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....,.
Expenses relating to leave pay and audit fees; whether it was proper of appellant and open to appellant to make provision for the costs in question
In its income tax returns, the appellant made provision for leave pay in its accounts in respect of its employees in the sum of US$10,193 for the year 2009; US$12,372 for 2010; US$22,947 for 2011; and US$24,207 for 2012.
It was common cause, that, the respondent disallowed the 2009 and 2010 provisions in these amounts but disallowed US$10,575 in the 2011 tax year and US$1,260 in the 2012 tax year.
The appellant contended, that, it was under a legal obligation to pay to its employees for the leave days accumulated at the end of each financial year and was therefore entitled to make provision for these leave days.
On the other hand, the respondent contended, that, the obligation to pay only arose when an employee went on leave or encashed his or her leave days as it was at that stage that the leave pay would be incurred for the purpose of trade or in the production of taxable income, otherwise the provisions were rendered non-deductible expenses by virtue of section 16(1)(e) of the Income Tax Act.
In the alternative, the appellant contended, that, the provision in the original income tax return having been deemed issued by the Commissioner, as his original assessment on the date of filing, was accepted and made in accordance with the practice then prevailing in the respondent's office for which the respondent was precluded by the proviso (i) to section 47(1) of the Income Tax Act from issuing amended assessments.
The respondent disputed, firstly, that, the mere acceptance of the self-assessed return amounted to a concession as to its correctness otherwise the provision permitting the respondent to investigate and verify the correctness of the self-assessments, as had been done on the appellant in the past, would be superfluous.
Secondly, it disputed the existence of such a practice as generally prevailing in its office at the time and characterised it as an arrangement which simply went unnoticed for years.
Audit Fees
It was common cause that the appellant was required, by law and proper corporate governance, to have its annual financial statements audited and would incur an audit fee in that regard.
In each of the four years in question, the appellant made provision in its respective financial statements for the audit fees in the sum of US$10,000 in 2009; US$15,000 in 2010; US$12,000 in 2011; and US$12,500 in 2012.
It was common cause that provisions are made and are deductible for accounting purposes in accordance with the requirements of International Financial Reporting Standards.
It paid the audit fees in the subsequent tax year but claimed them as a cost of undertaking business in the year of the assessment in which the audit pertained.
The respondent disallowed the whole amount claimed in 2009 and US$9,960 in 2010; US$2,049 in 2011; and US$491 in 2012.
In the alternative, the appellant contended, that, the respondent was precluded from re-assessing the audit fees by proviso (i) to section 47(1) of the Income Tax Act on the basis, that, the acceptance of the original self-assessments, which are deemed by law to have been the assessments made by the Commissioner, were made in accordance with the practice generally prevailing in the Commissioner's office at the time.
The two issues that arise in respect of these two provisions are:
(i) Whether or not these amounts are deductible under the general deduction formula, section 15(2)(a) of the Income Tax Act, notwithstanding that payment was only made in the following year.
(ii) The second is whether the respondent is precluded from issuing amended assessments in each of these four years by virtue of a practice generally prevailing in its office at the time.
In regards to the first sub-issue, the law is clear.
The general deduction formula caters for expenses incurred for the purposes of trade or in the production of income in the year of assessment.
The provisions of the section are met when the taxpayer has incurred, in the tax year to which the expenses relate, an unconditional legal obligation to pay the amount due notwithstanding that the actual payment is made in the following tax year: see G Bank Zim Ltd v Zimra 2015 (1) ZLR 348 (H)…, and the cases cited therein, where the Bank made commitment to pay certain amounts pertaining to voluntary retrenchments to employees in the 2009 tax year. Some employees had applied and the tax payer accepted the applications in that tax year while others only applied in the subsequent tax year in which the applications were accepted. The acceptance was conditional upon approval by the Minister of Labour and Social Services who granted such approvals for all employees in the subsequent year.
