Tax Avoidance and Tax Evasion

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HH207-15 : G BANK ZIMBABWE LTD vs ZIMBABWE REVENUE AUTHORITY
Ruled By: 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 paragraph 1 of the 17th Schedule of the Income Tax Act....,.

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 [Chapter 23:06] 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 a 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, exhibit 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). Ten (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, exhibit 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.”

Exhibit 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 exhibit 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 the 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 customers 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 multi-currency 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.

Counsel for the respondent 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 of the Income Tax Act 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.

Paragraph 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 of the Income Tax Act [Chapter 23:06]. 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.”

Counsel for the appellant 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 IHB 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…,:

“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. Exhibit 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.

Counsel for the appellant submitted that section 98 of the Income Tax Act 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 of the Income Tax Act in A v Commissioner of Taxes 1985 (2) ZLR 223 (HC)…,. 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…, in Commissioner of Taxes v F 1976 (1) RLR 106 (AD)…, 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 paragraph 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, Commissioner for Inland Revenue v IHB and AH King 1947 (2) SA 196 (A)…,.; (1947) 14 SATC 184 (A)…, amongst other things, established that there is no obligation on any taxpayer to earn income.

The examples suggested by counsel for the appellant and conceded by counsel for the respondent 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)…, 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…, 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.

HH621-15 : DELTA CORPORATION LTD vs ZIMABWE REVENUE AUTHORITY
Ruled By: HLATSHWAYO J

At the hearing of this matter I dismissed the appeal with costs and indicated that the reasons would follow. These are they.The facts of this case are largely common cause.On 23 May 1996, a firm of accountants, Messrs Deloitte and Touche (hereinafter “Deloitte and Touche”) wrote the following letter to ...

At the hearing of this matter I dismissed the appeal with costs and indicated that the reasons would follow. These are they.

The facts of this case are largely common cause.

On 23 May 1996, a firm of accountants, Messrs Deloitte and Touche (hereinafter “Deloitte and Touche”) wrote the following letter to the then Commissioner of Taxes (COT):

“Dear Sir,

BONUS SHARES (NINTH AND FIFTEENTH SCHEDULES TO THE INCOME TAX ACT)

The above term is not defined in the statute.

We would be grateful if you would advise us whether it is accepted that where a company, in declaring a dividend, allows its shareholders a choice of accepting cash or shares, those who opt for the latter receive “bonus shares”.

Yours faithfully

D and T”

The Commissioner of Taxes (COT) responded, on 8 July 1996, as follows:

“Dear Sirs

BONUS SHARES (NINTH AND FIFTEENTH SCHEDULES TO THE INCOME TAX ACT [CHAPTER 181])

You letter dated 23rd May 1996, reference RHMM/LWH/spw/12080, refers.

Please be advised that where a company declares a dividend which is immediately satisfied by issue of shares of an identical amount, no dividend is paid by the company and such shares constitute bonus shares.

Since there is no distribution of profits by the company and no property passed from the company to shareholders, what company does is to capitalise a portion of its profits. This does not constitute the payment of a dividend for income tax purposes. The fact that the company allows its shareholders an option of accepting cash or shares is not material.

Shares received in lieu of dividend are “bonus shares”.

Yours faithfully

T.I NCUBE (MRS)
For: ACTING COMMISSIONER OF TAXES”

The appellant, apparently acting on the strength of the above letter, did not pay withholding tax on scrip dividends issued subsequent to that letter.

On 24 November 2006, the Commissioner-General (COG) of the Zimbabwe Revenue Authority, who is the successor to the Commissioner of Taxes (COT), wrote to the appellant requesting it to deduct and account for withholding tax for three years prior to that date on scrip dividends issued.

The appellant wrote back, on 5 December 2006, objecting and averred that in 1996 the Commissioner of Taxes (COT) had given a ruling upon the strength of which the appellant had acted. Such ruling, the appellant alleges, is binding on the current respondent.

The respondent disallowed the objection on 30 January 2007 and maintained that the withholding tax was due and payable chiefly because a scrip dividend was a dividend and not bonus shares.

The appellant was aggrieved by the decision and filed the present appeal.

The appellant's case is that the letter by the Commissioner of Taxes (COT) amounts to an advance tax ruling which binds the respondent and suggests that the benefits which are derived from the 1996 letter to Deloitte and Touche accrue to it as well. The appellant also avers that a scrip dividend is equivalent to bonus shares which type of shares are not subject to income tax in terms of the 9th and 15th Schedules to the Income Tax Act [Chapter 23:06]. It is also the appellant's case that a scrip dividend is incorporeal property in lieu of cash. The appellant further contends that it would not be proper for the respondent to demand arrear taxes when it acted in line with an understanding with the Commissioner of Taxes (COT).

The respondent's main line of defence is that the Commissioner of Taxes (COT) letter to Deloitte and Touche, in 1996, did not amount to a tax ruling. Rather, the respondent argues, it was just a confirmation of a position as perceived by Deloitte and Touche. The respondent also avers that if any benefit is to be derived from the said letter, such benefit can only accrue to Deloitte and Touche and not to the present appellant because it was not privy to the communication or transaction between Deloitte and Touche and the Commissioner of Taxes (COT), the respondent's predecessor....,.

The respondent has taken the position that a scrip dividend is not the same as bonus shares, and, for that reason, is not exempt from tax in terms of the 9th and 15th Schedules to the Income Tax Act [Chapter 23:06].

In terms of sections 26 and 28 of the Income Tax Act, shareholders are liable to pay tax on their dividends. The company distributing such dividends is, at law, required to withhold such tax when it distributes the dividends and remit the same to the respondent. See sections 2(1) of both the 9th and 15th Schedules to the Income tax Act.

Dividends, for the purposes of shareholders' taxes, are defined in terms of the 9th and 15th Schedules to the Income Tax Act as follows:

“'dividend' means any amount which is distributed by a company to its shareholders…,.”

The most important principle, in relation to this, emanates from the reading of the section itself.

The wording of the letter from Messrs Deloitte and Touche, to the Commissioner of Taxes, becomes relevant. It speaks to the state of the transaction involved. It says in part “…, where a company, in declaring a dividend, allows…,.”

The very act of declaring a dividend is distribution of an amount to the shareholders.

At this stage, before any further considerations are made, the amount so declared is a dividend and subject to the withholding tax.

The fact that the shareholders are then allowed an election, after the declaration of the dividend, matters not. By then, taxes would already have accrued by operation of law.

The act of declaring a dividend is not linked to the choice the shareholders are given in whether to accept cash or take a scrip dividend. The former precedes the latter. At the point the former is declared, tax is chargeable. Therefore, as at the time a dividend is declared, the appellant is obliged to withhold tax for onward transmission to the respondent. What happens to the dividend after that stage matters not for purposes of taxation.

This position is buttressed by section 1(2) under both the 9th and 15th Schedules to the Income Tax Act. The sections are similar and they provide for the following:

“A dividend shall be deemed to be distributed when it is paid to the shareholder, credited to his account or so dealt with that he becomes entitled to it, whichever occurs first.”

The question whether the appellant capitalized its profits can only be determined by having due regard to the circumstances surrounding the transaction. This position was succinctly put forward by BENJAMIN J in Wilson v Commissioner for Inland Revenue 1926 CPD 63 70 in the following words:

“From a consideration of the judgment in that case, it appears the test to be applied is what was the intention of the company dealing with the matter; did the company intend that the sum dealt with should become income or capital. Thus, INNES CJ, in discussing the case of Bouch v Sproule (12 AC 385) said (at p.357):-

'It was a dispute as to whether the tenant for life or the remainder man was entitled to a bonus dividend applied in part payment of certain bonus shares. That depended upon whether the bonus was income passing to the tenant for life under the will or was an accretion of capital enuring to the ultimate benefit of the remainder man. So that the point which lies at the root of the present appeal fell to be decided: The facts were that the directors distributed certain accumulated profits (which had been temporarily capitalized) as a bonus dividend and allocated the new shares (partly paid up) to each shareholder, applying the bonus dividend in part payment of the new shares. Under these circumstances, it was held…, that the company did not pay or intend to pay any sum as dividend, but intended to do, and did, appreciate the undivided profits as an increase of the capital stock; the bonus dividend was therefore capital of the estate and the life tenant was not entitled to it or the shares.'

Again, in discussing the case of the Commissioner for Inland Revenue v Blott (35 T.L.R 687, 36 T.L.R. 575, 125 L.T 4970 he said (at p.358):

'The principle of Bouch v Sproule was applied – namely, that where the company has the power of capitalizing or distributing profits and decided to capitalize them, then the nature issued in respect of such profits was determined by the company's intention; and it was held that the procedure followed did not alter the real nature of the transaction.'

Again, a little lower down in the judgment he said (at p.361):

'The company ought, in the words of LORD HALDANE, to be 'dominant on the question whether the money in question was to be income or capital for all purposes.'”

It immediately becomes clear that for the shares to be considered bonus shares, it must have been a capitalisation of the undistributed profits at the instance of the company.

Once a dividend is paid out and the shareholder is given the option to use such cash dividend to buy more shares, such shares so bought are not bonus shares. This is no more than the shareholder electing to use his dividend to purchase more equity in a company.

The letter by Deloitte and Touche is clear in its tenor.

The choice is given to the shareholder whether to take the dividend in cash or in shares. There is nothing which stops the company from distributing the dividends in cash. In the same vein, there is nothing which would stop a shareholder from accepting some of the dividend in cash and the other part in shares. The intention of the company is paramount here - it was to distribute dividends to its members. It then gave the members a choice of accepting either cash or shares. The scrip dividend in this case does not cease to be a dividend. It is a dividend dealt in a particular way by the shareholder and not the company and it does not lose its status as a dividend. The scrip dividend, in these circumstances, is a dividend and not 'bonus shares.'

