Income
Tax Appeal
KUDYA
J:
This
appeal deals with five issues in four categories arising from the
disallowance of the tax deductions that were claimed by the appellant
in the tax year ending December 2009.
The
four categories are in respect of expenditure on computer software,
foreign currency accruals derived from leveraging a dividend pay-out
by a public company quoted on both the Zimbabwe Stock Exchange and
the Johannesburg Stock Exchange, a purported loan advanced to the
appellant by a related foreign bank, hereinafter referred to as the
related party, that was subsequently purportedly written-off and the
penalty imposed on the appellant by the respondent over the dividend
leverage.
The
appellant company is a registered commercial bank. The respondent is
a statutory body established in terms of the Zimbabwe Revenue
Authority [Chapter
23:11].
At
the appeal hearing, the appellant called the testimony of six
witnesses and produced 5 bundles of documents. Three of the witnesses
flew from the headquarters of the foreign based Banking group that
controls both the appellant and the related party. These were the
Group General Counsel who has been with the group since 2002, the
Financial Controller who has been with the Banking group since 2008
and the Head of Central Finance and Chief Finance Officer of the
Africa Division of the Banking group. The last three witnesses were
the Chief Finance Officer and the Head of Global Markets and Treasury
of the appellant and a tax consultant with a local firm of chartered
accountants.
The
5 bundles were the 71 paged bundle 1 of the correspondence between
the parties in the period 15 May 2012 to 21 November 2013, the 83
paged bundle 2, of which p. 11-83 cover the licence and service
agreements and the main agreement between the appellant and the main
software licensor, the 41 paged bundle 3 that contains the Reserve
Bank of Zimbabwe monetary policy statement on capitalisation of
financial institutions, the 29 paged bundle 4 that covers the
information on the dividend transaction and the 41 paged bundle 5
that contains the loan agreement and other ancillary documents
between the appellant and the foreign related Banking group.
The
respondent did not lead any oral evidence but was content to rely on
its 57 paged Commissioner's case.
On
18 November 2012, the respondent issued to the appellant three
amended assessments in respect of income tax for the tax years ending
December 2009, December 2010 and December 2011 [annexures A1, A2 and
A3 of the respondent's case and p. 41-43 of bundle 1,
respectively]. The appellant objected to these assessments and
penalties on 17 December 2012 in accordance with the provisions of
section 62 of the Income Tax Act [Chapter
23:06]
[annexure B of respondent's case]. The respondent failed to
determine the matter within three months. By virtue of section 62(4)
of the Income Tax Act, the objection was deemed disallowed.
An
appeal was duly noted to this Court on 27 March 2013.
The
noting of the appeal triggered a belated response dated 19 April 2013
to the earlier objection. The response disallowed every objection
except the one on interest earned on Nostro accounts and partially
allowed the objection to penalties. On 29 April the respondent issued
a further amended assessment, annexure G of the respondent's case,
for the year ending December 2009. Objection to the further amended
assessment resulted in yet another corrected assessment issued on 20
May 2013, annexure H of the respondent's case. The appellant paid
the assessed tax on 20 May 2013 in the sum of USD2,038,425.86 in
three installments between 1 June and 1 August 2013 [p71 of bundle
1].
This
appeal, by consent of the parties, is restricted to the objections in
respect of the deductions that were disallowed in the tax return for
the year ending 31 December 2009. The appellant indicated its
intention to proceed with the other aspects of the appeal, placed in
abeyance, soon after the delivery of judgment in this appeal.
THE
COMPUTER SOFTWARE
The
first issue for determination in regards to the software was whether
the expenditure on the software was of a revenue or capital nature.
The
appellant contended that the installation of new software for its
banking business at a cost of US$2,329,776.85 was for the purposes of
trade or the production of income and therefore deductible in
accordance with section 15(2)(a) of the Income Tax Act. The
respondent disallowed it on the ground that the expenditure was an
expense of a capital nature and was therefore not deductible under
that section.
The
evidence led by the appellant on the new software explained the
justification for the software and how it was implemented. The
appellant established through the evidence of both the local and
Group Chief Finance Officers the objective necessity for the new
software. In 2008, world record hyperinflation took its toll on the
Zimbabwean economy. The Public Accountants and Auditors Board,
Zimbabwe Accounting Practices Board and Institute of Chartered
Accountants of Zimbabwe issued a persuasive but not prescriptive 33
page Guidance: Change in Functional Currency 2009 document for use by
preparers and auditors of International Financial Reporting Standards
compliant financial reports in Zimbabwe, page 9 to 41 of bundle 3. On
the basis of hyperinflation estimated by the World Bank at 500
billion percent by the end 2008, multiple exchange rates escalating
at corresponding rates and multiple interest rates ranging from 100%
to 10,000% per annum the document categorised our moribund economy as
a dysfunctional economy.
The
digits in our currency grew exponentially to millions, billions,
trillions and quintillions. The monetary authorities removed a total
of 25 zeroes from the local currency (3 in 2006, 10 in August 2008
and 12 in January 2009). The core banking system, Bankmaster 7, of
the appellant could cope with up to 12 digits. Once the balance
reached 1 trillion, the system failed to cope and posted wrong
customer transaction values and account balances. Internal creation
of secondary accounts by splitting customer balances and in some
instances splitting a customer's account into 20 accounts to hold
various balances just in order to contain the figures, using the
manual system and constant removals of zeroes by the Bank in addition
to those at the national level and advising the customer to multiply
by a given figure to know the correct balances to reduce the digits
offered temporary rather than permanent relief. [See p5-10 of bundle
2 dated 27 April 2008 on procedures on tactical solution.] These
measures failed to curtail the presence of poor accounting records at
some of the branches of the appellant as at 13 May 2008 as
highlighted in the e-mail at pages 1-4 of bundle 2. The risk of a
complete system failure was highlighted by both auditors and internal
oversight committees of the Bank such as the Executive Management
Committee, the Board Audit Committee and the Board of Directors.
Permanent
relief came with the use of a new core banking system from Misys
International Banking Systems (Pty) Ltd (Misys) that had capacity to
accommodate up to 25 digits. The upgrade commenced with the execution
of the agreement on 31 May 2008. It was test run on 15 November 2008
and was completed in July 2009 at a total cost of US$2,329,776.85.
The total cost of installation was not disputed by the respondent.
The computation of the cost is set out at p 20 of bundle 2 and I
reproduce it below:
Total
cost of MUB system
GBP USD
Initial
licence fees [BA89-ZIM] 250 000.00 [361 300.00]
System
customisation and field configurations (ONO 9232-ZIM) 77
668.00 [112 245.79]
System
customisation and field configurations (ONO 9232-ZIM) 56 118.00
[81 101.73]
User
acceptance testing, conversion preparation; end
User
training and go-live [BA92 (1) ZIM] 424 342.00 [613
259.06]
Post
go-live support [BA 93 (1) ZIM] 113 600.00 [164
174.72]
Administering
support, analysing support requests, providing
Resolution,
testing/validating the support
Request
resolution [BA 93 (1) ZIM] 313 819.00 [453 531.22]
Accommodation
at Meikles for project team 295 000.00
VAT
paid 179 151.00
Project
overheads 70 013.33
TOTAL -------------------------------------------
1 235 547.00 544 164.33
RATE
1.45 1.00
TOTAL
(USD EQUIV) 1
785 612.52 544 164.33
GRAND
TOTAL 2 329 776.85_
The
main factual dispute between the parties was whether the appellant
purchased the computer software or not.