I held, that, the unconditional obligation to pay arose in the subsequent tax year notwithstanding the commitment made by the Bank, and the acceptance of some applications in the 2009 tax year to which the Bank sought to deduct these expenses.
The cases of Edgars Stores Ltd v Commissioner for Inland Revenue 1988 (3) SA 876 (A)…,; 50 SATC 81 (A)…, and ITC 1587 (1994) 57 SATC 97 (T)…, define the expression 'expenditure actually incurred' as “an unconditional legal obligation arising in the year of assessment whether or not that liability has been discharged during that year.”
In the latter case, Van DIJKHORST J stated thus:
“'Incurred' is not limited to defrayed, discharged or borne, but does not include a loss or expenditure which is no more than impending, threatened, or expected.
It is in the tax year in which the unconditional liability for the expenditure is incurred, and not in the tax year in which it is actually paid (if paid in the subsequent year) that expenditure is actually incurred for the purposes of section 11(a): Caltex Oil (SA) Ltd v Secretary for Inland Revenue 1975 (1) SA 665 (A) at 674; Nasionale Pers Bpk v KBI 1986 (3) SA 549 (A) at 564; Edgars Stores Ltd v CIR 1988 (3) SA 876 (A) at 888-9; CIR v Golden Dumps (Pty) Ltd (1993) 55 SATC 198 (A) at 205-6.
It is clear that expenditure may be deducted only in the year in which it is incurred: Sub-Nigel Ltd v Secretary for Inland Revenue 1984 (4) SA 580 (A) 589-591; Caltex Oil (SA) Ltd v SIR (supra) at 674.
It is not necessary for expenditure to be regarded as 'incurred' that it must be due and payable at the end of the year of assessment. As long as there is an unconditional legal liability to pay at the end of the year, the expenditure is deductible even though actual payments may fall due only in a later year: Nasionale Pers Bpk v KBI (supra) at 563-4; SILKE on South African Income Tax, 11ed, Vol 1 para 7.5 at page 7-13.”
To the same effect was ITC 1516 (1991) 54 SATC 101 (N) where GALGUT J said…,:
“It is now settled, for purposes of section 11(a), that 'expenditure actually incurred' is not limited to expenditure actually paid. It includes all expenditure for which liability has been incurred during the year, whether such liability has been discharged during the year or not: see Port Elizabeth Electric Tramway Co Ltd v CIR 8 SATC 13 at 15; 1936 CPD 241 at 244 and Caltex Oil (SA) Ltd v Secretary for Inland Revenue 1975 (1) SA 665 (A) at 674D-E.
A liability so incurred, must, however, be absolute and unconditional before it will qualify as a deduction for the purposes of section 11(a).
It will not be deductible in the year concerned if, for example, the liability is subject to a contingency; if, in other words, it is dependent upon an uncertain future event.
So much is clear from Nasionale Pers Bpk v Kommissaris Van Binnelandse Inkomste 1986 (3) SA 549 (A)…,.
The law, in regard to the problem before us, therefore, offers no difficulty.”
In the local case of Commissioner of Tax v 'A' Company 1979 (2) SA 411 (RAD)…, LEWIS JP cited with approval the definition of 'incurred' that was set out in the Australian case of Federal Commissioner of Taxation v James Flood (Pty) Ltd (1953) 88 CLR 493…, as equivalent to defrayed, discharged or borne of, encountered, and run into or fall upon and not to impending, threatened or expected or due and payable.
Case Law on Provisions for Leave Pay and Analogous Provisions
In ITC 674 (1949) 16 SATC 235, a provision for the payment of holiday allowances for a mandatory holiday that was due in the subsequent year was allowed on the basis that the appellants incurred mandatory and “absolute legal liability to pay” in the tax year in which the provision was made.
In contradistinction, holiday allowances in Federal Commissioner of Taxation v James Flood (Pty) Ltd (1953) 88 CLR 493 were disallowed as a deduction on the ground that they did not constitute losses or outgoings incurred under section 51(1), the section equivalent to our general deduction formula, section 15(2)(a) of the Income Tax Act.
