Capital Increases and Franco Valuta Under Ethiopian Law

This briefing has been published by Atkilit Bekele and Yemisrach Tassew of Mesfin Tafesse & Associates, Ethiopia, who have agreed to it being made available on Simmons & Simmons elexica.

This article will highlight the legal and practical aspects of in kind contribution. It will further discuss the issue in connection with the recent decision and issue of a letter by the Ministry of Justice (currently re-organised as the “Federal Attorney General”) concerning the notarisation of resolutions dealing with capital increase through in-kind contribution of goods, which are imported by shareholders on Franco-Valuta basis.

In-kind contribution of capital under Ethiopian law

Under the Commercial Code of Ethiopia (the Code), capital is defined as the original value of the elements put at the disposal of the undertaking by the owner or partners by way of contributions in cash or in kind. The Investment Proclamation 769/2012, under Article 2 (3) also defines capital as local or foreign currency, negotiable instruments, machinery or equipment, buildings, working capital, property rights, patent rights, or other business assets.

The Code provides that contribution of capital of a company can be made either in cash or in kind. The recently issued Commercial Registration and Licensing Regulation no. 392/2016 goes one step further and allows rights on intellectual property such as, patent, copyrights to be contributed as capital, upon authentication of shareholders’ resolution to this effect by a public notary.

The Code requires that when capital contributions are to be made in kind, the Memorandum of Association for establishment of a company shall show the nature and value of contributions in kind, the price at which the contributions are accepted, and the number of shares allocated to the shareholder in exchange.

In the case of share companies, it further requires a report prepared by experts appointed and sworn by the Ministry of Trade (the Ministry) to be submitted to the Ministry, as to the valuation of the contribution in kind. However, as per the Commercial Registration and Licensing Regulation no. 392/2016, a signed statement shall be submitted to the Ministry together with the application for registration, showing that the contribution made by the shareholder is to be transferred to the partnership or PLC within a year after the registration of the company is made. Where there is a contribution of intellectual property, minute or similar document authenticated by a notary public shall also be submitted to the Ministry.

After establishment, companies can increase their capital through contribution of shareholders made either in cash or in kind or through increasing the par value of existing shares. The main topic of this legal update is capital increase made by way of in kind contribution of goods imported on Franco-Valuta basis.

Franco-Valuta privilege

Franco-Valuta privilege is basically a permission to import goods on which foreign exchange is not payable following the strict payment procedures implemented by banks and regulated by the National Bank of Ethiopia (NBE). In other words, goods can be imported without the need for the importer to open a Letter of Credit (L/C), Cash Against Documents (CAD) or Telex Transfer (TT). The importation of goods on Franco-Valuta basis was first introduced in Ethiopia during the imperial regime, and regulations issued thereafter provided a list of goods and organisations entitled to use this privilege. Currently, it is governed by the Revised Regulation on the Importation of Goods on Franco-Valuta Basis, Council of Minister Regulation No. 88/2003 G.C. (the Regulation). This Regulation has repealed the previous Regulation No.8/1996, which allowed foreign investors to import goods and machinery on a Franco-Valuta basis.

The Regulation does not expressly entitle foreign investors to import capital goods on Franco-Valuta basis. It restricts its application only to goods imported by Ethiopian investors or foreign nationals of Ethiopian origin for investment activities including capital goods and raw materials adequate up to commissioning stage and for their personal use. However, the Directive on the Importation of Goods on Franco-Valuta Basis, issued by the Ethiopian Revenue and Customs Authority (ERCA) to implement the Regulation, Directive No 66/2013, as amended (the Directive), gives foreign investors the privilege to import goods using the franco valuta privilege. The Directive states that foreign investors which have invested in the manufacturing sector have the privilege to import the following goods:

• goods used in the undertaking of their manufacturing activity other than capital goods
• accessories for machineries which they have imported with tax incentives, and
• other accessories which are proved to be either unavailable or not manufactured in Ethiopia.

