This Selected Issues paper and Statistical Appendix describes how to improve value-added tax (VAT) compliance in Uganda. The paper highlights that although the VAT in Uganda has a single positive rate and broad coverage, its initial threshold of U Sh 20 million may have been set too low, and a number of items that should have been exempted were zero rated. This paper presents a brief survey of the financial sector of Uganda. Public sector reforms and the privatization program are also discussed.

Abstract

This Selected Issues paper and Statistical Appendix describes how to improve value-added tax (VAT) compliance in Uganda. The paper highlights that although the VAT in Uganda has a single positive rate and broad coverage, its initial threshold of U Sh 20 million may have been set too low, and a number of items that should have been exempted were zero rated. This paper presents a brief survey of the financial sector of Uganda. Public sector reforms and the privatization program are also discussed.

IV. The Privatization Program15

46. The privatization process started in 1992 with the objective of reducing the role of the government in the economy and creating an environment conducive to high and stable economic growth based on increased private sector development.

A. Legal Environment and Institutional Framework for Privatization

47. The main legal document giving direction to the privatization process is the Public Enterprise Reform and Divestiture (PERD) statute, which came into force in October 1993. The PERD statute listed all the existing public enterprises (107 total) and divided them into five classes. Out of 107 enterprises, 85 percent (i.e., 90 enterprises) were to be privatized by the end of 1997. Table 9 shows the distribution of public enterprises by these classes in 1993. The PERD statute was amended in 1997. The most important change was regrouping enterprises into classes and eliminating class III (i.e., government does not retain minority ownership in any enterprise); the definitions of classes I, II, IV, and V are the same as in the PERD statute of 1993. As Table 9 shows, the number of enterprises designated for full divestiture almost doubled since 1993. The total number of enterprises was also higher (114, compared with 107 in 1993); the increase was mainly due to counting subsidiaries and branches of companies as separate enterprises. In addition to the regrouping of enterprises, the amendment changed the payment method by buyers and emphasized the need for transparency in the process (see below).

Table 9.

Uganda: Public Enterprises as Classified by the PERD Statute

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48. The PERD statute also stated that all proceeds from privatization should be kept separate from the government budget and included in the Divestiture Account (DA). The privatization proceeds should be used to pay off debts, finance retrenchment packages for laid-off workers, and meet other restructuring costs of the enterprises prior to divestiture, if needed. The remaining funds could be used for general promotion of entrepreneurship in Uganda. Furthermore, the PERD statute provided an institutional basis for privatization by creating the Divestiture Reform Implementation Committee (DRIC), which was charged with implementing the policy on divestiture as stated in the PERD statute. However, the DRIC is not responsible for day-to-day implementation of the divestiture program, such as the valuation of enterprises, evaluation of bids, or negotiation of contracts; these tasks are carried out by the Privatization Unit at the Ministry of Finance (and approved by the Minister of Privatization).16

B. Overview of Progress

49. After a slow start in 1992/93 and 1993/94, the speed of privatization picked up (Table 10). By the end of December 1997, 78 enterprises had been privatized and an additional 2 were privatized soon thereafter. Most of the privatized enterprises operate in the manufacturing, agriculture, finance, tourism, and trading sectors. The 43 public enterprises remaining to be privatized include some of the largest public enterprises, for example, in transportation and communications.

Table 10.

Uganda: Number of Privatized Companies, 1992/93–1996/97

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Source: Privatization Unit, Ministry of Finance.

50. For the sample of 45 enterprises privatized between 1992/93 and 1996/97 for which the sale price is available (the remaining were liquidated), the total gross value of sales (measured by price, including liabilities) was approximately US$112 million, excluding US$26.9 million for one large enterprise (the Nile Hotel) which subsequently reverted to the Privatization Unit.17 The median price for which the enterprises were sold was US$0.65 million during that period. However, there was a large variation, ranging from US$240 to US$20.5 million. The four largest divestitures were Uganda Cement Hima (US$20.5 million), Shell Ltd. (US$12.8 million), Agricultural Enterprises Ltd. (US$12.7 million), and the Uganda Commercial Bank (US$11 million). These four sales accounted for 51 percent of total (expected) proceeds. Table 11 shows collections from divested public enterprises in shilling terms.