The holiday was based on the accrual of 14 leave days for every 12 months of continuous service which leave days had to be taken within 6 months of due date provided the continuous service was not broken by death, a strike, or absenteeism. In addition, it was mandatory to take such leave outside the year of assessment and the employee was paid his normal salary while on leave and prohibited from encashing such leave.
It was held, that, the factors that could break continuous service constituted contingent liabilities that undermined a definite obligation on the part of the employer to make payment to those employees who had not completed 12 months service before the end of the taxpayer's financial year, and, as such, had not incurred an outgoing proportional to the accrued leave days.
I understood this case to mean, that, the obligation to take the holiday allowance was in terms of the award, which was the source of the liability, incurred when the employee qualified to take leave in the year subsequent to the year of assessment.
In Commissioner of Tax v A Company 1979 (2) SA 411 (RAD)…, LEWIS JP referred to another Australian case of Nevill & Co Ltd v Federal Commissioner of Taxation for the proposition that the employer taxpayer had “at best, an inchoate liability in process of accrual but subject to a variety of contingencies” which liability would be completely incurred in the following year in respect of those employees who had not yet qualified to take annual leave notwithstanding that the amount regarding the labour as a whole had become predictable with certainty.
In Edgars Stores Ltd v Commissioner for Inland Revenue 1988 (3) SA 876 (A)…,; 50 SATC 81 (A), CORBETT JA distinguished between a conditional liability which arises in the year of assessment but is fulfilled in the following year and an unconditional liability which arises in the year of assessment but the amount of the liability is ascertained in the following year.
The later was exemplified by the local case of Commissioner of Tax v “A” Company 1979 (2) SA 411 (RAD) where the unconditional loss on a loan advanced was incurred in the year the debtor was placed in liquidation and was held that the likelihood of a recoupment of a fraction of the amount in a subsequent year did not transform the unconditional liability into a contingent one.
In contrast, in Edgars Stores Ltd v Commissioner for Inland Revenue 1988 (3) SA 876 (A)…,; 50 SATC 81 (A), the obligation to pay rental was found to be contingent upon the determination of turnover at the end of the lease period in the subsequent year and was not an unconditional obligation, the quantification of which took place at the end of the lease period.
The condition to pay rental, based on the turnover that was only quantifiable at the end of the lease period, was contingent upon the computation exceeding the basic rental paid, a position that could only be ascertained in the subsequent tax year.
The unconditional liability would thus be incurred only after the determination had been made that the turnover rental exceeded the basic rental.
The concession by the Commissioner, to apportion the turnover rental monthly, was held to be contrary to principle.
In ITC 1495 (1991) 53 SATC 216 (T), where the employee was entitled to take mandatory leave after working for a fixed period failing which he would forfeit the accumulated leave and the employer did not have any obligation to pay cash in lieu of leave other than in respect of any accrued leave days on death or retirement, it was held that the provisions made for the accrued leave days on death or retirement could not be deducted in the tax year in which they were provided for because they were contingent on the happening of an uncertain event. In other words, it was held that the unconditional liability to pay for such days was only incurred on death or retirement.
The principles derived from case law
It seems to me, that, the principles that emerge from the above cases are that where, by virtue of a statutory or contractual provision, the employer is required to pay an employee cash in lieu of leave, which leave accrued in the year of assessment but is due in the subsequent year and the application for encashment is made and approved in the year of assessment, the liability to pay is incurred in that year of assessment.
However, where application is made in the year of assessment and approved in the following year or where both the application and the approval are made in the subsequent year, then, the liability to pay is incurred in that subsequent year.
The facts on leave pay
The Managing Director stated, that, in 2007 and 2008 the appellant used the same method to claim provisions as it did in each of the four years and they were not disallowed.
