Problems applying tax treaties in Africa
The judgement of the Bordeaux Administrative Court of Appeal on 13 December 2016 highlights the harm resulting when tax is withheld at the source in contravention of the provisions of tax treaties. And yet, this is standard practice in Africa.
With more than thirty tax treaties in force in Africa, France is the country with the most extensive treaty network on the continent. This is more than either the United Kingdom or the United Arab Emirates, which have signed 24 and 20 treaties respectively in Africa.
While economic operators rely on treaties to determine the tax implications of their operations, they run into trouble when applying the treaties in practice.
In a judgement on 13 December 20161, the Bordeaux Administrative Court of Appeal held that taxes paid abroad in contravention of tax treaties should not be deductible in France. The fact that this judgement concerns tax treaties signed with Algeria, Cameroon and the Congo cannot be ignored.
The Court effectively considered that the tax treaties in question explicitly preclude the possibility of deducting tax paid in Algeria, Cameroon or the Congo from the computation of taxable income in France. No exception is made for cases when the taxpayer has been wrongly subjected to taxation in these States considering the applicable tax treaties.
This position, which we believe contradicts a judgement of the Conseil d’Etat on 20 November 20022 as well as runs counter to a correct interpretation of the scope of the tax treaties, provides an opportunity to revisit the problems of applying tax treaties in Africa.
Application problems often associated with withholding tax at source
These problems usually involve withholding tax on payments that residents of African countries make to non-residents for provision of services. These often involve payment for technical assistance or management fees.
In most cases, payments do not fall into the category of royalties for purposes of the relevant treaty, to the extent that they do not involve copyrights or entail any transfer of know-how. Thus, if the French service provider has no permanent establishment in the country in question, such payments should only be taxable in France.
However, this position is often not that of the tax authority in the African country concerned, which tends to apply a much broader interpretation of the term “royalties.” The tax authority may consider that any service provided involves some sort of transfer of know-how or that the term "technical studies" sometimes mentioned in the treaty's definition of “royalties” necessarily covers all technical assistance services.
In Algeria, the tax authority regularly required a withholding tax, either at the 24% common law rate or the 12% treaty rate depending on the case, on remunerations for services paid to French companies simply on the grounds that the services had been provided in Algeria, even though the relevant treaty provided otherwise.
This practice was the subject of a meeting between the French tax authority and the Algerian tax authority, during which it was determined that that remuneration for services should only be taxable in Algeria when the service provider had a permanent establishment in the country. The practice is now limited, although difficulties still persist.
Another example is provided by Morocco, where the tax authority often applies a 10% withholding tax on payments for all services, as well as on headquarters costs paid by Moroccan branches of French companies, in contravention of the relevant treaty provisions.
Exchange control regulations existing in these countries present an additional difficulty, in that the regulations require that local tax rules be complied with before the transfer of funds abroad. In practice, banks that are requested to transfer funds abroad will often require proof of payment of withholding tax regardless of the circumstances. Companies are then forced to pay withholding tax, even though it is not legally required just to ensure payment of the sums in question. They may then seek reimbursement of the overpayment by instituting legal proceedings, but this requires follow-up and can take some time.
In Guinea, the first bilateral tax treaty, which entered into force in 2004, was signed with France. Simply ignored at first, is starting to be respected and applied by the tax authority. Notwithstanding, isolated cases continue to be determined as though the treaty did not exist.
It should be noted that failure to properly apply a treaty is not always the fault of the local tax authorities by themselves. For instance, the persons receiving services from providers outside the country have been known to withhold tax at source on the payments made, either due to ignorance of the treaty provisions or as a precaution to avoid making a mistake and becoming personally liable for the tax that they failed to withhold, as well as for quite significant penalties.
As such, a French SME’s customer in Benin had deducted withholding tax from the payment for services it owed the French SME and remitted it to the Inland Revenue. Despite several attempts to demonstrate that the amounts withheld were not due under the applicable Benin-France treaty provisions and despite subsequent appeals to the Benin tax authority, the company to this day has not managed to obtain a refund of the contested amounts.
To reduce the frequency of such cases of wrongful withholding, it could be useful to ensure that the person who contracted for services understands in advance the applicable tax withholding rules under the treaty, for instance with a written statement from the tax authority or a lawyer.
There may be other problems that arise when the provisions of tax treaties are applied.
The 2013 finance law of Gabon introduced a limitation on the deduction of general headquarters costs, costs of studies or technical, financial or accounting assistance costs, etc. of 10% of taxable income when a foreign legal entity provides services to a Gabonese company by a foreign legal entity.
The tax treaty between Gabon and France, in effect as of 1995 u contains a non-discrimination clause. Taxpayers claimed that the limitation on the deductibility of sums paid to French companies contravened this provision. In effect, the limitation does not apply to sums paid to Gabonese companies. To our knowledge, the tax authority does not hold an official position on this point. There is a concern that Gabon, at the instigation of Côte d'Ivoire or Cameroon, will extend the application of this limitation to payments made to domestic companies in order to undermine the non-discrimination clause.
Nevertheless, the situation is improving...
And yet, such problems are becoming less frequent. Most countries have established a division in their tax administrations specializing in taxpayers that are large companies. These divisions are staffed by people who are more trained and experienced in the proper application of tax treaties.
Moreover, tax authorities have been abandoning challenges regarding withholding tax when the taxpayer claimed he has acted in accordance with a tax treaty's provisions.
Further, the use of tax treaties is increasing as a result of the growth of international business flows. African countries are led to extend their tax treaty network. There are now about thirty treaties signed by African countries since 2015.
Nevertheless, even when tax treaty provisions are applied correctly, companies are not always protected from unwelcome surprises. For instance, some States such as Mali and Senegal introduced provisions into domestic law that, although payments made to a foreign service provider may be exempt from income tax in the State involved, any VAT owed on such payments is not deductible by the debtor. In other words, while withholding tax is avoided under the applicable tax treaty, VAT at a rate of 18% is imposed on the beneficiary of the services in both of these countries.
Finally, some States such as Burkina Faso expressly prohibit “gross-up clauses” that involve paying tax on behalf of a third party. Thus, it is necessary to pay particular attention to tax clauses in service provision contracts, so that reconsideration of sometimes extremely high costs may be avoided. This attention is all the more important in the context of intra-group transactions, now that transfer pricing examinations are more frequent.
1 CAA Bordeaux - Cour Administrative d’Appel [Administrative Court of Appeal], 13 December 2016, No. 15BX01655.
2 CE (Conseil d'Etat), 20 November 2002, No. 230530, Etablissement Soulès.
Some problems of applying tax treaties in Africa – Article appeared in the Option Finance magazine on 10 April 2017