Banks on edge over govt plan to tax loans

The proposed tax on recipients of proceeds from auction has divided opinions and threatens to escalate the costs associated with raising capital and loan recovery.

This proposal could also significantly hamper business operations within the country, particularly for those relying on loans obtained through banks and other financial institutions.

The proposed amendment will also heighten the tax compliance responsibilities of banks. The banks will be required to register for VAT, issue tax invoices, and submit monthly VAT returns, which obligations they have previously been exempt from due to their dealings in VAT-exempt supplies.

Nevertheless, by yesterday evening, the Uganda Bankers Association (UBA) was optimistic that the proposed amendment would be dropped, following reported assurances from the tax body, Uganda Revenue Authority (URA), that the tax proposal was wrongly framed.

The assurances were made yesterday during a meeting to thrash out differences between representatives of the two entities at Parliament.

“We are optimistic. We made our case on the various tax proposals,” Mr Wilbrod Owor, the executive director of UBA, told the Monitor.

Asked specifically to address the issue of VAT on auctions, Mr Owor said URA officials had conceded on the issue and would provide clarification.

“Unless we have seen the changes, we cannot speak with certainty, but we are hopeful after assurances from URA,” he said.

But Mr Ibrahim Bbosa, the URA assistant commissioner for Public and Corporate Affairs, told Daily Monitor that the same meeting in which the UBA officials had received the alleged assurance was still ongoing and that the taxman would provide a substantive answer today.

Uganda’s tax policy strategy is to expand the tax base, improve tax adherence, and optimise administrative efficacy.

The tax

Currently, banks are not obligated to issue VAT invoices because of the VAT exemption they enjoy. However, the proposed amendment mandates them to incorporate VAT accountability into their operations.

The new measure proposed in Section 5(1)(ab) of the Value Added Tax (Amendment) Bill, 2024, aims to establish a new group of individuals responsible for VAT payments, namely, those who receive proceeds from auction.

If sanctioned by Parliament, this new tax regulation would transfer the VAT payment obligation for goods acquired through auctions from the auctioneers to the entities for which these auctioneers operate, such as banks and judgment creditors.

Previously, in 2023, the VAT Act underwent an amendment by introducing Section 10(4), which clarified that the sale of goods via auction is considered a sale made by the auctioneer as the supplier during the process of auctioning goods.

Daily Monitor has interviewed several lawyers and tax experts, who warn that the measure will have adverse effects beyond simply increasing the country’s resource envelope.

Given that financial institutions like banks will likely pass on the burden of the newly imposed 18 percent VAT to borrowers, many loan agreements will be drafted to account for this scenario.

Lawyer Bruce Musinguzi, a partner at Kampala Associated Advocates (KAA), was the first to flag the issue through a “tax alert” published with the firm senior associates, Charlotte Ahabwe and Ferdinand Tumuhaise.

“This will unnecessarily burden already distressed taxpayers, the effect of which will increase the non-performing loans, given that 18 percent of the said loans will become income to the government at the expense of the taxpayer,” Mr Musinguzi notes.

“The proposed amendment is clearly telling the taxpayers, ‘pay your loans, or if you fail and the bank sells your property, you will incur an additional 18 percent VAT’,” he says.

“In essence, the above amendment requires mortgagees such as banks, which are the recipients of money made from an auction, to pay VAT of 18 percent of the proceeds of the auction. To cement this, the Bill proposes to further amend Section 10(4) of the Act to the effect that the supply of goods through auction by an auctioneer in the course of auctioning goods is to be treated as a supply of goods by the recipient of the proceeds of the auction,” he adds.

Section 10(4) of the Value Added Tax Act, Cap. 349, is to be amended so that the recipient of the auction proceeds, who in most cases are financial institutions, will be responsible for accounting for the VAT when goods are sold through an auction.

This means if a financial institution sells a foreclosed item, by auction, URA expects it to remit VAT of 18 percent of the proceeds and consequently, the financial institution will have to charge this VAT to the buyer.

This proposed change builds on and alters last year’s amendment to the VAT Act, which indicated that during the auction process, the auctioneer is the supplier of the goods, and so is obligated to account for the VAT.

“Whilst it is thought that this change will mainly affect the bank’s disposal of foreclosed property, it may cause problems if Parliament does support its passing. The reason for this is that the recovery action (auctioning of collateral) that banks and or financial institutions take while seeking to obtain repayment of the money arising from an advancement of credit to a customer is closely linked to the supply of financial services, which are already exempt under the same VAT Act (do not give rise to the VAT charge).

“Therefore, to treat the general financial services as an exempt supply of services and then recovery of loan amounts through auction, which is part and parcel of the financial services is not a proper alignment of the law,” a tax lawyer, who requested not to be named because they are not authorised to speak for their organisation, told Daily Monitor in an interview.

In their missive, the KAA lawyers also argue that if the proposal by the Executive is sanctioned by Parliament, it will be at “odds with the nature of financial services.”

The proposed amendment, they argue, comes at a time when the High Court has already held that when one aspect of a financial institution is exempt under a provision of the law, it cannot be subject to tax under another provision.

The court ruled that funds obtained from the auction of mortgaged property are exempt from withholding tax. This exemption is based on the understanding that borrowers repaying the principal sum borrowed from a financial institution do not incur withholding tax; as such, repayments do not constitute income received by the financial institution. Rather, they are viewed as refunds of the amounts initially advanced by the financial institution. Interest income earned by banks is also exempt from withholding tax.

“The above decision applies equally to the proposed amendment. To put the above case into context, if the borrower fully repays the loan and the mortgage is discharged, no VAT is chargeable upon repayment and issuing of a mortgage discharge instrument. In the same way, where the mortgaged property is sold by the bank, no VAT should be payable, given that the intention is to recover the capital and interest from the mortgaged property as if the original borrower had paid it. This is especially so on the basis that dealings in loans by financial institutions are exempt from VAT,” Mr Musinguzi wrote.

Section 31 of the Mortgage Act, 2009, requires banks to account for the proceeds of the sold property by applying them to recovery of the outstanding principal loan amounts, interest and charges and other payments listed thereunder. Thereafter, any surplus is paid back to the borrower.

By selling mortgaged property, the bank is merely put in the same position, as it would have been if the borrower had paid their outstanding loan and interest. If anything, the bank may actually be put in a loss position, where the proceeds of the sale are insufficient.

The proposal

Section 10(4) of the Value Added Tax Act, Cap. 349, is to be amended so that the recipient of the auction proceeds, who in most cases are financial institutions, will be responsible for accounting for the VAT when goods are sold through an auction.

This means if a financial institution sells a foreclosed item, by auction, URA expects it to remit VAT of 18 percent of the proceeds and consequently, the financial institution will have to charge this VAT to the buyer. This proposed change builds on and alters last year’s amendment to the VAT Act, which indicated that during the auction process, the auctioneer is the supplier of the goods, and so is obligated to account for the VAT.