Multinational organisations operating in Africa face significant tax exposure and risks in the form of withholding taxes. “Multinationals considering doing business on the continent need to consider the potential tax treatment of their transactions upfront,” says Elandre Brandt, an International Tax Partner at PwC and Head of the Africa Tax Desk based in Johannesburg. “Contractual terms may have a significant impact on the applicable withholding tax, and may range from anything between five percent to as much as 30% of the gross amount of the transaction,” warns Brandt. “Planning for a withholding tax liability allows for certainty regarding the tax liability associated with any commercial transaction.”
Withholding taxes may be considered an atypical tax. If a company does not have an operating presence in a country, one would assume that this country does not have the right to tax any of its profits. “However, a withholding tax does just that – it taxes profits, while there is no presence in that country,” explains Brandt.
On the African continent withholding taxes are steadily increasing in number. According to recent research carried out by PwC withholding taxes are considered a high-level of concern among businesses. By global standards withholding taxes are generally high in Africa, particularly when considering that corporate tax rates are significant as well. The majority of businesses taking part in PwC’s ‘Africa Tax Survey 2013’ indicated that they would be less likely to consider South Africa as a location of the holding company for their African activities when withholding taxes on interest, dividends and royalties are in full effect. The full implementation of withholding taxes in South Africa has been delayed and currently expectations are that this will be 1 January 2015 for interest withholding tax and 1 January 2016 for withholding tax on services fees. Withholding taxes on dividends and royalties are already in effect. Despite this, Brandt says that the headquarter company regime, introduced in 2011 goes some way in making South Africa attractive as a holding company location for African operations. One of the reasons is that a headquarter company is not subject to these withholding taxes in South Africa.
Last year Tanzania introduced a new withholding tax of five percent applicable to, amongst others, professional and consultancy services. More recently, Ghana announced proposals in its annual Budget Review to increase its withholding tax from 15 percent to 20 percent on services. To date this has not been accepted by the Ghanaian Parliament.
Namibia also introduced a withholding tax of 25% (with effect from 30 December 2011) on various service payments. Zambia introduced a 15% tax on branch profit repatriations with effect from 1 January 2014 to replace the previous tax free position.
Overall the trend seems to be to increase or introduce withholding taxes. The goals of tax authorities can vary from raising extra tax revenue to obtaining more information. South Africa can be categorised in the latter category as the tax will only apply if the source is in the country. This means that the payment should relate to services which have been rendered in South Africa. Since services like management services are typically rendered from outside of South Africa for the benefit of the local company, expectations are that the South African withholding tax on services will not lead to actual taxation, but will merely be a source of information to the tax authorities to know who is doing what in the country. The tax authorities have also confirmed this is intended to be for information purposes and to assess whether the foreign company also has a so-called permanent establishment in South Africa and should subsequently be taxed.
Although Tanzania also basis its withholding tax on services on a source-based system, it seems that it is less likely for a taxpayer to get away from actually withholding the tax as is the case in South Africa. A payment will have its source in Tanzania where “the results of the activities are directed to or utilised by the residents of the United Republic,” according to the practice note contained in the commentary. The onerous administration application of the tax has also raised concern among taxpayers and some tax experts.
Ghana is similar in practice, although there is no specific guidance to date on how to interpret the new withholding tax laws.
There is not only an increase in the number of withholding taxes on the African continent, but also an increase in the tax rate. This will have an effect on companies operating in these countries, says Brandt. For example, if a South African entity receives US$100 from its subsidiary in Ghana for management services rendered to that subsidiary, in principle it will only receive US$80. This amount is subsequently taxed at 28 percent and if distributed again, (potentially) taxed with 15% withholding tax. This means that if one ignores potential tax credits in South Africa which are likely to be limited in any event, the shareholder of the South African company will remain with about US$49, which means an effective tax rate of more than 50%.
“One way for organisations to reduce the tax leakage is by considering their structure upfront and making sure that they understand the law that will be applicable to them,” says Brandt. “This should allow them to plan for the tax leakage by getting the pricing right, but also ensure that the correct withholding tax, if any, is being imposed taking into account applicable double taxation treaties. This is important, because the general tax credit system in South Africa is not available to the tax payer where the tax has been incorrectly or illegally withheld.”
There are also other ways to mitigate the tax leakage. For example, by assessing the opportunities a company has in terms of using double tax treaties or unilateral provisions. “However, when structuring this transaction it should be taken into account that the tax structure should at all times be supported by sufficient substance and be aligned with its business structure,” concludes Brandt.