Income
Tax Appeal
KUDYA
J:
This
is an appeal filed on 3 September 2013 by a registered commercial
bank in the High Court in terms of section 65 of the Income Tax Act
[Chapter
23:06].
It arises from taxation in the four areas of staff retrenchment
costs, Nostro accounts, Nostro charges [non-resident tax on fees] and
offshore loans.
At
the appeal hearing, the appellant called the evidence of 6 witnesses
and produced a compendium of documentary exhibits encompassing some
1,207 pages. These documents were contained in 2 large box files, 2
lever files and 1 flat file. In addition 10 loose leaf documentary
exhibits that served as a useful summary to the compendium were
produced. The respondent did not lead any evidence. It was content to
rely on the averments made in the 15 paged Commissioner's case and
the 76 paged Rule 11 of the Income Tax Rules documents.
On
16 November 2012, the respondent issued to the appellant three
amended assessments in respect of income tax for the tax years ending
December 2009, 2010 and 2011 [p 1-3 Rule 11 documents], respectively.
The
respondent objected to the assessments on 12 December 2012. The
objections in respect of the subject matter for which the present
appeal is concerned with were disallowed on 15 August 2013 [p 4-7 of
Rule 11 documents]. However, on 21 November 2013 the appellant
proceeded to issue further amended assessments for the tax year
ending 31 December 2010 and 31 December 2011, respectively, after
allowing deductions for VAT expenses incurred in the two years in
question.
The
issues for determination were:
1.
Whether the appellant correctly brought the provision for
retrenchment costs to account in its income tax return in the 2009
tax year;
2.
Whether the respondent was entitled to deem the appellant's
offshore Nostro accounts as interest bearing accounts and the
appropriate rate of interest;
3.
Whether the respondent was entitled to attribute interest earned by
non-resident related parties on loans made to businesses in Zimbabwe
to the appellant.
4.
Whether bank charges raised by offshore banks holding the appellant's
Nostro accounts amounted to fees under para 1 of the 17th
Schedule of the Income Tax Act.
I
will determine each issue in turn.
STAFF
RETRENCHMENT COSTS
The
facts
The
facts concerning staff retrenchment costs are common cause. They
emanate from the comprehensive testimony of the Human Resources
Manager for the appellant. He relied on the first 535 pages of the
appellant's bundle of documents, the 9 paged exh 1 and 15 paged exh
2.
On
26 November 2009 the Board of Directors for the appellant resolved
that:
“The
company undertakes a voluntary retrenchment exercise to reduce its
staff head count by up to two hundred and fifty-two (252) staff
members.”
The
minutes of that meeting are found on p1 and 2 of both the bundle of
documents and exhibit 1. The minutes reveal that the foreign based
parent company of the appellant pledged an amount not exceeding US$7
million to bankroll the costs of the exercise. The exercise was
headlined: Voluntary Separation Scheme in the minutes.
The
Board directed the roll out of an attractive package that would be of
interest to all levels of employees. The rationale, process and
package for the exercise which were set out on pages 3-6 of the
bundle and exh 1 were considered and approved by the Board before
they were unveiled in countrywide road shows to all members of staff.
The
rationale behind the decision of the Board was the downturn in
economic activity which triggered a drastic fall in business volumes
from average monthly transactions of US$1.9m in 2008 to US$380,000 in
2009 in the face of static staffing levels in excess to capacity.
The
process targeted all levels of staff. All interested staff were
required to submit formal applications by 31 December 2009. The
appellant reserved the right to approve or decline applications. The
separation package consisted of 2 months basic salary for every year
served up to a cap of 21 months.
The
results and costs of the exercise are set out on p7 to 9 of both the
bundle and exh 1. This is an extract of the information on pages 1 to
535 of the appellant's bundle. The documentation consists of each
employee's application letter for consideration in the exercise,
the appellant's pro forma letter of acceptance of the exercise and
a pro forma confirmation signed by each employee and the Zimbabwe
Revenue Authority Employee's Tax Deduction Directive. The bundle of
documents in respect of the exercise is in two files. The first file,
from p 1 to 395 contains information on the 74 employees while the
other file from p395 to 535 contains information on the remaining 27
staff members whose applications were accepted. A total of 74 members
of staff submitted applications for the exercise, which were received
by the appellant between 3 and 31 December 2009. All these
applications were accepted by the appellant on 31 December 2009. The
confirmation certificates in which each staff member affirmed
voluntarily and freely terminating employment were all signed by the
74 staff members between 7 January and 14 January 2010.
Each
applicant was given three months' notice to termination from the
date of acceptance. The gross cost of the voluntary retrenchment
exercise for the 74 employees was US$1,995,402. A further 27 staff
members submitted applications between 6 January and 2 February 2010.
These applications were accepted on the respective dates that they
were made. The confirmation certificates were signed by each
applicant between 13 January and 4 February 2010. Each applicant
served three months' notice from the date of acceptance. The gross
outlay to the appellant for these 27 members of staff was in the sum
of US$550,059.
The
dates on which approval for the exercise was sought from and granted
by the Minister of Labour and Social Services are summarised in exh
2. Between 8 January and 4 February 2010 the appellant submitted 6
batches of the 101 signed applications of the exercise for approval
to the Minister. The correspondence in question was referenced
Voluntary Separation Package for Staff. The Minister approved the
exercise in respect of 94 staff members in four letters dated between
12 January and 2 February 2010. In ink, the Minister referenced each
approval thus:
“Retrenchment
of [the names of the staff members].”
The
Minister's approval was typeset in these words:
“The
Retrenchment Board acknowledges receipt of correspondence referring
to the Works/Employment Council Agreement in Form LRR2. Please
proceed as per agreement.”
The
appellant submitted applications for each employee to the respondent
for a tax deduction directive. The tax directives were issued for
each employee for the tax year ending 31 December 2010 between 28
January and 26 February 2010. The tax deductions and the net amounts
received by each employee are summarised on p 7-9 of exh 1.
US$433,370
was taxed for all the 74 employees leaving them with a total net
amount of US$1,562,032. In regards to the 27, the tax deduction
amounted to US$101,797 and they received an aggregate amount of
US$448,262.
In
the return for the tax year ending 31 December 2009, the appellant
claimed a deduction of US$2,693,500.00 for the staff retrenchment
costs in terms of 15(2)(a) of the Income Tax Act as an expenditure
incurred for the purpose of trade and for conducting its business and
earning income in that year of assessment. The respondent disallowed
the deduction but included it in the amended assessment for the 2010
tax year.
The
Dispute
Both
Mr de
Bourbon,
for the appellant, and Mr Magwaliba,
for the respondent, were agreed that the costs of the exercise were
deductible in terms of section 15(2)(a) of the Income Tax Act.
Counsel were also agreed that the deduction is allowable in the year
the expenditure was incurred.
In
Caltex
Oil (SA) Ltd v Secretary for Inland Revenue 1975
(1) SA 665 (A) at 674; 37 SATC 1 (A) at 11-2. At 674E Botha JA
stated:
“It
is in the tax year in which the liability for the expenditure is
incurred, and not in the tax year in which it is actually paid (if
paid in a subsequent year), that the expenditure is actually incurred
for the purposes of sec 11(a).”
It
is accepted following the authority of Port
Elizabeth Electric Tramway C Ltd v
Commissioner for Inland Revenue 1936
CPD 241 at 244 and Commissioner
for Inland Revenue v
Delfos
1933 AD 242 at 257 that the actual amount of the expenditure incurred
can only be ascertained at the end of the year of assessment after
the computations have been done.
In
Edgar
Stores Ltd v
Commissioner for Inland Revenue 1988
(3) SA 876 (A) at 899A-C; 50 SATC 81 (A) at 90 Corbett CJ noted that
deduction is allowed where the taxpayer has incurred an unconditional
legal obligation during the year of assessment; in that year. He
emphasized that for a conditional obligation the deduction is
allowable in the year in which the condition is fulfilled. To the
same effect are the sentiments of van Dijkhorst J in ITC
1587
(1994) SATC 197 at 103-104.
In
paragraph 3 of his written heads Mr de
Bourbon
submitted in the main that the commitment to the retrenchment
exercise as a whole should prevail and in the alternative that the
commitment for all the employees whose applications were made and
accepted in 2010 should be disallowed as expenditure incurred in the
tax year ending 31 December 2009.
The
main submission runs contrary to the legal principles laid out in the
Edgars
Stores Ltd
case and ITC
1587,
supra,
in respect of expenditure arising from unconditional legal
obligations. It wrongly subsumes, contrary to the evidence adduced
during the appeal hearing that the appellant entered into an
unconditional legal obligation to pay the 27 employees by 31 December
2009. It was common cause that as at that date the 27 had not yet
applied for voluntary retirement nor had the appellant accepted their
applications. It could not at that stage have incurred an
unconditional legal obligation to pay them.
