i. What is a contract?
According to Tax Guide 21: “A contract is an agreement between two or more parties, which is enforceable by the law. A business transaction to buy and sell goods and services is a contract between the buyer and seller.” An offer and acceptance of business transactions or sale and supply of goods and services constitute a contractual arrangement. Such contractual arrangement may be in writing or verbal and the mode of payment in cash or on credit. The transaction is a contract and withholding provisions of Article 72 of the Income Tax Law 2009 shall apply.
ii. General contractor tax withholding requirements
Article 72 of the 2009 Income Tax Law stipulates that any payments to a licensed contractor shall be subject to 2% contractor tax and any payments to an unlicensed contractor shall be subject to 7% contractor tax. This contractor tax is intended to be withheld from the gross contract amount so that the financial burden of the tax falls on the contractor rather than the person or entity making the payment. The entity that withholds the contractor tax then submits the tax to the Ministry of Finance, and that tax is credited to the account of the contractor (so that the contractor can claim the tax withheld against future tax liabilities). While the tax law itself does not mention a threshold, paragraph 72.4 of the 2009 Income Tax Manual does. The exact text is as follows:
Article 72 does not provide a threshold amount below which no withholding tax is required. To reduce the compliance burden on taxpayers, a minimum threshold of Afs 500,000 has been set for contract withholding purposes. Transactions below Afs. 500,000 are not subject to withholding income tax. Payments for purchases of daily household consumption are usually below this minimum threshold and are not liable for withholding income tax. Payments on account of purchases or supplies made or services rendered to a legal or natural person aggregating below Afs. 500,000 in a tax year shall not be subject to withholding tax. However, if the aggregate of payments to one person on this account exceed this threshold in a tax year the entire payment to that legal or natural person shall be liable to contract withholding income tax under Article 72.
iii. Contract amount is less than AFN 500,000 but there is a written contract
There is no clause in the law or related published guidance that indicates that contractor withholding tax for written contracts should be handled any differently than for verbal or unwritten contracts. However, some taxpayers have faced pressure at the tax office to withhold contractor tax on written contracts even if the aggregate annual amount is less than AFN 500,000.
A conservative approach to minimize risk would be to withhold contractor tax on all written contracts, even if the annual aggregate amount is under AFN 500,000. Written contracts are typically more formal agreements between two formally registered companies, and if the vendor in question complies with the tax law, withholding contractor tax on payments to such a vendor should not increase the vendor’s final tax liability (because the tax withheld can be claimed by the vendor as a credit).
However, if a taxpayer is facing pressure at the tax office to pay contractor tax on written contracts below AFN 500,000 for prior periods where it is no longer possible to withhold, there is solid ground in the published tax law and related guidance for the taxpayer to maintain the position that contractor tax withholding is not required (even for written contracts) below an annual aggregate threshold of AFN 500,000.
In case you want to know more about how wage withholding tax and contractor withholding tax should be calculated and when is the due date for paying these withholding taxes as per the Afghanistan tax law, please click here and go to section 2 Withholding Taxes.