The submission by the appellant that “the company's accumulated profits have, as a matter of accounting practice, therefore been capitalised and thus the shareholder has received nothing out of the assets of the company for his separate use and benefit” cannot be correct.

The election to receive shares in lieu of a cash dividend in itself is a purchase of shares.

The choice given to the shareholder is that which shows that the profits have been distributed and the shareholder has elected to use his dues to buy more equity. Since a shareholder who accepts the dividend in cash is liable to pay tax, the fact that another has elected to deal with their dividend in a different manner does not make the dividend so received and utilised any less a dividend. The election to receive shares is a purchase of shares and the shareholder would have received something out of the assets of the company for his separate use and benefit. By distributing the dividend in the first place, the amount representing that dividend would have ceased to be part of the company's assets. The mere declaration of a dividend payable in one manner or the other means that such dividend ceases to be part of the company's assets and can be used by the shareholder in any manner he or she pleases.

On this premise, the contents of the letter by the Commissioner of Taxes (COT) to Deloitte and Touche do not capture the correct position of the law.

Equally untenable is the argument that a scrip dividend is not a dividend in that it is not an “amount distributed by a company to its shareholder.”

The fact of the matter is that the election only arises after the dividend is declared, the default position is that the dividend will be paid out in cash, an amount. When the shareholder elects to have shares instead, the shareholder would have disposed of his cash dividend and bought shares with it. The cash dividend which finances the purchase of shares is an 'amount.' The scrip dividend in that regard is also an amount.

It is not in doubt that after the appellant declared dividends, it invited its shareholders to decide whether to accept cash for the dividends or accept shares in lieu of cash. The acceptance of shares in lieu of cash simply means that the shareholders would have used their dividends to buy more shares in the appellant. The acceptance of shares in lieu of cash is no more than an instruction by the shareholder that his dividend ought to be used to purchase shares. This is totally independent from the declaration of the dividend. The declaration of the dividend is the act of the company and the acceptance of a scrip dividend is the act of a shareholder after the dividend has been declared.

Now, 'bonus shares' are shares which are given out by the company to its shareholders on a pro-rated basis and they are paid for from the company's undistributed reserve profits.

The intentions of the appellant are clear from the letter.

There was no scheme of the capitalisation of capital going on. The shareholders were given an election which they duly exercised. This is distinctly different from capitalization of undistributed profits.

The moment a company declares a dividend, and issues it out, the profits are distributed in the form of cash. The question of bonus shares does not arise as the company, by declaring a cash dividend, would have distributed the profits to its member. The question of bonus shares, which come about where a company does not distribute profits in cash and gives the members more shares in line with their shareholding in the company, does not arise in this case because the profits were distributed to the shareholder in cash as dividends.

'Bonus shares' are fully paid up using the company's reserve un-distributed profits.

The declaration of a dividend is, in its own, a distribution of profit. As such, the question of bonus shares cannot arise where such shares are paid for by proceeds from a dividend. In other words, a scrip dividend is not the same as a bonus share.

The Commissioner of Taxes was clearly wrong in saying that, in a script dividend situation, there is no distribution of profits and no property is passed from the company to the shareholders.

In a scrip dividend scenario, it is the individual shareholder who invests his dividend by purchasing more shares. In a bonus share arrangement, it is the company which pays for shares from the undistributed reserve profits and distribute the same to the members on a pro-rated basis. Both of these schemes result in shares for the members of a company but a scrip dividend is shareholder-driven and a 'bonus share' scheme is company-driven. As such, the principle relating to the two ought not to be conflated.

Perhaps the most important point to note is that where a dividend is declared, the shareholder becomes entitled to it and it attracts tax as at that point and the choice to take a scrip dividend can only be made after such tax is due by operation of law.

Now, regarding the retrospective effect of the Commissioner-General's (COG) measures, the revenue authority is not entitled, at law, to give anyone unlawful tax breaks and prejudice the fiscus.

Where the revenue authority has made an error, it is allowed to rectify it - even retrospectively.

SC140-21 : MBCA BANK (PRIVATE) LIMITED (Now known as Nedbank Zimbabwe Limited) vs ZIMBABWE REVENUE AUTHORITY
Ruled By: GUVAVA JA, UCHENA JA and MAKONI JA

This is an appeal against the whole judgment of the Special Court for Income Tax Appeals, dated 28 November 2019, upholding the respondent's amended assessment of tax against the appellant.FACTSThe facts of the case can be summarised as follows;The appellant is a registered Bank in Zimbabwe. It is also a ...

This is an appeal against the whole judgment of the Special Court for Income Tax Appeals, dated 28 November 2019, upholding the respondent's amended assessment of tax against the appellant.

FACTS

The facts of the case can be summarised as follows;

The appellant is a registered Bank in Zimbabwe. It is also a subsidiary of MBCA Holdings Limited a local holding company, which, in turn, is a subsidiary of Nedbank Limited (Nedbank) a South African company.

The respondent is an authority established in terms of the Revenue Authority Act [Chapter 23:11]. It is responsible for assessing, collecting, and enforcing payment of taxes to the State.

On 5 June 2012, the appellant filed its income tax self-assessment with the respondent for the tax year ending 31 December 2011.

On 27 June 2012, the respondent's Commissioner of Investigations and International Affairs launched a tax review of the appellant's operations for the period spanning January 2009 to May 2012.

The exercise resulted in the respondent issuing amended manual notices of assessment for Income Tax numbers 203324818 and 20324821 for the tax years 2010 and 2011 respectively.

The amended notice of assessment in respect of the 2010 tax year was subsequently withdrawn, whilst the amended assessment in respect of the 2011 tax year resulted in additional tax and penalties amounting to US$944,614=80.

The appellant objected to the amendment for the tax year ending 31 December 2011.

The respondent dismissed the objection after which the appellant appealed to the Special Court for Income Tax Appeals (the court a quo).

The issue before the court a quo was the validity of the amended assessment of Income Tax number 20324821, for the 2011 tax year.

The respondent disallowed the appellant's deductions pertaining to “expenditure incurred on general administration and management” in terms of section 16(1)(r) of the Income Tax Act [Chapter 23:06] and debts written off by the appellant in its income tax self assessment as “bad debts” in terms of section 15(2)(a) as read with section 15(2)(g) of the Income Tax Act.

It was established before the court a quo, that, the appellant is a subsidiary of MBCA Holdings Limited a local holding company, which, in turn, is a subsidiary of Nedbank Limited (Nedbank) a South African company.

In terms of section 143(1)(b) of the then Companies Act [Chapter 24:03] the appellant was deemed to be a subsidiary of Nedbank (South Africa).

During the 2011 tax year, Nedbank (South Africa) met several expenses on behalf of the appellant including travelling costs, telecommunications costs, and postage and freight costs. It also rendered services such as Group technology infrastructure and operation support services, system support service for the Africa Banking and e-commerce, strategic planning assistance, and risk advisory service assistance.

The appellant subsequently paid Nedbank (South Africa) for the incurred expenses and accounted for all the payments made thereto, including reimbursement, payment for services rendered, and general and specific administration costs through a single ledger account headed “Operating Costs”.

The respondent's amended assessment was based on its treatment of all the payments made to Nedbank (South Africa) by the appellant as general administration and management costs.

The respondent disallowed all amounts in excess of limits set in terms of section 16(1)(r)(ii) of the Income Tax Act.

In respect of bad debts, the respondent's position was that bad debts could only be claimed in terms of section 15(2)(g) of the Income Tax Act and that the debts written off as “bad debts” by the appellant, for the 2011 income tax year, failed to meet the criteria established in terms section 15(2)(g) of the Income Tax Act.

PROCEEDINGS BEFORE THE COURT A QUO

In proceedings before the court a quo, the appellant submitted, that, general costs and not specific costs fell under the purview of section 16(1)(r) of the Income Tax Act, while the respondent adopted the contrary view, that, section 16(1)(r) of the Income Tax Act did not differentiate between general and specific costs, but, rather, gave effect to all costs incurred by a subsidiary company to its holding company as general administration and management expenses which were deductible in terms of the formula provided by section 16(1)(r)(i)and (ii) of the Income Tax Act.

In determining the appeal, the court a quo held, that, section 16(1)(r) of the Income Tax Act constituted an anti-tax avoidance measure against a local taxpayer by limiting its allowable deductions in respect of general administration and management expenses incurred by a foreign holding company.

It held, that, the provisions were enacted by the legislature to prevent local subsidiary companies and their foreign holding companies from colluding to overload expenses on the local entity whilst simultaneously reducing its Zimbabwean tax liability and increasing the foreign entity's profits.

In respect of all the payments made by the appellant to Nedbank (South Africa), the court a quo held that section 16(1)(r) as read with section 26(2) of the Income Tax Act was applicable.

The appellant was therefore confined to the prescribed deductible income limits provided for in section 16(1)(r)(ii) of the Income Tax Act.

In view of the foregoing, the court a quo determined, that, the expenses deducted by the appellant in favour of Nedbank (South Africa) fell into the category of “expenditure on general administration and management” in terms of section 16(1)(r) of the Income Tax Act.

The court a quo took into consideration the Shorter Oxford English Dictionary definition of the term 'administration' and 'management' respectively, and determined that the former related to “the act of administering, management” and the latter to “the act or manner of managing, administrative skill.”

The court a quo was, however, of the view, that, the definitions were not the determinant factors of the issue, as “all of the appellant's contracted functions (were) headlined as management of sorts” in the appellant's accounting books.

It held, that, the pertinent issue for consideration was the proper definition of the word 'general' which definition was held to pertain to “all or most of the parts of the whole, completely or approximately universal within implied limits.”

After determining the issue of deductible income in terms of section 16(1)(r) of the Income Tax Act, the court a quo considered whether or not the bad debts claimed by the appellant were allowable deductions in terms of section 15(2)(g) of the Income Tax Act.

The bad debts claimed by the appellant, in its 2011 tax assessment, pertained to the sum of US$2,250,365=17 being unsatisfied loans due to the appellant from its four Bulawayo-based corporate clients.