Table 11.

Uganda: Collections from Divested Public Enterprises, 1992/93–1996/97

(In millions of Uganda shillings)

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Source: Ministry of Finance.

As of end-December 1997.

Includes Nile Hotel, which was subsequently repossessed by the government because the buyer did not meet the terms of payment specified in the contract.

51. Out of 45 sales of public enterprises (for which data are available) between 1992/93 and 1995/96, 15 were purchased by foreigners and 2 included some foreign investment. Foreigners will generate almost 70 percent of the expected proceeds from privatization sales of these 45 enterprises.18 While sales of assets/liquidations dominated privatization in the earlier stages, the sale of shares, combined with public flotation, is expected to prevail in the case of most of the larger public enterprises. The cash proceeds from divestiture slightly exceeded cash expenditures as of December 31, 1997. However, it is possible that future cash proceeds will not be sufficient to cover the cost of divestiture and reform of the larger enterprises; in this event, the speed of privatization could be constrained in the future unless alternative sources of funds are found.

52. The Ministry of Finance calculated the value of subsidies to public enterprises to amount to U Sh 208.5 billion in 1996. Most of this was in the form of indirect subsidies, broadly defined to include equity support, preferential interest rates, favorable tax treatment, and subsidies resulting from the enterprises’ monopoly position.

C. Stages of Privatizing Individual Enterprises

53. As a first step in the privatization process, the DRIC selects the companies to be sold from the list in the PERD statute. The criteria for selection included political considerations, market demand and expected degree of difficulty in selling the enterprises, and the availability of resources at the Privatization Unit. The privatization program initially focused on the smaller enterprises, leaving the larger ones (whose sales are more difficult and costly) to the latter stages. This strategy partly reflected a scarcity of technical capacity; at the same time, the intention was to establish momentum by privatizing a large number of small enterprises. This strategy was also considered useful in gradually building up more general public acceptance of the privatization program. However, the disadvantage of this approach is that the more difficult cases are left to be tackled at a late stage.

54. The Privatization Unit carries out—through independent auditors—a detailed audit of the enterprise to be privatized. The procedure can last up to six months and consists of a legal audit, asset evaluation, and price assessment. The objective of the legal audit is to determine the ownership structure of the enterprise, the contractual obligations of the enterprise, and the rights of the government during the privatization process.19 The case of Lake Victoria Bottling Company, which after its privatization was engaged in a long legal dispute with minority shareholders, illustrates the importance of a thorough legal audit (Box 1). The legal audit is particularly complicated in the case of the public enterprises nationalized in 1972 under the Expropriation Act that had belonged to Asian owners.20 If one of these enterprises is to be privatized, the legal auditor needs to trace the history back to before 1972 to see if there is pending litigation involving the previous owners.

Uganda: The Privatization of a Bottling Company

The Crown Company, established in 1950, is one of the oldest in Uganda. It was nationalized in 1972 under the Amin regime; in 1986, the government attempted to return it to the previous owners, but nobody claimed ownership. In 1992, when the company was singled out as one of the first ones to be privatized, the government owned 98 percent of the shares, and 2 percent of the shares were owned by the public.

The company was sold in 1992 for US$ 3.6 million; the buyer took on the company’s liabilities in value of US$ 2.6 million. The buyer took on also 400 employees and was responsible for paying them retrenchment packages in case of layoffs. The name of the company was changed to Lake Victoria Bottling Company. By 1995, an investment of US$5 million had been undertaken; the financing for it was obtained through loans from abroad. The most difficult and time-consuming matter in the privatization process was related to compensating the minority shareholders; this negotiation was concluded only recently.

The company’s annual output is 5.2 million cases of soft drinks a year, and it accounts for half of the Ugandan market. The main obstacles to operations reportedly include difficulty in obtaining credit, taxation (excise taxes), and a shortage of skilled labor. In January 1998, a foreign investment fund purchased 51 percent of the company’s shares, with the objective of significantly increasing production.

