Overseas services: A withholding tax challenge

By Kunj Sinai

Advancements in international trade and technology have contributed to a dramatic growth of cross border services. In Tanzania, when a local business procures services from a non-resident, then payment for these services is subject to a 15 percent withholding tax on gross consideration (unless the rate is reduced by a Double Tax Agreement). This withholding tax applies irrespective of the place of performance of the service – so not just when a non-resident service provider (NRSP) is physically in Tanzania to carry out services, but also when it performs the services from its home country.

Where services are performed remotely then the application of withholding tax, and especially at a high rate, is a concern as it is unlikely that the NRSP will be able to claim a tax credit in their home jurisdiction for tax suffered in Tanzania; and even if tax credit relief is available to the NRSP, in most cases such relief for foreign withholding tax will be partial (as relief is normally capped at an amount equal to the attributable tax on such income in the home jurisdiction).

What is the implication? Contractual terms for cross border service contracts will normally incorporate a clause to adjust the consideration to take account of any withholding tax implications so that the net amount paid to NRSP (i.e. after deduction of withholding tax) remains constant. In other words, the NRSP simply passes on the cost (of withholding tax) to the local customer resulting in an increased cost of obtaining the service.

What is the potential solution? One approach could be to consider a lower withholding tax rate (perhaps, 5%) where the place of performance by the NRSP is outside Tanzania. In fact from 2004 to 2016 under the Income Tax Act 2004 the required nexus to trigger a Tanzanian taxing right on services provided by a non-resident was by reference to location of performance of services (which required performance in Tanzania); on the premise that for services performed in another country the taxing right should rest with that country.

However, following this becoming a point of contention between taxpayers and the Tanzania Revenue Authority (TRA), the law was amended in 2016 to provide for withholding tax to extend to services performed outside the country.

A contract that states the consideration to be “net of tax” simply reflects the NRSP’s wish for certainty on the payment to be received after taking into account the taxes suffered in the customer’s country. In such a case, the agreed net consideration is adjusted (by grossing it up to cater for the 15 percent WHT) – for example, if the net consideration is $200 then the gross consideration becomes USD236 (being USD200 x 100/(100-15)) and so the customer pays (i) USD36 as the 15 percent tax to the TRA and (ii) $200 as the net amount to the service provider. This is the same economic result as where the contract is stated in gross terms for USD236.

As there is no tax leakage whether the consideration is stated net of tax (which is ultimately adjusted to a gross figure) or in gross terms, there should be no differential treatment.

However, the TRA’s perspective is that the “gross up” portion is non-deductible for tax purposes, and they support their position based on an amendment made to the law through the Finance Act 2016 (to include “withholding tax paid by withholder” as excluded expenditure for tax purposes). This disallowance of withholding tax is logical where the contract is not on a net of tax basis and the payer still grosses up the consideration or when the payer overlooks to withhold tax from a payment but later bears the cost by paying the tax to the TRA – in such a case the payer has borne a cost that was not a contractual obligation, namely the tax cost that should have been borne by the service provider. However, it is unclear how the same reasoning can be applied to a net of tax contract which results in a contractual adjustment to the contract consideration.

The issues in dealing with cross border services are clearly quite complex. One thing that is clear is that the application of withholding tax on payments for services supplied by non-residents even when performed overseas in practice results in additional costs for local businesses, and by extension an impact on competitiveness.

One measure that could help mitigate this cost would be lowering the withholding tax rate on services rendered by non-residents where place of performance is outside Tanzania – perhaps to five percent (from the standard 15 percent).

Kunj Sinai is a Senior Manager, Tax Services at PwC Tanzania.