Loan syndication benefits local borrowers, economy

The banking system in Uganda plays an important role in our country's economic development. Banks collect the savings of the individuals and lend them out to businesses, people, investors, traders, and manufacturers. Bank loans facilitate manufacturing, investment, trading, and commerce.

There is a limit to the amount of loan a bank may provide to a single borrower or group of borrowers under a common interest. This limit is set by the Bank of Uganda. The limit is aimed at reducing the risk of a bank's credit being concentrated in a single borrower or sector. This limits the exposure a bank may face as a result of the failure of that single borrower or sector to pay back the money borrowed from the bank. In addition to that, banks also have limits on the amount they can lend to borrowers, because of the size of the bank's balance sheet.

For example, a bank's customer may want to borrow sh37b (about $10m) for its business, and the bank's balance sheet may not be strong enough to provide that amount of money on its own. In such cases, the bank would co-ordinate with other banks in Uganda or outside Uganda to raise the sh37b needed by its customer.

The process involving a group of banks funding various portions of a loan for a single borrower is called loan syndication. Loan syndication often occurs when a single borrower requires an amount that is too large for a single lender to provide on their own, or when the loan amount is outside the scope of a single lenders' risk exposure.

Participating in a syndicated loan allows a small bank to make a loan to a large borrower that it could not otherwise make on its own. This is beneficial for the bank, the borrower, and the economy as a whole. It is beneficial to the bank as it allows it to participate in a large business financing transaction that it would not otherwise be able to do on its own. Leading a syndication enables the bank to enhance a customer relationship without exceeding credit risk appetite or breaching the permitted credit concentration limits.

Loan syndication is also beneficial to the borrower as it enables him or her to access the finance needed by dealing with one bank as opposed to having to borrow from different banks to raise the money he or she needs. Dealing with one bank is always cheaper for the borrower. It is also good for the economy as it allows the country to raise funding from the international global finance for big capital projects in which funding may not be available on the local market.

Commercial Banks operating in Uganda as subsidiaries prefer to work with their parent or sister Banks outside Uganda when arranging syndicated loans. This is done purely for commercial and business reasons.

The Uganda government's liberalized economic policy has resulted in fiscal, monetary, and tax policies that are all designed to encourage as well as enable Ugandan businesses to participate

freely as well as compete in the global economy. Examples of such policies include a liberalized foreign exchange market, a market-driven interest rate policy, and tax exemption on interest paid on loans raised from the regional and international financial institutions.

Currently, when a business borrows money from a bank in Uganda, it is not required to withhold tax on the interest it pays to the bank. This is because the interest the bank receives from the business will be taxed on the bank as its business income, and therefore there is no need for the borrower to withhold tax on the interest.

In order to ensure that businesses and borrowers in Uganda are not "locked" out from participation in the global financial services market, the tax laws in Uganda also exempts borrowers in Uganda from withholding tax on the interest they pay on loans raised from foreign banks. This tax exemption makes it cheaper for a Ugandan borrower to access finance from a foreign bank. Because of this tax exemption, a borrower in Uganda may find it cheaper to borrow from a bank in Kenya where the average commercial bank lending rate is currently about 13% compared to borrowing from Uganda where the average rate is about 20%.

This tax exemption also applies to interest paid on loans from foreign banks under loan syndication arrangements. According to the Income Tax Act of Uganda, where a Ugandan local person or business borrows money from a foreign bank, and the bank is of a public character, meaning its open to the general public, as opposed to being an exclusive bank for only a chosen few, and the money was borrowed from a bank outside Uganda, and the interest payable on the loan is paid to a bank outside Uganda; then the Ugandan borrower is not required to withhold tax on the interest payments made to the foreign bank.

This exemption from withholding tax on loans from foreign banks that are of public character puts them at par with the local Ugandan banks, from a tax perspective. This has resulted in businesses and investors in Uganda being able to access finance in the global financial market services market without any tax barriers.

I have seen some comments both on social media as well as the mainstream media saying that the government is losing money by not taxing the interest earned by foreign banks on the loans they advance to borrowers in Uganda. I do not agree with this. When it came to the tax policy choices on this issue, the government had two options. Option one was to tax the foreign banks on the interest they earn from the loans they lend to Ugandan businesses.

Option two was to create a favourable tax environment that would attract foreign banks to provide finance to Ugandan businesses. The government chose the second option, and that has resulted in a lot of foreign funds coming into our country to provide the badly needed capital both in form of debt and equity to finance private and public sector projects.

If the government chose to tax the foreign bank, the obligation to withhold the tax would be on the local borrower. Since the obligation would be on the local borrower, chances are that the tax cost would also be borne by the local borrower. It is very unlikely that a foreign bank that pays tax on the interest back in its home country, say Kenya would accept to pay tax in Uganda on the same interest.

The government knows this and that is why they chose the second option of exempting the interest from tax in Uganda. This is good tax policy and reflects international best practices.

The writer is a Certified Accountant and Chartered Tax Adviser