55. The legal audit is followed by the valuation of assets and liabilities. Finally, the auditors assess the value of shares in the company. Until mid-1996, the price per share was determined simply by dividing the value of assets (in some cases, the net worth) by the number of shares. This method, however, resulted in a large deviation of the expected price from the actual one (the actual price being much lower). Since mid-1996, the pricing of shares has been based on future earnings. While the prices derived in this way are closer to the prices actually obtained, the valuation may lead to public misconceptions about whether full value is being obtained from the sale. The privatization process was publicly criticized in 1994 after two large companies (Lake Victoria Bottling Company and East African Distilleries) were sold at what were considered “give away” prices. Acceptance of the privatization program increased after 1995, when some shares of privatized companies started to be offered to the public through auctions.

56. Based on the audit information, the Privatization Unit, together with the relevant sectoral ministry, prepares a Divestiture Action Plan that describes the enterprise’s activities, its financial situation, and ownership structure. The plan also proposes whether the enterprise should be restructured prior to being put up for sale, and if so, how.21 Finally, it specifies a proposed method of sale, expected price, and advertisement method. The Divestiture Action Plan must be approved by the DRIC before the enterprise is actually put up for sale.

57. In choosing the method of sale, the Privatization Unit has opted so far to sell assets (and taken responsibility for the liabilities) in enterprises with a negative net worth, and to sell the shares through either auction or tender offer in other enterprises. The largest enterprises, most of which are still to be privatized, will be sold through a combination of share sale and public flotation, that is, part of the shares will be offered for sale to the public, some of them through the recently opened stock exchange. One of the largest bottlenecks of the privatization process has turned out to be the preemptive rights held by the existing private shareholders of a number of public companies and joint ventures. This is because existing private shareholders have the right to be the first ones to receive the offer to buy the government’s shares, and, in some cases existing private shareholders also have the right to refuse any new shareholder. Basically, the government’s shares cannot be advertised for sale until the preemptive rights of the private shareholders are settled. Because of this legal impediment, privatization of at least eight enterprises has stalled, as the existing private shareholders have been reluctant to either purchase government-owned shares or let the government offer them to others.

58. The Privatization Unit prepares a sales announcement containing information on the firm’s activities and financial situation, as well as rules of the bidding process; the sales announcement serves also as advertisement material. In addition, in some cases, the Uganda Investment Authority directly approaches several potential investors. An example of this latter approach is the Kibimba Rice Company (Box 2).

Uganda: The Privatization of a Rice Company

Kibimba Rice Co. was established in 1977, with Chinese assistance, to produce rice. Because of poor cultivation practices, yields were low and production was eventually halted.

Tilda International Rice Co., a major rice producer based in the United Kingdom and with markets in 45 countries, was informed several times by the Uganda Investment Authority that Kibimba would be on the list of enterprises to be privatized. The Kibimba was advertised for sale in the Ugandan newspaper from July through August 1996. There were seven bidders; Tilda won, and was awarded the contract in October 1996. It took another half year, until March 1997, for Tilda to receive the exemption that allows it to grow rice on the leased land (in general, foreigners are not allowed to own land used for agricultural production). The production is now in a trial stage (output is 1,000 tons of paddy a year), but Tilda’s shareholders have already undertaken investment of US$3 million, and the company is finalizing details for a loan of US$32 million from IFC/DCFU. It is expected that by the end of 1998 the plant will operate at full capacity and produce 5,000 tons of paddy a year.

59. Currently, small enterprises are advertised locally for about one month and sold immediately afterward. Larger enterprises are advertised both locally and internationally for about three months; this interval is referred to as the “prequalification period,” during which potential investors have to demonstrate their commitment by paying a bid fee. After that, selected bidders have one month to submit their final bids. Bid requirements include the price and method of payment, and the business development plan; the weights given to the price and the plan in the final decision vary according to the type of business, and are known to bidders in advance (usually 70 points for the price, 30 points for the business plan). Sometimes, specific requirements are imposed on the bidders, such as maintaining employment at a certain level or undertaking investment. After the Privatization Unit selects the winning bidder, the DRIC must approve its decision.22

60. Once the bidder is approved by the DRIC, the final contract between the buyer and the government is signed. In some cases in the past, the winning bidder has exploited his position during this period (as the competitors are looking elsewhere) to renegotiate the contract. Even if the contract is not changed, because of weak law enforcement there is a risk that the buyer will not fully uphold the contract.23 In a number of cases, for example, buyers did not pay the agreed amounts for the enterprises as scheduled (Box 3). To eliminate the problem of nonpayments, the amended 1997 PERD statute states that “privatization sales shall generally be on a cash-only basis and extended terms of payment shall be avoided,” but exceptions can be granted.