The
correctness of the alternative submission by Mr de
Bourbon
hinges on whether the voluntary separation scheme was a retrenchment
exercise or not.
A
finding that the acceptance of the 74 applications on 31 December
2009 constituted voluntary retirement would inevitably make the
expenditure deductible. The basis being that the appellant incurred
an unconditional legal obligation to make payment to each of these
employees.
Mr
Magwaliba,
however,
submitted that the expense in relation to the exercise was properly
disallowed as the commitment made by the Board meeting was
conditional on approval of the exercise by the Minister of Labour and
Social Services. He contended that as such approval was only granted
in January and February 2010, the expenditure could not be deducted
in the tax year ending 31 December 2009.
It
is correct that the appellant termed the exercise a voluntary
separation scheme on page 1 of the extract of its minutes of 26
November 2009 [bundle and exh 1] and in correspondence to the
Minister of Labour and Social Services and the respondent. It,
however, referred to the exercise in the resolution on page 2 of both
the bundle and exh 1 replicated on p 75 of the Rule 11 documents as a
“voluntary retrenchment exercise”. In addition, in the letter of
objection of 12 December 2012 on page 8-11 of the Rule 11 documents
it called them on p 8 and 9 “staff retrenchment costs”, and,
alternatively, on page 9 “retrenchment expenses”. All the three
terms were again used by the appellant in its letter of 10 December
2012 on page 32 of the Rule 11 documents.
Mr
de Bourbon submitted that the exercise was in reality a voluntary
retirement or resignation scheme, which fell outside the purview of
the provisions of section 12C and 12D of the Labour Act [Chapter
28:01].
The
onus to show on a balance of probabilities that the scheme was not a
retrenchment exercise fell on the appellant.
The
discharge of the onus was complicated by the sole witness called by
the appellant on this aspect. He conceded under cross examination
that the scheme constituted a retrenchment exercise. His attempts to
correct the picture in re-examination failed to paper the cracks. His
prevarication on the point did not paint him as a credible witness in
that respect only.
The
documentation emanating from the appellant is replete with reference
to retrenchment exercise, retrenchment costs and retrenchment
expenses.
The
witness intimated that several discussions on the subject, which were
not minuted, were undertaken with the Minister of Labour and Social
Services. The appellant did not disclose the content of those
discussions. The result of those discussions were the approvals in
which the Minister treated the applications as retrenchments. The
approvals specified the involvement of the Retrenchment Board and
Works /Employment Council Agreement in Form LRR2. The contents of
these approvals contradicted the sole witness' evidence that the
issue was not handled by the Workers Committee, Works Council or
Employment Council as contemplated by section 12C(1).
The
procedure set out in section 12C for retrenchment is that the
employer who wishes to retrench more than 4 people must within six
months give written notice of its intention to the Works Council for
the undertaking and in its absence to an Employment Council and in
its absence to the Retrenchment Board. The employer is enjoined to
provide the names of the employees and reasons for the proposed
retrenchment to the Council or Board where the notice is given.
The
Human Resources Manager of the appellant stated that this was done.
The objective facts show at least that all employees were notified.
The rationale, process and package were disseminated in roadshows.
Section 12C(ii), in my view, appears to allow the majority of the
employees by agreement to supersede referrals to other Councils. The
Retrenchment Board is certainly permitted to perform the functions of
these Councils.
Section
12C(2)(3) and (4) provide the reason for referrals to the Councils.
It is to secure agreement between the employer and employees on the
need to retrench and the conditions for such retrenchment. The
overall duty of the Retrenchment Board is to recommend to the
Minister whether to approve or reject the retrenchment. The Minister,
in terms of section 12(9), then approves or rejects the retrenchment
exercise.
In
the present case, the employer and employees reached agreement on
their own in accordance with section 12D(2) without the involvement
of the Workers Committee, Works Council or Employment Council. The
rationale and process followed by the appellant met the requirements
of section 12D(1). The exercise carried out by the appellant was
aptly described by the Board resolution as a voluntary retrenchment
exercise, in my view, to distinguish it from a compulsory or forced
retrenchment. It meets the requirements of section 12C and 12D of the
Labour Act. In addition the whole exercise falls squarely into the
definition of retrenchment. Section 2 of the Labour Act defines the
word retrench in relation to an employee as follows:
“'retrench',
in relation to an employee, means terminate the employee's
employment for the purpose of reducing expenditure or costs, adapting
to technological change, reorganising the undertaking in which the
employee is employed, or for similar reasons, and includes the
termination of employment on account of the closure of the enterprise
in which the employee is employed;”
The
appellant correctly described in its documentation the process as a
retrenchment. That the exercise was a retrenchment is further
demonstrated by the provisions of para 4(p) of the 3rd
Schedule to the Income Tax Act, which exempts from income tax:
“an
amount accruing by way of the first US$5,000 or one third, whichever
is the greater, of the amount of any severance pay, gratuity or
similar benefit, other than a pension or cash in lieu of leave, which
is paid to an employee on the cessation of his or her employment,
where
his or her employment has ceased due to retrenchment under a scheme
approved by the Minister responsible for Labour or the Public
Service:
Provided
that the exemption provided in this subparagraph shall apply only in
respect of the first forty-five thousand United States dollars of any
such pay, gratuity or benefit payable to him in any one year of
assessment.”
Exemption
is due to those employees who are retrenched under a scheme approved
by the Minister, in this instance, of Labour and Social Services. It
cannot lie in the mouth of the appellant to argue that the Minister,
at its behest, approved a retrenchment scheme that was in fact a
voluntary resignation scheme. The principle of substance over form
satisfies me that the purported voluntary separation scheme in form
was in substance and reality a retrenchment scheme.
I
agree with Mr Magwaliba
that the commitment to pay the expenses of, in the words of Gubbay CJ
in Kadir
& Sons (Pvt) Ltd
v
Panganai & Anor
1996 (1) ZLR 598 (S) at 604C, the “proposed retrenchment” scheme
was conditional upon approval by the Minister. The condition was
fulfilled in January and February 2010. The scheme became an
unconditional legal obligation for the parties once approval was
granted. The expenditure for the retrenchment scheme was accordingly
incurred in the tax year ending 31 December 2010. The respondent
properly disallowed the deduction of US$2,693,500.00 in the tax year
ending 31 December 2009.
NOSTRO
ACCOUNTS
The
Background
The
respondent assessed the appellant for income tax over the 2009, 2010
and 2011 tax years. He observed “huge” balances of non-interest
bearing amounts in the Nostro accounts held by the appellant with
related parties that were in his view in excess of the monthly
transactional requirements of the appellant.
Purportedly
acting in terms of section 98 of the Income Tax Act he imputed
notional interest income to these accounts at the average local rates
prevailing in Zimbabwe at the time.
It
was common cause that the rates in Zimbabwe were much higher than the
prevailing rates in the jurisdictions in which the Nostro accounts
were held. The local interest rates applied were 12.4% for 2009,
11.65% for 2010 and 8.04% for 2011.
Notwithstanding
some averments in the respondent's correspondence and
Commissioner's case to the contrary, it is clear that the appellant
did not actually earn such interest. The respondent deemed the
appellant to have earned the ascribed interest income. He wrote back
into the gross income of the appellant a total of US$5,392,369.88 for
the 2009 tax year, US$11,429,964.09 for the 2010 tax year and
US$8,065,117.68 for the 2011 tax year.
The
appellant objected. The objection was disallowed, hence the appeal.
The
Facts
The
appellant relied on the oral evidence of its Head of Corporate
Reporting cum Deputy Chief Finance Officer who is also member of the
Bank's Asset and Liability Management Committee. In addition it
relied on the documents in its bundle running from p 536 to 579. The
bundle consists of the list of all the Nostro accounts held by the
appellant [p 536-538]. Pages 539-579 consists of the transaction
report of the debits from and credits to the Rand Nostro account of
the appellant for the period 1 January 2009 to 31 December 2012.
The
witness is responsible for all the reporting processes in the
appellant including tax payments and the filing of tax returns. In
that capacity he superintends over tracking balances, quantification,
and reconciliation of all the appellant's Nostro accounts. He
defined a Nostro account as a current account (also known as a
clearing account), which a Bank in one jurisdiction opens in another
jurisdiction to facilitate customer transactions in the currency of
that jurisdiction. It is thus a current account held by a Bank in the
books of a correspondent Bank in another country.
