Withholding taxes are giving rise to a vicious circle in Africa. As governments introduce higher and more withholding taxes on an ever-increasing range of services in an effort to protect their tax base, companies are developing complex structures to try to lower their tax liabilities.
Ultimately the result is that doing business in Africa is becoming more expensive.
Governments require local businesses that pay foreign multinational companies for interest, dividends, royalties, service fees and even the sale of real estate, to withhold a certain percentage of the payments and transfer that amount to the fiscus. The withholding taxes differ from country to country, and the rates fluctuate from 5% to 30%.
In South Africa withholding taxes have already been introduced on dividends and royalties, at 15%, with withholding taxes on interest and management fees to follow in 2015 and 2016.
PwC international tax partner Elandre Brandt says if withholding tax rates are reasonable, and if they are fairly standardised, companies will be less inclined to develop complex structures to fight them.
High withholding taxes considerably increase a company’s overall tax liability. Mr Brandt explains that if, say, a South African entity receives $100 from its subsidiary in Ghana for management services rendered to that subsidiary, in principle it will receive only $80 because of the 20% withholding tax on management fees in Ghana.
This amount is subsequently taxed at 28% in South Africa and can attract an additional withholding tax of 15% if the company distributes its profit in the form of dividends. “This means the shareholder of the South African company may remain with about $49, which means an effective tax rate of more than 50%.”
When companies consider this scenario, they price contracts in Africa to compensate for withholding tax leakage. If they can get some form of standardisation, companies will be able to rely on consistent application, Mr Brandt says.
A further benefit is, “People also do not have to overprice their services to compensate for ridiculously high withholding taxes. You will probably find that people will do less planning with lower rates. Why would you enter into complex planning structures if you are prepared to pay a 5% or any other reasonable withholding rate?”
The African Tax Administration Forum (ATAF) says African governments see withholding taxes as a solution to protect their tax base from base erosion and profit shifting, known as “Beps”.
The Organisation for Economic Co-operation and Development (OECD), where South Africa enjoys observer status, published a report on Beps in February last year, in response to the concerns raised by leaders of the Group of 20 countries about the activities of multinational corporations and their efforts to shift profits to lower tax jurisdictions.
ATAF executive secretary Logan Wort says although the issue of withholding taxes is not on the OECD’s agenda for addressing base erosion, it certainly is on ATAF’s. African governments see it as a response to tax losses arising from tax-dodging structuring of contracts and transactions.
“It is a viable consideration for African countries to protect their tax bases. It is not an instrument to punish companies, but is used to protect tax bases in the absence of rules about profit shifting.”
In many instances double tax agreements between countries give relief to withholding taxes by reducing the rate to no more than 5%, in order to prevent double taxation. However, says Mr Brandt, the treaties are not always adhered to. In Tanzania businesses withhold 10% of all their payments to foreign entities. South Africa’s treaty with Tanzania provides that a South African company offering a service to a Tanzanian company, but without a presence in Tanzania, should not be subject to withholding tax.
In practice the companies apply the 10% withholding erroneously, but will concede the error if it is pointed out. Their explanation is that the tax authority does not go after the foreign company that has received the money, but those Tanzanian companies that have not withheld taxes before paying foreign partners.
“They have this paranoia so they are extra cautious and withhold from the start, whether it is right or wrong.”
“A company might try to offset the tax against any future tax liability, but more often than not there is no future tax liability, so it is a loss,” Mr Brandt says.
“It is difficult to get a refund. “If you are lucky it can take three years, if very unlucky it can take five years and if you are extremely unlucky you never get it.”
Mr Wort says there is always the risk of double taxation, especially where no double-tax treaties exist. But the risk of double non-taxation is equally high for tax authorities. “We are not saying withholding taxes are the answer in the long term, but it serves as an interim measure while new global tax rules are being developed (through the Beps process).”
Mr Wort says it is quite understandable that these different tax rates can be an irritation to multinationals. There is certainly a case for the standardisation of rates.
However, tax is a sovereign issue, and ATAF cannot tell governments what the rates ought to be — although it could give some guidance on their alignment, he says.
This article first appeared on bdlive.co.za.