A withholding tax is a government requirement for the payer of an item of income to withhold or deduct tax from the payment and pay that tax to the government. Many jurisdictions around the world use this method of tax collection, in one form or another. PAYE (Pay-As-You Earn) is probably the most common form of withholding tax but there are others. In Tanzania, the income tax law also places withholding tax obligation on the payer of some specified types including service fees and professional service fees.
As a general rule, resident individuals not in business in Tanzania do not have obligation to collect withholding tax when making payments for any of the specified incomes.
Also withholding tax would not apply if the income or the person receiving the income is exempt. Withholding tax does not apply on payment of goods unless the payment for the goods is done by an institution whose budget is wholly or substantially financed by the government.
A resident person who pays another resident person a service fee for provision of ‘professional services’, must withhold tax from the payment at the rate of 5 per cent of the amount payable. However, if the professional services involve “construction works”, a special rule applies.
The Finance Act 2016 introduced a special rule for construction works.
wever, my experience for the past two years or so in this area suggests that the new rule is still unknown to some taxpayers.
Construction works, normally involve construction materials and services (labor) and therefore, a tax invoice from a contractor is most likely to have the two items.
The special rule requires that the payment which is subject to withholding should be based on the ratio 60 percent materials and 40 per cent services.
Suppose a tax invoice from your contractor reads “materials Sh90 million and labor Sh10 million, a total of Sh100 million before VAT”. If you are paying the contractor now, you are obliged to withhold tax of 5 per cent on Sh40 million (i.e. 40 per cent of Sh100 million) rather than the Sh10 million indicated on the invoice from your contractor. There are several aspects of the new rule that are not clear and may limit the intended anti-avoidance effect.
The rule is not clear in situations where a contractor bills for materials only (whether as part of the contract or a tax avoidance plan where the contractor decides to offer the services for “free” and maximize his profit on materials). The key phrase “construction works” has not been defined. The rule set a point rather than a minimum. What if the service component actually billed is higher than what is required by the law?
Recently, one of my clients wanted to make a payment to an air conditioner (AC) contractor engaged to just repair split units of his office. Apparently, the invoice had 90 per cent labour and only 10 per cent AC materials. The question was whether such AC repair qualifies as “construction works” and if it so qualifies, should withholding tax be on the actual labor indicated in the invoice (90 per cent) or just the 40 per cent required by the rule? Clearly, under this kind of cases, the rule provides a leakage rather than anti-avoidance.