The
appellant stated that it purchased the right to use the software and
not the software. The respondent contended that it purchased a copy
of the computer software and not merely the right of use.
The
local Chief Finance Officer of the appellant chaired the
implementation team for the new system and was involved in the
implementation of the whole project. He described the software that
was installed by Misys. It was an intangible program loaded on disc.
The licence and services agreement # BA 89-LA at p 70 of bundle 2 was
executed on 31 May 2008 between the licensor Misys of Dublin Ireland,
the intervener/guarantor for payment by the licensee, the related
party and the appellant as the licensee.
The
licence was a personal, non-exclusive and non-transferrable one for
the use of the software and documentation in exchange for maintenance
and services set out in the agreement. Clause 8.0 (i) bestowed:
“all
intellectual property rights in any tailoring or additional
functionality either created using the facilities of the software or
within the software developed by the licensee pursuant to clause 6
[the right of appellant to alter the software to suit peculiar
operational requirements for itself or other users] above shall as
between the licensor and the licensee vest absolutely in the licensor
and the licensee shall deliver such developments to the licensor and
execute such instruments as the licensor may reasonably request, at
the licensor's expense to give effect to the licensor's rights as
aforesaid.”
In
terms of clause 8(ii)(c) where the licensor licenced any additional
functionality to other customers it was obliged to provide a credit
voucher to the appellant. The maximum value for the appellant was set
at 50% of the contract value paid to the licensor by such new
customer. The amount due to the appellant was based on the total
development time and related expenses incurred in creating such
additional functionality. The appellant could offset the credit value
against 50% of the prevailing recurring licence fee or 25% of the
initial licence fee due. Where it had not been licensed to another,
it remained vested in the licensor.
In
terms of clause 8(iv) the licensee had the right to withhold the
additional functionality from the licensor. The licensor was
permitted to develop similar additional functionality on its own
initiative but could not utilise inside information to copy,
decompile, disassemble, reverse engineer or search for source codes
or underlying algorithms of such modifications. The licensor was
protected from liability and could be indemnified by the appellant
for any claims by other customers arising from the use of the
modification.
While
the import of clause 8 was to vest the modifications to the software
by the appellant to the licensor, the benefit that accrued to the
licensee from use of that software by third parties, in my view,
demonstrated that such software was an income producing machine.
Clause
15.0 provided a notice period of termination by either party of two
years and clause 16 placed the duty to pay for the software and other
supplies on the related party within 30 days of the due date of
invoice once the appellant failed to honour such invoice.
The
four schedules to the main agreement are set out on p 21 to 69 of
bundle 2. These four schedules to the agreement came into force on
the same day as the main agreement. In case of conflict between the
documents, the schedules superseded the main agreement.
Schedule
No # BA91 (1)–ZIM spells out the services to be provided to the
licensee by the licensor in terms of the main agreement. It is in two
parts. The first part deals with the time and material services to be
supplied to support user acceptance test, conversion preparation,
end-user training and go-live. It sets out the criteria for costing
the time and material services provided. The broad areas covered for
costing were based on notice period of the personnel and each
personnel grade daily fee rate, overtime, travel, accommodation and
visa costs.
Part
two set out the provisions expected from the licensee for the
implementation of the project. These were grouped into three
categories of technical facilities, business provisions and software.
Under technical facilities are listed 8 stages of implementation. The
first being the provision of infrastructure described as entire
hardware, operating system and standard software necessary for
overall licensee solution. The other stages involved connectivity
with third-party systems and provision of documentation, installation
of operating and other system software and configuration of the
hardware. Under business provisions fall testing concepts based on
test cases, test data and testing activities, training concepts,
documents and training implementation and management of the
implementation process.
Schedule
No. # BA93 (1)-ZIM for time and materials was also in two parts. It
listed the personnel expected from the licensee from administrative
support, analysts to validators and the criteria for the invoicing of
the licensee by the licensor. The technical facilities, business
provisions and software required were similar to those set out in BA
92(1) ZIM-part 2. Schedule No. # BA89-ZIM was a statement of the
software and documentation to be licenced and maintenance to be
provided to the licensee by the licensor. The licensed software was
identified as BankFusion Universal Banking [BFUB] release 1.0
consisting of 10 modules and 39 sub-modules, BankFusion Integration
Framework for Universal Banking [BFIFUB] release 1.0 consisting of
four modules and 12 sub-modules; BankFusion Design Workbench [BFDW]
release 1.0 consisting of 7 modules and 22 sub-modules. The licenced
software was further confirmed at p33 of bundle 2.
The
BFUB modules and sub-modules in parenthesis that were provided were
Foundation services [data management, financial processes, charges,
interest, limits, static data management, process scheduler, security
framework, event framework for authorisations and alerts], customer
party management [customer acquisition, party-relationship
management],retail deposits [current, time, notice, savings], retail
lending [origination, mortgages, consumer loans, commercial loans,
offsets], Treasury-Money market [Bills, CDs, securities, bonds],
Treasury–foreign exchange [spots, forwards, options, swaps],
payments [standing orders, sweeps, batch payment processing, money
transmission services], international payments (including swift)
[outward defined list of messages supported, SWIFT statements,
financial management [general ledger, profit and loss, balance sheet,
FX revaluation, accruals] and collateral management.
The
BF Integrated Framework for Universal Banking release 1.0 consisted
of Interaction methods being inward notifications, outward
notifications, request-response; integration protocols [XML, Byte
Stream, SMTP, WSDL JMX] application specific interfaces [branchpower,
CR2 ATM Sparrow system, IBSnet, MoneyGram, Fontis] external job
scheduler gateway.
The
BankFusion Design Workbench release 1.0 consisted of the following
modules and sub-modules: Producer design, Process design [business
object connector, sub-processor execution, process flow branching,
for loop, Do-while lop, While-do-loop, table lop]; external
interaction-screen designer [attribute Type definition, Attribute
Type validation, screen style definition, attributable event/rule
definition, sub-process calling function,] External
Interaction-message builder [byte stream, XML, Email (SMTP), Web
services, expression/rules builder, software component builder
[activity step, feature, extension points] and Business object
component builder [user-definition attributes, attribute ID
generator, attribute ID valuator).
I
have listed the modules and sub-modules of the software to dispel any
mystique that may be attached to the term. In my view, the modules
and sub-modules listed on p 29-30 of bundle 2 of the appellant's
case were the basic structures [frameworks] which produced the income
for the bank, they were not the income. They formed an integral and
indivisible part of the income generating machine for the bank. They
were much like the hardware for the bank.
The
initial licence fee [ILF] of GBP250,000.00 incurred was due on the
effective date of schedule #BA 89-ZIM and thereafter a recurring
licence fee [RLF] of GBP37,500.00 was due and payable in advance on
1 May each calendar year following delivery.
Schedule
No. ONO 9232-ZIM, was the statement of the services provided to the
licensee for specified scope of works. A fixed price of GBP77,668 was
set for the installation, configuration and system test of the
software and thereafter appropriate training based on technical
facilities, business provisions and software stated on p 37 of bundle
2. The phases of implementation were set out at pages 41-43. The key
activities and responsibilities of the parties were shown on p 44 to
48. Interface with third parties was the subject of pages 45 to 51
and deliverables and change of control from licensor to licensee were
stated from 49 to 61.
