Adverse economic aspects of withholding taxes in the Republic of Congo
The Republic of Congo has not escaped the wave of relocation occurred with respect to taxes on income, in many African countries for a good ten years
Indeed, the traditional taxation of Francophone African states is based on the principle of territoriality, reproduction of the French system by which it is derived.
However, in countries in development, this tax system has the disadvantage of not allowing the taxation of income whose source is located in these states, especially in technologically complex sectors of the economy, such as the oil industry because of a lack of human and material resources available locally.
That's why many states have incorporated into their tax law significant exemptions to the principle of territoriality, by the introduction of taxation on sales of services made by non-residents.
We will take remarkable illustrations of these developments in the tax systems in the Republic of Congo (not DRC); that State has the particularity to provide several types lump taxation in respect of income tax:
1) A simplified lump tax taking the shape of either a withholding tax, or a spontaneous statement, based on the sales of services, this regime applies to completions and works executed in Congo even partially;
2) A system of taxation of income earned by non-residents, and deriving from the Congo, in the form of withholding tax only (at 20%); this regime applies even in the absence of services provided in the Congo.
Note: what follows does not apply in case of a tax treaty.
1) With respect to the flat tax on sales of services:
Article 126 ter of the Tax Code provides that foreign legal persons engaged in the territory of the Republic of Congo under conditions of intermittent and precarious are subject to a flat tax (22% of net considered fixed income business, an effective taxation of 22% x 35% (tax rate) = 7.70% of turnover).
This article therefore limits the extraterritorial and lump taxation to the companies not installed in the State of taxation, and therefore which do not have accounting and logistics means in order to carry out an actual calculation of income.
However, in the para petroleum industry, this method of taxation has been extended for all economic operators established in Congo, either as a branch or even as a company incorporated In Congo.
To our knowledge, such a widespread application of lump taxation to such a whole portion of the economy is only found in the Republic of Congo.
This results in several serious drawbacks, such as:
- A discrepancy between the income actually earned, and finally taxed income;
- The impossibility to realize a return on heavy investment in industrial-type (for which the amortization is the main source of deficit).
Let us add that the application criteria are not well defined, so that, given the importance of petroleum activities on the economy of the Congo, most Congolese companies are potentially subject to the generality of these tax provisions.
Conclusion with this first respect:
One can therefore say that tax incurred by Congolese companies in the oil services sector is an obstacle to industrial investment in such sector, and on the other hand encourages services with high added value.
However, this tax has an economic logic in the sense that it affects the income of a service provided in the Congo.
It is not the same with regard to the withholding tax on income from the Congo in the absence of services provided in the Congo (below).
2) With regard to the taxation of a lump sum of income deriving from Congo:
Article 185 ter of the Tax Code provides that persons who have no domicile or tax residence in Congo, are subject to a withholding tax whose rate is set at 20%, provided that they have the income earned in the Congo or deriving from the Congo and/or resulting from work or services of any kind executed, provided or used in Congo.
This provision was originally intended to tax income earned in Congo, but not reported or not falling under any taxation.
So one can say that originally the text did not have an extraterritorial purpose.
However, the scope of the text was subsequently widely expanded, leading to theoretically integrate any income received from abroad, and may be related to the implementation of the provision in the Congo, regardless of the recipient.
In practice, although the scope also covers services provided in Congo, this provision is used to hit revenues deriving from Congo, made by foreign legal persons not being present in the country.
Such an application of this law results in an economic double taxation in the Congo because the tax authority does not consider the flat tax rate of 7.70% (see 1 above), as full discharge of any tax income bearing on the elements of the contract executed in Congo.
And so, it applies the withholding tax of 20% of the components of revenue already taxed at 7.70%.
A foreign company X runs in the Congo a service contract which is charged: 10,000 USD to the oil company in Congo, leading to a tax of 10,000 x 7.70% = 770 USD (actually, the gross up results in a tax effective rate of 8.34%).
But this company, in order to achieve this completion, must use the following means:
- Specialist staff leased to a foreign company S, for 2000 USD;
- Specific tools leases to another foreign company T, for 3000 USD.
External charges are equal to: $5,000 in total.
The tax authorities will carry out a tax audit, and will come to the following conclusions:
a) consider the $5,000 as income accruing to non-residents S/T, and will ask the provider company X the amount of the withholding tax,
b) consider that the tax base consists of the sum of $5,000 plus tax which was not retained and is therefore considered as additional income, leading to an effective tax rate of 25% ((125-20% =) 100) through the mechanism of gross-up;
c) apply a penalty of 100% for non-withholding tax within the legal period (on the 20th of the month following the actual payment).
Ultimately, the company X will pay:
1) 770 USD in case of use of the legal rate of 7.70%, 834 USD if one applies the gross up;
2) 5000 x 25% = 1250 USD as the principal tax;
3) 1250 x 100% = 1250 USD as a penalty for failure to withholding in the legal deadline,
in total: 3250 (or 3334 with gross-up) US Dolllars for a contract of 10,000 US Dollars,
either a tax rate greater than 32% of the gross turnover.
This economic double taxation involves serious consequences for economic development, and it is urgent to return to a healthy application of this tax, which should only apply to income from the Congo in respect of services rendered in the Congo.
More generally, one should not be able to apply a flat tax on amounts included in the basis of sales has already supported a flat tax.
Richard Moulet is the managing partner of Sutter & Pearce, a law firm having also an office in DRC (Kinshasa), and strong connections in CAR (Banqui). He was previously manager of Fidafrica* Cameroon and Fidafrica* Congo, associate partner with Fidafrica* Madagascar, then senior manager of Ernst and Young / Juridique et Fiscal Congo,
He is permanently resident in the Congo and based at Pointe-Noire.
Richard Moulet has a private law training in France, with a third degree level in business law and tax, and has been lawyer in France, specialized in Company law.
He is also active in the arbitration sector, being admitted as an Arbitrator with the OHADA Court of Justice, and member of the Arbitration Committee of the Chamber of Commerce of Pointe-Noire.
Richard can be contacted on +242 05523 5228 or by email at firstname.lastname@example.org