Nostro
accounts facilitate trade and transactions between countries of
varied currencies. He produced the list of all the 22 Nostro
accounts, exh 3 and pages 536-538 of the bundle, held by the
appellant throughout the world. The appellant holds Nostro accounts
with other Banks of the same name worldwide (related parties) and
other Banks not related to it (unrelated parties). 10 of the accounts
were held with related parties. The Nostro accounts, whether with
related or unrelated parties, are all held at arm's length.
The
witness stated that the most active Nostro accounts for the appellant
were the Rand account held in Johannesburg South Africa with an
unrelated party and the United States dollar account held in New York
with a related party. He stated that the deposits into the Nostro
accounts are made by customers and not by the appellant. The money is
deposited directly into the customer's account and reflected in the
Nostro account simply because the appellant is the banker to the
customer.
The
witness testified that Nostro accounts do not earn interest; a fact
confirmed by his Chief Finance Officer on p30 of the Rule 11
documents.
It
was evident from the evidence of the Head of Corporate Reporting that
the appellant did not earn any interest on the deposits in the Nostro
accounts. He produced a letter, exh 5, from the Director Global Head
of USD Clearing Product Management, Americas dated 2 September 2014
in response to a query raised on interest rates on clearing accounts.
The letter reads:
“We
are writing to you in response to your recent enquiries with regard
to the non-payment of interest on your clearing account held with us.
As
you will be aware, the global economy entered a recession (the Great
Recession) in 2009, which had significant implications on the banking
sector. The Federal Reserve took extraordinary actions in response to
the financial crisis to help stabilize the US economy and financial
system.
The
actions included reducing the level of short-term interest rates to
near zero. The Federal Fund's average rate since 2009 has been
about 13bps (0.13%) whereas the average yields for three month US
Treasury Bills since 2009 has been 8bps (0.08%) (refer to appendix to
this letter) [produced as exh 4].
As
a result of such low yields, interest rates on deposits placed in
banks in the United States were significantly impacted, with many
banks paying very little or no interest on deposits. We are aware
that in some cases some of our competitor banks would in fact charge
to hold customer deposits-resulting in 'negative interest' to
their customers. The low interest environment continues to persist to
date.
[Related
Bank] NY in general pays no interest on the majority of the clearing
accounts held for our clients, regardless of whether they are from
[related bank group] or from external parties.
We
therefore confirm that the non-payment of interest on your clearing
accounts with us has been and remains in line with market practice.”
Exh
5 confirmed that the appellant did not earn interest income on
deposits in its United States dollar Nostro account resident in New
York in the United States of America. The witness also produced exh
4, the Bloomberg US Generic Government 3 months' bond yield for any
placement funds for the period 2 January 2009 to 14 October 2011. The
average interest earned during that period was 0.08%. He confirmed
his Chief Finance Officer's observation that call accounts earn the
highest rate in those foreign jurisdictions.
The
witness indicated that the appellant could only earn interest on
transfer of the deposits from the Nostro account to an investment
account such as a call account. The bank also earns interest from
buying Treasury Bills or other interest bearing instruments. Interest
was paid on the placement funds and accounted for in the respective
tax years.
In
2012 a directive from Reserve Bank of Zimbabwe stopped the offshore
investment of funds from Nostro accounts.
It
was common cause that interest rates offered internationally on
placement funds were low as exemplified by the declared income earned
on those accounts.
He
disputed the averment that the Bank did not earn interest on Nostro
accounts in order to avoid paying tax and averred that the Bank was
in the business to earn income. He denied that the Bank entered into
transactional operation schemes with Nostro banks to deliberately
forego interest in order to postpone and avoid paying interest. He
stated that the appellant Bank operated Nostro accounts not as a
vehicle to avoid, postpone or reduce its tax obligations but as an
objective banking necessity; as would any other Bank worldwide.
His
testimony on the prevailing local position before RTGS was introduced
tallied with the response of the appellant's Chief Finance Officer
to the respondent of 10 December 2012 [p 30-33 of Rule 11
documents].The Chief Finance Officer indicated that in 2009 and 2010
before RTGS was introduced; the only option for local Banks was to
hold foreign balances either as cash or Nostro balances. All Banks
including the Central Bank opened correspondent bank relationships
and used Nostro accounts to hold such funds in foreign Banks. The
entire Zimbabwe National Payment System in this period was conducted
through Nostro accounts and the level of balances was high for all
Banks reflecting the size of clients for each Bank. He set out four
reasons for Nostro accounts. These were;
(i)
to ensure Bank liquidity to curtail a run on the Bank;
(ii)
to maintain minimum liquidity levels set at the time by the Reserve
Bank of Zimbabwe at 25% of customer's deposits;
(iii)
to safeguard depositor funds by diligent prudential lending and
thorough risk assessments of prospective clients; and
(iv)
to support prompt settlement of customers' transactions.
When
he was cross examined, he failed to state the balances sitting in the
NY Nostro account at the end of 2009, 2010 and 2011 respectively. He
did not dispute the averment that the balance in the New York Nostro
account at the end of 2009 was US$10.4 million. He, also, did not
dispute that the average monthly amounts held over the three years in
issue in that Nostro account was US$18 million of which US$2 million
routinely catered for the transactional requirements of customers
leaving US$16 million idle. He maintained that the primary purpose of
maintaining a Nostro account was to conduct customer business
transactions. The witness maintained that the Bank was not obliged to
lend money to earn income.
He
revealed that the decision to move money from Nostro to RTGS to cash
depended on the risk appetite and assessed needs of the Bank. He
maintained that at the commencement of the multicurrency regime the
Bank adopted a low asset to deposit ratio as it needed to fully
understand the risk factors bedevilling the local economy.
In
my view, the witness acquitted himself very well in respect of the
Nostro accounts. He could not term the balances in the Nostro
accounts huge.
The
respondent averred in the letter of 15 August 2013, disallowing the
objection, that the justifications for the balances of liquidity risk
management, safeguarding customers deposits and prompt customer
transaction settlement support did not eclipse the high balances that
remained after these reasons had been taken into account. The
magnitude of the balances, as disclosed in the cross-examination of
the head of corporate reporting, of US$16 million was not disputed.
Mr
Magwaliba
suggested to the witness that the average monthly transactions were
in the sum of US$2 million and US$16 million remained idle in the
Nostro accounts and that this pattern characterised the period from
2009 to April 2012.
While
the witness disputed they were huge, his immediate supervisor, the
Chief Finance Officer conceded they were huge. I am satisfied that in
the context of the operational requirements the balances were indeed
huge.
The
letter disallowing the objection further discloses that the
respondent accepted that Nostro accounts did not create an
entitlement to interest regardless of whether they were held with
related or unrelated parties. It invoked section 98 because the
balances went beyond meeting liquidity and transaction purposes.
It
was unclear why local rates were preferred to call rates prevailing
in the jurisdiction of the correspondent Nostro bank. It was also
unclear whether the proposal for the appellant to suggest other
interest rates was limited to local interest rates or not.
Para
14 of the respondent's case seems to concede that the computation
of applicable interest could be extended to the foreign jurisdiction
in which the deposits were made. That attitude is confirmed by the
acceptance of the interest income declared on call funds invested in
those jurisdictions. The view of the appellant was simply that the
respondent had no legal right to intrude into its operational space
in the absence of a local law that required it to move funds from the
Nostro accounts into Zimbabwe to lend at the prevailing local
interest rates.
The
Legal Arguments
The
basis for determining this issue lies in the provisions of section
98. It reads:
“98
Tax Avoidance Generally
Where
any transaction, operation or scheme (including a transaction,
operation or scheme involving the alienation of property) has been
entered into or carried out, which has the effect of avoiding or
postponing liability for any tax or of reducing the amount of such
liability, and which in the opinion of the Commissioner, having
regard to the circumstances under which the transaction, operation or
scheme was entered into or carried out —
(a)
was entered into or carried out by means or in a manner which would
not normally be employed in the entering into or carrying out of a
transaction, operation or scheme of the nature of the transaction,
operation or scheme in question; or
(b)
has created rights or obligations which would not normally be created
between persons dealing at arm's length under a transaction,
operation or scheme of the nature of the transaction, operation or
scheme in question;
and
the Commissioner is of the opinion that the avoidance or postponement
of such liability or the reduction of the amount of such liability
was the sole purpose or one of the main purposes of the transaction,
operation or scheme, the Commissioner shall determine the liability
for any tax and the amount thereof as if the transaction, operation
or scheme had not been entered into or carried out, or in such manner
as in the circumstances of the case he considers appropriate for the
prevention or diminution of such avoidance, postponement or
reduction.”
Mr
de
Bourbon
submitted that there was no legal obligation for the appellant to
have brought those funds onshore, earn interest and avoid the 2009
loss. He further submitted that the respondent had no legal duty to
direct how the appellant should run its business affairs.
