This is an appeal against four amended income tax assessments number 20211442 for the year ending 31 December 2009; 20211443 for the year ending 31 December 2010; 202211446 for the year ending 31 December 2011; and 20211448 for the year ending 31 December 2012 that were issued against the appellant by the respondent on 27 June 2014….,.
On 25 July 2014, the appellant objected to the amended assessments in terms of section 62 of the Income Tax Act [Chapter 23:06]. On 22 October 2014, all the objections were disallowed save for a few relating to penalties.
The appellant gave notice of its intention to appeal on 30 October 2014 and duly filed the present appeal on 18 December 2014.
The appellant called the evidence of two witnesses, an independent tax consultant, LM, who worked for the respondent for the 16 years to 2006 and its Managing Director. In addition, it produced four voluminous documentary exhibits in excess of 500 pages, exhibits 1 to 4.
The respondent called its Chief Investigations Officer, OM, who has held that office since 2011 but with a total of 14 years experience, produced a 9 paged documentary exhibit, exhibit 5, and relied on the mandatory R11 documents.
Background
The appellant was incorporated on 29 September 1995 and underwent two name changes, on 24 April 1996 and 9 October 2014….,.
The second name change was precipitated by the acquisition of the South African registered sister company by the appellant's holding company on 1 June 2005.
Sometime in 2010…, the respondent commenced the tax compliance investigation on the appellant that resulted in the amended tax assessments that gave rise to this appeal. The appellant's main business activities in the four years in question were in the importation, distribution, and marketing of motor vehicles and spare parts of a specified brand….,.
The 1996 Distributor-Assembler Agreement
Initially, on 24 June 1997, the appellant entered into a detailed 53 article distributor-assembler three year agreement, the original agreement, with NML, a Japanese conglomerate engaged in the development, manufacture, and assembly and worldwide distribution and sale of an international brand of various models of motor vehicles and spare parts, retroactively from 1 April 1996….,.
The appellant had access to the conglomerate's trademarks, trade names, and engineering technology and was authorised to purchase, manufacture, assemble, market, distribute, and sell certain models of the brand, knocked down components, and spare parts through a network of dealers appointed by the appellant and approved by the conglomerate in Zimbabwe.
The ordering, production, shipment prices, and payment of the vehicles and components, in an amount sufficient to cover the price, was regulated by Articles 5 to 7 of exhibit 3….,.
The appellant met the full cost and expenses of the shipment and demurrage, and storage costs of the vehicles and spare parts. The risk for loss or damage passed to the appellant once the goods crossed the ship's rail at the port of shipment - but ownership and title of the goods was retained by the conglomerate until the payment obligation had been discharged.
It was discharged by payment into an L/C bank account opened in the name of the conglomerate by a bank acceptable to the conglomerate by irrevocable letters of credit at sight in favour of the conglomerate at which point the appellant simultaneously received the shipping documents for the relevant goods through that opening bank.
Because the timelines for ordering and the confirmation of the orders and payment preceded the production of the vehicles, ownership passed to the appellant on delivery of the vehicle FOB past the ship's rail at the port of shipment.
The appellant was solely responsible for securing Government licences and permits required to complete payments for and importation of the ordered goods….,.
The terms and conditions contemplated a cash before delivery sale.
The conglomerate could export and deliver to, and sell in Zimbabwe, brand vehicles in its own name through the agency of the appellant and pay the appellant for the services rendered.
The conglomerate played an active advisory role in the establishment of the appellant's business and was entitled to receive prescribed mandatory reports at specified periods and to inspect the appellant's operations.
The appellant undertook to maintain sufficient working capital and investment capital to enhance its business activities.
Each party was, in terms of Article 39-2, responsible for any and all expenditure incurred and assumed in the performance of its duties, obligations, and responsibilities.
Article 44 provided that:
“This agreement does not constitute either party as the agent or legal representative of the other party for any purpose whatsoever. Neither party is granted any expressed or implied right or authority to assume or to create any obligation or responsibility on behalf or in the name of the other party or to bind the same in any manner whatsoever.”
