- New tax proposal threatens tax-free status of infrastructure bonds
- Potential impact on investor returns and government liquidity
Nairobi, Kenya – Infrastructure bonds issued by the government of Kenya have emerged as top-performing assets in the country’s fixed-income markets in recent years, attracting investors with tax-free returns that can reach as high as 18%. However, a recent proposal from the treasury, backed by members of parliament, could change this attractive feature.
“Withholding tax is proposed to be chargeable at 5% and 15% on interest earned by residents and non-residents respectively. This proposal seeks to increase government collections,” notes tax consultancy Grant Thornton in their analysis of Kenya’s finance bill. The new taxes are set to impact bonds with a maturity of less than three years.
Public Resistance and Legislative Hurdles
The finance bill has faced public resistance due to its provisions targeting basic necessities like milk, bread, and sanitary items to raise an extra Sh346 billion in tax revenue. Recent violent protests in major urban areas and the storming of parliament in Nairobi led President Ruto to reject the bill in its entirety, despite parliamentary approval. This rejection has slowed down his aggressive revenue collection plans, which also include the proposal to introduce withholding tax on infrastructure and green bonds.
Filling the Budget Gap
Following the withdrawal of the finance bill, Kenyan lawmakers are grappling with a significant budget deficit and are looking for ways to avoid repeating past mistakes. This has led some analysts to predict that taxing fixed-income investments, like bonds, could become a politically palatable option compared to more contentious proposals that disproportionately burden low-income earners.
Investors in fixed-income securities should be aware of this potential shift and prepare for how it might impact their returns beyond just tax bills. While a specific tax on infrastructure bonds may not be immediate, given the finance bill was not assented to by President Ruto, it highlights the potential for broader changes in this area in the coming months. The main concern is that such taxes could discourage investment in these assets, which the government has come to rely on heavily for additional liquidity.
In the past year, infrastructure bond issuances consistently exceeded government targets in terms of funds raised. The last issuance in February saw the government accepting bids worth Sh240.95 billion, more than threefold the advertised amount of Sh70 billion. It offered investors an attractive tax-free return of 18.46% in an economy where the inflation rate has oscillated between 6% and 8% over the past two years.
Another issued in November last year at a coupon of 17.93% saw the government accepting bids worth Sh67.05 billion against a target of Sh50 billion. Similarly, this pattern of outperformance was witnessed in the June issuance last year, which saw the government net Sh220 billion against an advertised amount of Sh60 billion.
Implications for Investors and the Government
Taxing these bonds could lead to lower demand, turning off a crucial source of liquidity for the government. Some experts also warn that investors might demand higher interest rates to compensate for the new tax burden, putting upward pressure on commercial banking rates.
Another concern with taxes on new infrastructure and green bonds is the potential distortion in the secondary bond market. Since the tax would only apply to new bonds, older tax-free infrastructure bonds that pay higher coupons than prevailing market rates could become more valuable to investors. Investors might choose to trade these older bonds for a profit instead of holding them to maturity, potentially distorting the market.