He
relied on the sentiments of Watermeyer CJ in dealing with a provision
in the South African tax legislation equivalent to our section 98 in
Commissioner
for Inland Revenue v
I H B and AH King 1947
(2) SA 196 (A) at 207-208; (1947) 14 SATC 184 (A) at 190-191.
The
essence of the sentiments being that section 98 cannot be invoked
against a taxpayer who abstains from earning income by closing his
business or resigning from employment or taking a lower paying job.
The learned CHIEF JUSTICE listed several circumstances in which the
equivalent to our section 98 would be inapplicable. He stated at p
208:
“These
two types of cases may be uncommon but there are many other ordinary
and legitimate transactions and operations which, if a taxpayer
carries them out, would have the effect of reducing the amount of his
income to something less than it was in the past, or of freeing
himself from taxation on some part of his future income.
For
example, a man can sell investments which produce income subject to
tax and in their place make no investments at all, or he can spend
the proceeds in buying a house to live in, or in buying shares which
produce no income but may increase in value, or he may invest the
proceeds outside of the Union, or make investments which produce
income not subject to normal tax in his hands, e.g. Union Loan
Certificates, deposits in the Post Office Savings Bank or shares in
public companies. He can also sell shares in private companies, the
holding of which may subject him to heavy taxation in his hands
although he does not receive the income which is taxed, or he can
sell shares in companies which pay high dividends and invest in
securities which return him a lower but safer and more certain
income. He might even have conceived such a dislike for the taxation
under the Act that he sells all his investments and lives on his
capital or gives it away to the poor in order not to have to pay such
taxation.
If
he is a professional man he may reduce his fees or work for nothing,
if he is a trader he may reduce his rate of profit or sell his goods
at a loss in order to earn a smaller income. He can also secure
deductions from the amount of his gross income, for example by
insuring his life. He can carry out such operations for the avowed
purpose of reducing the amount of tax he has to pay, yet it cannot be
imagined that Parliament intended by the provisions of sec. 90 to do
such an absurd thing as to levy a tax upon persons who carry out such
operations as if they had not carried them out.
Moreover,
the problem of deciding what the income of such persons for the tax
year would have been if they had not carried out such operations
would appear to be insoluble in some cases, if the countless
possibilities of what they might otherwise have done with their
capital or their labour are borne in mind.”
At
p 210 he distinguished two meanings to which the term could apply and
settled for the latter. He held:
“In
order to answer these questions it should be realised that there is a
real distinction between:
(i)
the case of a man who so orders his affairs that he has no income
which would expose him to liability for income tax; and
(ii)
the case of a man who so orders his affairs that he escapes from
liability for taxation which he ought to pay upon the income which is
in reality his.
Similarly,
there is a distinction between:
(i)
reducing the amount of tax from what it would have been if he had not
entered into the transaction; and
(ii)
reducing the amount of tax from what it ought to be in the tax year
under consideration.”
He
held at 210-11 that:
“If
the words 'avoiding liability' and 'reducing the amount' are given
the former meanings [(i) above] in sec. 90, then absurd results such
as those mentioned above will follow, but if the words be given the
latter meanings [(ii) above], though some difficulties will still
occur, absurd results are on the whole eliminated. The provision
contained in sec. 90, that the taxpayer shall be taxed as if the
transaction had not taken place, which suggests that he has escaped
from a liability to which he ought to have been subject, strongly
supports the view that the expression 'avoiding liability' and
'reducing the amount' should be given the latter meanings, and those
are the meanings which should be given to them.”
In
the present matter the appellant did not earn any income from the
Nostro accounts. Exh 5 demonstrates beyond a shadow of doubt that it
was not possible for the appellant to have earned income from those
Nostro accounts. The reality was that it was not going to earn any
income unless it moved the deposits to a call account.
Mr
de
Bourbon
submitted that section 98 did not apply to the facts of this matter.
In
Zimbabwe, Smith J set out the four requirements that must co-exist in
order to entitle the Commissioner to invoke section 98 in A
v
Commissioner of Taxes 1985
(2) ZLR 223 (HC) at 232F-233B. The four requisites are:
(a)
The presence of a transaction, operation or scheme;
(b)
Intended to avoid or postpone or reduce liability for any tax;
(c)
Through means or ways not normally employed or which create rights or
obligations which would not be ordinarily be created by parties
dealing at arm's length;
(d)
The Commissioner forms the opinion that the avoidance or postponement
or reduction of such liability was the sole or one of the main
purposes of the transaction, operation or scheme.
I
deal with each of these requisites in turn.
(a)
The appellant lawfully opened the Nostro accounts in question. The
amounts in the accounts were deposited by clients in the normal
course of business and not by the appellant.
The
respondent suggested that the holding of funds in excess of the
transactional needs for the clients was to the extent of the excess a
scheme because this went unabated for three consecutive tax years.
I
recognise as Smith J and before him McDonald JP, as he then was, in
Commissioner
of Taxes v F
1976 (1) RLR 106 (AD) at 115E did that the words transaction,
operation or scheme are all embracing and would apply to any activity
carried out by a taxpayer.
In
the circumstances of this case I would find that holding excess idle
funds in the Nostro accounts for three consecutive tax years
constituted a scheme.
(b)
The second element for determination is whether the scheme had the
effect of avoiding or postponing or reducing tax liability.
The
appellant stated that it could only earn income by moving the funds
from the Nostro accounts to call accounts. It established beyond a
shadow of doubt, and the point was accepted by the respondent in the
letter disallowing the objection, that Nostro accounts whether held
with related parties or not do not earn interest. It was also
accepted by counsel for the respondent in argument that the rates of
interest offered on offshore call accounts was negligible. The
appellant did not move the funds from the Nostro accounts onshore for
two reasons;
(i)
The first, proffered by the Chief Finance Officer of the appellant
and amplified by his deputy in evidence, was that in 2009 and 2010,
before the introduction of the RTGS platform in Zimbabwe, all funds
were transacted through Nostro accounts.
In
my view, that constituted the normal and usual method of operation
for local Banks including the Central Bank.
(ii)
The second was that the prudential risk management policies of the
appellant dictated that the money be kept in the Nostro accounts
rather than be invested onshore.
The
Bank had a low risk appetite and preferred to safeguard depositors'
funds rather than invest the funds in a fragile and uncertain market.
It does not appear to me that the scheme was entered into to avoid
earning income. It was carried out to preserve the funds.
(c)
The third element was not fulfilled.
It
was the normal method of operation for any Bank with a Nostro
account. It was not suggested by the respondent that the Nostro
accounts with unrelated parties were operated differently from the
ones in issue. The treatment and balances were the same for both
related and unrelated parties. The Deputy Chief Finance Officer
established that this was a common worldwide practice amongst all
banks holding Nostro accounts. No rights or obligations not normally
associated with this type of account were created for the related
parties.
(d)
The opinion of the Commissioner that the scheme was designed solely
or mainly to avoid tax liability was incorrect.
It
was common cause that the deposit of the funds in the Nostro accounts
did not create a tax liability for the appellant. The decision by the
appellant to hold the funds in the Nostro accounts rather than
investing them could not and did not create any tax liability for the
appellant. In the absence of such a tax liability, the Commissioner
could not properly come to the opinion that holding the funds in the
Nostro accounts was designed either solely or mainly to avoid,
postpone, or reduce a tax liability that did not exist.
In
deeming notional interest on the basis that the holding of huge
amounts of idle funds in Nostro accounts did not make commercial
sense for a Bank that derived most of its income from interest
earnings, the respondent lost sight of the fundamental principle
behind our income tax legislation. It is designed to tax income that
has been created. The income must have accrued to or been received by
the taxpayer. It is not designed to tax income which is not in and
has not come into existence.
That
the respondent was aware of this fundamental principle is
demonstrated by the contradictory averments that characterise para 13
of its pleadings.
It
first suggested that the appellant committed tax evasion before
imputing interest income that in reality was not earned. The bottom
line was that either way income had to exist before it became liable
to taxation. The income must either have accrued to or been received
or deemed to have accrued or been received by the taxpayer in order
to trigger tax liability.
In
any event, it seems to me that stripped of all the technical points
Kings
case, supra,
amongst other things established that there is no obligation on any
taxpayer to earn income. The examples suggested by Mr de
Bourbon
and conceded by Mr Magwaliba
demonstrate the point.
A
registered legal practitioner in private practice who chooses to do
pro
bono work
cannot be taxed on the notional income he could have earned. Nor
would he be taxed on the income differential if he elects to take a
less paying job in the public service. Indeed neither would a Bank be
assessed to tax on the highest interest rate offered in its or any
other jurisdiction against any lower rate it would have accepted.