Uganda: The Privatization of a Textile Factory

The case of NYTIL (Nyanza Textile Industries, Ltd.) illustrates the problems with collection of payments experienced during the privatization process. It also points to some of the impediments to development of the private sector in general.

Before it was privatized in 1995, production in the factory had been halted. The sale of the factory was advertised for two years before it was sold for US$ 10 million; there were only two bidders. So far, however, the investor has paid only US$2.1 million and is asking for a waiver on the rest of the payments, claiming that the value of assets was much lower than stated in the contract, and that most of the machines could not be used. An investment of US$14 million to replace the outdated machinery was undertaken. Currently, NYTIL has 20 percent of the domestic market share and is employing 1,000 people.

Some of the problems reported by the owners relate not to the privatization process itself but rather to general difficulties encountered. After acquiring the company, the new owner experienced difficulty in obtaining domestic credit, which carried high interest rates, and found loans abroad. Since most of the remaining market share is supplied through imports, inadequate customs control with respect to textile imports created additional competitive pressures. Also, the supply of electricity is uncertain and inadequate, reflecting the poor power supply in Uganda. Finally, skilled labor is scarce, and labor productivity low. These factors contribute to the problems of the company, which is operating below its capacity and is not generating profits.

D. Conclusions

61. Uganda has launched an ambitious privatization program that has generally had a positive impact on the economy. In many of the privatized enterprises, employment has increased, new investment has been undertaken, and the quantity and quality of output have improved. As the privatization program proceeds to tackle the larger enterprises, more difficult problems arise. These include the need to make careful preparations to solve the technical, legal, and social issues related to massive layoffs that face larger enterprises; the need to avoid excessive delays and lengthy negotiations that enable existing management and employees to engage in asset “stripping;” the importance of minimizing political interference; and the risks of delays caused by factors beyond the control of the government.

62. A steady adherence to the privatization program would increase the confidence of investors in the government’s commitment to privatization. Even though some delays are beyond the control of the government, steady progress in privatization can be achieved through better technical preparation and elimination of political interference. Moreover, improved transparency would increase the confidence of the public and investors in the privatization process, while minimizing justifications for political interference.

Bibliography

  • Ministry of Finance and Economic Planning, 1996, Background to the Budget 1996–1997, (Kampala, Uganda).

  • Ministry of Finance of Uganda, 1993, The Public Enterprise Reform and Divestiture Statute (Kampala, Uganda)

15

Prepared by Zuzana Brixiova.

16

In 1995, two units for implementing the PERD statute were created: (i) Parastatal Monitoring Unit (to monitor public enterprises), and (ii) the Privatization Unit (to handle the divestiture of public enterprises).

17

In the case of the Nile Hotel, the buyer did not meet the terms of payment specified in the contract, and the hotel was repossessed by the Privatization Unit. It is now again on the list of enterprises to be put up for privatization.

18

This does not include sales of enterprises with only partial foreign participation.

19

If the enterprise is fully owned by the government, it is first transformed into a limited-liability company.

20

In 1980, the nationalization decision was reversed, and in some cases joint ventures between the government and the former owners were initiated.

21

The 1997 amendment of the PERD statute states that “there will be a moratorium on new government investments in enterprises that are to be privatized except for financial and operational restructuring measures necessary to prepare the enterprise for sale.” Consequently, restructuring measures are limited to reducing liabilities and laying off workers.

22

On occasion, the DRIC has been forced to reverse its decision, owing to subsequent legal rulings. A recent example is Apollo (Sheraton) Hotel, where DRIC’s decision was reversed by the Inspector General of the Government. The DRIC ultimately awarded the contract to another bidder.

23

In some cases, the buyer has violated the contract by engaging in more risky projects than outlined in the business plan that was part of the contract and, consequently, could not make the agreed payment on schedule.