ROSENSTOCK LEGAL SERVICES KABUL THOMAS ROSENSTOCK* DIRK PETER HANEKOM* [email protected] [email protected] ++93 (0) 772-164-044 ++93 (0) 776-133-029 Background on the Confusion over the Applicability of Tax Exemptions to Sub-Contractors. August 2011 I. Taxation in Afghanistan Generally. The first modern income tax law applying to companies and individuals came into effect in 2005.1 On March 21, 2009, the current law (the “Tax Law”)2 came into effect. Amongst other changes, the Tax Law implemented a requirement to withhold from subcontractors and vendors. The income tax regime applicable to most companies doing business in Afghanistan under the Tax Law is primarily comprised of the following elements: • Business receipts tax (BRT) of 2-10% of gross revenue depending on the industry. Most contractors would qualify for the 2% rate (“Revenue Tax”); • Profit tax of 20% of net profits after allowable expenses (“Profit Tax”); • Obligation to withhold from landlords at between 0% - 15% (“Landlord Withholding”); • Obligation to withhold from employees up to 20% (“Employee Withholding”); and • Obligation to withhold from subcontractors, vendors or suppliers providing goods or services within Afghanistan, at either 2% or 7% (“Subcontractor Withholding”). II. Tax Exemptions in Afghanistan. Certain donors have negotiated preferential tax treatments for projects that they fund in Afghanistan through various bilateral agreements with the Government of Afghanistan (“Tax Agreements”). However, in many cases, donor and private company expectations for how these tax exemptions work differ dramatically with how they are interpreted and enforced by the MoF. The following chart shows some common assumptions about how tax exemptions work, and how they are actually enforced by the MoF: 1 Afghanistan Income Tax Law 2005, as published in Official Gazette Number 867, dated November 26, 2005. 2 Afghanistan Income Tax Law 2009, as published in Official Gazette Number 976, dated March 18, 2009. *Not admitted to practice the law of Afghanistan © 2011 All rights Reserved Rosenstock Legal Services ROSENSTOCK LEGAL SERVICES Chart IIA Common Assumptions Reality on the Ground as Implemented by the MoF Tax exemptions apply According to the MoF, tax exemptions do not apply automatically. automatically. Companies must apply for exemptions with the MoF on a project-by-project basis. Companies that are tax All companies are required to register to do business exempt do not need to and obtain a Tax ID Number. Registration is required register to do business. before companies can apply for tax exemption. Tax exemptions cover all tax Tax exemptions generally exempt companies from liabilities. Revenue and Profit Taxes, but no tax exemptions exempt companies from all of the withholding obligations. This is because the MoF does not consider withholding obligations to be taxes on the company with the obligation to remit. Subcontractors are entitled According to the MoF, the only Tax Agreement which to the benefits of tax extends benefits to subcontractors is the USAID exemptions. Agreement. Therefore no subcontractor at any level contracting with any U.S. Government agency other than USAID is entitled to any tax exemption. A single tax exemption In fact, tax exemptions are project/contract based. A covers the entire company. company can have some work which is tax exempt, and some which is not. A company can even have exemptions under multiple Tax Agreements as well as non tax-exempt work, in which case a company must follow several separate rules for complying with their tax obligations. The following chart shows how some of the most frequently referenced Tax Agreements are actually being enforced by the MoF: Chart IIIA Tax Category ISAF MTA Dip Notes USAID Cooperation Agreements Profit Tax Exempt Exempt Exempt Revenue Tax Exempt Exempt Exempt Withholding from International Staff Exempt Exempt Exempt Withholding from Local Staff Non-Exempt Exempt Non-Exempt Withholding from Landlords Non-Exempt Non-Exempt Non-Exempt Withholding from International Non-Exempt Non-Exempt Exempt Subcontractors Withholding from Local Subcontractors Non-Exempt Non-Exempt Non-Exempt International Subcontractors Eligible Non-Eligible Non-Eligible Eligible for Exemption? Local Subcontractors Eligible for Non-Eligible Non-Eligible Non-Eligible Exemption? NOT LEGAL ADVICE © 2011 All rights Reserved Rosenstock Legal Services Page 2 of 4 ROSENSTOCK LEGAL SERVICES III. Mixed Signals. A. ISAF MTA. On March 9, 2011 General David H. Petraeus issued a letter of interpretation (the “Petraeus Letter”), based on his authority as commander of ISAF as provided for in Article 7 of the ISAF MTA.3 According to this interpretation: • All International Contractors, whether prime or subcontractors are exempt from Afghan taxes. • All Local Contractors, whether prime or subcontractors, are subject to Afghan tax law. Notwithstanding the Petraeus Letter, the ISAF MTA is currently interpreted and implemented as follows by the MoF: • All prime contractors, whether international or local, are exempt from Profit and Revenue Taxes, but are subject to Landlord Withholding, Employee Withholding and Subcontractor Withholding. • All subcontractors, whether international or local, are not entitled to any tax exemptions and are subject to the full Afghan tax regime. • No contracts with U.S. Government agencies are subject to the terms of the ISAF MTA. All contracts with U.S. Government agencies are interpreted in light of the Dip Notes. B. Dip Notes. 4 On March 29, 2011 the Department of Defense issued a Memorandum concerning tax exemptions in Iraq and Afghanistan (the “DoD Memo”).5 According to the DoD Memo: • “DoD contractors, subcontractors, and their employees are exempt from any taxes or similar charges imposed under Afghan law…DoD contractors, subcontractors, and their U.S. or other non-Afghan employees are not subject to any taxes, customs duties or other similar charges while present in Afghanistan.” • “Afghanistan may require companies to register and file returns, although Afghanistan entities may not charge a fee for such registrations or filings.” Notwithstanding the DoD Memo, the Dip Notes are currently interpreted and implemented as follows by the MoF: 3 The Military Technical Agreement between the International Security Assistance Force (“ISAF”) and the Interim Administration of Afghanistan (the “ISAF MTA”). 4 Agreement regarding the Status of United States Military and Civilian Personnel of the U.S. Department of Defense Present in Afghanistan in connection with Cooperative Efforts in response to Terrorism, Humanitarian and Civil Assistance, Military training and Exercises, and Other Activities – Entered into force on May 28, 2003; Effected by exchange of notes September 26 and December 12, 2002 and May 28, 2003 (the “Dip Notes”). 5 March 29, 2011, Memorandum for Director of Defense Procurement and Acquisition Policy, from Department of Defense, Office of the General Counsel. NOT LEGAL ADVICE © 2011 All rights Reserved Rosenstock Legal Services Page 3 of 4 ROSENSTOCK LEGAL SERVICES • All prime contractors, whether international or local, are exempt from Profit Tax, Revenue Tax and Employee Withholding, but are subject to Landlord Withholding and Subcontractor Withholding. • All subcontractors, whether international or local, are not entitled to any tax exemptions and are subject to the full Afghan tax regime. • Companies which are required to register in Afghanistan are required to pay a registration fee. IV. Additional Resources. • Afghanistan/Contractor Tax Issues Update, presented by Raymond S.E. Pushkar, Mckenna Long & Aldridge LLP at the ABA Annual Meeting, Toronto, Canada, August 6, 2011. NOT LEGAL ADVICE © 2011 All rights Reserved Rosenstock Legal Services Page 4 of 4 .