The appellant was also required to purchase a specified minimum number of vehicles, gain market share, and, in the event of a decline due to circumstances beyond its control, implement agreed counter measures to arrest the decline or risk termination of the agreement.
It appears to me, that, these were standard terms and conditions found in international contracts for the facilitation of international trade as demonstrated by their striking similarity with the conditions found in Lendalease Finance (Pty) Ltd v Corporacion de Mercadeo Agricola & Ors 1976 (4) SA 464 (A) especially in regards to the payment arrangements and the passing of both risk and ownership.
The 1 August 2007 Memorandum of Understanding
The appellant and the related party…, whom I shall refer in this judgment as the intermediary, signed a memorial of the procedures for importation of vehicles into Zimbabwe in the Memorandum of Understanding dated 1 August 2007.
The intermediary was required to place monthly production orders with the brand suppliers. The importation value of the consignment was reflected in a manual invoice issued by the intermediary to the appellant. The vehicles were imported into Zimbabwe and held in the appellant's bonded warehouse as consignment stock with the intermediary retaining ownership of the vehicles until payment was made. Once payment was made, the invoice was stamped by customs officials and duty and other imposts paid for the consignment by a clearing agent before ownership was transferred to the appellant. The appellant, in turn, invoiced and transferred the vehicles to an authorised dealer for sale.
The Distribution Agreement of 25 April 2011
On 25 April 2011, the appellant and the conglomerate entered into a “Distribution Agreement”…, consisting of 39 Articles with retroactive effect…, from 1 February 2007.
It appeared to be a reproduction of an incomplete Distribution Agreement dated 31 January 2007 that was only signed and initialled by the appellant's Managing Director….,.
It substituted the original agreement.
The preamble, structure, and, in most respects, the contents, mirrored word for word the original agreement. The noticeable change was the wholesale removal of the right to purchase knocked-down kits for assembling from and the transfer of technological assistance and assembly by the conglomerate to the appellant.
Articles 21, 22 and 23 mirrored word for word Articles 5, 6 and 7 of the original agreement in respect of the ordering, production, and shipment of the vehicles and spare parts.
Article 24, like Article 10 in the original agreement, dealt with the supply of spare parts whose purchase prices were computed on a cost, insurance and freight (CIF) or free on board (FOB) basis derived from a price list provided by the conglomerate.
The grounds for termination were generally similar to those in the original agreement.
The Memorandum on Sales and Purchase of the Conglomerate Vehicles of 25 April 2011
The appellant and the conglomerate entered into a memorandum on Sales and Purchases of brand vehicles with the intermediary, retroactive from 1 February 2007, soon after signing the Distribution Agreement.
The appellant appointed and the conglomerate approved the appointment of the intermediary as the intermediary for the sale and purchase of the vehicles from the conglomerate under the Distribution Agreement.
The three parties agreed that the intermediary would purchase the vehicles from the conglomerate and sell them to the appellant.
The parties all incorporated the ordering, pricing, and payment and supply of spare parts provisions in Articles 21, 23 and 24 of the Distribution Agreement. They further agreed that any violation or default of those provisions, by the intermediary, would be ascribed to the appellant.
The Management Services Agreement between the Appellant and the Intermediary of 2 March 2009
On 2 March 2009, the appellant and the intermediary entered into a Management Services/Technical Services Agreement which was governed by the laws of Zimbabwe and took effect on 1 March 2009.
They were motivated by the introduction of the multi-currency financial regime in Zimbabwe. It was to run for an indefinite period. The intermediary undertook to:
“Provide administrative services, financial services and support and logistical services and support to help appellant achieve its goals in terms of gaining market share, growth and profitability…, ensure that new developments and systems will be properly communicated together with appropriate facilitation of technical support, system materials and training…, (and) be available to provide help and guidance on any aspect of the business mentioned, at the request of appellant.”
In regards to the computation of the fees, the parties agreed that:
“The intermediary will calculate the fees based on both the turnover reported by appellant and also the level of input that has been provided in terms of this agreement. The fees to be provided for shall be 2% of turnover; however, this will not necessarily be the amount finally invoiced. The amount finally invoiced shall not exceed 4% of turnover.”
