Withholding tax - a continuing source of controversy
Businesses in Tanzania are required to withhold tax on various payments, including payments for service fees to non–resident service providers. Prior to July 2016, withholding tax (WHT) only applied to such payments either where services were rendered in Tanzania or where the payer for the services was the Government of Tanzania then irrespective of place of performance.
So, where the payer was not the Government, the question was whether services had been rendered in Tanzania. This interpretation was a matter of dispute between taxpayers and the Tanzania Revenue Authority (TRA), as TRA took the view that place of performance is irrelevant. In May 2016 in a landmark ruling in the PanAfrican Energy case the Court of Appeal ruled in favour of the taxpayer. In particular, it confirmed that WHT is not applicable on services performed outside Tanzania.
Hardly had the dust settled after this ruling, and a legislative amendment was passed to seek to capture into the WHT net any payment for services performed outside Tanzania.
This was by way of a Finance Act 2016 amendment (effective from 1 July 2016) which introduced a definition of the term “service rendered” to mean “transmitting or delivering of service in the United Republic of Tanzania irrespective of the place of performance of service”.
Whilst the object of this change was clear, for various reasons it is not so clear that in strict technical terms it achieves its objective.
However, based on events that transpired before the change, it is clear that the intention of the amendment was to subject WHT on all services paid for by a person in Tanzania irrespective of location of performance. Given this background, the prudent approach to avoid any conflict with the TRA would be to charge WHT on all payments to non–resident service providers.
On the downside, the imposition of WHT on services performed abroad is likely to result in increased costs for local businesses as the overseas service provider will pass on the cost of the double taxation likely to arise.
The double tax cost arises as it is unlikely that foreign tax authority will allow any tax credits on the basis of internationally accepted understanding of source rules that are based on place of performance.
For example, Company X is a non-resident that performs services from a place abroad to a beneficiary in Tanzania (Company Y), with a value of say $1,000. Company Y would pay a net amount of $850 after withholding $150 tax (at 15 per cent). If we assume Company X’s profit before tax is 20 per cent of revenue, this would mean a profit of $200. Assuming corporate income tax (CIT) is charged at the same rate as in Tanzania (that is 30 per cent), Company X will suffer CIT charge of $60 together with the WHT of 150 (assuming no credit has been provided) resulting to a total deficit of $10!
Even in the unlikely event that there is a right to a tax credit in the other country, it will be of little help if our withholding tax rate remains high. To use the example above the benefit of the credit would be to eliminate the home jurisdiction liability of $60 so the liability would be limited to the Tanzania WHT of $150 – but this would still represent 75 per cent of the $200 profit, leaving an after tax profit of $50 from the $1,000 contract.
Of course, Company X would not accept this and instead would seek to shift the burden of WHT to Company Y by contracting so that any WHT cost is effectively grossed up so that in net terms Company X still receives the $1,000.
The result would be to increase the fee and lower Company Y’s profitability. Alternatively, to maintain its margins, Company Y may in turn increase the price for its goods/services to the final consumer in Tanzania.
So what to do? Well, based on the above, for business purposes, ideally WHT should not apply on services performed abroad. Alternatively, where applied then the rate should be lower (say 5 per cent), similar to rate applicable to local services (as the margin for services is similar irrespective of whether these are local or foreign services) and result in less risk of double taxation for the supplier; ultimately this should feed through to lower costs for the local customer, who hopefully can become more competitive as a result.
Jeremiah Mbwiga is Senior Associate at PwC Tanzania - Tax Services. The views expressed do not necessarily represent those of PwC. For updates on tax and other matters follow @pwc_tz or visit www.pwc.com/tz