It
is clear to me that where the activities of a taxpayer do not or fail
to create income; it is beyond the remit of the Commissioner to wear
the mantle of an investment adviser to the taxpayer and suggest to
the taxpayer avenues for more income creation. I would add, as an apt
reminder to the respondent, the words of Beadle CJ in Commissioner
of Taxes v Rendle 1965
(1) SA 59 (RAD) at 61B that:
“It
is not for the Commissioner to direct how a taxpayer should run its
business.”
It
further seems to me that the Commissioner has no mandate to usurp the
role of the onshore regulatory authority in respect of Nostro
accounts. It was up to the appellant to deal with the deposits as it
pleased subject of course to the requirements of both onshore and
offshore regulatory authorities.
Silke
in Income
Tax in South Africa
at para 19:14 is to the same effect. The learned authors suggest
that:
“If
by this interpretation Internal Revenue considers that it is entitled
to impute rights or obligations to a transaction that do not exist in
the actual bargain between the parties, for example, to assume a
reasonable rate of interest when none was actually stipulated, it is
considered that it misinterprets s 103(1). On the basis of this
principle, it is considered that the Commissioner is not entitled to
apply s 103(1) in order to subject to tax a lender of an
interest-free loan on an amount that he could have earned by way of
interest had he charged it, a professional man who renders services
to another person free of charge or a trader who sells trading stock
at a price below its current market price. In all these circumstances
there is no amount 'received or accrued' on which an assessment
may be framed. The existence of such an amount, it is submitted is an
essential requisite for the application of s 103(1).”
I
am satisfied that the respondent wrongly invoked section 98 to the
Income Tax Act to bring to account notional interest to the gross
income of the appellant in the three tax years in issue.
OFFSHORE
LOANS
The
respondent wrote back into the appellant's taxable income for the
tax years 2009, 2010 and 2011 interest paid by six onshore borrowers
on the basis that it was purportedly earned by the appellant.
The
appellant objected on 12 December 2012.
After
an exchange of correspondence between the parties, the respondent
disallowed the objection on 15 August 2013. The disallowance was
based on the nature and scope of the loan agreement and the original
approvals from the External Loans Coordinating Committee (ELCC) of
the Reserve Bank of Zimbabwe.
In
a bid to establish that the loan agreements executed between the
appellant and the onshore payers of interest did not reflect the true
position governing the loans in issue the appellant called the
evidence of 4 witnesses.
The
first witness on this aspect of the appeal was the Head of Corporate
Banking of the appellant. The second was the Managing Director of a
local tobacco company. The third was an Executive Director of another
local tobacco company. The fourth and last witness was the Company
Secretary of a large local manufacturing and distribution
conglomerate.
In
addition it relied on pages 580 to 1037 of the bundle, the 170 paged
exh 6 and exh 7, 8, 9 and 10.
The
evidence of the head of corporate banking cut across all the six
local companies that purportedly executed loan agreements with the
appellant. He referred to the Master Risk Participation Agreement
(MRPA) [p 9 to 29 of exh 6 and 615-630 of the bundle] concluded on 12
June 2002 between the appellant and the offshore related party. It
was conceived as a vehicle to provide suitable local borrowers with
offshore funding at a time Zimbabwe was experiencing endemic foreign
currency challenges.
The
MRPA laid the general framework for the execution of acceptance
agreements in the form of Schedule 1 to the MRPA between the two
Banks. In the event of inconsistency between the Acceptance Agreement
and the Master Agreement, the provisions of the Acceptance Agreement
prevailed. The Acceptance agreements were of two forms. The first was
a Funded Risk Participation agreement and the second was an Unfunded
Risk Participation agreement. There were three important designations
in the MRPA. These were Grantor, Participant and Obligor.
A
grantor could be any one of the two Banks who offered the other, the
participant, a participation in the funding or in the risk associated
with the non-payment of the whole or any part of the amounts loaned
out. A participant could be any one of the two Banks that accepted a
participation in the risk that would be assumed or the amount
advanced. The obligor was the borrower of the funds.
In
a funded participation [clause 3 of the MRPA on p11 of exh 6], the
Bank providing the funds was the participant. The participant was
obliged to deposit the funds representing the extent of the exposure
it was willing to assume with the grantor before it was disbursed to
the borrower. It was required in terms of clause 3.2 to indemnify the
grantor to the extent of the risk percentage on any default by the
borrower. The grantor was required to promptly allocate to the
participant its share of the payments made by the borrower inclusive
of interest, commission and fees accruing or expenses incurred.
In
an unfunded risk participation, in terms of clause 4 of the MRPA, the
participant would pay it's pro rata share of the risk percentage of
the principal, interest, fees, costs and expenses to the grantor in
case of default by the borrower. The participant would pay the
participation percentage from any recoveries made from the borrower.
The
witness clarified that a funded risk participation was invariably
fully funded by the offshore related party while an unfunded risk
participation was fully funded by the appellant with the offshore
related party sharing in the risk of default to an agreed percentage.
In both instances the appellant was the grantor while the offshore
related party was the participant. Clause 5 of the MRPA dealt with
the appropriation of payments made by either party. Clause 6.4
outlined the relationship between the parties. The parties accepted
that the MRPA or any acceptance agreement or any other agreement or
understanding did not constitute the grantor an agent, fiduciary or
trustee of the participant. The grantor's rights could not be
transferred or assigned except for the right in clause 7.5 to sue the
borrower for the whole amount owing. The participant had no rights to
deal with, make payments to or receive payments from the borrower in
the loaned amount. The parties were not in partnership, joint venture
or association. The grantor was not required to indemnify the
participant on its participation share.
In
the event of default by the borrower, the grantor was obliged to
notify the participant in terms of clause 7.3. In terms of clause
11.6 privity of contract and associated benefits to third parties who
were not party to the MRPA were expressly excluded. In terms of
clause 14, English Law and Courts were conferred jurisdiction over
both the MRPA and any Acceptance Agreement derived from it.
It
was the testimony of the Head of Corporate Banking that despite the
contents of clause 6.4 the appellant considered itself an agent of
the participant. This was also confirmed by the evidence of the other
three witnesses who testified on this aspect. They regarded the
appellant (the grantor) as an agent of the offshore related party
(the participant).
He
established that the Exchange Control (Tobacco Finance) Order 2004 SI
161/2004 [p 1-3 of exh 6; p 580-582 of bundle] and the Exchange
Control (Cotton) Order 2008 [p 4-8 of exh 6; p 583-587 of bundle]
required that offshore funds be utilised for the growth and purchase
of auction and contract tobacco and seed cotton. The loans were
approved by the ELCC. Tobacco buyers were precluded by section 4(3)
and contract growers by 4A(3) from either drawing on corporate
foreign currency account or purchasing, borrowing or raising foreign
currency onshore from the interbank market or authorised dealers or
any domestic source whatsoever to purchase contract or auction
tobacco. A similar bar was placed against seed cotton merchants by
the relevant statutory instrument. In both instruments onshore funds
were defined as:
“any
funds, moneys, deposit, loan, line of credit advance from customer or
parent company or other funds or facility whatsoever (in the tobacco
order)/wheresoever (in the seed cotton order) located or obtainable
within Zimbabwe.”
He
identified 2 facility letters pages 30 to 40 and 41 to 51 of exhibit
6 for one of the 3 tobacco merchants. All the other documentation for
the tobacco company in question being master participation documents,
rate fixed advice and correspondence run from p 631 to 807 in the
bundle [p 627 -726 contains acceptance agreements for the facility
letter of 29 June 2011 and the various draw downs and security
compliance certificates. The facility letter of 29 June 2011 was not
produced in evidence or in any of the documents]. The first, dated 4
June 2009 for US$25 million was for the purchase and processing of
tobacco for export for the 2008/2009 season and financing inputs and
equipment for contract growing and purchase of tobacco in the
2009/2010 season.
The
second facility letter, dated 26 August 2010 for US$35 million was
for purchase of tobacco in 2009/2010 and inputs for 2010/2011 season.
The
Managing Director of the tobacco company in question confirmed
accessing these offshore loans. The 3 paged exh 8, dated 17 December
2009 and 31 March 2010, were the bank statements of account produced
by the Managing Director to confirm that his company maintained a
current account 0101 2524708 50 with the foreign lender in accordance
with the facility letters. The statements showed that the borrower
received US$26 million in 2009 and US$3 million in 2010 from tobacco
buyers. It paid out capital and interest on in the sum of
US$3,031,210 on 9 March 2010. The tobacco company in question repaid
the capital and interest into the evidence account 01012 252708 50 of
the foreign lender.