And, in respect of payment, they agreed that:
“Payment of the management fees shall ordinarily be made in the year following that on which the fees have been based on receipt of an invoice from the intermediary. For cash flow purposes, it will be permissible to make part payments, but, at least two half-yearly payments will be required.”
The implementation and operation of the agreements
The evidence of the appellant's Managing Director was that the intermediary, a Mauritian registered short-term credit financier interposed between the conglomerate and the appellant in the purchase of the vehicles and spare parts destined to Zimbabwe.
Customers in Zimbabwe would place an order on the brand model of their choice, either to the appellant or an approved dealer appointed by the appellant. The appellant would group the orders and submit a bulky order of the required stock of vehicles, four (4) months in advance, to the intermediary, which, in turn, placed orders with the conglomerate.
The conglomerate would build the ordered vehicles for the intermediary.
The intermediary would purchase the vehicles, in its own name, from the conglomerate, and consign them directly to the appellant's bonded warehouse in Zimbabwe.
The intermediary retained ownership of the consignment in bond until it was paid.
Ownership vested in the appellant upon payment of the purchase price equivalent to the value for duty purposes.
Thereafter, the appellant would, where applicable, pay customs duty, surtaxes, and VAT based on the agreed value, through a clearing agent, before the consignment was released from the bonded warehouse and delivered to the approved dealer and end user.
The appellant used to import stock from a South African related party and the conglomerate under value rulings 18 and 29 of 2001 before the advent of the French holding company. These were replaced by value ruling 15 of 2007, on 5 November 2007, following upon protracted negotiations between the appellant and the respondent that commenced on 26 March 2006….,.
A sample of the documents used in the consignment of the vehicles from the intermediary to the appellant were captured on pp14 to 38 of exhibit 2 and pp1 to 9 of exhibit 5.
These were commercial invoices, telegraphic transfers, and Zimra certificates of origin, bills of entry, and customs clearance certificates.
These commercial invoices…, denoted the intermediary as the supplier and the appellant as the purchaser and consignee.
The vehicles were fully described by model, chassis and engine number, colour, and year of manufacture.
The order number, dates of issue and delivery, method of shipment, origin and destination together with the terms of payment, the free on board purchase price, the cost of freight, insurance and total CIF price, denominated in United States dollars, were also indicated.
The certificates of origin…, certified that each vehicle was manufactured by the supplier in South Africa and bore the same information contained in the commercial invoice in regards to the supplier, consignee, and description of the vehicle.
The bills of entry…, were completed by the clearing agent and identified the intermediary as the exporter or consignor.
They identified the country of supply and destination, the description, and total invoice value of each vehicle separately from the freight and insurance charges.
The customs clearance certificates…, for each vehicle were issued by Zimra.
They contained the full description of the vehicle shown in the commercial invoice. The cost, freight, and insurance price for each vehicle sold was captured in a combined invoice…, issued by the intermediary to the appellant, which the appellant submitted to its bankers with instructions to pay the intermediary by telegraphic transfer….,.
The sequence of dates on these documents showed that an advance payment by telegraphic transfer was made on 12 February 2007, the certificate of origin was presented on 15 April 2007 while the commercial invoice was issued on 24 April 2007 and the vehicle was cleared by a bill of entry at the port of entry on 9 May 2007. Thereafter, a customs clearance certificate was issued on 19 June 2007.
It was common ground, that, the intermediary's consignment was delivered to Zimbabwe and warehoused by the appellant in bond.
It was common cause, that, the appellant did not suffer any exposure to foreign currency risk or credit risk since the end users were required to make payment before the relevant vehicles were dispatched from South Africa…, in 2009 and 2010.
However, in 2011 and 2012, the appellant was exposed to foreign currency risk through the importation of inventory, the liability of which was settled in South Africa in a carrying amount of US$264,729 and US$294,956 respectively….,.
