Understanding Rwanda’s thin capitalisation limits and shareholder loan taxation

Introduction

Rwanda’s Income Tax Act (Law nº 027/2022 of 20/10/2022, as amended) contains specific thin capitalisation rules aimed at curbing excessive debt financing within corporate groups. These rules are particularly relevant where shareholder or related-party loans form a material portion of a company’s funding mix.

At the centre is a 4:1 debt-to-equity threshold for loans between related persons, which directly affects the deductibility of interest and certain foreign exchange losses. Understanding how this ratio is computed and applied is essential for early-stage and growth companies, founders, and investors structuring shareholder loans.

Legal framework and the 4:1 ratio

Article 25(10°) of the Income Tax Act provides that interest arising from loans between related persons is a non-deductible expense to the extent total loans exceed four (4) times the company’s paid-up equity. For this calculation, paid-up equity excludes provisions, reserves, and retained earnings, emphasising initial capital contributions over accumulated profits.

In addition, Article 25(11°) clarifies that realised foreign exchange losses on total loans between related persons that exceed the 4:1 threshold are also non-deductible.

Who are “related persons”?

Under Article 3(1°) of the Income Tax Act, related persons include individuals or entities that directly or indirectly participate in the management, control, or capital of another entity. The concept is elaborated in Ministerial Order nº 003/20/10/TC of 11/12/2020 establishing general rules on transfer pricing, which applies to controlled transactions between related persons. The thin capitalisation rules generally exclude banks, insurers, and other regulated financial institutions.

Tax effect when the ratio is exceeded

Where the 4:1 ratio is breached for related-party loans, the portion of interest corresponding to the excess debt becomes non-deductible for corporate income tax purposes. The company may still pay the interest, but it cannot reduce taxable profit by that amount, effectively increasing the corporate income tax liability.

Similarly, realised foreign exchange losses attributable to the excess related-party debt are non-deductible. The practical effect is to treat that portion of financing as if it were not pure debt for tax purposes, thereby increasing taxable profits, currently taxed at 28%.

Hybrid financing instruments

Convertible notes and other hybrid instruments often exhibit features of both debt (fixed interest, repayment obligations) and equity (convertibility). Rwandan tax law does not provide explicit guidance on their classification for thin capitalisation purposes or broader tax treatment, creating uncertainty for startups and investors.

Classification implications

If a hybrid is treated as debt, it falls under the 4:1 thin capitalisation test, affecting interest deductibility. Interest income is generally subject to 15% withholding tax, potentially 5% if listed on the capital market (Article 60 of the Income Tax Act).

If treated as equity, payments may be characterised as dividends, typically subject to 15% withholding tax, or 5% for listed securities where the beneficiary is a Rwandan or EAC resident taxpayer. Notably, the Investment Code (Law n° 006/2021) exempts withholding tax on up to five dividend issuances by a start-up to angel investors, subject to conditions (including a maximum investment of USD 500,000).

This incentive can be attractive if a convertible note is treated as equity at conversion or if payments are construed as dividends from the outset. In addition, dividends and interest from financial services are exempted from VAT.

Practical guidance

• Assess capitalisation: Before entering into related-party loans, review paid-up equity and model the 4:1 impact on interest deductibility and foreign exchange loss treatment.
• Consider equity alternatives: For angel investors and qualifying start-ups, leverage Investment Code incentives, including withholding tax exemptions on up to five dividend distributions and capital gains tax relief on primary equity issuance.
• Document and price at arm’s length: Ensure related-party loan terms, pricing, and conditions comply with transfer pricing requirements and are comparable to independent-party arrangements.
• Address hybrids early: For instruments such as convertible notes, seek guidance from RRA or structure terms to align closely with existing definitions of debt or equity to minimise classification ambiguity.

Conclusion

While the 4:1 debt-to-equity ratio for related-party loans is clearly defined, the absence of guidance on hybrid instruments requires careful planning. Early-stage companies, founders, and investors should work with legal and financial advisors to structure financing efficiently, manage risks, and focus on growth with confidence.

The writer is a Corporate and Legal Services Lead at Andersen in Rwanda.