Technical service fees
One of the most controversial aspects of African tax treaties relates to withholding tax (WHT) on technical service fees.
High WHT rates, restrictions on deductibility, Double Tax Agreements not being respected and limited double taxation relief, all mean that WHT on technical services is often the single highest cost of doing business in Africa.
The overall trend in Africa seems to be an increase in WHT rates. African countries are disproportionately importers of technical services and therefore exposed to profit-shifting. Hence the levy of high WHT by tax authorities.
Transfer Pricing and the levying of high WHT
Many developing countries are still inexperienced in dealing with complex transfer pricing. In contrast, WHTs are relatively easy to implement – therefore many developing countries have introduced WHTs on services, particularly technical services and management services.
Often, low margins may be earned on services fees, in order to comply with transfer pricing rules. A WHT levied on gross service fees can thus result in far more taxes being payable as compared to normal corporate income tax, which is levied on net service fee income.
Current TP principles and practices do not deal adequately with a situation where WHT is levied on intercompany group services, especially if there is a source conflict between the jurisdiction which renders the services and the jurisdiction which benefits from the service.
Multinational enterprises operating in Africa face significant tax exposures and risks due to WHTs. Proper planning is required to reduce tax leakage.
Limitations on the deductibility of services for the payor
Generally, domestic tax legislation allows the deduction of service fees if:
- general requirements for deductibility are met, and
- the arm’s length principle is complied with.
However, there are many countries which limit the deductibility of service fees, based on thresholds (e.g. a maximum %) or specific approval or the availability of locally sourced service providers.
Some of these countries include Ghana, Gabon, Guinea, Chad, DRC, Cameroon, Ivory Coast and Zimbabwe.
Double taxation agreements
Where the double taxation agreement does not provide for WHT on service fees i.e. where there is no service fee article in the DTA, the general business profits article should apply to the service fee and the service fee should only be subject to tax in the respective foreign country if a permanent establishment exists in that country. Where there is no permanent establishment, no WHT should apply. In practice, the domestic rate is applied. This is not a legitimate levy of WHT and creates problems in claiming the WHT as a foreign tax credit in the home country.
The taxpayer is left with Mutual Agreement Procedures to claim tax from a foreign country, which is not feasible.
In South Africa, the taxpayer may be restricted to a section 6quat deduction as opposed to a section 6quat rebate. The denial of a foreign tax credit can be a significant tax cost.
How can we help?
How you structure your business is a critical question as you expand globally. The right structure will protect your assets, improve your currency position, support your business operations, facilitate future business expansion and changes, and optimise your overall tax rate. Trying to unscramble a sub-optimal structure entered into in haste or without full consideration of relevant facts is complex and expensive, so it’s important to plan upfront.
Structuring an international business is both a science and an art – this is our specialist area of expertise. Regan van Rooy is an international tax and structuring advisory firm focussing on Africa. We have offices in South Africa, Mauritius and Ireland and we can help you with any international tax or structuring query.