In
the excerpts to the financial statement of the appellant, from
annexure J to annexure M3 to the Commissioner's case, covering the
2009, 2010 and 2011 financial years the appellant treated the
computer software as an intangible asset and amortised it. In the
notes of its accounting policies replicated in the three financial
years in annexure M1, M2 and M3, the appellant stated that:
“Intangible
assets: computer software:
Generally,
costs associated with developing or maintaining computer software
programmes and the acquisition of software licenses are recognised as
an expense as incurred. However, direct computer software development
costs that are clearly associated with an identifiable and unique
system, which will be controlled by the bank and have a probable
future economic benefit beyond one year, are recognised as intangible
assets. Capitalisation is further limited to development costs where
the bank is able to demonstrate its intention and ability to complete
and use the software, the technical feasibility of the development,
the availability of resources to complete the development, how the
development will generate probable future economic benefits and the
ability to reliably measure costs relating to the development. Direct
costs include employee costs arising from software development and an
appropriate portion of relevant overheads. Subsequent expenditure on
computer software is capitalised only when it increases the future
economic benefits embodied in the specific asset to which it relates.
Direct computer software development costs recognised as intangible
assets are amortised on the straight line basis at rates appropriate
to the expected useful lives of the assets (two to 10 years) and are
carried at cost less accumulated amortisation and accumulated
impairment losses. The carrying amount of capitalised computer
software is reviewed annually and is written down when impaired.”
The
economic benefit of the MUB system, as conceded by the local Chief
Finance Officer, did not just have a probable future economic benefit
beyond one year, but was still in use even as he testified on 1
September 2014, some 5 years later.
The
respondent contended that the future economic benefit that accrued to
the appellant was synonymous with the enduring benefit test
propounded in British
Insulated Helsby Cables Ltd v
Atherton (1926)
AC 205. It was held in that case that where an expenditure was made
with a view to bringing into existence an asset or an advantage for
the enduring benefit of trade, there was very good reason for
treating such expenditure as properly attributable to capital and not
to revenue.
In
my view, the computer software installed by the appellant was
intended to procure an advantage for the enduring benefit of the
appellant's banking business. It was not transient but durable in
nature. The two year notice period to discontinue use and the length
of the future economic benefit of up to 10 years enunciated in the
accounting policy is clear testimony of the enduring nature of the
software. The expenditure on the software thus amounted to capital
expenditure.
The
respondent also relied on
Amway India Enterprises v
Dy CIT
(2008) 111 ITD 112 for the submission that software expenditure was
of a capital rather than revenue nature. The case extensively
surveyed the Indian tax topography and extensively examined American
cases in point. In paragraph [43] and [44] it unveiled the “three
tests generally applied to decide the nature of expenditure as to
whether it is capital or revenue, (as) the test of enduring benefit,
ownership test and functional test” that are based on practical and
business point of view and sound principles of accountancy.
In
India expenditure is treated as capital expenditure either when it
results in the acquisition of ownership of a capital asset [ownership
test] or when it results in the accrual of an advantage of an
enduring nature to the user in the capital field [the enduring and
functional test]. Accrual of benefit in the capital field was defined
in para [44] to mean a benefit that forms part of the profit–making
apparatus of the taxpayer's business.
In
the present matter, I agree with Mr de
Bourbon
that the appellant did not acquire ownership of the software. The
first arm of the test does not apply to it. The use of the software
by the appellant's own admission resulted in accrual of an enduring
benefit to its business. The treatment of the software as an
intangible asset, albeit in compliance with International Financial
Reporting Standards and the recommendations of the Public Accountants
and Auditors Board, the potential to derive revenue from tailoring or
additional functionality of the software and the close affinity of
the software to computer hardware [incorporation of information in
the software into the user's computer-programmed at user's site
or from remote supplier site by wireless or use of punch cards, discs
magnetic tapes], in my view, all form part of the profit making
apparatus of the appellant's business. After all, software, in my
view, constitutes the living and inseparable force of a computer.
My
conclusions in this regard resonate with those of the Special Bench
in the Amway
case,
supra.
That Special Bench was set by the President of India, in terms of
Indian tax legislation, to determine the issue whether software was
of a capital or revenue nature in view of the many conflicting
decisions of various Division Benches in India. It was to provide a
holistic determination on the issue.
The
facts were that the assessee, Amway claimed a deduction for
expenditure incurred for software in its tax return for 2001-2002 tax
year. It acquired 8 computer application software programmes whose
nature and purpose were outlined in the judgment. The assessee
contended that the expenditure was incurred in obtaining the licence
to use the application software was of a revenue nature as it only
facilitated its day to day operations and that the life of such
software was invariably short and bound to become technically
obsolete pretty quickly. The assessing officer found all the software
had long lasting use of between 3 and 4 years. He dismissed the claim
on the basis that the software was part of the plant and machinery of
the assessee and gave an enduring benefit to it. The taxpayer
appealed to the Division Bench. The taxman contended that acquiring a
licence to use software was the common mode of “purchase” of
software and that expenditure incurred of such software that gave an
enduring benefit to the assessee was of a capital nature. The
Division Bench held that computer software was an intangible asset
that constituted an integral part of a computer and without which a
computer could not function, was of a capital nature.
The
appeal was set before the Special Bench.
The
taxpayer argued before the Special Bench much along the lines
followed by Mr de
Bourbon
in the present matter, that it was a mere non-exclusive licensee with
no title for improvements, modifications and derivatives as these
were vested in the licensor.
The
Special Bench held firstly, in para [55] and [61] on the authority of
various Supreme Court of India cases that software was not an
intangible but a tangible asset “though a licensee, the person
purchasing the disk or other medium containing the software is owner
to the extent of the rights comprised in the license.” Secondly
that the acquisition of computer software or for that matter the
licence to use such software amounted to an acquisition of a tangible
asset for which the assessee became the owner thereof; thirdly that
where the life span of the software was under two years it could be
considered as revenue expenditure but where the utility value went
beyond two years as long as it met the functional test such
expenditure would be considered an accrual of an enduring nature and
lastly that the application of the functional test was more important
and relevant to the consideration of whether software expenditure was
of a revenue or capital nature regard being had to its use in the
business of the taxpayer.
I
am satisfied that applying practical business and sound accounting
principles emanating from International Financial Reporting Standards
that informed the treatment of software as an amortised intangible
asset in the financial accounts of the appellant for three
consecutive years all expenditure attaching to computer software was
of a capital nature. I, therefore, agree with Mr Magwaliba
that Commissioner
of Taxes v
Rendle
1964 RLR 463 (AD) at 466-7 dealt with deduction of designed and
fortuitous expenditure of a revenue nature and does not apply in the
instant case.
The
first issue referred for determination, whether the cost of computer
software acquired by the appellant was a revenue expense which was
allowable as a deduction in terms of section 15(2)(a) of the Income
Tax Act or constituted an expenditure of a capital nature and thus
not allowable as a deduction is answered in favour of the respondent.
The cost of the computer software acquired by the appellant was not
deductible as it constituted capital expenditure. It was properly
disallowed.