In the tax periods under review, the appellant had 20 employees in the administrative, reception, managerial, sales, parts, finance and logistics and drivers divisions.
A sample contract of a bookkeeper, dated 3 May 2011, was produced…,. In regards to annual leave, paragraph 9.1 states:
“Your annual leave will be calculated as follows:
Annual leave 22 working days; you may accumulate leave up to a maximum of twice your annual leave entitlement.
The company may require you to take your leave during the annual December shutdown period. If you do not, at that stage, have any leave accruing to you or have insufficient leave accruing to you, then, you will be required to choose between taking unpaid leave or accepting paid leave which will be off-set against leave that will accrue to you in the future (such leave will be termed advance paid leave).
If you should resign, or your employment with the company be otherwise terminated before your advanced paid leave has been set-off, then, you acknowledge and consent to the deduction or off-set against any moneys which may be owed to you by the company, of an amount equal to the salary paid on the days when the advance paid leave was taken for those days which have not been off-set against accrued leave.”
The Managing Director stated, both in his evidence in chief and under cross examination, that, cash in lieu of leave was payable based on request from the employee who had a right to such payment and 95% of the employees took up that right.
However, until the request was made and approved, the appellant would not know whether the employee would seek encashment or the number of days sought to be encashed and the amount.
Any leave days over the maximum would be forfeited.
He could not say whether it was paid in the year the leave accumulated or in the subsequent year, but, was content to aver that it was paid based on accumulation of the days up to the two year maximum.
The Chief Investigations Officer stated, that, while it was well and proper to make a provision for prospective leave under the International Financial Reporting Standards for accounting purposes, such a provision could not be claimed for income tax purposes before it was actually incurred for the purposes of trade or in the production of income.
The obligation to pay the employee arose when the employee's application for the full or partial encashment of his leave entitlement was approved.
Counsel for the appellant argued, that, the appellant's employees had an absolute legal right to convert the leave days which accrued in the course of the year of assessment.
He further argued, that, the appellant accordingly incurred an absolute liability to pay for these leave days each time the days accrued even though actual payment was made in the following tax year.
In other words, counsel for the appellant contended, that, the employee had an absolute legal right to encash such days on accrual.
The contention flounders on the proposition propounded in Nevill & Co. Ltd v Federal Commissioner of Taxation and approved in Commissioner of Tax v A Company 1979 (2) SA 411 (RAD), that, the employer taxpayer had, at best, an inchoate liability in the process of accrual but which was subject to a variety of contingencies and which liability would only be completely incurred in the following year in respect of those employees who had not yet qualified to take annual leave notwithstanding that the amount regarding the labour as a whole had become predictable with certainty.
The evidence disclosed, that, employees could take voluntary leave or be forced to take leave during the annual December shutdown.
In the forced leave category, were employees who had accumulated the required leave days and those who either had not accumulated any leave days or had accumulated insufficient leave days.
The appellant and its Managing Director did not disclose, either to the Commissioner or this Court, whether the annual December shutdown took place and the exact dates when it did so in each of the years in question.
They did not tender any evidence concerning the corporate diktat nor indicate when it was issued and what its contents were.
We do not know whether it affected all or some of the employees.
No evidence was led on the number who took full voluntary leave, unpaid leave, advance paid leave, or those who took partial voluntary leave or even those who took forced leave combined with encashment.
In respect of those who went on voluntary leave, he failed to disclose when they applied for such leave and whether they sought full or partial encashment of their accrued days and when and whether such leave was approved.
There was simply no evidence on whether any leave was ever taken or encashed in each of these years.
All these administrative factors were relevant to determine when the unconditional legal obligation to pay arose.
If the corporate diktat forced every employee to take leave during the annual December shutdown, then, no provision for leave pay could be made for the duration of the shutdown because the employees would be paid from the ordinary funds allocated for their wages and salaries during that period, which would be deductible in the subsequent tax year.