According to Article 8 (3) of the Directive, the discretion to grant foreigners this right is given to the Deputy Director of the respective branch office of ERCA.

Previously, it was a common practice for eligible investors, who imported goods using the Franco-Valuta privilege, to register the imported good as an in-kind contribution of the shareholder who has made the payment for the purchase of the good abroad, and request registration of the capital increase by presenting a notarized shareholders’ resolution for the capital increase corresponding to the contribution.

Recently, the Office of the Federal Attorney General which is the supervisory organ of the Federal Document Authentication and Registration Agency (the DARA), has issued a Circular addressed to DARA with a copy to the Ethiopian Investment Commission (EIC) stating that DARA should not accept request for capital increase by way of contribution in-kind relating to goods imported by a shareholder through Franco-Valuta.

The office of the Attorney General’s concern and restriction emanated from its interpretation of the beneficiaries of the Franco-Valuta privilege as only investments and companies, as opposed to “shareholders”. In a typical exemplary scenario, a Franco-Valuta privilege arises when one shareholder of an Ethiopian resident company finances the purchase of a good abroad by paying the supplier directly with the required foreign currency and the company facilitates its importation into Ethiopia on Franco-Valuta basis. Once the company receives the goods, the shareholders’ will pass a resolution for the increase of company’s capital and allocate the additional shares created as a result of the capital increment to the shareholders’ who financed the purchase of the capital good. The Attorney General’s Office objects this kind of arrangement claiming that the privilege is used by individuals whereas only companies through which the investment is made are intended to be the beneficiaries.

The goods imported on Franco-Valuta basis are imported duty free. As per Article 130 of the Customs Proclamation 859/2015, it is prohibited to transfer duty and tax exempted imported goods to a person who is not enjoying similar privileges or use them for a purpose other than which the duty free privilege is granted or place them under the possession and service of others before payment of the duties and taxes applicable to them. In the context of the typical scenario described in the foregoing paragraph, the office of the Attorney General interprets that the Company has transferred its right of duty free importation on Franco-Valuta basis for its shareholders who do not enjoy the same privilege by the law.

In its initiative to redirect the use of the Franco-Valuta privilege to its intended targets and eliminate abuse, the Ministry provided in its Circular how to legitimately use the Franco-Valuta privilege and register contribution in-kind as a capital increment. Thus, as per the Circular and the requirements of other applicable laws, companies should follow the following steps in order to legitimately use the Franco-Valuta privilege:

1. first, the shareholders shall hold shareholders’ meeting with the agenda of making use of the Franco-Valuta privilege their company is entitled to and endorse it
2. second, discuss and approve the means by which the privilege would be financed indicating the source of capital and how the capital should be allocated to the shares of the shareholder financing the use of the privilege
3. third, reduce these deliberations and approvals into minutes and resolutions
4. fourth, get the Resolution notarized at DARA
5. fifth notify the concerned institutions such as EIC and ERCA which will give the permission for the importation of the good on Franco-Valuta basis, and
6. finally, register the capital at EIC as per the resolution, and obtain capital registration certificate.

If the shareholders decide to finance the purchase of the good to be imported through the use of the Franco-Valuta privilege using shareholder loan or any other third party loan (external loan), such shall be recorded in the minute and simultaneously obtain the approval of the NBE as required by the applicable law, so that the repayment process can be smooth.

The Circular does not address how goods imported before the issue of the Circular are to be treated. This created a problem for both the implementing institutions on how to accept applications for capital increase through contributions made by way of importation of a good using the Franco-Valuta privilege and for investors who have goods on the way of importation. EIC requested the Office of the Attorney General give it an explanation on the implementation of the circular and a revision in light of the fact that it is creating difficulties for foreign investors.

In conclusion, it should be noted that until a clear regulation is passed, in order to use the Franco-Valuta privilege permitted by law, eligible investors should carefully take the above steps with prior consultation with the relevant government agencies such as DARA, EIC and ERCA, before ordering or importing their goods for the purpose of their investments.