An old friend called me a few weeks back. Having just started his company, he had provided professional services to his client, but his client only paid 95 per cent of the agreed fee. He is ‘forcing me to pay taxes in advance’, he said, asking for my opinion on whether that was okay and what legal action he should take.
I explained to this fried that his client was right to deduct 5 per cent from his payment. The tax is called withholding, which is tax that is withheld by a payer/recipient of the service before the payee get hold of the payment. Employee will relate to this tax pretty easily, your employer remits your ‘PAYE’, by the time your salary hits the account, your taxes have already been paid. This type of withholding tax is called a final withholding tax, that is you cannot claim a deduction when you suffer the withholding tax.
For non-final withholding tax, when one suffers withholding tax, such as the 5 per cent withholding tax on professional services provided by a resident person, the person who suffers withholding tax can claim a credit against their final liability at the time of filing their tax returns. In order words, this type of withholding tax is therefore not a tax per say, but an advance payment of tax which one can use as credit.
When thinking about withholding tax, one needs to address four key questions. Is the income sourced in Tanzania? Is the nature of the service or goods one that attracts withholding tax? Has a payment been made? And how do double taxation agreements impact how much withholding taxes to be paid?
The income tax law is clear that payment for services provided by non-residents to resident persons in Tanzania are subject to 15 per cent withholding, subject to any rate reductions or exemptions that may be provided by double taxation agreements.
It is therefore very likely that payments for services that a resident taxpayer makes to a foreign entity or individual will be subject to withholding tax, irrespective of where the services are actually being performed. This is a recent phenomena, as in the past, if the services were provided by non-residents outside the United Republic, these services would not attract withholding tax.
For local services, the law provides that a payment for the provision of ‘professional services’ attracts withholding tax at the rate of 5 per cent. The difference between resident and non-resident service providers is not just the rate, but also the finality of the tax.
Withholding tax for services provided by a resident person is not final, but withholding tax for payments made to non-residents is final.
One myth to be aware of is that ‘payments’, with respect to withholding tax, are not restricted to actual transfers of cash. The definition of ‘payments’ in the law is deliberately broad to include a ‘creation of an asset or liability’.
In other words, once you accrue a liability, withholding tax is triggered irrespective of whether you have made a payment to the supplier of the service. It does not even matter if you have received an invoice or not.
Recently, the Kenyan court of appeal ruled over a withholding tax, deciding against the taxpayer, in a way that is consistent with what is the practice in Tanzania.
The Court held that a payment is deemed to have been made even where no money has passed over. Furthermore, the Court pointed out that the sense in which the word “deduct” is used for withholding tax purposes, does not require physical movement but includes book entries recognising amounts due, taking into account the fact that income tax regime is based on the accrual system.
What this means is that taxpayers need to fund tax payments upfront and face additional challenges of accurately accounting for withholding tax subsequently.
The timing of accruals is critical. This is especially important as sometimes credits/rebates are given or suppliers do not impose expected charges such as interest or penalties.
Taxpayers therefore need to spend time reconciling the correct withholding tax position in order to avoid interest and penalties associated with errant reporting or payments of their withholding tax obligations.
Samuel Ndandala is a senior manager with Deloitte Consulting. The views expressed herein are those of the author and do not necessarity represent the views of Deloitte