Introduction

Businesses and in particular any person managing the day-to-day payments and accounts of a business should understand their withholding tax obligations, and the cost of non-compliance. When this is not done, the business may be exposed to various tax risks including interest and penalties.

Withholding tax refers to the amount of tax retained by one person when making payments to another person in relation to goods supplied or services rendered by the payee. A person who receives or is entitled to receive a payment from which income tax is required to be withheld is a withholdee.  The person required to withhold income tax from a payment made or to be made to a withholdee is known as the withholding agent.

Withholding Tax Mechanism

Withholding tax is a mechanism by which a payer of an amount subject to withholding tax is obliged to collect an amount of income tax by applying a specified rate of tax.  The person whose income tax is withheld is deemed to have paid income tax equal to the amount of tax withheld.

The Income Tax Act, 2004, CAP 332, provides a definition of the term “payment” to include the transfer of assets or money, the transfer or decrease of a liability, the provision of services, the use or availability for use of money or an asset and the creation of an asset in another person.  The term payment is widely defined in the Income Tax Act to include other items other than transfer of money modes of payment.

Remittance of Withholding Tax and Issuance of Certificate

The withholding agent is required to remit the tax withheld within seven days from end of the calendar month in which the tax was withheld.  In return the withholding agent shall provide the withholdee with a withholding tax certificate and the later will use the certificate as an evidence of tax paid by way of withholding tax.

Advantages and Importance of Withholding Tax System

       1. Persons Not Required to File a Return

Withholding tax system suits a tax collection system where a payment is made to a person who is not required to file a tax return by virtue of exclusion from the requirement to file a tax return. For instance a case with employees in respect of payment of employment income.

       2. Payments Made to Non-Residents

Withholding tax is a good income tax collection system for a payment made to a non-resident whose payment is sourced from United Republic of Tanzania and who is not obliged to file a tax return.  It is thus important for a person managing various payments to be conversant with source of payments rules as provided for under the Income Tax Act as well as by way of decided cases.

       3.Preventing Tax Evasion

Withholding tax is way of combating tax evasion especially income tax on payments whose recipient thereof may not or are not required to file a tax return. The withholdee is tasked to collect the tax and remit to the tax authority. In the absence of withholding tax agent the tax may end up not being collected.

Risks Associated with Withholding Tax

Tax payers should be aware of the risks associated with non-compliance with the prevailing withholding tax system including the following –

• Failure of some employers to deduct taxes on some emoluments especially those paid outside the normal payroll system.
• Failure to include amounts in respect of benefits in kind in withholding tax schemes.
• Failure to deduct withholding tax. The Income Tax Act is categorical that when the withholding agent fails to withhold income tax from a payment eligible for withholding tax the withholdee shall jointly and severally be liable with the withholding agent for the payment of the tax.
• The withholding agent may fail to recover from the withholdee the amount of withholding tax paid but not deducted from the withholding agent. A withholding agent who fails to withhold income tax but pays the tax that should have been withheld to the Commissioner is entitled to recover an equal amount from the withholdee.
• There is also a risk that interest or penalties will be imposed on the withholding tax agent in case of any non-compliance. There is a restriction to deduct the amount of interest or penalties from the income of the withholding agent. These amounts cannot be recovered from the withholdee.
• Failure to properly interpret tax laws on applicability of withholding tax on some payments such as interest, royalty etc.

Final Withholding Tax Payments and Non-Final Withholding Tax Payments

 A final withholding tax payment is payment which a tax withheld thereon satisfies the final tax liability of the withholdee or recipient.  Any payment not specified as a final withholding payment under section 86 of the Income Tax Act is effectively a non-final withholding payment. For instance, withholding tax on professional services fee when payment is made to a resident person.

The amount of tax withheld for non-final withholding payments is eligible for reduction from the final tax liability of the tax payer.  However, the withholdee is required to possess a withholding tax certificate as an evidence of any tax withheld to qualify for a tax credit.

Withholding Tax Credits and International Tax Credit

Withholding tax credits or eligibility to reduce the amount of tax withheld at source from the final tax liability or quarterly instalments are only available to income tax arising from non-final withholding tax payments.  The Income Tax Act also provides for eligibility of tax credits of the tax withheld in foreign state in respect of a reported foreign income earned by a resident person.

Withholding Tax on Service Fee to a Resident Person

You may recall that the Finance Act, 2013 introduced withholding tax obligations on service fee paid to a resident person, the enactment of which was amplified by a Practice Note issued in August 2013.  The Finance Act, 2016 has amended the withholding tax on service fee paid to a resident person and confined it to only professional services. The definition of professional services has also been provided by way of amendment of Income Tax Act by the Finance Act, 2016.

Professional services are defined as services rendered by a person licensed as a practitioner by any recognized professional body and shall include other services or activities of an independent business character including consultancy, legal, architectural, engineering, supervisory, accounting, auditing, medical artistic, survey, theatrical performance, sports, exhibition, private security services, private investigation and consultancies in various disciplines or any entertainment held or given other than those for remuneration under contract of employment.

Construction Works

The amendments on withholding tax made through Finance Act, 2016 also cover construction works except that the payment which is subject to withholding shall be based on the ratio of 3:2 for materials and services respectively. This implies that 40% of the value of a construction work    will be taken as services and 60% as materials. This change is significant and is likely to be challenged from the point of view of the basis for determining the ratio. The previous guidance under the Practice Note referred to above where the tax payer was required to separate the value of services from that of materials to establish the tax base for withholding tax was more reasonable.

Withholding Tax on Payments to an Approved Retirement Fund

Another important change through the Finance Act, 2016 which may be overlooked is the imposition of withholding tax on payments in respect of dividends, interest or rent paid to an approved retirement fund.  The amendment was effected by removing approved retirements funds from the persons whose payments are excluded from withholding tax obligations.  Through this exclusion, payments of rent, interest or dividends to an approved retirement fund are effectively subject to withholding tax from 1 July 2016.

Service Rendered

Another major amendment through the Finance Act, 2016 in relation to withholding tax is the introduction of the term ‘service rendered’. This has been defined as transmitting or delivering of service in the United Republic of Tanzania irrespective of the place of performance of service. This change has probably been triggered by the concluded protracted withholding tax case in May 2016 where the Income Tax Act was not requiring 15% withholding tax to apply on payment for services performed outside Tanzania.

Through the change introduced in the Finance Act a withholding tax of 15% will now apply for service fees payments to be made to non-resident service providers.

Conclusion

In addition to the risks associated with withholding tax discussed above, tax payers should also be aware that there have been a number of litigations arising out of applicability of withholding tax to some payments leading to high costs of litigation. A number of recently decided tax cases have come up with several implications to taxpayers regarding eligibility for withholding tax.