It was common ground that the appellant received vehicle prepayments in the sum of US$2,064,187…, in 2010 that was subsequently revised to US$4,693,512…, in the 2011 financial statements, US$3,086,165 in 2011…, and US$755,673…, in 2012.
Summary of the Tripartite Arrangement
The nature and scope of the tripartite arrangement between the parties was concisely set out by counsel for the respondent in paragraph 5 of his written heads of argument.
A customer placed an order to the appellant through an approved dealer appointed by the appellant. The appellant placed orders with the intermediary, which, in turn, procured the motor vehicles from the conglomerate.
The appellant received the motor vehicles in Zimbabwe and kept them in a bonded warehouse.
Ownership of the motor vehicles remained with the intermediary until duty had been paid by the appellant.
The purchase of a motor vehicle by a customer resulted in the payment of duty to the respondent by the appellant before the vehicle was released to the customer.
The intermediary was paid the transaction value of the motor vehicle, which, according to the letter of the appellant to the respondent, of 8 August 2007, included a 5% administration charge and interest of the selling price on the price list…, in which was incorporated its mark-up of between 7.5% and 10%.
The appellant was responsible for rentals, marketing expenses, and payment of duty.
It sold the vehicles to the dealers at a mark-up of 7.5% and the dealers sold the vehicle to the end customer.
Concessions made at the commencement of the appeal hearing
At the commencement of hearing, the appellant confirmed the concession first made in the letter of 19 June 2014, that, it was remiss in failing to charge the intermediary a mark-up of 7% for transit services rendered in the sum of US$2,240 for 2009, US$2,505=87 for 2010 US$2,198=13 for 2011 and US$3,273=40 for 2012 in respect of vehicles exported by the intermediary to Zambia, Malawi and Tanzania.
Again, the appellant conceded, that, it paid management fees to the intermediary when such fees were not due in the sum of US$130,000 in 2009, US$140,000 in 2010, US$256,629 in 2011 and US$140,000 in 2012.
In the same vein, the respondent conceded, that, it wrongly raised notional interest at the rate of 24% in the sum of US$97,279=92 in respect of the 2012 loan to GS and in the sum of US$106,953=12 for 2010, US$266,879=52 for 2011 and US$124,666=80 for 2012 in respect of the loans availed to ADI.
Assessment of witnesses
The appellant acted in a devious manner in regards to management fees. Its conduct amounted to a deliberate act of transfer pricing which was done with intent to avoid tax.
The production of backdated agreements gave the impression that these were created as a response to the tax investigation.
This was apparent from the purported agreement of 31 January 2007 which had the appellant's signatures only that was rejected by the respondent and resulted in the production of duly signed agreement of 25 April 2011 backdated to 1 February 2007.
The Managing Director misled the court that the appellant provided functional analysis input under duress, contrary to his letter of 12 July 2013 in which he requested two weeks within which to provide the requested information, thus affording the appellant in excess of a month from the date of the initial request.
He disputed making prepayments to the intermediary yet the financial statements, in note 17 on p71 of exhibit 1, show that US$4,693,512 was paid in 2010 and US$3,086,165 in 2011 before the vehicles were exported in bond.
He falsely averred, and thus copied the evidence adduced by the Tax Consultant in his presence, that, the audits for his company commenced in November of each year in contradistinction to the timelines indicated in the audit engagement letter.
The tax consultant prevaricated on what the respondent's generally prevailing practice in regards to provisions was.
The chief investigations officer failed to demonstrate how he arrived at the apportionment ratio he used in his functional analysis. He testified that the appellant misled the respondent by claiming ownership of the consignment stock at the time he applied for the value ruling, contrary to the contents in the letters written by the appellant at that time.
The issues referred for determination
At the pre-trial hearing of 2 June 2015, the following issues were referred for determination. In view of the concessions made by the respondent at the commencement of trial, it is no longer necessary to outline in respect of the loans advanced by the appellant to GS and ADI.