The respondent was not satisfied, that, the debts written-off by the appellant constituted bad debts in terms of section 15(2)(g) of the Income Tax Act.

The appellant contended, that, loss sustained and written off by a banking institution or money-lending business (such as itself) from loans, constituted a deductible loss as contemplated in section 15(2)(a) of the Income Tax Act.

The appellant argued, that, bad debts in the case of banking institutions and money-lending institutions come into existence by operation of law as contained in paragraphs 20, 22, 24 and 25 of the Banking Regulations 2000, SI205 of 2000 (the Regulations).

The appellant wrote off the four unsatisfied loans in terms of paragraph 22(e) of the Banking Regulations 2000, S.I.205 of 2000, at the lapse of 360 days, which, it argued, placed them in the ambit of section 15(2)(a) of the Income Tax Act.

The court a quo held, that, a past due date loan could not be categorised as a loss when the loan was well secured and/or where legal action to satisfy the loan has commenced. It held that a loan could be classified as a loss when it is established that it can no longer be recovered.

It was established, that, the appellant had not commenced legal proceedings against its first borrower when the debt was written off.

It was therefore held, that, the appellant had failed to discharge the onus upon it to prove, on a balance of probabilities, that the loan was not recoverable at the time that the loss was declared.

In respect of the appellant's remaining three borrowers, it was established, that, their matters were under legal proceedings, wherein the respondent had secured judgments against the borrowers but had only partially recovered the total amount due to it. Sureties for the three borrowers had not yet been sued.

The court a quo held, that, the appellant had failed to establish, on a balance of probabilities, that the debts written off were unrecoverable and constituted a loss.

It held, that, the appellant had failed to establish loss as provided for in terms of paragraph 22(e) of the Banking Regulations 2000, S.I.205 of 2000 or debt in terms of section 15(2)(g) of the Income Tax Act, thus precluding the appellant from claiming income tax deductions thereon.

The court a quo therefore dismissed the appellant's appeal.

Aggrieved by the decision of the court a quo, the appellant noted an appeal to this Court on the following grounds:

GROUNDS OF APPEAL

“1. The court a quo erred in finding that there is no distinction between the expenditure incurred on general administration and management as contemplated by section 16(1)(r) of the Income Tax Act [Chapter 23:06] and remuneration for reimbursement of specific services or expenses paid by a subsidiary to a holding company.

2. The court a quo erred in finding that the disputed expenses constituted expenditure on general administration and management as contemplated by section 16(1)(r) of the Income Tax Act and were properly disallowed.

3. The court a quo erred in finding that bad debts written off by a commercial bank (specifically in terms of the Banking Regulations SI205/2000) cannot constitute expenses incurred for the purpose of trade or in the production of income as contemplated by section 15(2)(a) of the Income Tax Act.

4. The court a quo erred in finding that the disputed debts could not be categorized as losses in terms of paragraph 22(e) of the Banking Regulations.

5. Alternatively, the court a quo erred in finding, that, the disputed debts were not bad debts and therefore deductible from the appellant's income in terms of section 15(2)(g) of the Income Tax Act.”

The appeal raises two issues for determination:

1. Whether or not the court a quo erred in determining that there was no distinction between general costs, as provided for in section 16(1)(r) of the Income Tax Act, and specific costs incurred by a subsidiary in favour of its foreign holding company.

2. Whether or not the court a quo erred in finding that the disputed debts were improperly written off as bad debts and therefore not deductible from the appellant's income in terms of section 15(2)(a) or section 15(2)(g) of the Income Tax Act.

SUBMISSIONS MADE BY THE PARTIES

Counsel for the appellant submitted, that, the court a quo did not make a finding on the nature of the services, but, rather, the recipient of the services. He further submitted, that, the nature of the expenses was not distinguished as that is not in the judgment of the court a quo.

On the deductibility of bad debts, he argued, that, as per Salisbury Board of Executors Ltd v Commissioner of Taxes 1941 SR 147, such deductions depended on whether the losses are in the course of the business of banking or money lending.

He contended, that, debts written off constitute losses of a revenue nature.

Counsel for the appellant submitted, that, section 15(2)(a) and (g) of the Income Tax Act are distinct and it was difficult to see which one the court a quo was using between the two.

He asserted, that, section 15(2)(a) of the Income Tax Act applied primarily to and regulates a situation where there is a secondary consideration. He contended, that, in terms of section 15(2)(a), all that needs to be proved is that bad debts were written off. Counsel for the appellant argued, that, the criterion in the banking regulation was met bringing the claim in the purview of section 15(2)(a) and not (g) of the Income Tax Act.

Counsel for the respondent submitted, that, the judgment of the court a quo is correct.

He argued, that, when interpreting any statute, the context is a major consideration as indicated in Zambezi Gas (Pvt) Limited v N R Barber (Pvt) Limited & Anor SC03-20.

Counsel for the respondent submitted, that, the appellant and Nedbank (South Africa) are related parties.

He further argued, that, the agreement between the parties stated that the services were general.

He contended, that, the heading thereon is management support agreement between the appellant and Nedbank (South Africa) and that the nature of the services is clear from the agreement itself.

Counsel for the respondent argued, that, the purpose of section 16(1)(a) of the Income Tax Act is not to distinguish between general and specific costs.

He submitted, that, a specific service may be paid for in an exercise of rendering general and administrative services. He further submitted, that, in any event, the appellant's witness stated, that, all expenses can be labelled under specific expenses.

Concerning the issue of bad debts, counsel for the respondent submitted, that, Salisbury Board of Executors Ltd v Commissioner of Taxes 1941 SR 147 is not relevant in this case as section 15(2)(g) of the Income Tax Act was not in existence in its current form at the time of the (1941) judgment.

He argued, that, the thrust of the respondent's submission is that there were no actual losses incurred.

He further argued, that, in 2011, the appellant held security which was sufficient to cover the debts and that it was its duty, in terms of section 15(2)(g) of the Income Tax Act, to be satisfied that the debts were bad.

Counsel for the respondent contended, that, the discretion of the Commissioner was properly exercised.

In response, counsel for the appellant submitted, that, the respondent was attempting to use the agreement to blanket all expenses as general when there is a clear distinction in the provision of services.

Concerning the issue of bad debts, he argued, that, the main consideration was that it was a loss incurred in the course of trade.

APPLICATION OF THE LAW TO THE FACTS

1. Whether or not the court a quo erred in determining that there was no distinction between general costs, as provided for in section 16(1)(r) of the Income Tax Act, and specific costs incurred by a subsidiary in favour of its foreign holding company

The first and second grounds of appeal raised by the appellant challenge the application of section 16(1)(r) of the Income Tax Act to the expenses it incurred in favour of its holding company, Nedbank (South Africa).

The appellant contends, that, it made payments for specific services to Nedbank (South Africa), which payments were distinct from general administration and management expenses as contemplated in section 16(1)(r) of the Income Tax Act.

The appellant is of the view, that, had the legislature intended that there should be no distinction between general and specific expenses, the inclusion of the qualifying term “expenditure incurred on general administration and management” would not have been included.

The appellant further submitted, that, the interpretation adopted by the court a quo would be applicable had the relevant provision read “expenditure incurred in favour of a holding company” without the aforementioned qualification.

In the case of Parkington v Attorney General 1869 LR 4 H.L. 100, 122 LORD CAIRNS, commenting on interpretation of fiscal statutes, said:

“As I understand the principle of all fiscal legislation it is this: If a person sought to be taxed comes within the letter of the law he must be taxed, however great the hardship may appear to the judicial mind to be. On the other hand, if the Crown, seeking to recover the tax, cannot bring the subject within the letter of the law, the subject is free, however apparently within the spirit of the law the case might otherwise appear to be.”

I respectfully agree with the position of the law as stated by his Lordship.

To this I would add, that, if an amount to be taxed, or the percentage at which a subject has to be taxed, or the formula for taxation is established, the subject will be taxed at the established amount, percentage rate, or in terms of the amount established by the formula.

The law applicable to the determination of this issue is provided for by section 16(1)(r)(i) and (ii) as read with section 26(2) of the Income Tax Act [Chapter 23:06].

Section 16(1)(r)(i) and (ii) of the Income Tax Act provides as follows:

“(1) Save as is otherwise expressly provided in this Act, no deduction shall be made in respect of any of the following matters...,.;

(r) In the case of expenditure incurred on general administration and management in favour of a company of which the taxpayer is the subsidiary or holding company or (where the company is a foreign company) the local branch

(i) Incurred prior to the commencement of trade or the production of income or during any period of non-production, any amount in excess of zero comma seventy-five per centum of the amount obtained by applying the following formula —

A – (B + C)

Where —

A represents the total expenditure qualifying for deduction in terms of section fifteen;

B represents the expenditure on general administration and management paid outside Zimbabwe by such local branch or subsidiary, whether or not such expenditure was incurred by the head office of that foreign company;

C represents expenditure qualifying for deduction in terms of section (2) of paragraph (f) of subparagraph (i) of section fifteen;

(ii) Incurred after the commencement of trade or the production of income, any amount in excess of one per centum of the amount obtained by applying the above formula.”…,.

Section 26(2) of the Income Tax Act provides as follows:

“(2) For the purposes of this section, any amount paid outside Zimbabwe by a local branch or subsidiary of a foreign company in excess of the amount allowable as a deduction in terms of paragraph (q) or (r) of subsection (1) of section sixteen shall be deemed to be the payment of a dividend upon which non-resident shareholders tax shall be charged, and the term 'dividend' shall be so construed for the purposes of the Ninth Schedule.”…,.

It is trite, that, the objective of interpretation of statutes is to discover the intention of the legislature, which, once established, must be applied as the law governing the interpreted provisions of the statute.

It is also trite, that, provisions of a statute must be interpreted within the context of the statute in which they are found.

