Tanzania in International Tax Law: Reinforcing Tanzania rules on controlled foreign corporations
From a territorial tax perspective, one of the issues that Tanzanian policymakers grapple with is international tax planning by apparently profitable internationally oriented firms that seek to legitimately lower their tax bills in Tanzania.
How is this achieved? Typically, by structuring income to receive more favourable tax treatment or by devising means to write-off certain expenditures against taxable income.
According to some research studies, international tax planning can at times lead to erosion of a country’s tax base and to shifting profits to low or no-tax jurisdictions having little or no economic activity.
To protect its tax base, Tanzania introduced rules in the Income Tax Act, 2004 (ITA-2004) to determine when the income of a company doing business in a foreign country should be taxed and when foreign income is exempt from taxation.
This is where controlled foreign corporation (CFC) rules provided for under section 73-76 of the ITA-2004 come in.
CFC rules operate as an international anti-tax avoidance measure in response to the risk that Tanzania resident persons with a membership interest in a foreign subsidiary can strip the tax base of Tanzania by way of shifting income into a CFC.
It should be noted that although a CFC may trigger the Tanzanian Tax Administration (Transfer Pricing) Regulations 2018 if it is deemed to be an associate of a local entity, the CFC is not itself deemed to be a resident of Tanzania for tax purposes.
CFC rules also determine when a Tanzania resident person has a membership interest in a foreign subsidiary and which earnings of the subsidiary and how much of those earnings are taxed.
On the word of section 73(2) of the ITA-2004, a CFC shall be treated as distributing to its shareholders at the end of each year of income of the CFC its unallocated income.
And subject to certain exemptions set out in the Second Schedule to the ITA-2004, a distribution that a Tanzania shareholder is deemed to have received from the CFC must be included in the gross income of the shareholder for tax purposes.
In the absence of these rules, CFCs afford profit shifting opportunities and deferral of tax.
Be that as it is, there are concerns that offshore cell companies, including protected cell companies, have become key vehicles for tax treaty shopping and other profit shifting arrangements despite the presence of CFC rules—in terms of which protected cell companies have become the focus of many tax authorities around the world.
However, Tanzania’s CFC rules do not contain specific provisions dealing with offshore cell companies.
Against this backdrop, should protected cell companies fall within the Tanzanian CFC regime?
But first, what is a protected cell company (PCC)? A PCC is a single legal entity which exists in certain jurisdictions (such as, the Isle of Man, Guernsey, Seychelles, and Mauritius) consisting of a “Core” and numerous companies that are known as “cells”.
Each cell of the PCC is independent, with its own distinct name, bank account, and independent manager.
In addition, the assets and liabilities of each cell are legally ring-fenced from those of other cells.
The Core is owned by a third party who exercises control over the PCC and provides services to the PCC’s cells, which are normally owned by unconnected companies.
This makes it impossible for any cell owner to exercise economic control over the PCC as a whole.
As an individual cell is, quintessentially, not a legal person separate from the PCC; in other words, as it is not a company as such, it may not be treated as a CFC (controlled foreign corporation).
Therefore, Tanzania should borrow a leaf from the United Kingdom where CFC rules contain specific provisions treating each cell of an offshore cell company as separate stand-alone foreign company for CFC purposes.
This would entail inserting a definition of “protected cell company” under section 3 of the ITA-2004 and amending the definition of “controlled foreign corporation” to include the defined “protected cell company”.
Consequently, if a membership interest in any constituent cell of the PCC is held by a Tanzanian resident, the cell would be deemed to be a CFC notwithstanding the ownership of any of the other cells.
In this sense, let me pen off with this illustration: A protected cell company (PCC) located in Guernsey with the Core of the PCC is managed and controlled by Guernsey’s residents.
The PCC has 5 cells; cell A, owned by a Tanzania resident company, provides certain specialized services solely to the Tanzania resident company.
Since the Tanzania resident company completely owns the cell, the cell—being independent—qualifies as a CFC; and for that reason, it will be treated as distributing to the Tanzanian resident company its unallocated income.
Paul Kibuuka ([email protected]) is a tax and corporate lawyer, tax policy analyst, and the chief executive of Isidora & Company.
