(a). Tax Implications of Equity and Debt Financing for Expedia

Equity

• The returns a person receives for holding equity in a company is dividend. (See definition of dividend in section 133 of Act 896)
• Dividend is not deductible for tax purposes. (See section 130(4) of Act 896)
• Dividend paid is subject to a withholding tax of 8%. (See section 115 and First Schedule to Act 896)
• A dividend paid to a resident company by another resident company is exempt from tax where the company which receives the dividend controls either directly or indirectly at least 25% of the voting power of the company paying the dividend. (See section 59(3) of Act 896)
• Where a company which is controlled by not more than five persons and their associates does not distribute to its shareholders as dividends, a reasonable part of the income of the company, the Commissioner-General may treat any part of the company’s profit as dividend after considering the current business requirement of the company and any other requirement necessary for the maintenance and development of the business. (See section 59(8) & (9) of Act 896).

Debt

• The returns on a loan or debt obligation is interest. (See definition of interest in section 133 of Act 896)
• Interest paid on debt obligations which is employed in the business or used to purchase an asset which is employed in business is generally deductible for tax purposes thereby reducing the corporate income on which tax is imposed. (See section 10 of Act 896)
• Interest on debt paid to a person other than an individual is subject to a withholding tax at 8%. (See section 115 and the First Schedule to Act 896)

The table below illustrates the difference between tax implications of an investor financing the activities of a company with either through debt or equity. For purposes of the illustration below, it is assumed that the CEO of Expedia expects a return of GHS10,000 from his investment either in the form of debt or equity in the Ghanaian company. It is also assumed that the CEO of Expedia will establish a subsidiary of the Expedia in Ghana instead of establishing a company in Ghana in which he is the direct shareholder.

From the scenario above, it is preferable for the investor to finance the activities of the company with debt instead of equity given the total tax exposure on the investment.

(b). Tax Treatment of Related-Party Loans

Candidates are expected to discuss the anti-avoidance provisions in Act 896 such as the need for arm’s length transactions and the thin capitalization rules which can be employed by the Commissioner-General to defeat tax avoidance schemes using the vehicle of related-party loans.

Arm’s Length Transactions

Section 31 of Act 896 provides that the income and tax implications of arrangements between persons in a controlled relationship must reflect the arm’s length standard. The arm’s length standard requires persons who are in a controlled relationship to quantify, characterize, apportion and allocate amounts to be included in or deducted from income to reflect that which would have been made between independent persons. Therefore, if a person provides a loan to a related person, the terms of the loan which includes the interest payable on the loan must reflect the interest an independent person in a similar circumstance would have paid on the loan. If the interest rate does not reflect that which would have been charged between independent persons, the Commissioner-General is empowered to adjust the interest to reflect the arm’s length standard. Therefore, the view that the related party lender can manipulate the interest rate to reduce corporate income tax liability is not entirely accurate since the Commissioner-General can adjust the arrangement.

Thin Capitalization

Another provision available to the Commissioner-General to prevent tax avoidance via related party loans is thin capitalization.

Section 33 of Act 896 provides that where a resident entity which is not a financial institution and which 50% or more of the underlying ownership is held by an exempt person either alone or together with associates has a debt to equity ratio in excess of 3:1 at any time during a basis period, a deduction is disallowed for any interest paid by that entity on the part of the debt which exceeds the 3:1 ratio.

Exempt person is defined in section 33 of Act 896 as either a non-resident person or a resident person for whom interest paid by a resident entity constitutes exempt income. Regulation 20 of the Income Tax Regulations, 2016 (L.I. 2244) defines “debt” to mean an obligation to pay an amount owed to an exempt person and “equity” to mean the sum of Stated Capital and Income Surplus.

Thus, if an exempt person who owns at least 50% of the underlying ownership in an entity provides a loan to that entity, the allowable deduction for interest will be restricted to that part of the loan which does not exceed three times the equity of that person in the entity.