The Constitutional Court, in the case of Chihava & 2 Ors v Provincial Magistrate Francis Mapfumo N.O. & Anor CC06-15…, said:

“The starting point in relation to the interpretation of statutes, generally, would be what is termed 'the golden rule' of statutory interpretation. This rule is authoritatively stated thus in the case of Coopers and Lybrand & Others v Bryant 1995 (3) SA 761 (A) at 767;

'According to the 'golden rule' of interpretation, the language in the document is to be given its grammatical and ordinary meaning, unless this would result in some absurdity, or some repugnancy or inconsistency with the rest of the instrument.'…,

In his book 'Principles of Legal Interpretation - Statutes, Contracts and Wills' 1st Ed. at p57, EA KELLAWAY echoes this statement….,. The learned author, at p62, states:

'Even if a (South African) court comes to the conclusion that the language is clear and unambiguous, it is entitled to reject the purely literal meaning if it is apparent from the anomalies which flow therefrom that the literal meaning could not have been intended by the legislature.'”…,.

At pp7 to 8 the court said:

“The principles set out in the dicta cited above can aptly and instructively be summarized as follows:

(i) The Legislature is presumed not to intend an absurdity, ambiguity, or repugnancy to arise out of the grammatical and ordinary meaning of the words that it uses in an enactment.

(ii) Therefore, in order to ascertain the true purpose and intent of the Legislature, regard is to be had, not only to the literal meaning of the words, but also to their practical effect.

(iii) In this respect -

(a) The words in question must be capable of an interpretation that is 'consistent' with the rest of the instrument in which the words appear;

(b) The state of the law in place before the enactment in question is a useful aid in ascertaining the legislative purpose and intention, and

(c) Where an earlier and later enactment (or provision) deals with the same subject matter, then, in the case of uncertainty, the two should be interpreted in such a way that there is mutual consistency.”…,.

Section 16(r)(i) and (ii) as read with section 26 of the Income Tax Act establish that the intention of the legislature was to prevent related parties from colluding to overload expenses on the local entity whilst reducing Zimbabwean tax liability and increasing the foreign entity's profits.

It is clear, that, the limitation of deductible expenses provided for by section 16(r)(ii) in respect of expenses incurred after the commencement of trade or the production of income, arrived at after calculations in terms of the fomula in section 16(r)(ii) cannot be exceeded.

The use of the words “any amount paid outside Zimbabwe by a local branch or subsidiary of a foreign company in excess of the amount allowable as a deduction in terms of paragraph (q) or (r) of subsection (1) of section sixteen shall be deemed to be the payment of a dividend upon which non-resident shareholders tax shall be charged” limits the amount allowable to the amount imposed by the formula.

It is apparent from these provisions, that, a limit of allowable deductions has been set and has to be complied with by a tax payer and enforced by the respondent.

I am satisfied, that, the interpretation adopted by the court a quo is consistent with the intention of the legislature and cannot therefore be said to constitute a misdirection.

The intention of the legislature, in section 16(r)(i) and (ii) as made clear by section 26 of the Income Tax Act must be given effect.

Whether or not the court a quo erroneously made findings concerning the literal and ordinary grammatical meaning of the term “general administration and management” as averred by the appellant, is of no consequence as the overriding consideration in the circumstances, in my view, is that the intention of the legislature supersedes a literal interpretation of a provision of a statute.

To uphold the assertion, that, a subsidiary “will be unduly taxed for expenses legitimately accrued to its holding company” would be incorrect, because, that provision specifically relates to foreign-incurred expenditure and the need to avoid abuse of the local tax system to the benefit of foreign entities.

I am of the view, that, the interpretation proffered by the appellant would have the effect of creating room for every local entity in a similar position to claim expenditure for specific costs to the detriment of the objectives of the law.

I respectfully associate myself with the reasoning and interpretation of the court a quo. Its decision should therefore be upheld....,.

The court a quo correctly interpreted section 16(1)(r) as read with section 26 of the Income Tax Act [Chapter 23:06] as having been enacted to prevent Zimbabwean companies, which are subsidiaries of foreign holding companies, from colluding to overload expenses on the local entity whilst reducing Zimbabwean tax liability and increasing the foreign entity's profits.

HH99-18 : C F (PVT) LTD vs ZIMBABWE REVENUE AUTHORITY
Ruled By: KUDYA J

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

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.

In correspondence, and the determination to the objection, as well as in pleadings, evidence, and argument, the respondent advanced two reasons for abandoning the Value Ruling in the present matter and electing to assess the appellant for income tax purposes on a different basis:

(i) The first was that the Value Ruling applied to the determination of the duty value of the imported motor vehicles, which constitute the subject matter of the income tax appeals.

(ii) The second and alternative contention was that the respondent was not bound by the Value Ruling as from 1 March 2009 and throughout the tax years in which the appeals relate because the appellant reneged on one of the terms and conditions going to the root of the Value Ruling in that it failed to inform the Commissioner General of the Management Fees/Technical Fees Agreement entered into with the intermediary on 2 March 2009.

Whether the Customs and Excise Value Ruling binds the Commissioner in an Income Tax matter

Counsel for the appellant contended, that, the Commissioner was bound by the Value Ruling in question in the present income tax appeals even though it was made to resolve a Customs and Excise question.

Counsel for the respondent made contrary submissions on the point.

Counsel for the appellant contended, that, as a single entity, the Zimbabwe Revenue Authority was obliged by the fundamental provisions section 68 of the Constitution and section 3(1)(a) of the Administrative Justice Act [Chapter 10:28] to act in a lawful, reasonable, and fair manner in utilising its opinion formed under the Customs and Excise Act on the transaction value of the imported motor vehicles to the computation of the purchase price under the Income Tax Act.

He contended, that, the Commissioner could not possibly justify the change of opinion, reflective as it was of his state of mind, in the finding that the relationship between the appellant and intermediary did not influence the transaction value.

He further contended, that, the importer had proved, to the satisfaction of the Commissioner, that, the transaction value closely approximated the values referred to in section 106(2) of the Customs and Excise Act.

Counsel were however agreed, that, there was no specific section in the Scheduled Acts which require the Commissioner to act in the manner advocated by counsel for the appellant.

The foundational provisions of the Revenue Authority Act [Chapter 23:11]

It is indisputable, that, the respondent is created by section 3 of the Revenue Authority Act [Chapter 23:11] as a single entity with the seamless functions outlined in section 4, amongst which is the assessment, collection, and enforcement of the payment of all revenues under the administrative purview of a single Commissioner-General appointed in terms of section 19.

However, in terms of section 20 and 21, the Board also appoints Commissioners in charge of such departments or divisions that the Board may establish but who serve under the control of the Commissioner General and who administer the Scheduled Acts listed in the First Schedule amongst which are the Customs and Excise Act and the Income Tax Act.

The Commissioner-General is empowered to exercise the functions conferred on each of these Commissioners and may delegate such authority to any member of staff.

The delegated authority, unless set aside by him, is deemed to be his authority.

In terms of section 34D, the Commissioner General may personally, or by proxy, make an advance tax ruling on any provision of any of the Acts in the First Schedule of his own accord or on application by an interested person to a taxable transaction.

Tax is defined in the Fourth Schedule as “any tax, duty, fee, levy, charge, penalty, fine or any money levied, imposed, collected or received in terms of any of the Acts specified in the First Schedule” while “relevant Act in relation to an advance tax ruling means any one the Acts specified in the First Schedule in respect of which the ruling is made or sought.”

The context and the 13 minimum contents of an Advance Tax Ruling are provided in paragraph 2(2) of the Fourth Schedule to the Revenue Authority Act.

Sub-paragraphs (2)(c) to (f) require a complete description of the proposed transaction for which the ruling is sought and its impact on the tax liability of the applicant and a citation of the relevant statutory provisions or issues and reasons why the proposed ruling should be made.

It is apparent to me, contrary to the contention propounded by counsel for the appellant, in paragraph 12(b) of his written heads of argument, that, the application for the Value Ruling, set out in exhibit 2, does not meet these minimum requirements in respect of the Income Tax Act.

In this regard, the submission made by counsel for the appellant, in paragraph 10 of his written heads of argument, to the effect that one ruling in respect of one Schedule Act fits all the other Scheduled Acts in regards to the same imported item, is devoid of any merit.

The differentiation applied by the respondent was lawfully grounded in the minimum requirements for an Advance Tax Ruling provided in paragraph 2(2) to the Fourth Schedule of the Revenue Authority Act.

Again, the Value Ruling falls woefully short of the requirements of paragraph 6 of the same Schedule failing as it does to apply to the relevant Income Tax Act.

While the facts and circumstances may be the same as in the value ruling, the four requirements in paragraph 6 are conjunctive; so, the failure to fulfil any one is fatal to the appellant's contention seeing it falls outside the time frame of the advance ruling and the requirement to update the Commissioner with any new information affecting the value ruling.

The attempt to export the favourable interpretation in paragraph 4(1) of the Fourth Schedule to the Revenue Authority Act, from the Customs and Excise Act to the Income Tax Act, flounders on the phrase “apply the relevant Act” defined with reference to the specified Act in respect of which the ruling was made or sought.

The value ruling was not sought and obtained in terms of the Income Tax Act but in terms of the Customs and Excise Act.

In the alternative, counsel for the appellant submitted, that, like should be treated alike otherwise it would be unconscionable for the respondent to alter its opinion merely for the sake of extracting as much income tax from the appellant as it did with respect to customs duty on the same facts and circumstances.

He submitted, that, by making the Value Ruling, the respondent, in essence, determined, as contemplated by section 106(2) of the Customs and Excise Act, that the two related parties acted at arm's length, a consideration in convergence with the requirements of section 24 of the Income Tax Act.

He argued, that, the juxtaposition of a different and contradictory opinion on the purchase price, under the Income Tax Act, to the transaction value under the Customs and Excise Act of the self-same imported vehicles, was both illogical and unlawful.