The
second issue was whether or not the respondent was bound by a
decision made by the Department of Taxes in 1999 regarding the
treatment of the cost of acquitting computer software when computing
taxable income.
It
was common cause that the 1999 decision was not a general binding
ruling and had no binding effect in 2009 or at all. It does not meet
the criteria set out in Schedule 4 of the Revenue Authority Act
[Chapter
23:11].
The decision does not bind the respondent.
The
tax consultant testified on the purported existence of a tax practice
since 18 May 1999. He further indicated that the claim for deduction
in the 2009 tax return was submitted on the basis of the purported
practice. He stated that the appellant became aware of the change in
the purported practice on receipt of the first set of amended tax
returns disallowing the claim. In the notice of objection, notice of
appeal, appellant's case and reply to the Commissioner's case,
the appellant raised the doctrine of legitimate expectation arising
from the communication of 18 May 1999 between a firm of chartered
accountants that acted as the tax consultant to the appellant and the
respondent [annexure I of respondent's case and p. 17-19 of bundle
2]. In that letter, the respondent treated computer software as a
consumable item and classified expenditure either by purchase or
development as revenue expenditure deductible in terms of section
15(2)(a) of the Income Tax Act. It was common cause that the general
letter of enquiry and the response did not constitute a general
binding ruling contemplated in general by the 4th
Schedule and in particular by para 5(3) thereof of the Revenue
Authority Act, supra.
Mr
de
Bourbon
submitted that proviso (i) of section 47(1) of the Income Tax Act
precludes the respondent from issuing an amended assessment on a tax
return submitted in terms of the purported departmental practice
reflected in the letter from the respondent of 18 May 1999. The
proviso reads:
“47
Additional assessments
(1)
If the Commissioner, having made any assessment on any the tax payer,
later considers that---
(a)
An amount of taxable income which should have been charged to tax has
not been charged to tax; or
(b)
In the determination of an assessed loss —
(c)
Any sum granted by way of credit should not have been granted
Provided
that----
(i)
No such adjustments or call upon the taxpayer shall be made if the
assessment was made in accordance with the practice generally
prevailing at the time the assessment was made;
(ii)
Subject to proviso (i), no such adjustment or call upon the taxpayer
shall be made after 6 years from the end of the relevant year of
assessment, unless the Commissioner is satisfied that the adjustment
or is necessary as a result of fraud, misrepresentation or wilful
non-disclosure of facts, in which case the adjustment or call may be
made at any time thereafter;
(iii)
The powers conferred by this subsection shall not be construed so as
to permit the Commissioner to vary any decision made by him in terms
of subsection (4) of section sixty-two.”
I
was able to find four cases from this jurisdiction that dealt with
the precursor proviso (i) to section 47(1). These are: X
v
Commissioner of Taxes
1978 (1) SA 605 (R) at 614H-615A, 618A and 619G where the taxpayer
was obliged to establish on a balance of probabilities the existence
of the alleged practice by cogent and not vague evidence; LW
v
Commissioner of Taxes
1967 (3) SA 70 (R) at 77D; NCGF
Ltd v
Commissioner
of Taxes
1960 (4) SA 919 (SR) at 922 and Commissioner
of Taxes v
New
Consolidated Goldfield Ltd
1962 (1) SA 886 (FC) at 891-2.
It
does not appear to me that the tax consultant established a practice
generally prevailing at the time the assessment was made. The tenor
of his evidence was a carry-on of the averments in the objection of
the existence of a tax ruling issued in 1999. It was clear to me that
the letter in question was not a tax ruling. It did not satisfy the
requirements of para 2 and 5 of the 4th
Schedule of the Revenue Authority Act. The erroneous cancellation of
the purported tax ruling by the respondent's chief investigator in
the present case in his letter of 7 August did not confirm the
existence of the practice. Section 3(4) that he sought to rely on for
the cancellation was repealed in its entirety without substitution by
the Finance Act No. 8 of 2011 with effect from 16 September 2011. The
existence of such practice was disputed by the respondent in its case
and was put in issue during the cross examination of the tax
consultant. In my view, an opinion wrong at law cannot establish a
practice. The respondent was therefore, not precluded by proviso (i)
to section 47(1) of the Income Tax Act from issuing an amended
assessment.
In
the light of these findings, I agree with Mr de
Bourbon
that the respondent is obliged to allow the deduction of special
initial allowance on the cost of the software in question at the rate
prescribed in the Income Tax Act.
I,
therefore, hold that software expenditure was of a capital nature.
The respondent correctly disallowed the claim for deduction of
US$2,329,776.85 from the appellant's tax return for the year ending
31 December 2009.
THE
DIVIDEND TRANSACTION
The
third issue was whether the amount obtained by the appellant in the
dividend transaction should be treated as the appellant's taxable
income or as non-taxable income when calculating the appellant's
taxable income.
The
facts relating to the dividend transaction were common cause. The
Head of Global Markets for the appellant and the local Chief Finance
Officer testified on what transpired. The 29 paged bundle 4 confirmed
the paper trail of the events.
On
17 December 2008 the appellant was requested by a foreign based
company to act as its agent in payment of an interim dividend for its
Zimbabwe registered shareholders. The time table for the last day of
trade for receipt of dividend, 2 January 2009, the ex-dividend share
trade, 5 January 2009, the currency conversion date, 9 January 2009
and the dividend payment date, 12 January 2009 were all provided.
ZAR45,580,500.00, described by the local Chief Finance Officer as a
capital amount to pay the dividend, was transferred into the Nostro
account of the appellant on 8 January 2009. It was instructed to pay
the non-resident shareholders on the Zimbabwe register in United
States dollars. The sum of R366,503.40 was converted to US$38,989.72,
according to p. 17 of bundle 4, at the rate ZAR9.40: US$1 and
appropriated for that purpose. The balance of R45,213,996.60
equivalent to US$4,521,340.00 was converted to
ZW$158,729,988,063,723,967.24 (ZW$158,7 trillion), which at that time
was the functional local currency, for payment to local registered
shareholders. The exchange rate used for the conversion on 9 January
2009 was ZW$3,510,638,287.87 to ZAR1.00 [p. 9 and 16 of bundle 4].
On
12 January 2009 the appellant transferred the sum of ZW$158,7
trillion to the local transfer secretaries for payment. The local
resident shareholders were duly paid in the local functional
currency.
The
appellant utilized its own stock of local currency of ZW$158,7
trillion and retained the equivalent sum of US$4,521,340.00 in its
New York Nostro account. Between 13 and 16 January 2009, the
appellant sold US$2 million inclusive of commission of 5% amounting
to US$100,000.00 to the Reserve Bank of Zimbabwe and remained with a
balance of US$2,521,340.00. The commission was accounted for in its
income tax return for the tax year ending December 2009.
The
introduction of the multicurrency regime on 29 January 2009,
practically though not legally, rendered the local currency defunct.
In line with the requirements of the International Financial
Reporting Standards and recommendations from the Public Accountants
and Auditors Board of Zimbabwe the appellant debited the sum of
US$2,521,340.44 in its United States dollar balance sheet and made a
corresponding credit entry in its Zimbabwe dollar balance sheet. It
excluded local currency in its United States dollar denominated
financial statements for the period 1 January to 31 December 2009.
