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Kenya is proposing a special tax regime on startups’ Employee Share Ownership Plans (ESOPs), as it aligns to its plan to spur innovation.

The finance bill 2023 proposes the deferment of taxes on employee-allocated shares, recommending for them to apply after the expiry of five years from the time of share-award, or when an employee sells them, or leaves the company.

The taxable benefit will be based on the fair market value of the startup’s shares at the end of the five years or at the time of the disposal, and where unavailable, the tax commissioner will make the determination based on the startup’s financial statements. If the changes are adopted, the special tax regime will come into effect on July 1.

Currently employees pay taxes, immediately, on the gains accrued between the dates they became eligible and when they exercised the share option.

“The way our (Kenyan) Income Tax Act works is that anything that an employee derives as a consequence of the employment is a taxable benefit. One of the benefits is also being given shares in a company [and] under the current Income Tax Act, that benefit becomes taxable immediately. Now, what they’re proposing to do is to delay the payment of that,” Daniel Ngumy, corporate law expert and partner at Anjarwalla & Khanna told TechCrunch.

“The drafting of the provision, in my view, generally almost captures the rationale, with an exception of provision three and four (refer to paragraph three) because the fair market value of the taxable benefit in five years could be high… I think it does not give them any real benefit, and will likely be amended because it gives them a worse outcome,” said Ngumy.

Startups offer employees equity as a way to retain talent, reward teams, and inculcate a culture of ownership to ensure that the prospects of the shareholders are aligned with those of the staff.

The special tax regime will be applicable to startups incorporated in Kenya, have an annual turnover of less than Sh100 million ($731,255), have been in existence for less than five years, and are not formed as a result of splitting or restructuring of another or an existing business. Startups in management, professional or training business are excluded.

The new tax follows remarks by Kenya’s President William Ruto, during the American Chamber of Commerce regional business summit earlier in March, where he hinted at the change saying that he had received complaints over the imposition of benefit tax “even before any value is realized.”

The shift, he said, is part of its government’s plan to make Kenya an attractive business destination, and the Africa’s top innovation center.

Kenya remains one of the top four market destinations in Africa in terms of VC investment.

Kenya plans special startups’ employee-equity tax regime by Annie Njanja originally published on TechCrunch