The judicial definition of an opinion

The word opinion is not defined in any of the Taxes Acts. It has been judicially defined in a number of cases:

In Judes v District Registrar of Mining Rights, Krugersdorp 1907 TS 1046…, INNES CJ equated a decision, in the absence of a qualification, with a final determination.

Both Herbert Porter & Co Ltd and Another v Johannesburg Stock Exchange 1974 (4) SA 781 (W)…, and Knop v Johannesburg City Council 1995 (2) SA 1 (A)…, defined decision as “the final and definite result of examining a question” and “adjudication in the juristic sense, i.e. a final and definite result in consequence of examining a question”, respectively.

These definitions were adopted in Media Workers Association of South Africa & Ors v Press Corporation of South Africa Ltd (Preskor) 1992 (4) SA 791 (A)…,. This was a labour matter in which the relevant statutory provision stipulated that “an assessor shall be a person, who, in the opinion of the Chairman of the Court, has experience in the administration of justice or skill in any matter which may be considered by the Court.”

By reference to The Shorter Oxford Dictionary, it was held, at 796E, that, an opinion was a matter of speculation which could not be proved by any available evidence to be right or wrong.

In the local case of R v Foster 1962 (1) SA 280 (SR)…, BEADLE CJ held that:

“Opinion means something different from 'intention'…,. If the long and complex definition of 'opinion' in the Shorter Oxford Dictionary is examined, it will be seen that the meaning of 'opinion' includes only such things as 'a judgment' or 'a belief of something'. It does not include merely an intention.”

However, in R v Sibanda & Ors 1965 RLR 363…, an opinion of a court was equated with a judgment derived from objective facts and not a belief.

In my view, the publication and contents of the Value Ruling No.15 of 2007, and the accompanying correspondence, demonstrated that the Commissioner-General was alive to the powers vested in him generally by Part X, and, in particular, by section 106 and 113 of the Customs and Excise Act.

It seems to me, that, the provisions in Part X delineate almost all the possible ingredients that constitute a transaction value for the purposes of computing the duty value of an imported item under the Customs and Excise Act.

In summary, the ruling was that the sum payable to the intermediary was the value for duty purposes and that amount was religiously treated by the appellant as the purchase price of the motor vehicles in all its tax returns from the time it took effect.

And rightly so, for those ingredients, in my view, are similar to the considerations which must necessarily constitute the purchase price of such an imported item for Income Tax purposes.

In ruling on the transaction value for duty purposes, the Commissioner General made a final and definitive determination amounting to an “adjudication in the juristic sense, i.e. a final and definite result in consequence of examining a question” or a 'judgment' as indicated in Knop v Johannesburg City Council 1995 (2) SA 1 (A) and R v Foster 1962 (1) SA 280 (SR), respectively.

That final and definite determination was that the relationship between the appellant and the intermediary did not influence the price actually paid for the goods concerned.

The opinion of the Commissioner was that the parties acted at arm's length in setting the transaction value.

The finding was based on the objective assessment of the information provided to the Commissioner, which information would, more or less, be used to determine the purchase price of the imported vehicles.

The introduction of a different statute would not change the value of the motor vehicles nor the finding that the parties had an arm's length relationship, especially in view of the respondent's refusal to refund the duty, surtax, and VAT paid on the higher transactional value.

Clearly, the appellant cannot approbate and reprobate in respect of the same motor vehicles simply because the imposts are levied under two different statutes.

Contrary to the submission by counsel for the respondent, in paragraph 11.2 of his written heads of argument, I am satisfied, that, the assessment and payment of import duties and taxes based on the transaction value of these vehicles, which was objectively ascertained by the respondent, is binding on the respondent.

The appellant has shown that it knows of no other means and the respondent has not discharged the evidentiary onus that shifted to it of showing how the purchase price required for the computation of taxable income on these vehicles could have been arrived at other than in the same way that was used to ascertain the transaction value.

Was the respondent entitled to invoke section 24 of the Income Tax Act to compute notional income?

The respondent conducted a tax compliance investigation of the appellant in respect of the four years in question. It was dissatisfied with the transactions between the appellant and the intermediary, who were related parties.

The basis of the disquiet was that import documents showed the appellant as the owner of the vehicles in the bonded warehouse when in fact ownership vested in the intermediary who insured them whilst in bond.

The prepaid forex amount on the price list was the Carriage Insurance Paid (CIP) price equivalent to 40% of the total cost of the vehicle.

In addition, the appellant was responsible for the payment of rentals for the bonded warehouse, advertising and promotion expenses, clearing charges, and management fees, which expenses it claimed from its income.

At the same time, the owner of the motor vehicles incurred comparatively less costs and enjoyed more of the profits in a foreign tax jurisdiction beyond the reach of the respondent.

The respondent formed the opinion, that, the arrangement was intended to reduce the appellant's profits in Zimbabwe and transfer them to this other tax jurisdiction to the obvious detriment of the Zimbabwe fiscus.

In the result, the appellant invoked the provisions of section 24 of the Income Tax Act, and, in collaboration with the appellant, conducted a functional analysis of the transactions in the supply chain, from the purchase of the vehicles from the conglomerate by the intermediary to their disposal to the dealers by the appellant, and concluded that the transactions between the two were not conducted at arm's length.

On the basis of functional analysis, it apportioned and adjusted the income, expenses, and profits earned from this supply chain in the ratio of 61% to the appellant and 39% to the intermediary.

Even though these expenses were paid by the appellant, the respondent disallowed the portion attributed to the intermediary.

Functional Analysis

The Chief Investigations Officer testified, that, this was an international best practice adopted by revenue authorities to assess the true income earned by related parties from transactions carried out for mutual benefit that fail the arm's length test.

In its simplest form, a functional analysis determines what part of a transaction was undertaken by the various parties involved in that transaction.

In the present case, the parties were the manufacturer (conglomerate), the intermediary, the appellant, and the parent company.

The respondent categorised the functions under, functions performed; the attendant risks; and the assets used and apportioned percentages to the work performed by each player.

The respondent raised the functional analysis method around April-May 2013 on realising that the appellant was paying both management fees and a mark-up of between 7.5% and 10% on the conglomerate bought-out price to the intermediary.

On 24 June 2013, it supplied the appellant with the “Appellant's Functional Analysis” document…,.

The document was divided into six columns headed functions, and each of the names of the four parties involved in the taxable transaction was indicated. The last column was reserved for comments.

The functions covered, firstly, management and administrative services and the associated tasks of communication with customers, the handling of payment from buyer and to suppliers, provision of accounting and management services and maintaining customer negotiations, accounting and financial records and inventories.

The second function was in respect of marketing and customer liaison and the associated tasks for the development, preparation, approval, implementation and funding of marketing strategies and programs which incorporated negotiations with buyers, liaison with suppliers and dealers, and the preparation of pre-shipping exit customs documents and the payment of clearing, shipping, freight and importation expenses.

The risks were in respect of credit, exchange and business risk and covered the insurance of vehicles and the loss of inventory and warehousing.

The assets used covered warranties, skilled and technical employees, intellectual property rights, and vehicles and office accommodation.

At the request of the respondent, on 12 July 2013, the appellant allocated 100% to those tasks that were wholly undertaken by each party and inserted comments in the column provided for that purpose.

Again, on 14 August 2013, the appellant provided a more detailed percentage allocation against the other tasks.

In respect of the management and administrative function, the task of communicating the intention to buy was allocated 100% to the appellant.

The other tasks were allocated as follows:

(i) Payments from the buyer - appellant 95% and the intermediary 5%;

(ii) Payments to the conglomerate - the intermediary 100%;

(iii) Maintenance of accounting records, negotiation records with buyers and preparing financial reports - the appellant 100%;

(iv) Inventory control system - the appellant 50% and the intermediary 50%;

(v) Management support - the French holding company 100%; and

(vi) The financial support for funding and liaison with suppliers - the intermediary 100%.

Under the marketing and customer liaison function, the tasks were allocated as follows:

(i) Developing marketing strategies - the appellant 100%;

(ii) Funding - 96.5% to the appellant and the conglomerate 3.5%;

(iii) Implementation of marketing programmes, negotiation with buyers and liaison with the dealers - appellant 100%;

(iv) Payment of clearing charges and transport fees - appellant 85% and the intermediary 15%;

(v) Price negotiations with the supplier/conglomerate - appellant 60%, the intermediary 10%, and the French holding company 30%; and

(vi) Pre-shipping, customs exit documents, and freight to the place of importation in Zimbabwe - the intermediary 100%.

In regards to the risks function, the tasks were allocated as follows:

(i) Insurance risk from embarkation in the country of manufacture to sale in a bonded warehouse in Zimbabwe - intermediary 100%;

(ii) Credit and exchange rate risks - intermediary 100%; and

(iii) Business risk - appellant 50% and intermediary 50%.

And, in regards to the use of assets function, the tasks were allocated thus:

(i) Warranties - appellant 10% and the conglomerate 90%;

(ii) The use of intellectual property rights - the conglomerate 100%;

(iii) The use of technical skills - the appellant 25%, the intermediary 25%, the conglomerate 25%, and the French holding company 25%; and

(iv) The use of operational vehicles and rentals - appellant 100%.

On 21 November 2013, the respondent concluded the functional analysis by averaging the percentages inserted by the appellant with its own and allocated 61% to the appellant and 39% to the intermediary.

The vehicles sales gross profit of US$1,252,021 for 2009; US$3,110,196 for 2010; US$6,338,185=46 for 2011; and US$4,918,389=78 for 2012 were based on total gross sales figure that did not include the intermediary's invoices.

These gross profit figures were derived from the difference between the appellant's local sales and the landed costs comprised of the conglomerate's FOB costs and shipping costs, finance charges, and handling and clearing charges.

The Commissioner disregarded the gross profit recorded in the appellant's statement of comprehensive income of US$837,160 for 2009; US$2,327,853 for 2010; US$3,953,949 for 2011; and US$3,615,881 for 2012.