Its capital account showed United States dollar assets had increased
by US$2,521,340.44. A corresponding accounting entry was posted to
the income statement to balance the account. The amount was not shown
as income but was treated in the same way as were other assets such
as buildings, furniture and foreign currency balances acquired in
local currency. These were revalued into United States dollar
balances and an accounting credit entered in the income statement
representing current year reserves, merely to complete the double
entry accounting framework.
It
was the local Chief financial officer's uncontroverted testimony
that the US$2,521,340.44 was credited to the income statement to
fulfil these double entry accounting requirements prompted by
dollarization. It did not represent taxable income. In the tax return
submitted to the respondent, the appellant claimed a deduction
against income for the sum in issue. The respondent disallowed the
claim made by the appellant that this amount constituted an asset of
a capital nature and added it back to income for the appellant for
the year ending December 2009 as being an exceptional gain made as
result of the introduction of the multi-currency regime.
The
appellant's objection was disallowed hence the present appeal.
The
appellant contended that the sum of US$4,521,340.00 from which the
balance of US$2,521,340.00 derived was of a capital nature and could
not be assessed to tax as income. The respondent contended that it
was income.
The
local Chief Finance Officer and Head of Global Banking averred that
the ZW$158.7 trillion exchanged for US$4,521,340.44 was capital in
the hands of the appellant. The appellant used the local currency to
purchase the United States dollars, which remained a financial asset
in its hands. His evidence was that one asset was disposed of and
another purchased. The amount in issue did not change character
merely because the appellant held on to it. The basis on which the
respondent treated the amount as income is not apparent. Four
reasons were advanced in the determination of the respondent of 30
November 2012. The first was the purported absence of proof that the
money came from the foreign based company. The second was the absence
of communication between the appellant and the foreign based company
in regards to purchase of the dividend outlay. The third was the
absence of instructions to transfer the amount to the transfer
secretaries and the fourth was the exceptional foreign exchange gain
derived from the appellant's ordinary course of trade. The fourth
reason was cast in different wording in the para 17 and 19 of the
Commissioner's case where it was contended that the appellant
benefited from purchasing the amount at favourable exchange rates.
Mr
de
Bourbon
contended on the authority of Meman
& Anor v
Controller of Customs & Excise
1987 (1) ZLR 170 (SC) at 173G and Standard
Chartered Bank Zimbabwe Ltd v
China Shougang International SC49/2013
at p.3 of the cyclostyled judgment that the appellant became the
owner of the funds on deposit. He accordingly submitted that the
funds were capital assets in the hands of the bank from which it
could derive income.
The
approach to adopt was spelt out in Natal
Estates Ltd v
Secretary for Inland Revenue
1975 (4) SA 177 at 202G-203A thus:
“In
deciding whether a case is one of realising a capital asset or of
carrying on a business or embarking upon a scheme of selling land for
profit, one must think one's way through all of the particular
facts of each case. Important considerations include, inter
alia,
the intention of the owner; both at the time of buying the land and
when selling it (for his intention may have changed in the interim),
the objects of the owner, if a company, the activities of the owner's
ipse
dixit
as to intention, where the owner subdivides the land, the planning
extent, duration, nature, degree, organisation and marketing
operations of the enterprise; and the relationship of all this to the
ordinary commercial concept of carrying on business or embarking on a
scheme for profit. Those considerations are not individually decisive
and the list is not exhaustive. From the totality of the facts one
enquires whether it can be said that the owner had crossed the
Rubicon and gone over to the business, or embarked upon a scheme, of
selling such land for profit, using the land as his stock-in-trade.
Lastly, one does not lose sight of the incidence of onus of proving
non-liability, imposed by sec 82 of the Act, on the person claiming
such non-liability, in this case the appellant.”
The
commercial concept of a Bank is to mobilise deposits for purposes of
earning revenue income from charges and fees, interest and
investments. The obvious stock-in-trade of a Bank, amongst others, is
money. The deposits the Bank mobilises according to Meman
and
Standard
Chartered Bank Ltd
cases, supra,
are owned by the Bank in the sense that the Bank has ultimate control
of those funds. It would seem to me that the deposits held by a Bank
would constitute trading capital for the Bank. It is accepted in
Banking Law and practice that capital exists in two forms. It may
either be fixed capital or floating/circulating capital. In Solaglass
Finance Co (Pty) Ltd v
CIR
1991 (2) SA 257 (A) 269I-270G Friedman AJA stated:
“As
what the appellant lost was capital which it advanced to the various
debtors and which has become irrecoverable, it is necessary to decide
whether the capital thus lost was fixed or floating (sometimes called
circulating) capital. If it was fixed capital, the loss was of a
capital nature; and if it was floating, the loss was of a revenue
nature.
See
Stone
v
Secretary for Inland Revenue 1974
(3) SA 584 (A) at 595A-B.
The
distinction between fixed and floating or circulating capital was
explained by Innes CJ in Commissioner
for Inland Revenue v
George Forest Timber Co Ltd
1924 AD 516 at 524, as follows:
“Capital,
it should be remembered, may be either fixed or floating. I take the
substantial difference to be that floating capital is consumed or
disappears in the very process of production, while fixed capital
does not; though it produces fresh wealth, it remains intact.”
See
also the New
State Areas
case supra
at 620-1 where Watermeyer CJ, after quoting the above passage,
stated:
“As
to the latter (expenditure of a capital nature), the distinction must
be remembered between floating or circulating and fixed capital. When
the capital employed in a business is frequently changing its form
from money to goods and vice versa (eg the purchase and sale of stock
by a merchant or the purchase of raw material by a manufacturer for
the purpose of conversion to a manufactured article), and this is
done for the purpose of making a profit, then the capital so employed
is floating capital. The expenditure of a capital nature, the
deduction of which is prohibited under section 11(2), is expenditure
of a fixed capital nature, not expenditure of a floating capital
nature, because expenditure which constitutes the use of floating
capital for the purpose of earning a profit, such as the purchase
price of stock in trade, must necessarily be deducted from the
proceeds of the sale of stock in trade in order to arrive at the
taxable income derived by the taxpayer from that trade.”
In
Ammonia
Soda Co v
Chamberlain
[1918] 1 Ch 266 Swinfen Eady LJ defined fixed capital as follows at
286:
“That
which a company retains, in the shape of assets upon which the
subscribed capital has been expended, and which assets either
themselves produce income, independent of any further action by the
company, or being retained by the company are made use of to produce
income or gain profits.”
At
286-7 he described circulating capital in the following terms:
“It
is a portion of the subscribed capital of the company intended to be
used by being temporarily parted with and circulated in business, in
the form of money, goods or other assets, and which, or the proceeds
of which, are intended to return to the company with an increment,
and are intended to be used again and again, and to always return
with some accretion. Thus the capital with which a trader buys goods
circulates; he parts with it, and with the goods bought by it,
intending to receive it back again with profit arising from the
resale of the goods. A banker lending money to a customer parts with
his money, and thus circulates it, hoping and intending to receive it
back with interest.”
The
distinction and its tax ramifications was approved by Botha JA, who
delivered the majority decision in Solaglass,
supra,
at 277J-278A in these words:
“I
have had the benefit of reading the judgment of my Brother Friedman.
In his judgment it is held (a) that the capital which the appellant
lost as a result of being unable to recover the loans in question was
not fixed, but circulating capital, and therefore of a revenue
nature, and that the losses in question were accordingly deductible
in terms of s11(a); and (b) that the losses were not disqualified
from deduction by reason of the provisions of s 23(g). I agree with
(a), but I respectfully differ on (b).”