The
acceptance agreement for the first facility letter is at p 727-730 of
the bundle. The grantor was the appellant while the participant was
the offshore related party. The participant funded the loan in the
sum of US$22 million and assumed risk at a margin and interest of
Libor plus 4%. The facility letter was for US$25 million with a
margin and interest rate of Libor plus 6%. It would appear from these
two documents that the appellant might have contributed US$3 million
and taken the balance of the risk of Libor plus 2%.
The
evidence of the Head of Corporate was that all the money was supplied
from the offshore related party at the margin and interest rate
stated in the facility letter to whom all the capital and interest
were remitted.
It
seems to me that he did not fully disclose the nature of the
relationship between the appellant and the offshore related party in
this regard. I find that he was therefore untruthful in this regard.
The acceptance agreement for the facility letter of 26 August 2010
was not produced in evidence. It also does not form part of the
documents in the bundle.
The
facility letters were generally worded thus:
“BANKING
FACILITIES
The
appellant (the Bank) is pleased to confirm (subject to the conditions
precedent and upon representations and any warranties as set out
herein) its willingness to make available to your company (the
Borrower) the uncommitted banking facilities (the facilities)
outlined below on the terms and conditions set out in this letter, as
modified by the Bank from time to time and (where applicable) terms
and conditions set out in the appendix.”
The
facilities became available on receipt of originals security
documents, a certified copy of Board resolution, the RBZ approval for
the facilities, requisite insurance policy and opening of an evidence
account at the Bank (the Evidence Account). The interest rate
differed in each facility letter. In the first it was set at the
aggregate of Libor plus 6%, in the second was risk price of 3.75 and
establishment fee of 2.3%.
Other
conditions specific to each onshore borrower were stipulated. These
were submissions of monthly schedules, management accounts, audited
financials, proof of seasonality, and submission of quarterly crop
records to the appellant on set timelines. In addition, Customs
Declaration Forms (CD1) of the projected export revenue to be routed
and processed through the appellant and insurance cover with
reputable offshore insurer reflecting the appellant as the loss payee
were also stipulated. The borrower undertook to the appellant to take
comprehensive insurance.
All
sales proceeds from the tobacco sold were to be remitted to the
appellant for the credit of the Evidence Account. The balance of the
Evidence Account would be applied towards the reduction of any
outstanding loans due to appellant and the residue paid to the
Borrower. The Bank would only act on instructions received from or
verified by the Local Agent for the operations of the Evidence
Account. The Borrower was required to issue instructions to its
overseas buyers to remit funds to the Bank for credit to the Evidence
Account. The evidence account was supplied.
The
choice of law clause conferred jurisdiction on the local courts.
A
four paged appendix consisting of 13 clauses was attached. The
appellant was permitted to cede its rights in the facility to third
parties. Clause 13 on disclosures identified the appellant as the
Bank. The confidentiality clause regarded the contents as the
property of the appellant.
The
facility letters of the second tobacco company were dated 30
September 2009 [p 61-72 of exh 6] for US$1 million and 6 May 2010 [p
52-60 of exh 6] for US$3 million. The full documentation for the
second tobacco company runs from p808 to 854 of the bundle. The
acceptance agreements filed are for the facility letter for 6 March
2012. The two facility letters made no reference to the opening of an
Evidence Account. There were no acceptance agreements for the two
facility letters for this company that are the subject of the appeal.
The
facility letters of the third tobacco company were dated 7 May 2009
[p 111-122] for a loan of US$15 million and 21 September 2010 [p
123-135] for a loan of US$45 million. There were no documents filed
in respect of the third tobacco company in the bundle of documents.
The acceptance agreements in respect of the two facility letters for
the third tobacco company were not produced in evidence. The Accounts
Director of the third company stated that his company accessed the
offshore component of the loans. His company would instruct appellant
to pay off the loan on maturity through the Evidence Account. His
company did not access local funds as that would have been contrary
to law.
The
facility letters for the seed cotton company are dated 3 July 2009 [p
136-149] for US$2.5 million and 29 June 2010 [p 150-158] for US$3
million. The conditions were markedly different to those of the
tobacco companies but the framework of the facility letters was
similar to the tobacco ones especially the appendices. There were no
other documents filed of record or produced in evidence in respect of
the seed cotton company. The booking location stated in the facility
letters was the appellant. The interest rate was set at Libor plus
cost of funds plus 6%.
The
facility letters in respect of the second and third tobacco companies
and the seed cotton company made no reference to an Evidence Account.
They were all formatted differently from the facility letters of the
first tobacco company in that respect. They were formatted much like
the three onshore funded facility letters for the manufacturing and
distribution conglomerate. Two of the three facility letters for the
conglomerate that were admittedly funded onshore by the appellant
were dated 24 August 2009 for a loan of US$10 million [p 73-86 of exh
6] and 22 September 2010 for a loan of US$20 million [p 87-103 of exh
6].
The
witness averred that the appellant acted as the agent of the offshore
related party. He further stated that the appellant did not receive
any interest from any of the four clients. The interest was paid to
the Evidence Account of the offshore related party on the instruction
of the appellant.
The
facility letter for the cement manufacturer was dated 30 August 2010.
The loan of US$3 million was required to finance the importation of
mobile equipment, compressors, factory consumables and other capital
equipment for the quarry and other factory operations. The other
documents for the cement company run form p 908 to 1037. The booking
location on the facility letter for 30 August 2010 was the offshore
related party. The tenor was a year and interest was the aggregate of
the cost of the funds to the appellant plus 2.5%.
Amongst
the conditions, condition (c) and (f) on p 104 of exh 6 stand out
like a sore thumb. Both grant the sole discretion to roll over the
loan to the appellant. The appendix to the facility letter is a
carbon copy of the appendices in the tobacco and cotton facilities.
The choice of law clause imbues the appellant with the choice of
recovering any outstanding amounts in the Magistrates' Court in
Zimbabwe. The acceptance agreement in respect of this facility letter
was not produced.
The
Head of Corporate Banking disclosed that the facility letters dated
24 August 2010 [p 73-86] for US$10 million and 22 September 2010 [p
87-102] for US$20 million were in respect of onshore funds availed to
the manufacturing and distribution conglomerate. He produced the 28
paged exh 7, the facility letter dated 19 October 2011. It differs
from all other facility letters thus far analysed in design, content
and coverage. The total commitments made in the facility letter were
in the sum of US$60 million. It was a revolving loan facility for the
general corporate purposes of the borrower. Clause 11.6 and 25
conferred jurisdiction on the English Courts. In schedule 1 para 11
the guarantor provided security in favour of the appellant.
The
Head of Corporate Banking claimed that the appellant did not have the
capacity to loan out such an amount. He produced exh 9, the loan draw
down advice from the offshore related party dated 17 November 2011 as
evidence of the direct payment of interest into the Evidence Account
of the offshore related party. It stipulated the loan amount of US$60
million, the tenor of 182 days. The rate setting information was
provided as were remittance instructions. The all-in-all rate was
7.43% and the interest in the sum of US$2,253,766.67 was payable on
17 May 2012.
He
produced exh 10, the acceptance agreement in the format of schedule 1
to the MRPA. It is in respect of the US$60 million loaned out to the
manufacturing and distribution conglomerate. The grantor was the
appellant. The participant was the offshore related party. The
obligor was the manufacturing and distribution conglomerate. The
guarantor was the offshore holding company for the borrower. The
participation was fully funded by the participant. The interest rate
was Libor plus 6.75%.
Exh
9 further stipulates the remittance instructions. It reads:
“Please
arrange to pay us the total due of US$12,253,766.67 on 17 May 2012 at
maturity to the following Standard Settlement instruction:...,.”
The
nominated account number for payment happens to be the one indicated
in Exh 3 as the Nostro account of the appellant, account number 3582
088442 001 Ref: LPU/ [the Conglomerate (Pvt) Ltd].
The
appellant sought authority from the ELCC to borrow offshore funds on
behalf of non-tobacco clients. On 6 October 2009 [p159-162 of exh 6;
p592-595 of bundle] the ELCC approved an ordinary non-tobacco pre and
post shipment finance facility in the sum of US$50 million. The
lender was indicated as the offshore related party and the borrower
was the appellant. The approval also covered a further US$50 million
for tobacco financing. Again, the borrower was indicated as the
appellant and the lender was the offshore related party. Both
facilities had an expiry date of 31 August 2010.
Again,
on 9 September 2010 [p163-166; p596-599] the External Loan
Coordinating Committee approved an enhanced ordinary non-tobacco pre
and post shipment facility increasing the loan amount from US$50
million granted on 6 October 2009 to US$100 million sought by the
appellant from the offshore related party at an interest rate of
Libor plus 4%. The tobacco pre and post shipment facility was also
increased from US$50 million to US$100 million with an interest rate
of Libor plus 3% expiring on 31 August 2011. The borrower/beneficiary
was the appellant while the lender was the offshore related party.