Counsel for the appellant correctly criticised the functional analysis methodology as an arbitrary, unscientific, and an opinion based on value judgment and not on a formula.

He accurately observed, that, the imputed gross profit was out of step with the comparable prices of similar vehicles offered in Zimbabwe by other brand competitors.

He correctly contented, that, the Chief Investigations Officer did not explain how his tabulated figures, and, especially, the vehicle sales gross profit figures, were computed and more importantly how he arrived at the 61:39 split.

In my view, even the more detailed functional analysis percentage apportionments provided by the appellant, on 14 August 2013, in annexure H of the Commissioner's case, failed to disclose how the 61:39 split was achieved.

Apparently, it was invoked on the weak basis of a purported concession to profit-sharing made by the appellant in a letter of 9 September 2011, which letter did not form part of the pleadings or evidence in this case.

The evidence at hand established, that, the appellant, at all times, disputed ever sharing any profits with the intermediary.

The real reason for ascribing profit sharing between them, as eventually disclosed by the Chief Investigations Officer, was that they each added a mark-up of 7.5% to their respective purchase prices.

The respondent thus formed the opinion, that, the parties shared profits equally and not the costs - which burden was borne by the appellant. The respondent found the position contrary to the arm's length principle.

Is it part of our law

Counsel for the appellant submitted, that, functional analysis was not part of our law notwithstanding that the respondent foistered it upon the appellant.

He further submitted, that, it was illogical and irrational and did not form part of the South African or OECD transfer pricing system.

In regards to transfer pricing, he argued, that, until the introduction of section 98A to the Income Tax Act by the Finance Act No.1 of 2014, on 1 January 2014, there were no statutory provisions dealing with this subject in our law.

The concept of transfer pricing, as explained by KEITH HUXMAN and PHILIP HAUPT, in Notes on South African Income Tax 24ed (2005) involves the manipulation of prices, income, and expenses by associated companies operating in different tax jurisdictions in order to reduce profits in a higher tax jurisdiction.

It is invariably measured by the arm's length principle.

It seems to me, that, transfer pricing could be dealt with under the general deduction formula in section 15(2)(a) of the Income Tax Act as was the case in South Africa when ITC 569 (1944) 13 SATC 447 was decided before the introduction of section 31 in Act 58 of 1962 and the subsequent publication of Note 7, which delineated transfer pricing transactions in that country.

While our law did not have a specific transfer pricing provision until 1 January 2014, it seems to me that the issue could be dealt with under the general deduction formula, or either section 24 or section 98 of the Income Tax Act if the requirements in those sections were met.

It is clear that the functional analysis methodology is not specifically provided for in our law.

Nor was transfer pricing specifically provided for in our law prior to 1 January 2014.

The respondent relied on the provisions of section 24 of the Income Tax Act to invoke the functional analysis methodology.

The correspondence between the parties, both before and after the objection, and, especially in the summary of evidence filed by the appellant in preparation of the appeal hearing, recognised the existence of the functional analysis concept.

In the objection letter, the appellant recognised functional analysis as an international practice.

And, in its summary of evidence, the appellant was ready to call evidence to show how functional analysis was prepared and the context in which it applied.

Indeed, in argument, counsel for the appellant referred to the pillars on which it stands as comprising the functions of the targeted parties in the chain of supply, the nature and type of assets or resources deployed used, and the risks assumed by each party in the supply chain.

These were applied by the respondent in the functional analysis it conducted in collaboration with the appellant.

To the extent that it is a recognised method of assessing taxable income earned, or deemed to have been earned by a taxpayer, I would, on the sparse evidence before me, hold that there is nothing in our law that would preclude the Commissioner from applying it in suitable cases.

Whether or not this was a suitable case to employ functional analysis, in determining the appellant's taxable income, depends on whether or not the provisions of section 24 of the Income Tax Act applied to the circumstances pertaining to the appellant.

I agree with counsel for the respondent, that, the genesis of the provisions section 24 of the Income Tax Act can be traced back to English Company Law.

Incorporated companies, whether related or independent had always been regarded as separate and distinct entities. In time, in order to answer the pressing questions raised by the conduct of related parties, and, especially holding companies and their subsidiaries, the English courts imported the concepts of assignment and agency into the relationship and this was quickly adopted by both the South African and Zimbabwean courts.

Expressions such as:

'an assignee of the holding companies': see Harold Holdsworth & Co (Wakefield) Ltd v Caddies (1955) 1 All ER 725 (HL)…, and DHN Food Distributors Ltd v London Borough of Tower Hamlets (1976) 3 All ER 462 (CA);

'an agent of the holding company…, conducting its business for it': see In Ritz Hotel Ltd v Charles of the Ritz Ltd v Anor 1988 (3) SA 290 (A)…,.; and

'one economic entities': see Moodie v Industrial & Pipe Employees Trust (Pvt) Ltd and Industrial and Pipe Ltd SC165-97…, and CC Sales Ltd v David Dyer & Dajen (Pvt) Ltd HH230-98 were used to remove the separate and distinct nature of these corporate entities.

While the facts of each case in which these expressions were used were different from the present case, the principles derived from these cases resulted in the legislative intervention crystallised in section 24 of the Income Tax Act that sought to treat the activities of subsidiaries that shared management, control, and capital, and that breached the arm's length principle, as “one economic entities.”

I do not think, that, the respondent's legal right to invoke the provisions of section 24 of the Income Tax Act, in making the adjustments to the appellant's tax liability arising from either the failure to declare all the income earned or claiming unjustified deductions, can be gainsaid.

The section stipulates that:

“24. Special provisions relating to determination of taxable income in accordance with double taxation agreements

The Commissioner may —

(a) If any person —

(i) Carrying on business in Zimbabwe, participates directly or indirectly in the management, control, or capital of a business carried on by some other person outside Zimbabwe; or

(ii) Carrying on business outside Zimbabwe, participates directly or indirectly in the management, control, or capital of a business carried on by some other person in Zimbabwe; or

(iii) Participates, directly or indirectly, in the management, control, or capital both of a business carried on in Zimbabwe by some other person and of a business carried on outside Zimbabwe by some other person; and

(b) If conditions are made or imposed between any of the persons mentioned in paragraph (a) in their business or financial relations, which, in the opinion of the Commissioner, differ from those which would be made between two persons dealing with each other at arm's length;
determine the taxable income of the person carrying on business in Zimbabwe as if such conditions had not been made or imposed but in accordance with the conditions, which, in the opinion of the Commissioner, might be expected to have been made or imposed between two persons dealing with each other at arm's length.”

The first point to note is the anomalous reference in the heading to double taxation agreements which is not embodied in the provisions of the section.

I agree with the submission by counsel for the appellant, that, by virtue of section 7(a) of the Interpretation Act [Chapter 1:01] the reference to double taxation agreements should be disregarded in construing the section.

HH99-18 : C F (PVT) LTD vs ZIMBABWE REVENUE AUTHORITY
Ruled By: KUDYA J

The OnusCounsel for the appellant submitted, on the authority of Commissioner for Inland Revenue v Conhage (Pty) Ltd (formerly Tycon (Pty) Ltd 1999 (4) SA 1149 (SCA)…,; 61 SATC 391 (SCA)…, that, the onus was on the Commissioner to show, on a balance of probabilities, that the arrangements between the ...

The Onus

Counsel for the appellant submitted, on the authority of Commissioner for Inland Revenue v Conhage (Pty) Ltd (formerly Tycon (Pty) Ltd 1999 (4) SA 1149 (SCA)…,; 61 SATC 391 (SCA)…, that, the onus was on the Commissioner to show, on a balance of probabilities, that the arrangements between the two related parties in question were not at arm's length.

I declined to follow the South African position in CRS (Pvt) Ltd v Zimbabwe Revenue Authority HH728-17…,.

For the reasons set out in that case, I remain of the view, that, the onus provisions of section 63 govern the interpretation of section 24 and the aligned provisions of section 98 of the Income Tax Act to the extent, that, the taxpayer challenges the tax liability attributed to it by the Commissioner.

In other words, I hold, that, the onus is on the taxpayer to show that the Commissioner was wrong in forming the opinion that the arrangements concluded between the taxpayer and a related party were not at arm's length rather than on the Commissioner to show that his opinion was correct.

This finding accords with the general thrust of our common law principle that he who alleges must prove.

In an appeal such as this one, it is the taxpayer who is challenging the correctness of the Commissioner's opinion by averring that it was wrong. It is not the Commissioner who has come to court for the confirmation of the correctness of his opinion.

The duty to establish the error in the opinion must surely lie on the party that impugns the correctness of such an opinion.

In the present matter, the party driving the challenge is the appellant and the onus must squarely fall on it.

That is the further reason why I hold, that, the onus is on the appellant to show that the opinion of the Commissioner that the arrangements between the appellant and the intermediary were not at arm's length.

This approach appears to be consonant with the sentiments of MORTON ACJ in Elite Wholesale (Rhodesia) (Pvt) Ltd v Commissioner of Taxes, Southern Rhodesia (1955) 20 SATC 33 (SR)…,.; 1955 (1) SA 350 (SR)…, where he said:

“In my view, the appellant has discharged the onus upon him, for, in the evidence before us, I find no feature connected with any of the transactions which would justify the exercise of the Commissioner's powers under section 28(1).”

Section 28(1) read:

“Whenever the Commissioner is satisfied that any transaction, or operation, has been entered into or carried out for the purpose of avoiding liability for the payment of any tax imposed by this Act, or reducing the amount of any such tax, any liability for any such tax and the amount thereof may be determined as if the transaction or operation had not been entered or carried out.”

In any event, what triggered the appeal in the present matter was that an amount was assessed to tax; which amount the appellant avers was not liable to tax because it was wrongly created.

While it is correct that this Court rehears the matter; the case remains an appeal lodged by the taxpayer challenging the process undertaken by the Commissioner in adjusting his tax liability.