The
principle that I extract from the distinction set out in the above
cited cases is that a gain or loss arising from fixed capital would
be of a capital nature while a loss or gain arising from floating
capital would be of a revenue nature.
The
appellant did not disclose whether ZWD158,7 trillion was fixed
capital or floating capital. The evidence of both the local chief
financial officer and global head of banking disclosed that the
amount in question was derived from the appellant's own funds. The
impression I had was that the witnesses were referring to floating
capital. In the words of Innes CJ in George
Forest Timber
case, supra,
the ZW$158,7 trillion was consumed and disappeared in the very
process of production. It did not remain intact. It was therefore
floating capital. The new product was ZAR45,213,996.60 which was soon
thereafter converted to US$4,521,340.40.
Mr
Magwaliba
submitted
that the appellant made a profit of US$2,521,340.40 on the dividend
transaction for which he is liable to income tax. He relied on the
appellant's statement on page 7 of bundle 1. The tax consultant
wrote to the appellant on 5 September 2012 that:
“As
explained in the letter of 6th
June 2012, [the foreign company] transferred ZAR45,580,499.95 to
[appellant] to fund dividend pay-outs to their shareholders (resident
and non-resident shareholders in Zimbabwe in January 2009). As the
economy had not yet dollarized in January 2009, the dividend pay-out
to Zimbabwean shareholders was to be in Zimbabwe dollars thus
[appellant] negotiated with the Reserve Bank of Zimbabwe (RBZ) for a
rate for the transaction in comparison to the official ZWD:USD
exchange rates obtaining then. The ZAR:USD exchange rate at the time
resulted in the ZAR amount translating to USD4,560,330.16.
USD2,000,000.00 of this was sold to the RBZ in exchange for ZWD. A
further USD38,989.72 was paid out to non-resident shareholders, and
[appellant] then provided the ZWD equivalent of USD2,521,340.44 that
was paid to the Zimbabwe residents. This is reflected in the table
provided to you showing:”
[The
table did show that the amount converted to ZWD158,7 trillion was the
sum of USD4,521,340.44 and not USD2,521,340.44.]
Mr
Magwaliba
reasoned that the equivalent amount to ZAR45,213,996.60 of
USD4,521,340.40 should have been exchanged at the official exchange
and not at the favourable exchange rate negotiated with the Reserve
Bank of Zimbabwe.
He
contended that the favourable exchange rate resulted in the disposal
of USD2 million for ZWD158,7 trillion that was paid out to the local
registered shareholders while the balance of USD2,521,340.40 accrued
to the appellant as profit. He suggested that had the appellant
exchanged the whole amount at the official rate all the
USD4,521,340.40 would have been taken up by the Reserve Bank and the
local shareholders would have received the correct value on the
dividends while the appellant as a middleman would have maintained a
zero balance. He found confirmation for his contention in annexure N
to the commissioner's case, the tax computation by the appellant
for the tax year ending December 2009 in which it claimed a deduction
of the alleged profit from taxable income as a revaluation of
investment property.
The
contentions and submissions by Mr Magwaliba
are not supported by the evidence led in this court. The evidence was
that the balance of the rands that remained after appropriating
payment for foreign shareholders on the Zimbabwe register was all
converted to Zimbabwe dollars at the favourable rate negotiated with
the Central Bank. There is no evidence to support the suggestion that
USD2 million was converted to ZWD158,7 trillion. Had such evidence
been adduced, the submission might have had merit. The tenor of the
contentions and submissions seeks to deny the appellant the right it
exercised to interpose as the purchaser of the rands directly
converted into Zimbabwe dollars in accordance with the mandate of the
foreign company that paid out the dividend.
In
my view, the rands did not constitute revenue income but remained
floating capital of equivalent value albeit in form of foreign
currency. It seems to me that the ZAR45 million when resident in the
Rand Nostro account of the appellant was not revenue income. It was
floating capital from which revenue income would be earned on
disposal as clearly exemplified by the sale of the US$2 million to
the Reserve Bank of Zimbabwe or on investment. It would be illogical
to aver that the appellant purchased the foreign currency that it
already owned. The two local employees of the appellant testified
that ZW$158,7 trillion constituted capital in the possession of the
appellant. It would also be illogical to aver that the appellant
exchanged the local currency it owned for the United States dollars
it already owned. In Meman's
case
at 173G McNally JA warned that:
“whether
you could call that the Bank's own money, would depend on the
context, in particular what you are contrasting it with.”
In
the context of the present matter, the ZAR45 million did not become
the appellant's money. It was deposited with specific instructions
to transmit it in functional currency to the transfer secretaries for
payment of dividends to shareholders in the Zimbabwe register. In my
view, whoever the owner of the funds was between the company that
transmitted them to the Nostro account of the appellant, the transfer
secretaries and the shareholders in the Zimbabwe register, what is
clear is that these funds were held in trust by the appellant. The
appellant could not in context be the owner of the funds at that
stage.
The
instructions from the company that declared the dividend were that
the rands be converted to United States dollars for the payment of
the 106 foreign shareholders registered on the Zimbabwe register and
the balance in Zimbabwe dollars for the account of the local
shareholders. The documentation establishes that this was done at the
rate of ZAR9:40 to US$1 and ZW$3.5 billion to ZAR1.
The
appellant utilised its own Zimbabwe funds to purchase the rands. The
evidence of two of its local employees that it utilised local capital
funds to purchase the rands was not disputed. It thereafter converted
the rands into United States dollars a portion of which it sold to
the Reserve Bank of Zimbabwe. It earned commission from the sale. The
respondent did not question this transaction but was happy to treat
the amount sold to the RBZ as the income earning apparatus.
I
am unable to distinguish between the portion that was sold to the RBZ
and the one that remained in the appellant's possession. It seems
to me that both sums were capital in nature. I am unable to
conceptualize how a capital sum in Zimbabwe dollars that is utilised
to purchase an equivalent amount in South African rands that are
converted to United States dollars could be apportioned to revenue.
The RBZ transaction suggests that had the local currency remained
functional, the appellant would have had at some stage to dispose it
to best advantage or utilize it to earn income.
I
am satisfied that the appellant has discharged the onus on it to show
on a balance of probabilities that the sum of US$2,521,340.40
constituted capital and not revenue. While I find in favour of the
appellant in regards to the nature of the amount in issue, I hold
also that it was remiss of the appellant to claim this amount as an
allowable capital deduction, in circumstances that are not sanctioned
by the Income Tax Act, from taxable income.
LOAN
AGREEMENT OR BESTOWED BENEFIT
The
fourth issue for determination was whether the amount of
R27,632,759.71 that was provided to the appellant by the related
party was a genuine and bona
fide
loan or was in effect a grant camouflaged as a loan.
The
facts on this issue are generally common cause. The parties disagree
on their interpretation. All the three foreign based witnesses called
by the appellant and the local chief financial officer testified on
what transpired. The documents in the 41 paged bundle exhibit 5 cover
the events connected to this issue.
The
appellant executed an agreement of supply with the supplier of the
MUB core banking system on 31 May 2008. In terms of clause 16 of that
agreement the related party undertook to meet the financial
obligations of the appellant to the supplier in the event that the
appellant failed to pay for the supplies within 30 days of the due
date of invoice.