Sharing of profits/transfer pricing
1. Whether or not the respondent is precluded from adopting its current stance on this issue on account of either:
1.1 The value ruling issued by it; or
1.2 The fact that duties and taxes were assessed and paid to it on a different basis.
2. Whether the respondent is entitled to invoke section 24 of the Act to deem income to have accrued to the appellant which was not actually received by it.
Expenses relating to Leave Pay and Audit Fees
1. Whether it was proper of the appellant and open to the appellant to make provision for the costs in question.
2. Whether the respondent was precluded from issuing amended assessments by virtue of the provisions of section 47 of the Act.
Penalties
1. What, if any, penalties are payable to the respondent.
I proceed to deal with each issue in turn.
Sharing of profits/Transfer Pricing
1. Whether or not the respondent is precluded from adopting its current stance on this issue on account of either:
1.1 The value ruling issued by it; or
1.2 The fact that duties and taxes were assessed and paid to it on a different basis.
2. Whether the respondent is entitled to invoke section 24 of the Act to deem income to have accrued to the appellant which was not actually received by it.
The respondent's current stance
The position adopted by the respondent during the investigation, objection, determination, and espoused in correspondence with the appellant, and in evidence and argument at the appeal hearing was to disregard the values of the motor vehicles received into the country by the appellant that were accepted by the Commissioner-General in the Value Ruling No.15 of 2007 of 5 November 2007 issued under sections 106 and 113 of the Customs and Excise Act [Chapter 23:02] in preference to the values derived from the functional analysis purportedly computed in terms of section 24 the Income Tax Act.
The Value Ruling
The Value Ruling No.15 of 2007 was issued on 5 November 2007. It replaced two other value rulings, Numbers 18 and 29 of 2001.
The transaction value accepted by the respondent, in the first value ruling, was based on the “invoiced prices plus dutiable adjustments” and in the second value ruling it was based on the invoice price plus Yen12,500 on each complete CKD kit and automobile CBU plus dutiable adjustments value and an uplift on the spare parts of 5% of the invoice price plus dutiable adjustments.
The transaction value of the consignment stock provided in section 113(2) of the Customs and Excise Act also included all costs, charges, and expenses incidental to the sale and handling and transport costs from the port of exportation to the port of importation in Zimbabwe.
The application preceding Value Ruling 15 of 2007 was necessitated by the change of ownership in the appellant through the purchase of 75% of the appellant's capital by a French company which also wholly owned the share capital in the intermediary. The holding company instigated the substitution of the conglomerate and the South African company in the supply matrix by the intermediary with the result that the appellant was designated as the importer and the intermediary as the supplier in the Value Ruling Number 15 of 2007.
The Ruling stated that:
“MOTOR VEHICLES
Invoiced prices plus dutiable adjustments are acceptable.
SPARE PARTS
Invoiced prices plus dutiable adjustments are acceptable.
Transaction Value, TV, Method applicable.
Subject also to the inclusion of all costs, charges, and expenses not mentioned above which are incidental to the sale and to placing the goods on board the means of transport they are removed from country of exportation. Any subsequent costs, charges, and expenses incurred in delivering the goods to the place of importation in Zimbabwe should also be included in terms of the Customs and Excise Act.”
The covering letter of the same date explained that:
“Based upon the information you have provided regarding your importations from the intermediary - RSA, the following value ruling number 15/2007 has been issued by the Commissioner General of the Zimbabwe Revenue Authority in terms of section 106 and 113 of the Customs and Excise Act [Chapter 23:02] as amended.
The value for duty purposes will consist of the total price paid or payable (directly or indirectly) for the goods, plus any necessary dutiable adjustments referred to in section 113 of the Customs and Excise Act [Chapter 23:02].
Your necessary dutiable charges/adjustments include the cost (not already included in the invoice) of any packages, packing, loading, handling, transport, and insurance associated with the transportation of the goods to the place of importation in Zimbabwe.
Provided that the relative amounts can be distinguished from the price of the goods and the necessary documentary evidence is furnished with the customs entry, the cost of transport and insurance beyond the place of importation may not be included in the value for duty purposes.
