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Author: Tax Matrix Team

Due to technological developments, intangible properties have become a huge component of most companies’ statement of financial position. The body of accountancy recognises them as capital expenditure because they have a probable future inflow of economic benefits. They are an identifiable non-monetary asset without physical substance. The Organisation of Economic Cooperation Development in their Transfer Pricing Guidelines for Multinational and Administrators 2017 version have classified them into marketing and trading intangibles. Marketing intangible assets are comprised of brands, trademarks, trade names, customer relationships and copyrights. On the other hand, trading intangibles include assets, patents, and products designs, manufacturing warehouse and supplier relationships. Whichever the case may be, for accounting purposes, intangible assets are capital items. Their acquisition or development cost is capitalised for accounting purposes after meeting the recognition criteria stipulated by International Accounting Standards 38 and written off over their useful life provided they have a definite useful life.  The tax fraternity also recognises them as capital items not qualifying for deduction in the computation of income tax. The fact that intangible asset is treated as capital asset does not automatically make it qualify for capital allowances. Only expenditure on acquisition or development of computer software qualifies for capital allowance as fully explained in this article.

Computer software as per the Income Tax Act (Chapter 23:06) definition meansany set of machine-readable instructions that directs a computer’s processor to perform specific operations”.  The claiming of capital allowances on computer software is a recent development following from the case of D Bank Ltd v ZIMRA (FA 06/13) [2015] ZWHHC 135. In this case, D Bank sought to claim it as an operating expenditure qualifying for full deduction in the year it was incurred. The court dismissed the claim arguing that the expenditure was capital in nature and a prohibited deduction in terms of the law.  It was also barred from capital allowances because the expenditure had not been classified as expenditure qualifying for purposes of capital allowances. In view of the importance and growing size of this expenditure in financial institutions and Information Technology companies, the government amended the law to correct the anomaly with effect from 1 January 2015. It amended the definition of “article” in the 4th Schedule of the Income Tax Act (Chapter 23:06) to include tangible or intangible property in the form of computer software that is acquired, developed to or used by a taxpayer for the purposes of his or her trade, otherwise than as trading stock. The effect was to grant capital allowance on computer software expenditure incurred by any taxpayer deriving income from trade and investment, except for mining entities with effect from 1 January 2015. A trader, other than a miner can therefore choose either to claim Special Initial Allowances or wear & tear on computer software expenditure. Special Initial Allowance is an investment allowance which is claimed over a period of four or three years, for big businesses and Small to Medium Enterprises respectively. Where one has opted for wear and tear instead of SIA, the claim is equal to 10% per annum on the written value of expenditure on computer software regardless of size of the business.

While this was a welcome relief for persons deriving income from trade and investment, mining entities have been secluded from enjoying the benefit. The Minister of Finance and Economic Development, Prof. Mthuli Ncube in his 2020 National Budget Speech has however proposed to correct this imbalance by extending capital allowances on expenditure incurred by persons earning income from mining operations on acquisition and development of computer expenses with effect from 1 January 2019. Thus, tangible or intangible property in the form of computer software that is acquired, developed or used by the tax payer in connection with its mining operations and has been classified as capital expenditure for purposes of claiming capital redemption allowance.

Whether or not a taxpayer is a mining entity or not, the provision for capital allowances will not be applied on computer software acquired or developed for resale or sale. The expenditure will be treated as cost of goods or inventory of the taxpayer in the determination of taxable income. Meanwhile licence fees or royalties on computer software is neither tax deductible nor treated as capital expenditure ranking for capital allowances except annual and renewal fees. These are treated as deductible expenses in the computation of income tax.

Any person paying licensee fees (royalties) to a non-resident person, whether or not they are once off or renewal fees, is required to deduct non- resident tax on royalties at 15% of the royalties. A lower rate may apply if the non-resident licensor is a resident of a country that has concluded a tax treaty with Zimbabwe. Value added tax (VAT) on imported services is also applicable. This is an obligation of the resident person importing the services and is levied at the rate of 15% of the open market or invoice value of the imported services.

In conclusion taxpayers should be mindful of penalties and interest that may arise from incorrect deduction of expenditure on computer software acquired or developed by them for use in their business. The tax benefit arising from this expenditure can only arise from claiming capital allowances on this expenditure. To correct the imbalances, miners would also be getting capital redemption allowances on computer software expenditure acquired or developed for use in their trade come 1 January 2020.

Non-executive directors play a key role in good corporate decision-making hence the importance of engaging honest and experienced non-executive directors despite the size or status of an entity. They can make valuable contributions in determining corporate strategy and provide guidance on achieving strategic goals and the allocation of corporate resources to support strategic plans. The independence, objectivity and business acumen of non-executive directors compliment the detailed knowledge and experience of executive management. They are responsible for managing the affairs of a company through board meetings. There are however, concerns regarding the current tax regime of non-executive directors. Their effective tax rate is higher compared to their compatriots in business. Unlike companies; independent contractors etc; non-executive directors hardly have expenses attached to board fees hence they are taxed on gross fees.  The Minister has moved in to address this anomaly through pronouncement made in the Finance Bill number 3 of 2019 and with effect from 1 January 2020 non-executive directors will be relieved of the onerous burden and are possibly one of the biggest winners of 2020 National Budget. These measures are fully explained below.

