“Sorry Team, but we have to increase the project budget by 20%”, says Jason during a board meeting having just noted that the project contract was signed net of all taxes. Jason is a Finance Director of a multinational beverage manufacturer. The Company contracted a Chinese supplier to design a multimillion end-to-end supply chain ERP for their manufacturing plant. These or similar situations are commonplace in many boardrooms.
Sorry Team, but we have to increase the project budget by 20%
What are the tax implications? is a seldom-asked question by many businesses and individuals while signing commercial contracts. Although tax implications is a significant consideration in any transaction, not many parties to a commercial agreement concern themselves with the same, partly because tax implications are neither immediate nor direct and because many are just not aware of the significance of the same. Why should you, however, consider tax implications of the contract you are about to sign?
Every business transaction has a tax implication; meaning there are tax costs attached to it, whether directly or indirectly. And when the tax implications of a contract materialize, the result is a tax cost/burden. Either or both parties in the transaction have to bear this cost, which can be high or low depending on the instant circumstances. Without proper understanding of the attendant tax implications, a party to a commercial contract may suffer unwarranted tax burden which could otherwise have been shared or avoided altogether.
Take for example a contract involving cross-border trade, where decisions ought to be informed by the domestic tax laws of the countries involved. If not considered, an entity’s income may suffer tax in more than one country, what is termed as juridical double taxation; or it’s income may also be taxed in the hand of more than one entity, the term for which is economic double taxation.
Unless there is a Double Tax Agreement to eliminate the double taxation, the cost of doing business would unnecessarily increase, which cost could easily be reduced or entirely avoided if the business considered tax implications of its business decisions. For Jason’s case above, the company had to bear the withholding tax burden of their cross-border solar panel importation and installation, which ordinarily would have been borne by the Chinese supplier.
Contracts with non-resident entities must spell out how the tax costs of such transactions would be borne, whether by one or the other or both parties, otherwise conflicts are bound to arise when the associated tax implications materialize, leading to potential loss of business or severed business relationship.
At employment contract level is also a consideration of tax implications important. Most employers and employees seldom consider the tax implications of their employment relationships or remuneration clauses in the employment contracts. Poorly drafted employment contracts may give a connotation of the employee being an independent consultant rather than an employee, attracting entirely different tax implications.
In most countries, the tax implications on certain employment benefits like pension contributions, medical cover, and repatriation expenses, differ for local and expatriate employees. While some of these benefits would be non-taxable for local employees, the same would be taxable for expatriate employees under certain circumstances. One then needs to be clear who bears this tax burden, whether the employer or the employee, before having it signed, sealed, and delivered.
Perhaps the leading argument for this proposition would be the cost associated with noncompliance with tax laws relevant to the transactions in question. Like Kenya, tax noncompliance in several countries has serious consequences, ranging from late payment penalties and interest to civil or criminal charges. Failure to consider tax implications of your planned business transaction ultimately results in risks of exposure- blind spots whose remedial costs can be punitive and overtaxing.
For instance, where noncompliance has led to tax assessments by the relevant revenue authority like the KRA, the cost of pursuing tax dispute resolution may be quite high. Further, should a taxpayer in question seek a tax compliance certificate to conclude a potential business deal, the same can be denied until the alleged tax liabilities are settled. The delays associated with this may lead to potential loss of clients if their needs are urgent. We have also seen instances in the region where tax noncompliance has led to many businesses closing shops.
Whether by having an internal tax department or with the help of a competent tax consultant, anyone intending to enter into a commercial arrangement should have his contracts reviewed and all possible tax implications considered and clarified before execution. This will afford you peace of mind in knowing that there are no tax blind spots in your plans.