The point missed in Commissioner for Inland Revenue v Conhage (Pty) Ltd (formerly Tycon (Pty) Ltd 1999 (4) SA 1149 (SCA)…,; 61 SATC 391 (SCA), so it seems to me, is that section 63 of the Income Tax Act, is engaged once the challenge relates, inter alia, to any amount not liable to the tax.

The onus therefore lies on the taxpayer to show, that, the Commissioner's opinion, or satisfaction, as the case may be, that the appellant infringed section 24 or section 98 of the Income Tax Act, was wrong.

In my view, the Commissioner does not bear the onus of establishing that his opinion was correct. All that is required of him is to set out, in the determination to the letter of objection, the basis for his opinion or satisfaction, and, as PONNAN JA indicated in Commissioner for the South African Revenue Services v Pretoria East Motors (Pty) Ltd [2014] 3 All SA 266 (SCA)…, this is derived from the averments made by the taxpayer during the investigation.

The Commissioner does not create any evidence, but bases his opinion or satisfaction on the information availed to him by the taxpayer.

The essential elements of section 24 of the Income Tax Act

The essential requirements envisaged by section 24 of the Income Tax Act are that:

1. Any person -

(a) Who carries on business in Zimbabwe, takes part, directly or indirectly, in the management, control or capital of a business of another person outside Zimbabwe; or

(b) Who carries on business outside Zimbabwe, takes part, directly or indirectly, in the management, control, or capital of a business of another in Zimbabwe; or

(c) Takes part, directly or indirectly, in the management, control, or capital of both a business operating in Zimbabwe by another person and a business operating outside Zimbabwe by another person; and

2. The business or financial conditions governing their interactions are, in the opinion of the Commissioner, inimical to those of two persons dealing with each other at arm's length;

3. Then, the Commissioner shall determine the taxable income of the person carrying on business in Zimbabwe by ignoring the conditions concluded by the parties and invoking the conditions which, in his opinion, would have been concluded by two parties acting at arm's length.

In accordance with the concluding words of section 24 of the Income Tax Act, these requirements are invoked against the person who carries on business in Zimbabwe.

The section was designed to deal effectively with business transactions between a taxpayer and another person that fail the arm's length test.

The transactions must fall within the ambit of the provisions of section 24 of the Income Tax Act before the Commissioner can determine the income tax liability of the taxpayer by ignoring the terms and conditions agreed to by the parties that are not at arm's length and supplanting them with the conditions the Commissioner believes would reasonably have been imposed between persons transacting with each other at arm's length.

In the language MORTON ACJ in Elite Wholesale (Rhodesia) (Pvt) Ltd v Commissioner of Taxes, Southern Rhodesia (1955) 20 SATC 33 (SR)…,.; 1955 (1) SA 350 (SR)…, the Commissioner takes the “sale into the taxpayer's accounts.”

Any Person

It was common ground that the appellant was a person who carried on business in Zimbabwe in each of the four tax years in question.

It was also agreed that the intermediary carried on business outside Zimbabwe but it was in dispute whether or not it carried on business in Zimbabwe.

It was also agreed that the French holding company partook, directly or indirectly, in the management, control, and capital of both the appellant and the intermediary.

There was no evidence adduced to show that any of these three related parties participated, directly or indirectly, in the management, control, or capital of the conglomerate which manufactured and supplied the vehicles to the intermediary for the account of the appellant.

However, the Distribution Agreement permitted the conglomerate to participate in the management of the appellant.

Partakes, directly or indirectly, in the management, control or capital of a business of another outside Zimbabwe

The meaning of the phrase “business of another outside Zimbabwe” was the subject of considerable dispute between counsel.

Counsel for the appellant contended, that, the words referred to a business that was located outside Zimbabwe. He argued that the intermediary's business was located outside Zimbabwe and the appellant, who was located in Zimbabwe, therefore did not take part in the management, control, or capital of the intermediary.

Counsel for the respondent contended, that, the words equally applied to a business person located outside Zimbabwe but whose business was located either in Zimbabwe or outside Zimbabwe.

He contended, that, the intermediary operated a business in Zimbabwe that was managed by the appellant. He therefore argued that the relationship between the appellant and the intermediary fell into the ambit of this requirement.

The pleadings, the documentary exhibits, and the oral evidence of the appellant's Managing Director, which were not contradicted by any evidence led on behalf of the respondent, established that the appellant was not involved in the management, control, or capital of any business located in a foreign country.

It was not a shareholder in such a company nor did it manage or control, by itself or by proxy, any such company.

While it was a related company to the intermediary, it did not take part in the management, control, and capital of the intermediary.

The appellant did not participate in the management, control, or capital of the French holding company or the conglomerate.

The question of whether the appellant managed the bonded warehouse on behalf of the intermediary is determined by the answer to the question of who the importer of the consignment stock was.

The appellant maintained, that, it managed the bonded warehouse as the importer of the consignment stock, for its own account.

There was argument between counsel on whether the appellant was the importer of the consignment stock or not.

Counsel for the appellant relied on the bills of entry for the contention that the appellant was the importer while counsel for the respondent argued that it was the consignee.

The Chief Investigations Officer testified on the existence of three types of bills of entry in our law:

(i) The first was the Bill of Entry into Zimbabwe;

(ii) The second was the Bill of Entry into a bonded warehouse; and

(iii) The third was a Bill of Entry for removal from bond for consumption in or for export out of Zimbabwe.

His testimony was confirmed by the definition of both Bill of Entry and Entry in section 2 of the Customs and Excise Act.

A Bill of Entry is defined “as a prescribed form on which an entry is made.”

Entry is defined thus:

“'entry' in relation to clearance of goods for importation, warehousing, removal from a warehouse or exportation, means the presentation in accordance with this Act of a correctly completed and signed declaration on a bill of entry in writing, and, where direct trader input facilities exist, includes the recording of the required information on the Customs computer system, using procedures approved by the Commissioner, or using a computerised procedure approved by the Commissioner, together with such bills of lading, invoices, price lists and other documents showing the purchase value of the goods together with the freight, insurance and other charges on the goods required to be declared by any provision of this Act;”

In regards to import and importer, the Customs and Excise Act states that:

“'import' means to bring goods or cause goods to be brought into Zimbabwe;

'importer' in relation to goods, includes any owner of or other person possessed of or beneficially interested in any goods at any time before entry of the same has been made and the requirements of this Act fulfilled;”

In an almost analogous case of AT International Ltd v Zimra 2015 (2) ZLR 143 (H)…, by reference to the definition of 'import' 'importer' and 'entry' of section 2 of the Customs and Excise Act, I held that a foreign registered company was the importer of goods that had been purchased in South Africa and consigned to a local company in Zimbabwe.

In the present case, the intermediary met the definition of importer.

Whether the appellant was “any other person possessed of or beneficially interested in the goods at any time before their entry had been made and the requirements of the Act fulfilled” is a question of fact to be decided on the basis of the available evidence and the relevant provisions found in Part III of the Customs and Excise Act.

The appellant did not possess, but was, in terms of the Distribution Agreement and the Tripartite Agreement, beneficially interested in the goods before their entry into Zimbabwe.

These vehicles were coming to Zimbabwe in terms of the Distribution Agreement at the instance of the appellant and for the business of the appellant.

Accordingly, I agree with counsel for the appellant, that, the appellant was the importer.

As the importer, the appellant carried the obligation to warehouse the vehicles. It was in the business of selling vehicles. The appellant was contractually bound by the Distribution Agreement not only to purchase and sell a prescribed minimum number of vehicles but also to grow the business and enhance its market share.

These objectives could only be achieved, among other ways, by promoting and advertising the brand.

Both our common law and statutory law recognise the reservation of ownership.

In Rennie Grinaker Holdings (Pvt) Ltd v Sociedade Intercontinental de Compressors Hermeticos Sicom Ltda 1997 (1) ZLR 173 (SC)…, KORSAH JA approved and applied the dictum in Lendalease Finance (Pty) Ltd v Corporacion de Mercadeo Agricola & Ors 1976 (4) SA 464 (A)…, where CORBETT JA said:

“According to our law, unlike certain other legal systems, ownership cannot pass by virtue of the contract of sale alone: there must, in addition, be at least a proper delivery to the purchaser of the contract goods…,. Whether delivery alone will suffice depends in general upon the intention of the parties…,.; and, in this connection, important considerations are;

(a) Whether the contract contains conditions affecting the passing of ownership…,.; and

(b) Whether the sale is for cash or credit.”

Again, section 17 of the Income Tax Act reads:

“17. Special provisions relating to hire-purchase or other agreements providing for postponement of passing of ownership of property

If any taxpayer has entered into any agreement with any other person in respect of any property the effect of which is that, in the case of movable property, the ownership shall pass, or, in the case of immovable property, transfer shall be effected from the taxpayer to that other person upon or after receipt by the taxpayer of the whole or a certain portion of the amount payable to the taxpayer under the agreement, the whole of that amount shall, for the purposes of this Act, be deemed to have accrued to the taxpayer on the date on which the agreement was entered into:”

In any event, as was clearly pronounced in Commissioner for Inland Revenue v Conhage (Pty) Ltd (formerly Tycon (Pty) Ltd 1999 (4) SA 1149 (SCA)…,; 61 SATC 391 (SCA)…, the passing of ownership is not an essential element to a sale.

It does not seem to me, that, the reservation ownership is synonymous with the operation by the appellant in the management, control, or capital of the business carried on by the intermediary outside Zimbabwe.

I accordingly find that the appellant did not manage any business of the intermediary in Zimbabwe.

However, in my view, section 24(a)(i) of the Income Tax Act locates the business outside and not inside Zimbabwe.

I therefore agree with counsel for the appellant, that, the appellant did not participate, directly or indirectly, in the business of the intermediary outside Zimbabwe.