The
appellant entered into an undated one-paged loan agreement on pages
2, 4 and 25 of bundle 5 with the related party. The related party and
the appellant are both subsidiaries of a foreign based holding
company. The agreement was witnessed by two separate witnesses for
each signatory. The related party advanced a temporary interest free
loan facility to the appellant to cover the costs incurred by the
appellant in the development and implementation of the new MUB core
banking system already dealt with under the first issue. The loan
facility was advanced to enable the appellant to settle financial
obligations in foreign currency for the MUB core banking system. It
was structured in such a way that the related party paid the relevant
charges due from the appellant from 1 May 2008 directly to the
suppliers of the hardware and software of the core banking system.
The appellant undertook to repay all funds paid by 31 December 2009.
The
suppliers of the hardware and software invoiced the appellant within
30 days of rendering each supply and service. The invoiced amounts
were honoured by the related party within a further 30 days of the
invoiced date. The related party was invoiced with a charge of
GBP250,000.00 equivalent to ZAR4,3 million by MIBS for BankFusion
software supplied to the appellant. On 20 October 2008 the related
party successfully applied for exchange control authority [p. 5 of
bundle 5] from the South African Reserve Bank to make payment even
though it had committed itself to pay without exchange control
approval. The retrospective approval of the incurred contractual
obligation and authority to make prospective payment [p.6 of bundle
5] dated 12 November 2008 were premised on the undertaking by the
related party that the appellant would be invoiced separately to
reimburse the related party and that no offset against management
fees was contemplated. Again on 14 May 2009 [p7 of bundle 5] the
related party applied to the exchange control authority in its
country of domicile for payment of US$294,681.94 equivalent to
ZAR2,504,796 to TCL of the United Kingdom due for computer parts and
accessories essential to support the appellant's IT systems
infrastructure supplied to the appellant. It confirmed that the
appellant held Reserve Bank of Zimbabwe exchange control authority to
pay but was unable to do so due to the endemic shortage of foreign
currency in Zimbabwe. Further, it confirmed that it would recover the
amount from the appellant once it was in a position to pay. The
application was approved on 25 May 2009 [p8 of bundle 5] on the basis
of the anticipated recovery. The appellant established through the
evidence of its witnesses and the documents on page of bundle 5 that
the related party paid the equivalent of the total sum of
ZAR27,632,795.71 to the three suppliers.
The
appellant repaid ZAR3,597,753.73 to the related party in three
tranches on 19 January, 18 June and 6 August 2009. The dates of
repayment and amounts paid are set out in the appellant's bank
statement of 3 January 2010 with the related party at p. 11 of bundle
5.
The
debts incurred by the related party on behalf of the appellant
between 19 August and 30 September 2008 were all cleared with the
payment on 16 January 2009 [p.12 and 26 of bundle 5] of a lump sum of
ZAR2 million equivalent to US$200,000.00 for which exchange control
applications to purchase such foreign currency was made to the RBZ on
15 June 2009 (for US$150,000.00 and 4 August 2009 for US$50,000.00 on
p.12 and 14 of bundle 5] for IT support and development costs. The
US$200,000.00 was transmitted from the appellant's Nostro account
with the Deutsche Bank Trust Company in New York to the related party
on 23 June [p.18-21 and 30-32 of bundle 5] and 5 August 2009 [p
22-24 and 27-29 of bundle 5]. The related party, however, paid the
suppliers of the appellant the debit balance due of ZAR24,035,041.98
between 24 March and 6 August 2009. The related party paid the
equivalent of ZAR17,723,954 to MIFS for system development and
implementation, ZAR654,429 to TGL for hardware and ZAR656,659 to OT
for training purposes. The breakdown of these payments is set out in
the Zimbabwe New Account reconciliation of 19 August 2009 on p. 10
and 35 of bundle 5.
The
outstanding loan amount owed by the appellant as at 30 November 2009
in the sum of ZAR24,035,042 was cancelled by the related party on 31
December 2009. The signatory to the loan agreement and his two
previous witnesses appended their signatures on the loan facility
cancellation document on p3 of bundle 5. The cancellation recorded
that the total loan amount paid to the three vendors was in the sum
of ZAR24,035,042 being payments of ZAR17,723, 954 to MIFS for system
development and implementation, ZAR654,429 to TGL for hardware and
ZAR656,659 to OT for training purposes.
The
cancellation, according to the evidence of the general Group Counsel,
the Head Group Central Finance/Chief Finance Officer, the Financial
Controller of the related party and the local Chief Finance Officer,
was prompted by the need to recapitalize the appellant in the wake of
new United States dollar denominated prescribed minimum capital
requirements for all financial institutions mandated by SI178/2008
and decreed by the Reserve Bank of Zimbabwe in a mid-monetary policy
statement dated 30 July 2009 on pages 39 to 41 of bundle 5.
The
statement recognised the existence of capital erosion and diminution
of bank balances of financial institutions denominated in local
currency by chronic hyperinflation and the change-over to the
multicurrency system. A phased plan for enforcement of the prescribed
minimum capital requirements was outlined. All financial institutions
were required to meet one-half of the prescribed capital levels,
being US$6,25 million by 30 September 2009 and the full levels of US$
12,5 million by 31 March 2010 for commercial banks such as the
appellant.
The
e-mail exchanges between the local and group chief finance officers
commencing on 4 November and ending on 9 December 2009 is covered
from page 15-17 of bundle 5. The appellant requested for its Sundry
Creditors account of liabilities as at 31 October 2009. It also
requested for the account to be dispatched every month end. The
indebtedness as at 12 November 2009 was indicated. In consequence of
the write-off of the outstanding debt as at 30 November, a nil debtor
book balance was submitted on 8 December 2009. On 9 December the
local chief finance officer wrote to his head office counterpart that
the write-off would “definitely go a long way toward our
capitalisation exercise.” He was advised in the response of the
same day that the group general counsel was making progress on the
legal issue with a likelihood of the related party directors signing
off some proposed resolution on capitalisation (transfer to
reserves). The e-mail supports that the appellant tracked the debt
and the write-off was linked to capitalisation.
In
the monetary policy statement, the Reserve Bank of Zimbabwe indicated
that the recapitalisation plans submitted by financial institutions
showed that capital injections were expected from holding companies,
private placements, rights issues, mergers and strategic partnerships
with new investors. The appellant did not produce to the respondent
or this court the recapitalisation plan it submitted to the Reserve
Bank of Zimbabwe. Neither did it produce the resolution, if any, that
the directors of the related party passed in regards to the
capitalisation of the appellant.
In
response to an enquiry of 12 March 2013 from SARS the related party
revealed on 5 July 2013[p 36-38 of bundle 5], amongst other things,
that the standard repayment terms availed to the appellant was 30
days from the date of payment to the supplier. The related party was
invoiced by the suppliers on 24 March, 28 April, 20 May and 8 June
2009. Save for the repayment of ZAR3,597,753.73, the appellant was
unable to pay. For tax purposes, the related party debited the
appellant's loan account and credited its own income statement. It
did not make any tax adjustment in the 2009 income tax return but
claimed the loan write off as a deduction of a money lender. The
related party wrote-off the outstanding loan account. The related
party cleared the appellant's loan account in its balance sheet
with a corresponding expense in the related party's income
statement.
