At 25 percent, Egypt’s highest tax rate is competitive, and global companies can gain additional tax benefits through Egypt’s network of over 50 tax treaties, many of them with European nations. However, current policies of Egypt’s tax administration create significant obstacles for non-resident foreign companies seeking to benefit from the treaties’ withholding tax breaks. Such red tape in the tax system creates additional costs for companies doing business in the country and could diminish Egypt’s appeal to foreign investors.
Tax decree requires full withholding, regardless of treaty
In December 2009, Egypt’s former finance minister issued a decree requiring that, regardless of the terms of a treaty between Egypt and another country, Egypt’s usual 20 percent withholding tax rate be applied to all interest and royalty payments made to non-residents. Non-residents would now have to apply to the tax authority to secure a reduced withholding under a treaty and apply for a refund of the tax overpaid. In many countries, treaty-based withholding tax reductions can be applied when the payment is made, as long as the payer can show that the payment qualifies. Under the Egyptian decree, the procedure for applying for treaty-based refunds after-the-fact is cumbersome and processing times for tax refunds are lengthy.
Where services are rendered by nonresident entities, the Egyptian tax treatment would be as follows:
- Where a tax treaty exists between Egypt and the country of the nonresident service provider:
- If the service was completely rendered by the non-resident provider outside Egypt, no Egyptian withholding tax would apply on the service fee.
- If the service was rendered by the non-resident provider in Egypt and the service would create a permanent establishment for the provider in Egypt under the terms of the treaty, then there would be two alternatives:
- the service recipient must withhold 20 percent on each gross payment made to the non-resident provider, or
- the non-resident must register as a legal presence in Egypt, prepare audited financial statements, file annual income tax returns and pay Egyptian income tax at 20 percent on net taxable income up to EGP10 million per year and 25 percent on net taxable income in excess of EGP10 million per year; the service recipient could then withhold 2 percent from each invoice issued by the provider, who would be entitled to offset the withheld amount against its income tax liability in its annual income tax return.
- If the service is rendered by the non-resident provider in Egypt but no permanent establishment is created under the treaty, no Egyptian withholding tax applies on the service fee.
- If there is no tax treaty between Egypt and the country of the service provider, 20 percent withholding tax would apply, regardless of whether the service was rendered inside or outside of Egypt.
In practice, on receiving services in Egypt from non-residents, companies often simply apply withholding tax at the 20 percent rate without reviewing the relevant contract to determine whether a permanent establishment exists. Companies can then find themselves on the hook for the underpaid tax, which is an unfortunately common cause of dispute between Egyptian companies and foreign service providers. Such disputes arise because the tax authority will collect an amount in dispute from the payer, who may be unable to recover the amount from the non-resident recipient.
Free-zone entities are not obliged to make withholdings on payments to nonresident recipients. Rather, the payer is obliged to provide the tax authorities with a list of its non-resident payment recipients, and the tax authority itself will attempt to collect the tax (either directly or via the tax authority in the recipient’s home country).
If the non-resident’s services in the free zone create a permanent establishment there, then the domestic withholding tax at 2 percent will apply. Contracts between free-zone entities and nonresidents should be carefully reviewed to identify and avoid permanent establishment issues.
Dealing with withholding tax issues
To help avoid these problems, contracts with non-residents can include tax clauses under which the non-resident agrees to receive payments from companies on a net basis. This strategy ensures amounts are properly withheld while eliminating the need to apply for withholding tax refunds from the Egyptian tax authority. Under this approach, the service recipient would be required to gross-up the payment and calculate and remit the withholding tax to the tax authority within fifteen days following the month of payment
Streamlining tax administration to improve competitiveness
With Egypt’s new government still settling in, it is too early to tell what measures it will take to enhance the country’s attractiveness to foreign investors. More tax rate reductions, incentives and exemptions to encourage foreign investment could soon be under review. One way the country could improve its tax competiveness quickly and relatively cheaply is by reducing red tape in the country’s tax administration, among other things, by easing and expediting procedures for achieving treaty-based withholding tax reductions and processing refund requests.
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