Question: The deployment of system and application software improves information and knowledge management inside banks and financial institutions, insurance companies, telcos and other firms in Tanzania,. Also, it and can lessen transaction costs, as well asnd increase reliability and speed in delivering services to established and new customers. How are payments made by local firms to non-resident software licensors/owners for the purchase of computer software taxed in Tanzania? Specifically:, are the payments subject to withholding tax?
Answer: Recently, Tanzania’s highest court, the Court of Appeal of Tanzania (“the Court”) rendered its judgment in Celtel Tanzania Limited v. Commissioner General (TRA) Civil Appeal No. 56 of 2018 along with its companion case of National Microfinance Bank Limited v. Commissioner General (TRA) Civil Appeal No. 68 of 2018 in which it considered the same question of whether amounts paid by local firms to non-resident software licensors/owners for the purchase of computer software are royalty payments subject to withholding tax in furtherance of section 83(1)(b) of the Income Tax Act, 2004 (“the ITA, 2004”).
In the Celtel Tanzania Limited case, the appellant telco submitted that it purchased software not as an intangible asset (copyright i.e. the right of the author to control the use of his/her work for a limited period of time) but instead as a fixed asset (copyrighted material i.e. an original work of authorship which is fixed in a tangible medium of expression).
Consequently, in the telco’s view, the payments made to the non-resident software licensor constituted business profits in the hands of the licensor and were not rental/lease payments for time-limited usage of the software. The respondent, the Commissioner General (TRA), submitted that the payments were made by the appellant telco for the lease of the software and, thus, constituted royalty payments which are subject to withholding tax under the ITA, 2004.
The Court agreed that the payments for computer software purchases are payments in exchange for the licence (right) to use the software; that’s to say, royalties in respect of which withholding tax is payable. In reaching this conclusion, the Court closely scrutinized the terms “lease” and “royalty” as interpreted in section 3 of the ITA, 2004 and the title of the software purchase agreement, whereupon it noted that the agreement unambiguously granted the telco a license to use the software, such that the payments made were for temporary use of the software.
In the National Microfinance Bank Limited case, the Court yet again reasserted its position in Celtel Tanzania Limited pursuant to a review of the software purchase agreement titled ‘“Software License Agreement’” (SLA) and a finding of a clause in the agreement providing for the non-exclusive and non-transferrable right of the appellant bank to use the banking software supplied to it by a non-resident software licensor, Neptune Software PLC of the United Kingdom (“Neptune”). Consequently, the Court held that the SLA constituted a lease and that the payments made by the bank to Neptune for the use of the software were royalty payments which should suffer withholding tax.
Why the decision matters
These cases are worthy noting because the Court of Appeal of Tanzania specifically held in favour of the Commissioner General TRA that the software purchase payments made by Celtel Tanzania Limited (now , Airtel Tanzania Limited) and National Microfinance Bank Limited (now, National Microfinance Bank Plc) constituted payments for the licence (right) to use the software in question i.e. royalty payments in respect of which withholding tax is payable, thus creating judicial precedent which allows the TRA to impose withholding tax on every software agreement encompassing parallel clauses. The precedent binds the Tax Revenue Appeals Board and the Tax Revenue Appeals Tribunal.
It therefore behooves of businesses in Tanzania to begin paying close attention to their software purchase agreements. Hence, custom drafting is always the best idea because it is very dangerous to adopt boilerplate agreements which contain generic clauses.
Comparatively, the position reached in Tanzania on the taxation of computer software payments aligns itself with the position obtaining in neighbouring Kenya, a major gateway to the East African economic bloc and one of the top five providers of FDI into Tanzania.
Nevertheless, the position in India is different from that in Tanzania and Kenya: Indian courts have held that computer software purchase payments, being payments for purchase of copyrighted materials rather than copyright, are not royalty payments and, therefore, withholding tax does not apply.
The decision in the Celtel Tanzania Limited and National Microfinance Bank Limited cases should encourage firms in Tanzania to review standard software purchase agreements presented to them by software licensors/owners with a view to proposing changes in the wording of the agreements, if possible.
Paul Kibuuka (email@example.com) is a tax and corporate lawyer, tax policy analyst and chief executive of Isidora & Company.