The
evidence of the Group General Counsel of the holding company and the
financial controller of the related party established that
intra-group loan agreements were deliberately short form memorials
that served the dual purpose of creating joint contractual
obligations on the one hand and accounting and audit trail on the
other. The Group General Counsel further established that section 70A
of the South African Bank Act of 1990 requires a Bank controlling
holding company for which the Group General Counsel worked and which
owned both the related party and appellant to meet the minimum
capital requirements prescribed by the relevant regulatory
authorities in the jurisdiction its subsidiaries operated in. The
holding company complied with the Reserve Bank of Zimbabwe directive
to recapitalize the appellant by waiving the loan repayment and
appropriating the proceeds to capital.
The
legal arguments
The
respondent basically contented that the appellant and the related
party consummated a simulated loan agreement to camouflage a grant or
subsidy advanced to the appellant. Accordingly, it treated the sum of
ZAR27,632,795.71 as a grant or subsidy as contemplated section
8(1)(m) of the Income Tax Act and added it back to gross income in
the appellant's 2009 tax return.
Mr
de
Bourbon
for the appellant submitted that the appellant had discharged the
onus on it to establish that the amount in issue constituted a loan
and was therefore not subject to income tax.
Mr
Magwaliba,
submitted on the authority of Commissioner
for South African Revenue Services v
MWK Ltd 2010
ZASCA 168; 2011 (2) SA 67 (SCA); (2011) 73 SATC 55 that the loan
agreement was a simulated agreement. At para 55 Lewis JA stated
that:
“[55]
In my view the test to determine simulation cannot simply be whether
there is an intention to give effect to a contract in accordance with
its terms. Invariably, where parties' structure a transaction to
achieve an objective other than the one ostensibly achieved they will
intend to give effect to the transaction on the terms agreed. The
test should thus go further and require an examination of the
commercial sense of the transaction: of its real substance and
purpose. If the purpose of the transaction is only to achieve an
object that allows the evasion of tax, or of a peremptory law, then
it will be regarded as simulated. And the mere fact that parties do
perform in terms of the contract does not show that it is not
simulated: the charade of performance is generally meant to give
credence to their simulation.”
He
contended that the loan agreement was not a genuine one
notwithstanding that three repayments were made. The disquieting
features he advanced were the short form nature of the agreement. It
was interest free. It was not dated. It did not set out specific
repayment dates. It was apparent that the appellant would not be able
to repay within 30 days of the related party's payment. The related
party was not the parent company and did not bear the legal
obligation to capitalize the appellant both under South African
legislation and Zimbabwean law. He contended that the cumulative
effect of these factors was that the loan agreement did not make
commercial sense and submitted that the real substance and purpose of
the loan agreement was to benefit the appellant by bestowing a grant
or subsidy to it.
In
my view, the loan agreement contained the essential features that
constitute such an agreement. The loan amount was not specifically
stated but it was easily ascertainable. It was constituted by “all
the costs incurred (from 1 May 2008) by the appellant relating to the
development and implementation of a new MUB core banking system”
paid by the related party to the vendor and suppliers of hardware
equipment required to support the new system. It was common cause
that the amount expended for this purpose was in the sum of
ZAR27,632,795.71. The loan agreement also stated the date on which
repayment of the loan was due. It was 31 December 2009.
The
uncontroverted oral testimony of the Group Finance Officer and the
Financial Controller of the related party was that the understanding
between the parties was that repayment was due on each paid invoice
thirty days after such payment. The Group Chief Finance Officer
testified to numerous e-mails and telephone calls made to the
appellant for payment of the amounts whenever they fell due while the
Financial Controller stated that she used to dispatch intra-group
debtor's statements on a monthly basis to all African entities that
fell within her purview reflecting all payments made on their behalf
by the related party.
That
the amount that was eventually written off constituted a loan was
apparent from the short form agreement, the existence of an agreement
with the suppliers, the applications to the South African Reserve
Bank exchange control for approval to make payments and the
reimbursement undertakings made therein. That the loan agreement was
genuine was also demonstrated by the three repayments of 19 January,
18 June and 6 August 2009 in the aggregate sum of ZAR3,597,753.73. It
was common cause during the trial that proof of these repayments were
supplied to the respondent on 12 September 2012 notwithstanding the
averment in paras 22 and 25 the respondent's case filed on 23
August 2013 disputing the submission of such proof. It was
established by the appellant that it cleared its indebtedness as at
19 January 2009. The e-mail communication between the local chief
finance officer and various personnel in the related party's office
culminating in the e-mail of 9 December 2009 established the
negotiations preceding the loan cancellation.
The
three witnesses from the related party justified the use of the short
form agreement. It was an intra-group agreement for which detailed
terms and conditions redolent in similar agreements with unrelated
parties was not necessary. It was meant to record the existence of
the loan and to satisfy accounting and audit requirements. In my
view, it does not appear that at the date the agreement was
concluded, which preceded the first application to the South African
Exchange Control of 20 October 2008, the parties had foreknowledge
that Zimbabwe would introduce the multicurrency regime on 29 January
2009 and thereafter rebase capital requirements for financial
institutions through the mid-year monetary policy of July 2009. That
the related party was not the Bank holding company responsible for
recapitalizing the appellant actually reinforces the genuineness of
the loan. In any event, it cannot from the facts be found that the
only purpose for concluding the loan agreement was to evade tax.
Accordingly, I hold that the loan agreement did not constitute a
simulated agreement.
I
am satisfied that the appellant established on a balance of
probabilities that the loan amount constituted part of its working
capital and not revenue income in its hands. The character of the
loan as capital income could not have changed to revenue income by
reason of cancellation, for the simple reason, amongst others, that
it had already been consumed by capital goods.
The
appeal in respect of the loan write-off is allowed.
PENALTIES
In
the light of my finding that the amount that accrued to the appellant
from the dividend transaction was capital and not revenue, the appeal
against the penalty imposed must succeed and is accordingly allowed.
Mr
de
Bourbon
prayed for costs. I do not consider the appellant to have succeeded
to a substantial degree. I believe that this is a proper case to
request each party to bear its own costs.
DISPOSITION
Accordingly,
The appeal against the disallowance on the claim for deduction of
software expenditure in the sum of US$2 329 776.85 is dismissed.
2.
The appeal against the dividend transaction and the loan write-off is
allowed.
3.
The amended assessment of 20 May 2013 for the year ended 31 December
2009 together with the penalty imposed therein is set aside.
4.
The respondent is directed to issue a further amended assessment for
the year ending 31 December 2009:
(a)
disallowing the deduction of software expenditure in the sum
US$2,329,776.85;
(b)
allowing the deduction of the prescribed special initial allowance in
terms of the Income Tax Act in respect of the expenditure on software
in (a) above;
(c)
disallowing the deduction of US$2,521,340.44 from the taxable income
of the appellant;
(d)
exempting the loan write-off of US$485,059.93 from the taxable income
of the appellant;
5.
The respondent shall refund the balance due to the appellant arising
from the implementation of the directive in para 4(a) to (d) above
from the US$2,038,425.86 adjustment paid by the appellant to the
respondent between 1 June and 1 August 2013.
6.
Each party shall bear its own costs.
Atherstone
& Cook, the
appellant's legal practitioners
