs Uganda Revenue
Authority provides some relief; two important issues to note from the above
case;
Standard of Proof
Where a taxpayer provides reasonable information like loan agreements, proper disclosure of the loans in the financial statements, and there is statement by the lender (Director or Shareholder) confirming the existence of the loan, the tribunal ruled that on the balance of probability, it is reasonable to conclude that the loan was obtained.
Re-characterisation of the loan
TAT noted that whilst the Commissioner General has statutory powers to re-characterise a transaction, those powers must be exercised judiciously and rationally. To re-characterise a transaction, there must be some basis. In most re-characterisation decisions by URA, they always recharacterize loans as revenue. In the ruling, the members of TAT wondered, “…. why has the respondent (URA) opted to re-characterise loans as income/revenue/sales and not as equity since the funds originated from shareholders?”.
The above ruling provides some guidance to taxpayers who raise business finances internally with the key consideration being, the nature of documentation in place to support these transactions.
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