Operates a business outside Zimbabwe and partakes, directly or indirectly, in the management, control, or capital of a business in Zimbabwe

In regards to this requirement, the person who operated a business outside Zimbabwe was the intermediary. The person who operated a business in Zimbabwe was the appellant.

The financial statements of the appellant showed that it paid management fees to the intermediary in respect of administrative, stock control, and management in the sum of US$130,000 in 2009; US$140,000 in 2010; US$256,629 in 2011; US$140,000 in 2012.

The scope of such management fees was covered in the agreement of 2 March 2009.

The appellant failed to establish the activities conducted on its behalf by the intermediary. It strenuously asserted, in correspondence of 19 May 2013 and even in the objection of 25 July 2014, that it received bona fide management services from the intermediary.

However, on 14 November 2014, the appellant made a half-hearted concession that it had erroneously paid management fees to the intermediary.

At the commencement of hearing, counsel for the appellant abandoned the appeal in respect of management fees.

I do not find, on the facts, that, the intermediary participated in the management or control or capital of the appellant.

I find that when the intermediary received orders from the appellant, and placed them with the conglomerate, it was managing its own business under the directing mind of its Board of Directors. The appellant did not play any role in this process.

Accordingly, the provisions of sub-paragraph (ii) of paragraph (a) of section 24 of the Income Tax Act was not met.

Partakes, directly or indirectly, in the management, control, or capital in some other business operating both in and outside Zimbabwe

The French holding company, and not the appellant or the intermediary, participated directly or indirectly in the management, control, or capital of the appellant who operated in Zimbabwe and the intermediary who operated outside Zimbabwe.

Accordingly, I also find, that, the provisions of that subparagraph were not met.

It is not necessary for me to consider the requirements of paragraph (b) of section 24 of the Income Tax Act as these are conjunctive with either of the sub-paragraphs in paragraph (a) of section 24 of the Income Tax Act.

I do it for the sake of completeness.

The business or financial conditions governing the relationship, in the opinion of the Commissioner, that differ to those of two people dealing at arm's length

The persons identified as “any of the persons” mentioned in paragraph (a) to which paragraph (b) applies were the appellant and the intermediary.

In regards to the conditions that were made or imposed between the intermediary and the appellant, both counsel for the respondent, in paragraph 10.4 and 10.5, and counsel for the appellant, in paragraph 31 of their respective written heads, agreed that the business or financial conditions related to the reservation of ownership and its consequential costs of advertising and promotion, rent, clearing charges, and management fees.

These were exclusively met by the appellant.

Counsel for the respondent submitted, that, it was the duty of the intermediary, as owner and importer, to meet the warehouse, marketing, promotion, and advertising costs on the one hand, and the clearing costs, as required by the definition of importer in section 2 of the Customs and Excise Act, on the other.

His submission collapses in the face of my finding that the same definition of importer also covered the appellant.

It would appear to me, that, the legal duty to pay these charges and imposts fell on the appellant.

Counsel for the respondent further contended, in paragraph 10.1 of his written heads, that, there was no real need for interposing the intermediary in place of the parent company in the purchase of the motor vehicles.

It does not seem to me, that, it was within the power of the Commissioner to dictate to taxpayers who their contracting parties should be.

In any event, the reasons stated by the appellant for interposing the intermediary, spelt out in its letter of 26 October 2007 in support of the value ruling, were not impeached.

The intermediary had the foreign currency required to meet the minimum purchase orders required of the appellant in the Distribution Agreement with the conglomerate.

In addition, our law does not discourage middleman from interposing for profit in any lawful commercial activity of their choice as did the intermediary.

This, the intermediary proceeded to do, by imposing a mark-up for its services as the intermediary and financier, which mark-up was incorporated in the transaction value, which, in turn, was equivalent to the purchase price paid by the appellant.

I do not find that the intermediary imposed these conditions on the appellant.

I also do not find that the appellant wrongly increased its deductible expenses and correspondingly transferred profits to the intermediary.

Opinion that they were not at arm's length and normal conditions

The reservation of ownership is an arm's length condition recognised both in our common law and by statute.

Rennie Grinaker Holdings (Pvt) Ltd v Sociedade Intercontinental de Compressors Hermeticos Sicom Ltda 1997 (1) ZLR 173 (SC) and Lendalease Finance (Pty) Ltd v Corporacion de Mercadeo Agricola & Ors 1976 (4) SA 464 (A) demonstrated, that, the reservation of ownership is a standard condition in contracts of sale governing international trade.

The use of bonded warehouses was also a common and normal internationally accepted standard in the motor industry designed to promote the free and easy flow of global trade and accessibility of the vehicles in the importing country.

It seemed to me, that, the cost structure of the intermediary incorporated all the ingredients that went into the landed price of the vehicles.

The evidence of the appellant, that the carriage insurance paid price comprised the free on board selling price of the manufacturer, the cost of freight to the bonded warehouse, insurance of the vehicles in transit to and in the bonded warehouse, and the mark-up of the intermediary was not impugned.

The respondent did not find the amounts charged to have been outside the normal open commercial terms charged in similar transactions by the appellant's competitors.

It seems to me that the appellant discharged the onus on it to show that the opinion of the Commissioner was wrong.

Counsel for the appellant contended, that, the determination under section 24 of the Income Tax Act was limited to the computation of taxable income, as defined in section 8(1) of the Income Tax Act as “the amount remaining after deducting from the income of any person all the amounts allowed to be deducted from income under this Act.”

He argued that the respondent was not empowered to raise notional vehicles sales gross profit, and, thereafter, derive taxable income from that figure.

The submission lacks merit for the reason, that, taxable income is a derivative of gross income and income and not a standalone amount.

Our Supreme Court, in Zimbabwe Revenue Authority v Murowa Diamonds (Pvt) Ltd 2009 (2) ZLR 213 (SC)…, requires courts to discard the literal textual construction in favour of the purposive contextual interpretation where the application of the former leads to an absurdity or repugnancy or inconsistency with the rest of the statute.

It seems to me, that, to adopt the submission moved by counsel for the appellant would lead to an absurdity and would be inconsistent with the rest of the statute.

The computation of taxable income is not a stand-alone process but is preceded by the computation of gross income from which all exemptions are deducted to arrive at the income from which further allowable deductions are removed before arriving at the taxable income: see also Commissioner for the South African Revenue Services v Pretoria East Motors (Pty) Ltd [2014] 3 All SA 266 (SCA)…, and Commissioner for Inland Revenue v Delfos 1933 AD 241…,.

I am, however, satisfied, that, the respondent wrongly invoked section 24 of the Income Tax Act in the present matter.

Accordingly, there was no room for it to apply the functional analysis principle in this matter.

HH99-18 : C F (PVT) LTD vs ZIMBABWE REVENUE AUTHORITY
Ruled By: KUDYA J

In Commissioner of Taxes v F 1976 (1) RLR 106 (AD)…, MACDONALD JP described tax avoidance in strong language as an evil.The imposition of penalties in fiscal infractions is predicated on both individual and general deterrence. Every taxpayer is required to shoulder its fair share of the tax burden for ...

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Tax Avoidance and Tax Evasion

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HH207-15 : G BANK ZIMBABWE LTD vs ZIMBABWE REVENUE AUTHORITY
Ruled By: KUDYA J

HH621-15 : DELTA CORPORATION LTD vs ZIMABWE REVENUE AUTHORITY
Ruled By: HLATSHWAYO J

SC140-21 : MBCA BANK (PRIVATE) LIMITED (Now known as Nedbank Zimbabwe Limited) vs ZIMBABWE REVENUE AUTHORITY
Ruled By: GUVAVA JA, UCHENA JA and MAKONI JA

HH99-18 : C F (PVT) LTD vs ZIMBABWE REVENUE AUTHORITY
Ruled By: KUDYA J

HH99-18 : C F (PVT) LTD vs ZIMBABWE REVENUE AUTHORITY
Ruled By: KUDYA J

HH99-18 : C F (PVT) LTD vs ZIMBABWE REVENUE AUTHORITY
Ruled By: KUDYA J

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Tax Avoidance and Tax Evasion

View Appeal HH207-15 : G BANK ZIMBABWE LTD vs ZIMBABWE REVENUE AUTHORITY Ruled By: KUDYA J

HH621-15 : DELTA CORPORATION LTD vs ZIMABWE REVENUE AUTHORITY Ruled By: HLATSHWAYO J

SC140-21 : MBCA BANK (PRIVATE) LIMITED (Now known as Nedbank Zimbabwe Limited) vs ZIMBABWE REVENUE AUTHORITY Ruled By: GUVAVA JA, UCHENA JA and MAKONI JA

HH99-18 : C F (PVT) LTD vs ZIMBABWE REVENUE AUTHORITY Ruled By: KUDYA J

HH99-18 : C F (PVT) LTD vs ZIMBABWE REVENUE AUTHORITY Ruled By: KUDYA J

HH99-18 : C F (PVT) LTD vs ZIMBABWE REVENUE AUTHORITY Ruled By: KUDYA J

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Zimbabwe

View Appeal
HH207-15 : G BANK ZIMBABWE LTD vs ZIMBABWE REVENUE AUTHORITY
Ruled By: KUDYA J

HH621-15 : DELTA CORPORATION LTD vs ZIMABWE REVENUE AUTHORITY
Ruled By: HLATSHWAYO J

SC140-21 : MBCA BANK (PRIVATE) LIMITED (Now known as Nedbank Zimbabwe Limited) vs ZIMBABWE REVENUE AUTHORITY
Ruled By: GUVAVA JA, UCHENA JA and MAKONI JA

HH99-18 : C F (PVT) LTD vs ZIMBABWE REVENUE AUTHORITY
Ruled By: KUDYA J

HH99-18 : C F (PVT) LTD vs ZIMBABWE REVENUE AUTHORITY
Ruled By: KUDYA J

HH99-18 : C F (PVT) LTD vs ZIMBABWE REVENUE AUTHORITY
Ruled By: KUDYA J