Often in life, we find a problem and solution but cannot link the two –
a famine and a food surplus but no funding and no transport, for example. We
have this problem in Kenya with regard to the food of the economy – investment.
There is plenty evidence of money in Kenya looking for opportunities –
witness the hunger for new shares offered on the Nairobi Stock Exchange. At
the same time, businesses have difficulty finding sources of long term funding
and our major infrastructure projects are dependent on donors and foreign financiers.
Why this feast and famine?
The reason for this mismatch is the difference between the requirements of
Kenyan investors and the requirements of the businesses and projects that need
capital. The investors generally want ready access to their funds. Bank deposits
or unit trusts are suitable for the risk averse and quoted shares for the risk
takers. For longer term investment, insurance policies with reputable institutions
and retirement benefit schemes are the preferred option. These funds are recycled
into the market. Deposits with banks generally go into short term loans and
overdrafts for business, corporate bonds issued by blue chip companies and treasury
stock. Money invested in quoted shares goes to established companies with a
track record of profitability. Money invested in unit trusts, insurance policies
and retirement benefit schemes goes into blue chip corporate bonds, treasury
stocks and quoted shares.
Very little of this money ends up funding longer term business development,
business start-ups or the infrastructure that Kenya needs. The reason is that
the investor in such projects must be able to invest for longer periods and
must have sufficient capital to spread risk by investing in a portfolio of projects.
A venture capital investor in start-up and growing businesses will typically
invest for a period of, say, seven years and will expect to make much of the
return on investment by way of capital gain at the end of the period. An investor
in an infrastructure project may invest for a twenty year period, but will expect
regular income after the initial construction phase. Banks and unit trust need
to be able to repay depositors and unit holders on demand out of the funds they
hold and therefore cannot generally commit to such long term funding and insurance
companies sell their policies as safe investments with pretty well guaranteed
returns.
If we are to match the availability of funds from investors with the need for
longer term and risk capital for investment, we need a new vehicle to do so.
While the vehicle may be new to Kenya, I believe we can look to history for
an answer. In the nineteenth century, there was huge demand for risk capital
to develop infrastructure in the American west. At the same time, industrial
development in Britain had created a growing middle class with money to invest.
The two were linked with the creation of a new type of company called an Investment
Trust. Investors clubbed together to subscribe for shares in the Investment
Trust and the Trust could then commit the funds to a portfolio of investment
opportunities, spreading the risk. The subscribed capital was not due for repayment
so the managers of the Investment Trust could take a long term view and as a
company they could borrow to increase the funds available for investment. If
investors wished to get their money back, they did so by selling their shares
and so did not place any demand on the Investment Trust for cash.
Investment Trusts are still around today in the UK and generally specialise,
either geographically or by type of investment, for example, Venture Capital
Trusts investing in start-ups, growing businesses and management buy-outs and
buy-ins. The closest we have in Kenya to such Investment Trusts are unquoted
companies such as Acacia Fund Limited and Trans-Century Limited.
The sole quoted example is ICDC Limited.
If Investment Trusts are so useful in turning the small investors’ money
into long term risk capital, why do we have only one company of this type available
to the Kenyan public? The answer is that without adapting the tax rules, they
suffer double taxation. Essentially, income received by the company is taxed
on the company, and is taxed again when distributed to the shareholder. Perhaps
even more important, capital gains that would be tax free in the hands of a
direct investor suffer a tax called compensating tax when distribute to shareholders.
Using an Investment Trust to create a long term investment fund creates additional
tax that the direct investor does not suffer. Our tax rules penalise the conversion
of small investors’ money into a fund to provide for the country’s
investment needs.
This issue has been partly recognised in the rules for approved Venture Capital
Companies, such as Acacia Fund, which are given tax exemptions to remove double
taxation. They have proved of limited use in Kenya because they are largely
restricted to investing in the shares of unquoted small or medium, Kenyan resident
companies in a restricted number of industry sectors. As such it is not a suitable
vehicle for the smaller investor. Indeed, larger investors as well are looking
to diversify and spread risk by investing regionally, in loans and bonds as
well as shares, and in a balanced portfolio of industries. As such the Venture
Capital Company is a lame, if not totally dead, duck. ICDC has also been given
specific tax exemptions to deal with this issue.
Giving similar tax exemptions to quoted Investment Trusts, subject to Capital
Market Authority regulation, would not result in loss of tax revenue –
there is currently little revenue from public investment companies of this sort.
The tax rules for unit trusts, insurance companies and retirement benefit schemes
already ensure that investing collectively through these vehicles does not create
a double tax charge. By creating new sources of long term investment for the
Kenyan economy, legislating for Investment Trusts would increase tax revenues
rather than the reverse.
Subject to meeting certain regulatory requirements, Investment Trusts listed
on the Nairobi Stock Exchange should be permitted to distribute income and capital
gains to shareholders without the double taxation that otherwise arises when
investment is channelled through a company. Kenya’s corporate law is similar
to the environment that invented the Investment Trust. We don’t need to
re-invent the wheel. Let’s give Kenyan investors, large and small, the
opportunity to invest long term in Kenya’s infrastructure and economy
without suffering double taxation. This does not mean giving tax exemptions
and losing tax revenue. Instead, it is removing a disincentive to effective
investment with the prospect of increased tax revenues from increased investment
and economic growth.