The
witness characterised the non-tobacco facility as a global
arrangement rather than a specific one. He stated that the Reserve
Bank of Zimbabwe required approval by the ELCC even for non-tobacco
loans from offshore to obviate the need to seek exchange control
authority to repay as this would be embedded in the approval before
loans were disbursed to clients.
The
US$60 million was included in the US$100 million non-tobacco facility
approval. He stated that the ELCC was aware of the legal requirement
for tobacco merchants to access funds offshore but approved the
appellant as borrower well knowing that the money was for clients
rather than for the appellant's own use.
He
was unable to shed light on the ELCC approval dated 7 December 2011
[p167-170 of exh 6; p 600-603 of bundle]. It was for US$200 million
divided equally between ordinary non-tobacco and tobacco pre and post
shipment finance with maturity dates of 31 July 2010 and 31 July
2011, respectively that predate the date of the authority. Both had a
coupon rate of Libor plus 6%. The approval in question was, however,
corrected by the ELCC on 14 June 2012 [page 36-39 of Rule 11
documents]. The coupon rate for the non-tobacco loan was reduced to
Libor plus 4% and the expiry date was amended from 31 July 2010 to 31
August 2012 while for the tobacco facility the coupon rate was
reduced to Libor plus 3% and the maturity date was amended to 31
August 2012. The other information remained the same.
He
portrayed the appellant as an agent of the offshore related party in
administering the loan. He maintained funds were disbursed to the 6
onshore companies from offshore and that the borrowers also made
direct interest payments offshore. In regards to the conglomerate, he
averred that the appellant did not have capacity to loan out more
than 25% of its capital to any one entity. He confidently affirmed
the absence of the interest payments in the profit and loss interest
account as proof that the money was never credited to the appellant.
The
evidence of the Head of Corporate Banking in respect of the
manufacturing conglomerate was confirmed by the Company Secretary of
the conglomerate. He took part in the discussions that gave rise to
the loan facility. It was clear to him that the appellant fronted the
offshore related party.
Representatives
of the lender sat in the discussions to acquaint themselves with the
borrower. He stated that the money came directly from the foreign
Bank through the appellant. He stated that the appellant had no
capacity to raise such a sum of money. He, however, acknowledged that
his company did not execute any agreement with the foreigner lender.
The
movement of the US$60 million is shown on p 906 and 907 of the
bundle. The money was deposited into the appellant's Nostro account
in NY on 17 November 2011 and credited to the local bank account of
the borrower on the following day. He confirmed that payment of
interest instructions by his company to the appellant were triggered
by the interest rate fix, exh 9. The appellant would debit the
company's bank account and credit the offshore related party's
nominated account. The interest repayments in each 6 month period was
in the region of US$2.2 million.
The
evidence of the Head of Corporate Banking was supported by the three
witness who testified on behalf of the borrowers. They all maintained
that notwithstanding the contents of the facility letters, they
sourced offshore loans from the offshore related party. They remitted
interest to the offshore related party. The appellant was merely a
conduit pipe who facilitated easy access of the funds and sought
approval from the Reserve Bank of Zimbabwe on behalf of both the
borrowers' and the offshore lender.
There
was a plethora of disquieting features in the testimony of the Head
of Corporate Banking.
He
disputed that any money was paid to the appellant by the offshore
lender contrary to the stipulation in clause 3 of the MRPA. He
disputed that the appellant borrowed funds from the onshore lender,
again contrary to all the approvals he produced that emanated from
the Central Bank. The lender was clearly indicated as the offshore
related party and the borrower and in later approvals the beneficiary
as the appellant.
The
unexplained discrepancy between the first facility letter and the
acceptance agreement in respect of the first tobacco company did not
engender confidence in his testimony. More importantly, the failure
to produce the acceptance agreements of all the other facility
letters save for the one in respect of the conglomerate, exh 7, and
rate fix documents in respect of all the facility letters undermined
his credibility.
The
impression left in my mind was that the appellant was deliberately
hiding information in corporate underbrush.
The
similarity of all the letters save for the first two for the first
tobacco company with the ones the appellant admitted were provided
with local funds undermined the appellant's case. There was no
reference to any Evidence Account in these facility letters. The
choice of law clause conferred jurisdiction on the local courts. The
calculation of the computation of the interest rate in respect of the
cement manufacturer demonstrated that it was receiving onshore
finance from the appellant.
In
my view, it was simply incredible that the appellant did not have the
capacity to fund the requirements of the conglomerate. It admitted to
funding the conglomerate in the aggregate sum of US$30 million from
onshore funds. In any event it held approvals from the ELCC to on
lend funds borrowed offshore to both tobacco and seed cotton
merchants and other non-tobacco customers. I was satisfied that the
Head of Banking, for reasons best known to himself and the appellant
chose to mislead this court about the true nature of the interest
payments that were paid by the six onshore companies.
The
issue for determination is whether the respondent was entitled to
attribute interest earned by non-resident related parties on loans
made to businesses in Zimbabwe to the appellant.
It
was common cause that the facility letters were all in the name of
the appellant. The appellant set the terms and conditions for
accessing the loan amounts. The parties were required to provide
Board of Directors' resolutions, various security documents, and,
in some instances, proof of an offshore Evidence Account. The
appellant was the link between the borrowers and the External Loan
Coordinating Committee of the Reserve Bank of Zimbabwe. It applied
for approval of both tobacco and non-tobacco pre and post shipment
offshore loans. The approvals identified the appellant as the
borrower and the offshore related party as the lender.
The
respondent understandably took the view that the appellant was
borrowing offshore funds for onshore lending.
This
view was in part derived from the letter from the Central Bank of 12
February 2013 on page 23 and 24 of the Rule 11 documents. The Central
Bank advised that current exchange control regulations allowed
authorised dealers to access offshore lines of credit for on lending
and own use while local companies were permitted to directly access
offshore loans from offshore lenders including their holding and
sister companies. The letter further indicated in line with the
Exchange Control Directive ECD01 dated 31 July 2009 during the period
to 5 February 2013, that authorised dealers were allowed to process
offshore loans of up to US$5 million under the advice of the External
Loans Coordinating Committee whilst offshore loans in excess of US$5
million required prior approval by the ELCC. The prior approval of
the use of the onshore funds borrowed offshore for the purchase and
growth of tobacco and seed cotton may have dulled the collective
conscience of the parties from the possible breach of the law.
The
ELCC approvals granted to the appellant on 6 October 2009, 9
September 2010 and 7 December 2011 as corrected on 14 June 2012
identified the appellant as the borrower of offshore funds emanating
from the offshore related party for both tobacco and non-tobacco pre
and post shipment loans.
It
was on the basis of the contents of the paperwork represented by the
facility letters and the ELCC approvals that Mr Magwaliba
maintained that the interest purportedly paid by the borrowers to the
related offshore party accrued to the appellant. He forcefully
contended that the facility document created legal rights and
obligations between the appellant and the specified onshore clients.
It created the cause for payment of interest to the appellant and did
not establish a similar cause for payment to the offshore related
party. He relied on Commissioner
of Inland Revenue v
Lever
Brothers and Unilever Ltd 14
SATC 1 at p 10 where Watermeyer CJ observed that:
“The
provision of credit is the originating cause or source of the
interest received by the lender.”
The
onus to show that the interest in issue accrued to the offshore
related party, in terms of section 63 of the Income tax as
interpreted in such cases as Commissioner
of Taxes v
A
Company 1979
(2) SA 409 (RA) at 416
lies
on the appellant.
The
thrust of the appellant's case and evidence from the four witnesses
it called on this aspect appeared to me to be that the interest was
in reality received by the offshore related party. The witnesses
indisputably established this fact through a variety of documents
such as the interest rate fix and bank statements.
Interest,
like any other income, is also taxed on the basis of accrual. Accrual
denotes legal entitlement.
The
facility documents seem to appropriate interest to the appellant.
They point to the appellant as the provider of the credit to whom
interest payments were due. In the parlance of Watermeyer CJ in the
Lever
Brothers'
case supra
the
provision of the credit was the originating cause or source of the
interest.
The
appellant, however, argued that the interest could not have accrued
to it because it was not the actual lender of the money. It merely
facilitated the provision of the loan amount to the borrower.
The
four witnesses confirmed this fact.
The
appellant also relied on the MRPA and acceptance agreements it
executed with the offshore lender. The MRPA mandated the execution of
an acceptance agreement between the appellant and the lender to
record the relationship between the parties in a funded or unfunded
risk participation.
The
appellant did not produce any acceptance agreement in respect of the
cotton company, two of the tobacco companies and the cement company.
The acceptance agreement for the one tobacco company that was
produced left unanswered questions that undermined its probative
value.
