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Orient Bank shareholders take URA to court

Saturday December 04 2010
bankpix

Entrance to the Orient Bank in Kampala

The hunter is suddenly the hunted as the original shareholders of Orient Bank slug it out with the Uganda Revenue Authority, in a case that will be watched closely by Uganda’s corporate world.

Indeed, its outcome could have far reaching ramifications for the tax collector and individuals or companies that have transferred their interests to third parties in the past few years.

Coming hot on the heels of a similar dispute between URA and oil exploration firm Heritage Oil, the case is also bound to be of interest to former shareholders of banks such as DFCU, Bank of Baroda, Nile Bank and three microfinance institutions.

The three microfinance institutions have recently been taken over by Kenyan and Nigerian financial institutions in a major swoop on Uganda’s banking sector.

On November 4, Ketan Morjaria, Rajni Karia and Jay Karia secured an injunction in the Commercial Division of Uganda’s High Court that blocked the tax collector’s attempts to enforce payment of nearly $18 million that the URA is claiming as capital gains tax on the April 2009 final transfer of 80 per cent of Orient’s shares to Nigeria headquartered PHB Bank.

At issue is whether the URA was acting within the law when it retrospectively billed the trio for capital gains tax on a transfer of shares that had taken place more than a year before tax laws were amended to make such transactions taxable.

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In dispute also is whether the shares were capital or business assets.
According to sources familiar with the case, in the transfer of shares to PHB, Morjaria and the two Karias made a profit of $59.7 million on their original investment of $3.5 million.

The full transfer price was $63.2 million, making it one of the biggest transactions in Uganda’s banking industry in recent times.

The share sell-off itself was forced by amendments to the Financial Institutions Act in 2004 that sought to bar an individual or related individuals from owning more than 49 per cent of a registered financial institution.

The amendments to the law were informed by a spate of bank failures in the 1990s that cost taxpayers billions. The Bank of Uganda was forced to compensate depositors of failed financial institutions.

The common denominator of all the guilty banks was that they were family-owned and inadequately capitalised, with heavy shareholder involvement in management and insider trading.

Like other players in the sector, Orient Bank was forced by the Financial Institutions Act 2004 to raise capital levels and given a grace period within which to dilute the stake held by the family.

Owning up to 97 per cent of Orient at the time, the Karias are father and son while Morjaria is related to them through his marriage to Rajni Karia’s daughter.

In November 2008, the Karias entered into a sale agreement with PHB and completed the sale on April 29, 2009. The bank was valued at $79 million and the Karias opted to sell 80 per cent of the shares, bagging $63.3 million.

Soon after, the URA wrote to the Karias asking for copies of the transaction documents, which were duly provided.

There followed a period of correspondence between URA and the Karias’ tax advisors during which it was argued that while there had been a gain on capital, there was no provision in the tax laws at the time for collection of the tax on transactions by private individuals or companies.

In July 2010, the tax laws were amended to provide for capital gains tax on transfer of assets by private companies and URA subsequently informed the Karias that it would try to recover tax on the sale of their shares. The Karias rushed to court as URA went ahead to raise an assessment of $17.9 million.

To bolster its case, the URA delved deep into commercial law to say they were assessing the gain as an“ Adventure in the Nature of Trade,” a term that itself raises questions over whether this one-off transaction forced by circumstances that the shareholders could not have anticipated when they set up the bank 19 years ago.

Experts say for the transaction to qualify as an Adventure in the Nature of Trade, selling and buying of shares must have been the principal business of the Karia’s.

In correspondence over the issue, the Bank of Uganda agrees the shares were capital and not business assets, an interpretation that the URA accepts but insists the transaction was an Adventure in the Nature of Trade.

Experts in financial law say the Karia’s can point to the 16-year period within which no shares were traded to argue that this was a transfer of capital assets and not an act of trade.

And that they were long term investors in much the same way as someone can make profits when they dispose of a family house.

There was no immediate comment from the authority over the issues but The EastAfrican has learned that even as the URA heads to court, there is no unanimity within the authority over the interpretation of the law.
Additional reporting
by Bernard Busuulwa

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