Mozambican tax treaty spells trouble
Portuguese interpretation puts different spin on ‘permanent establishment’, resulting in double taxation
WORLDWIDE, countries enter into treaties with each other to avoid double taxation. Double taxation arises when the same amount of income is taxed in the hands of the same person in more than one country and neither country provides relief from tax incurred in the other country.
A problem has been identified in respect of the treaty between SA and Mozambique that results in double taxation. The guiding principle is that the income of a South African resident is taxable only in SA, except to the extent that the income is attributable to a permanent establishment of that person in Mozambique. If a permanent establishment is created in Mozambique, then the South African person must register for tax in Mozambique and pay tax in that country on the income that is attributable to the permanent establishment.
A permanent establishment is a fixed place through which the business of an enterprise is carried on. In the case of construction contracts, a special rule applies, and a permanent establishment arises in respect of “a building site, a construction, assembly or installation project or any supervisory activity in connection with such site or project, but only where such site, project or activity continues for a period of more than six months ...”
Apparently, the problem with the double tax treaty between SA and Mozambique is that the English and Portuguese versions are interpreted differently as to when a permanent establishment arises.
The interpretation of the English version, which is applied by the South African Revenue Service (SARS), is that a permanent establishment is only created in Mozambique when a South African person has been in the country, carrying on business activities, for more than six months.
On the other hand, the Portuguese version, which is used by the Mozambican tax authorities, is interpreted to mean that a permanent establishment will be created in that country if the contract with the Mozambican customer provides for services to be rendered for more than six months, even if the South African is only present for one day during the contract period.
In these circumstances, Mozambique will seek to tax the South African person on his business profits at the rate of 32% and SA will seek to tax the person (assuming it is a company) on the same profits at the rate of 28%.
SA may not provide any tax credits for the Mozambique tax suffered because the authorities believe a permanent establishment was not created in Mozambique and therefore it has incorrectly taxed the profits.
SA has introduced a new limited tax credit provision into the Income Tax Act that may provide some limited relief
The principles generally applied in determining when a site is first established are found in paragraph 19 of the Organisation for Economic Co-operation and Development (OECD) Commentary on the Model Tax Convention relating to Article 5: Africa Desk: “A site exists from the date on which the contractor begins his work, including any preparatory work, in the country where the construction is to be established ...” On this basis, preparatory work carried out in SA does not constitute a permanent establishment in Mozambique, but, once the contractor moves on site, the period for deter- mining the six-month requirement commences and will terminate on the date that the contractor’s activities on the site finally terminate. The taxable income attributable to the site will be determined by reference to the services actually performed on site and not to the entire services performed both outside and within Mozambique.
The interpretation applied by the Mozambican tax authorities is clearly in conflict with international opinion that the critical determinant is the duration of services actually performed within the host country.
This is a matter that can only be resolved by the tax authorities. A stated objective of the treaty is to promote and strengthen economic relations between the two countries.
However, in these circumstances, South Africans were actually better off in the absence of the treaty.
SA has introduced a new limited tax credit provision in the Income Tax Act that may provide limited relief to the South African taxpayer in certain circumstances, but the risk of double taxation remains. South Africans intending to do business with Mozambican clients or customers should plan to try to avoid adverse tax implications.