Thin capitalisation rule plays a key role in protecting Botswana’s tax base. They prevent companies especially multinationals from using excessive related-party debt to shift profits offshore through inflated interest deductions. The rule promotes balanced -financing and companies dealing with each other at arm’s length and helps the country to get a fair share of tax revenue. Ultimately, thin capitalisation rules help create a more transparent and equitable corporate tax environment. It is quite imperative for companies to be cognizant of this rule when doing financial or tax planning.
Though Botswana Income Tax Cap 52:01 does not necessarily explicitly mention ‘thin capitalization’, it just provides guidelines that prevent excessive allowable interest deductions.
Who is affected:
The concept applies to companies that are financed with a high level of debt compared to equity. Excessive debt can allow a company to deduct large interest payments thereby reducing taxable profits significantly. Income Tax (Amendment) Act, 2019 amended Section 41(A) by introducing limits to the deduction of interest expenses through the 30% rule.
30% EBITDA rule :
The net interest expense is only allowed a deduction with a ceiling of 30% of tax EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). Any excess of the net interest expense is added back to profits to be taxed normally at prevailing company income tax rates.
Example:
A Botswana company (ABC Proprietary Limited) is funded mostly by a loan from its foreign parent as below:
Equity: P200,000
Related-party loan: P2,000,000
Interest charged: P200,000/year
This creates a 10:1 debt-to-equity ratio, which is unusually high and raises eyebrows of the taxman.
🔍 How BURS may look at it:
BURS may deem this as excessive and upon assessment apply a reasonable debt level (e.g.,3:1).
Allowed debt: P600,000 (30% *P2,000,000)
Excess debt: P1,400,000
💡 Tax Effect
Only interest on the allowed debt is deductible.
Interest charged: P200,000
Interest disallowed: P140,000
Interest allowed: P60,000
The excess P140,000 is added back to taxable income and charged at 22% income tax rate.
Who is exempt:
The limitation however exempts companies whose main line of business is banking or insurance, variable rate loan stock companies and micro, small or medium enterprises (SMMEs). SMMEs in this case refers to companies which do not own 20% shareholding or more in another company or that have another company owning at least 20% of their shares.
Implications of the thin cap rule:
- Higher Tax Liability: When excessive interest is disallowed, companies pay more corporate tax.
- Strengthened Transfer Pricing Compliance: Companies must prove that loan amounts, interest rates, and terms between related parties are at arm’s length and commercially reasonable.
- Impact on Financing Strategy: Companies may need to redefine their capital structure by introducing more equity and reducing over reliance on intra-group loans.
- Audit Risk and Penalties: Non-compliance can trigger increased tax payable, with possible penalties and interest charges during BURS audits.
- Increased documentation requirements: Signed loan agreements, financing policies, and commercial justifications must be maintained for BURS.
Conclusion
Thin capitalisation rules ensure that profits earned in Botswana are taxed fairly in Botswana. By discouraging excessive related-party debt, they protect the tax base and promote transparent, commercially sound or arm’s length transactions. Businesses needs to remain abreast on these requirements to avoid increased taxes and possible interests and penalties.