The
appellant, therefore, failed to establish the basis for the remittal
of interest to the offshore related party.
It
produced a relevant acceptance agreement for the loan facility
provided to the manufacturing and distribution conglomerate. I would
have found for the appellant in regard to the conglomerate were it
not for the unexplained remittance details in exhibit 9 which seem to
direct payment of capital and interest to the appellant's New York
Nostro account listed in exh 3.
I,
therefore, hold that the appellant has failed to demonstrate that it
did not earn the interest deposited into the offshore Evidence
Account held with the offshore related party.
WITHHOLDING
TAX
The
last issue for determination is whether the bank charges that were
raised by offshore banks holding appellant's Nostro accounts
amounted to fees under para 2(1) of the 17th
Schedule of the Income Tax Act. The para reads:
“2.
(1) Every payer of fees to a non-resident person shall withhold
non-residents' tax on fees from those fees and shall pay the amount
withheld to the Commissioner within ten days of the date of payment
or within such further time as the Commissioner may for good cause
allow.”
Fees
are defined in para 1(1) of the 17th
schedule in the following terms:
“1.
(1) In this Schedule, subject to subparagraph (2) —
'fees'
means any amount from a source within Zimbabwe payable in respect of
any services of a technical, managerial, administrative or
consultative nature, but does not include any such amount payable in
respect of —
(2)
For the purposes of this Schedule —
(a)
fees shall be deemed to be from a source within Zimbabwe if the payer
is a person who or partnership which is ordinarily resident in
Zimbabwe;
(b)
in determining whether or not non-residents' tax on fees should be
withheld, the question as to whether or not —
(i)
the payer is a person or partnership ordinarily resident in Zimbabwe;
or
(ii)
the payee is a non-resident person;
shall
be decided by reference to the date on which the fees are paid by the
payer;
(c)
fees shall be deemed to be paid to the payee if they are credited to
his account or so dealt with in that the conditions under which he is
entitled to them are fulfilled, whichever occurs first;
(d)
not relevant.”
The
averments made by the appellant in para 34 to 37 of its case are
that:
34.
The foreign banks in which the appellant held its Nostro accounts
raised transaction related charges in respect of cash repatriation,
cash ordering or Visa card costs.
35.
The appellant paid those charges directly to the Banks concerned
without deducting therefrom any amount in respect of withholding tax.
36.
The Respondent contends that the charges raised by the Banks holding
the Nostro accounts, which were paid by the Appellant constitutes
fees.
37.
The Appellant contends that the payments made were in respect of bank
charges and not in respect of fees, whether of a technical,
managerial or consultative nature and are not subject to the
withholding tax.
The
Head of Corporate Banking testified how transactions were conducted
in the Nostro accounts.
A
customer/client would instruct the appellant to make payment to a
third party. The appellant generated a telegraphic transfer through
SWIFT, a safe international payment processing platform used by all
Banks to transfer money from one Bank to another, to transfer the
funds from its relevant Nostro account to the third party's
designated Bank account.
In
line with international banking practice, Swift automatically charged
a fixed rate against the Nostro account based on the number of
clearing transactions that operated through the system. SWIFT charged
the related account directly from that transaction by debiting the
account without raising an invoice. He also stated that the Nostro
bank charged normal bank charges in line with the requirements of the
regulatory authorities in which they reside.
When
he was cross examined he equated the Nostro bank charges with fees
paid by customers of local Banks for services rendered and charges
levied for maintaining an account with the local Bank. He clarified
that the appellant was charged fees for particular transactions that
went through the Nostro accounts. He stated that the appellant
maintained a mirror account for each Nostro account to track
transactions in each account. He conceded that the debit represented
money earned by the foreign Bank.
Mr
de
Bourbon
submitted that the appellant was not liable for withholding tax on
two grounds;
(i)
The first was that the payment was not made from a source within
Zimbabwe; and
(ii)
The second was that the services for which the charges were levied
were not of a technical, managerial, administrative or consultative
nature.
He
relied on Sunfresh
Enterprises (Pvt) Ltd t/a Bulembi Safaris
v
Zimra 2004
(1) ZLR 506 (H).
In
that case, Cheda J held inter
alia
that payment of a commission by a foreign client to a foreign
marketing agent of a local Safari operator outside the country did
not under para 1(1) of the 17th
Schedule of the Income Tax Act constitute payment of fees from within
Zimbabwe even though the originating cause was in Zimbabwe.
It
seems to me that the facts in Sunfresh
are distinguishable from the present facts.
In
casu,
the appellant conceded in its pleadings that it paid the charges
debited by the Nostro Banks. Para 1(2) of the 17th
Schedule deems the source to be from within Zimbabwe if the payer is
ordinarily resident in Zimbabwe. The appellant is ordinarily resident
in Zimbabwe.
If
the commission in the Sunfresh
case was deducted from the overall hunting fee remitted to the safari
operator as submitted by Mr de
Bourbon,
I would with respect differ from the finding of Cheda J. The payment
by the foreign client to the foreign based agent, in my view, would
simply constitute a prepayment on behalf of the safari operator. It
would have been subject to withholding tax.
In
the present matter, the charges were interchangeably referred to as
fees by the Head of Corporate Banking.
Mr
de
Bourbon
submitted that the Nostro bank charges were not subject to
withholding tax as they did not fall under any one of the four
categories of technical, administrative, managerial or consultative.
It
seems to me that the four categories in question are merely
adjectives which describe a particular activity. According to the
Shorter
Oxford English Dictionary
'administer' means inter
alia
“to manage;” “to handle” while 'administrative' is
defined as “pertaining to management.” One of the many
permutations of 'to manage' is “to deal with carefully”. Like
McDonald JP in Commissioner
of Taxes v F, supra, at
115F where he was of course referring to “transaction, operation or
scheme”, I would agree that each of the words “technical,
managerial, administrative and consultative” that is used in the
para under consideration:
“is
of wide and general import and there are a few activities of a
taxpayer which will not be appropriately described by one or other of
them.”
The
activities that were carried out by the Nostro Banks on the various
Nostro accounts and by SWIFT clearances were administrative in
nature. The clearing or processing of transactions by SWIFT were, in
my view, both administrative and technical. They involved the use of
software that does not issue invoices but systematically and
automatically debits the cost of each transaction on the account.
I
am satisfied that the charges raised by offshore Banks holding
appellant's Nostro accounts amounted to fees under para 1 of the
17th
Schedule of the Income Tax Act.
CONCLUSION
For
the avoidance of doubt, I answer the first issue referred to trial
against the appellant. It did not properly bring to account the
retrenchment costs in its tax return for the year ending 31 December
2009. The respondent properly disallowed it in the 2009 tax year.
In
regards to the second issue of imputing notional interest to Nostro
accounts I hold that the respondent was not entitled to deem the
appellant's offshore Nostro accounts as interest bearing accounts.
The respondent erred in adding notional interest back to taxable
income.
As
for the third issue, on offshore loans, the respondent was entitled
to attribute interest earned by non-resident related parties on loans
made to businesses in Zimbabwe to the appellant. He correctly added
it back to income in the respective tax years that it was earned.
And
in respect of the last issue on withholding tax, I hold that the
respondent properly raised withholding tax on the bank charges that
were raised by offshore banks holding the appellant's Nostro
accounts as they constituted fees under para 1 of the 17th
Schedule of the Income Tax Act [Chapter
23:06].
COSTS
The
appellant did not achieve anything approximating substantial success.
I will order each party to bear its own costs.
DISPOSITION
Accordingly
it is ordered that:
1.
The appeal in respect of retrenchment costs, interest on offshore
loans and non-resident withholding tax be and is hereby dismissed.
2.
The appeal in respect of Nostro accounts be and is hereby allowed.
3.
The amended assessment issued by the respondent on 16 November 2012
for the tax year ending 31 December 2009, and the amended assessments
issued on 21 November 2013 for the tax years 31 December 2010 and 31
December 2011, respectively, be and are hereby set aside.
3.
The respondent is directed to issue further amended assessments in
respect of each of the three years in accordance with the contents of
this judgment by:
(i)
Disallowing the deduction of retrenchment costs in the sum of
US$2,693,500.00 in the tax return for the tax year ended 31 December
2009.
(ii)
Exempting payment of imputed notional interest from Nostro accounts
in the tax years ended 31 December 2009, 31 December 2010 and 31
December 2011.
(iii)
Adding back to income the interest paid by the six companies in each
of the three tax years in question.
(iv)
Adding back to income the withholding tax on the bank charges raised
by all the offshore Banks holding the appellant's Nostro accounts
at the appropriate rate for each of the three tax years in question.
(v)
Each party shall bear its own costs.
Gill
Godlonton and Gerrans, the
appellant's legal practitioners