The Commissioner General has made the ruling in accordance with the principles of the WTO valuation code based upon the present terms and conditions of trading between yourselves and the supplier concerned, as made known to the Department.
Any changes of these terms and conditions of trading must be notified to this office immediately.”
In a further covering letter of the same day, the respondent confirmed that the appellant was the importer.
However, this view was contrary to the insurance attestation on pp73 and 74 of exhibit 2, covering the 2007 calendar year, in which the French based insurance brokers certified that the intermediary's vehicles sold to the appellant were validly insured against damage and that the insurance policy was subject to automatic renewal from year to year. The risks covered were identified in bold print as:
“all risks from the warehouse of the seller to the warehouse of the consignee in Zimbabwe, on CIF value.”…,.
Sections 104 to 119 in Part X of the Custom and Excise Act [Chapter 23:02] deal in detail with the computation of the value for duty purposes.
The value, for duty purposes, is derived from the transaction value of the goods or services imported or due to be imported into Zimbabwe. The formula is provided in section 105(1) and in the opening words of section 106(1) of the Custom and Excise Act in these terms:
“105 Value for duty purposes
(1) For the purpose of assessing the amount of any duty payable on any imported goods and for the purpose of any declaration or oath which may be required by this Act or any other enactment in relation to any question of value or duty in connection with the importation of goods, or goods which are likely to be imported, the value of such goods shall, subject to this Act, be the transaction value thereof as established or determined in terms of sections one hundred and six to one hundred and twelve.
106 Transaction value: primary method of valuation
(1) Subject to this Act, the value for duty purposes of any imported goods shall be the transaction value of the goods, that is to say, the price actually paid or payable for the goods when sold for export to Zimbabwe, adjusted in terms of section one hundred and thirteen, if —“…,.
The price actually paid or payable on imported goods is defined in section 104 of the Customs and Excise Act as the aggregate of all payments made or to be made on these goods by the importer to the seller that is to the satisfaction of the Commissioner and the value determined by the Commissioner of any consideration or services rendered or to be rendered by the importer for the benefit of the seller.
The concept of related parties is captured in section 104(3) of the Customs and Excise Act to include individuals who, inter alia, are officers or commissioners in each other's businesses or corporate bodies in which any other person, directly or indirectly, owns, controls or holds at least 5% of the issued shares of both or both are so controlled by a third person or control a third person or are members of the same family.
In terms of section 104(4) of the Customs and Excise Act, any sole agent or distributor or concessionaire of the other who falls into any of the categories listed in subsection (3) is deemed to be a related party under Part X of the Customs and Excise Act.
There are five other elaborate methods of computing the transaction value of goods for duty purposes set out from section 107 to section 112 of the Customs and Excise Act.
These comprise of the first alternative method and second alternative method which are based on the values of identical and similar goods, respectively, exported to Zimbabwe at about the same commercial level and the same quantity at about the same time.
The third alternative deductive method is based on comparative sales between unrelated parties of similar or identical goods less any commissions, mark-up, cost of sales, transport, loading and unloading, handling and insurance costs within Zimbabwe from the place of importation and any duty or tax payable locally on importation or sale of the goods.
The fourth alternative method relies on the manufacturer's production costs plus mark-up.
The final alternative method is a fall back method, which incorporates the preceding four methods with necessary modifications.
The respondent is precluded from resorting to fictitious or higher alternative values from the country of origin or to any prescribed minimum custom values.
The adjustments prescribed by section 113 of the Customs and Excise Act are additional to the price actually paid or payable by the importer to the seller to the extent that they were incurred by the buyer and were excluded in the price actually paid or payable. These includes: packing, loading and unloading, handling, transport and insurance, royalties and licence fees for the use of intellectual property rights, transport and insurance from the place of manufacture to the place of export to place of importation into Zimbabwe but the costs incurred within Zimbabwe, from the place of importation, are excluded from the transaction value.
It is clear from the provisions of section 114 of the Customs and Excise Act, that, the value of any imported goods in the Bill of Entry does not constitute the value determined and accepted by the Commissioner for duty purposes.