In regards to encashed days, the payment would be incurred on the date on which the approval was granted and not on the date of payment.
The submission made by counsel for the appellant, that, the absolute legal obligation to pay occurred when the leave accrued was therefore contrary to authority.
The unconditional legal obligation to pay arose when the administrative conditions dictated by the exigencies of the corporate diktat and contractual terms were fulfilled.
These administrative factors were sorely missing in the testimony of the appellant.
The appellant failed to establish, on a balance of probabilities, that, the provisions for leave pay were incurred in each of the tax years in which it claimed the deductions.
The Managing Director indicated, that, the appointment of auditors and the contract of audit were made prior to the end of the financial year.
This was confirmed by the engagement letters dated 29 August 2011 and 27 September 2012 for the 2011 and 2012 audits.
The 2011 audit fees and expenses were, by agreement, based on the number of hours spent on the audit engagement while the 2012 fees were “billed as agreed from time to time and payable on presentation” at the standard rates in force when the service was delivered.
The auditors estimated fees of US$12,008 from 277 hours for the 2011 audit and US$15,825 for 250 hours in 2012.
The 2012 audit was projected to commence in December 2012 and end in February 2013 (wrongly stated as 2012 p29 but corrected on diagram on p40 of exhibit 4 dated 18 October 2012).
The audit timetable on p40 of exhibit 4 was at variance with the evidence of the two witnesses called by the appellant, that the substantive audit covering the first 11 months took place in 2012 and only mop up audits were done in 2013.
The auditors projected that meetings with management would be held in December 2012 and January 2013 while planning and risk assessment and the compilation of the financial statements and the tax review would be done in February and the presentation of management reports and the distribution of the final audit reports would take place in March 2013.
The Chief Investigations Officer testified, that, provisions denoted an impending service that was accounted in the year of assessment under the accounting prudence concept.
He however, indicated, that, such provisions were treated as reserve funds which were not deductible in the year of assessment but in the following year being the year on which they were incurred.
The testimony of the Chief Investigations Officer, that the real audit encompassed the compilation of the statement of financial position, statement of comprehensive income, statement of changes in equity and cash flows, and, thereafter, the invoicing for the work done, was confirmed by the auditors engagement letters and projections.
The essence of his testimony was that, by agreement of the parties, the liability to pay was incurred on the dates on which each stage of the contract was performed and not on the date on which the contract of engagement was entered into.
My reading of the contracts of engagement is that the appellant incurred inchoate liability to pay at each stage of performance and an absolute liability to do so on the date on which performance was completed and the amount actually expended quantified and brought into account.
The onus to show when the audit commenced and when it was completed lay on the taxpayer.
The principle of law that LEWIS JP appears to have approved in Commissioner of Tax v A Company 1979 (2) SA 411 (RAD)…, by reference to the two Australian cases of Federal Commissioner of Taxation v James Flood (Pty) Ltd (1953) 88 CLR 493 and Nevill & Co. Ltd v Federal Commissioner of Taxation and the English case of Edward Collins and Son Ltd v IRC 12 TC 773…, was that an expenditure or loss arising from the terms and conditions set out in a contract is incurred when the contracted work is performed.
This view is supported by the underlined words by WATERMEYER AJP in Port Elizabeth Electric Tramway Co. Ltd v CIR 8 SATC 13 (1936) CPD 241…, that:
“But, expenses 'actually incurred' cannot mean actually paid. So long as the liability to pay them actually has been incurred they may be deductible. For instance, a trader may, at the end of the income tax year, owe money for stock purchases in the course of the year or for services rendered to him. He has not paid such liabilities but they are deductible.”…,.
The clear principle arising from these cases is that the unconditional obligation to pay is incurred when the work is done or the services are rendered.
In my view, the provisions made in respect of the audit fees constituted a contingent liability, the performance of which was “impending, threatened, or expected” in the future.
The appellant wrongly sought to deduct them in the years in which the provisions were made.
