The National Treasury has revived its plans to impose a five percent withholding tax on interest earned on infrastructure bonds with tenures of at least three years.
The infrastructure bonds (IFBs) have been tax-free since they were first issued in February 2009 —meaning that they will be taxed for the first time if the proposal, which was previously contained in the shelved controversial Finance Bill, 2024, is approved by Parliament.
“The proposed Tax Laws (Amendment) Bill, 2024 proposes to introduce taxation of interest income from infrastructure bonds at the rate of five percent. This will apply to the bonds that will be issued from the date this provision becomes operational,” the National Treasury said on Friday.
IFBs are used by the government to finance the development or construction of specified infrastructure projects. The bonds have been popular in the market due to their interest-free profile.
The Finance Bill, 2024, had set withholding tax on income from infrastructure bonds at five percent for residents and 15 percent for non-residents on papers with maturities of at least three years and issued after June 1, 2024.
However, the proposal faced a backlash from financial experts during the public participation on the Finance Bill, 2024, who cautioned that taxing the bonds would trigger a demand for high interest rates by investors to cover for the returns lost to tax.
IFBs were first introduced in 2009 and have remained exempt from tax.
In contrast, regular Treasury bonds are subject to a withholding tax of 15 percent for papers maturing within five years and 10 percent for those with a tenor longer than five years.
Demand for existing infrastructure bonds is expected to soar if the reintroduced provision sails through, as holders are unlikely to let go of tax-free papers.
The government has leveraged the high demand for infrastructure bonds to meet its domestic borrowing needs as other fixed income bonds struggle to garner the same level of interest from investors.
The government, for instance, mobilised Sh319.6 billion from infrastructure bonds in the fiscal year ended June 2024, with the bulk of investors being commercial banks.
The lenders held Sh954.5 billion of the outstanding Sh1.7 trillion infrastructure bonds as of June, while non-banks held Sh758.6 billion worth of IFBs, including retail investors.
Non-residents meanwhile held a partly Sh13.9 billion of outstanding IFBs.
IFBs accounted for just over a third of net domestic debt or 35.41 per cent in the period under review.
The imposition of withholding tax on interest on IFBs may reduce their attractiveness to investors, although the rate remains comparatively lower than that on regular government securities.
The attractiveness of IFBs remains high at present, with the February bond, for instance, fetching a premium of up to Sh112 per a Sh100 unit of the paper in the secondary market at the end of last month.
The National Treasury had previously proposed taxing green bonds at the same rate as the IFBs.
