Introduction

Signing contracts is not just a matter of appending your signature on paper but a matter of life and death. Caveat subscriptor is a trite principle at law which is roughly translated as “signatory beware”. It entails that the signatory is bound by his signature and cannot deny existence of obligation included in the document he has signed.  The parties involved in a contract, the risk involved and the rights and responsibilities to be carried out under the contract, including dispute resolution mechanism, remedy clauses among others must be known before appending one’s signature. Besides the commercial disputes that can arise between the contracting parties, contracts are instruments which may invite unwanted taxes if poorly drafted. To the extent that contracts and reality or conduct are at variance the later prevails for tax purposes. Therefore contracts will only become worthless papers in the eyes of the taxman. It is important to be more diligent when signing contracts and engaging tax persons to analyse your contract before you sign. In addition, the contracts should be at arm’s length i.e. the agreement should be at fair market value especially for contracts between related parties. Arm’s length implies the contract terms are fairly reflective of the market conditions and are not constraint due to the relationship between the parties.

Non-arm’s length or abnormal contracts

Section 23 (1) of the Income Tax Act (ITA) Chapter 23:06 provides that ‘where any person carrying on a trade in Zimbabwe purchases any property from any other person at a price in excess of the fair market price, or where he sells any property at a price less than the fair market price the Commissioner may, determine the fair market price at which such purchase or sale shall be taken into his accounts or returns for assessment”. This was the subject of debate in Elite Wholesale (Rhodesia) (Pvt) Ltd v COT (1955) 20 SATC 33, a case that involved a low marked up sale transactions between associates. The Commissioner alleged that markup was low and increased it to 15% on cost. However he lost his case after failing to prove the basis for adjustment. The court held that “If the transaction is a perfectly innocent one, the mere fact that a reduction in income has resulted is not a sufficient justification for the exercise of the power. An occasion for its exercise arises when there is something about the transaction which indicates an intention to evade assessment or tax, something which shows a lack of good faith or the presence of ‘moral dishonesty in the taxpayer’s mind’”. Contracts entered with the sole or main purpose of avoiding or postponing can also be stripped of the value and reconstituted by the Commissioner in terms of s 98 of the ITA. The section allows him or her to make adjustment raising additional tax, plus penalty and interest. Literally section 98 is invoked where the Commissioner is of the view that transaction, operation or scheme entered into or carried out by the taxpayer has the effect of avoiding, reducing or postponing tax liability, and having regard to the circumstances under which it was entered into or carried out it was by means or manner which would not normally be employed in the entering into or carrying out of such a transaction etc. and as resulted created non-arm length rights or obligations.

Contracts between related parties

The prices exchanged by related parties are often not reflective of the market conditions. Some of  the transactions between related parties can be offering technical support services within group set ups; financial assistance in terms of  loans, guarantees and extended credit terms; intangible transactions for example the use of brand, know how, IP, royalties; making available equipment either for rental payments or no consideration. Transactions like these need careful consideration of tax issues involved in terms of transfer pricing. For accounting purposes there will not be any problem in terms of pricing as financial statements are prepared based on figures. When it comes to the taxman it will be a different issue. Some companies find themselves in a scenario whereby they trade with a company in which the controlling shareholding of the company is also part of the board of the company with which that company is transacting with and enter into abnormal contracts that are predicated at tax avoidance or evasion. Upon whiff of this sort of arrangement, the taxman immediately invokes the provisions of section 2A(1)of the ITA which provide that “where a person, other than an employee, acts in accordance with the requests of another person, whether or not the persons are in a business relationship and whether or not those requests are communicated to the first-mentioned person, both persons shall be treated as associates of each other for the purposes of this Act”. The effect of this is that taxpayers will be deemed associates and this triggers application of section 98B which deals with transactions of associates. The ramifications of this kind of arrangement is well captured in subsections (1) and (2) of section 98B which provide that: “(1)Where a person engages directly or indirectly in any transaction, with an associated person, the amount of taxable income derived by a person that engages in that transaction shall be consistent with the arm’s length principle,….(2) Any amount of income that would have accrued to either of the associated persons in a controlled transaction and been taxable in Zimbabwe, shall, in the absence of the arm’s length principle be included in the taxable income of either or both of them and be liable to be taxed accordingly”. In summary associated parties transactions must satisfy the arm’s length test as provided in section 98B as read with the 35th Schedule to the ITA. The Minister in his last week National Budget Speech emphasized transfer pricing policy document for associated enterprises.

Contracts with non-residents

Nonresidents often bargain for tax reduction incurred by them on the foreign lands and often bring about the clause all taxes of the country to be borne by the payee. The effect is that any underlying taxes thereof will be borne by the recipient contrary to the provisions of the 17th , 18th ,19th Schedule and s 15(2)(a) of the ITA. These taxes must be borne by the non-resident person, but because local payees hardly pay attention to these clauses or bargain for them they end up bearing the taxes. Taxes paid on behalf of the non-resident are deemed donations and disallowed for Income Tax for Income Tax purposes in terms of s15 (2) (a) of the ITA.

Conclusion

Although taxpayers have freedom of contract, they should give careful consideration to every little detail to avoid disputes with the taxman especially when drafting the terms that govern their contracts. Contracts are just not a signature on paper, they must be carefully read, understood and unfavorable clauses corrected.