The current law stipulates that non-executive directors are subject to 20% withholding tax on their fees. The tax is deducted and remitted to the ZIMRA by the company paying the fees. The director will then receive a withholding tax certificate as evidence that the tax has been deducted and paid over to ZIMRA. He/she will then be required to compute income tax and pay Quarterly Payments Dates (QPDs) as and when they fall due. Just like any other person in business, the director will file an income tax return after the year end. The QPDs and the final income tax are both based on 25.75%  tax rate from which the director will  be entitled to offset against this tax liability the withholding tax deducted by the company at source. The government has now scrapped the 25.75% tax on non-executive directors’ fees together with the requirement to pay QPDs and income tax, as well as filing of income tax return. The 20% withholding tax deducted by the company has been made a final tax thus simplifying the tax rules; and reducing the effective tax rate and the administrative burden for the non-executive directors.

Additionally in terms of the existing laws, a non-executive director not in possession of a valid tax clearance certificate suffers an additional 10% withholding tax on his payment. This means that a corporate which pays fees to a non-executive director not in possession of a valid tax clearance (IFT263) is required to deduct 10% withholding tax in addition to the 20% withholding tax on the non-executive directors’ fees. With effect from 1 January 2020, this is no longer a requirement. The government has exempted non-executive directors from the requirement to avail their tax clearance to corporate bodies paying them directors’ fees. This is a huge relief for non-executive directors considering that under the current tax regime the company would potentially deduct 30% for a non-executive director not in possession of a valid tax clearance certificate.  

It is important to note that, whilst the non-executive directors have been offered relief, if they receive anything over and above their fees which would be in the nature of remuneration normally given to employees they risk being treated as employees and the possibility of paying higher tax under such circumstances. Thus there are risks regarding the emergence of hybrid payments (e.g retainer fees, fuel allowance, home security services, accommodation, cellphone etc) made to non-executives over and above or as substitute to board fees and sitting allowances. In summary, non-executive directors are often conflicted when it comes to tax matters because of lack of tax knowledge. Apparently some non-executive directors are aware of the tax rules but know that if proper tax rules were to be applied by the “book” this would result in reduced earnings. Unfortunately for companies and non-executive directors ZIMRA is aware of these practices and is intensifying tax audits on payments made by companies to their non-executive directors to uncover any form of non-compliance.

Although the 20% withholding tax on non-executive director’s fees has been made a final tax, the non-executive directors are not relieved of the VAT implications of the fees in case the fees alone or together with his or her other business income exceeds VAT registration threshold. In such a case, the director will be liable to pay and file VAT returns. Meanwhile, the Minister through his 2020 National Budget Speech has declared the VAT registration threshold to be reviewed upwards to ZWL1 000,000 with effect from 1 January 2020.

In conclusion, non-executive directors are one of the biggest winners of the 2020 National Budget. Come next year, they will not be required to pay income tax and file returns since 20% withholding tax has been declared to be the final tax. In addition, they have been relieved from withholding tax on contracts for lack of tax clearance although the general practice for most appointments to such positions is that one must have a tax clearance. Meanwhile, payment of hybrid fees still exposes non-executive directors to tax risk of being classified as employees. Non-compliance with tax obligations relating to the payment of fees to NEDs may damage a company’s reputation for good governance and risk management. On the part of NEDs, integrity could also be questionable if one receives unauthorized board fees such as hybrid fees alluded to above; hence payment of tax is also a moral obligation.

The government introduced transfer pricing legislation on 1 January 2016 in order to regulate transactions involving members of the same group (subsidiaries and associates) within Zimbabwe or across the border. The rules require these transactions to be conducted at arm’s-length. A transaction is deemed to be at arm’s length if its price is similar to the one charged between independent enterprises in similar circumstances. Transactions that are under the spot light include the sale of tangible goods, provision of services, licensing of intangible and financial transactions. However, the focus of this article are financial transactions (intra-group loans). There are no specific rules for testing whether financial transactions are at arm’s length, in fact the general rules for testing arm’s length would apply. We fully explain the methodology for testing arm’s length financial transaction below:

The two components that are important in testing whether a loan or financial transaction is at arm’s length are the interest rate and the quantum of the loan. The interest rate refers to the charge the borrower is willing to pay for the funds advanced to it and this should be comparable between related parties versus that chargeable between independent parties in similar circumstances. The rate should incorporate the compensation required by the lender for the use of his money known as the base rate (risk free interest) and the premium chargeable by the lender for the risk of default imposed on the borrower of not paying payback the loan.  The risk free interest is the rate applicable when lending to the government or State because the chances for a government or State defaulting on loan obligations are next to nothing.  This rate depends largely on the currency of the loan, its tenure, the date the loan is made and whether the interest rate if fixed or floating rate. The relevant currency is that of the lender and the longer the term the higher the interest rate to compensate for the long use of money.  The risk premium is meant to compensate the lender for probability of the borrower defaulting on his/her loan. The key considerations are the creditworthiness of the borrower and the macro environment.  The borrower can bargain for a better risk premium if he has security, collateral, asset backing, interest cover, comfort letters, cashflow, covenants, guarantees, good track record, good business project etc.  The macro economic environment is also a key input in coming up with the risk premium. In a volatile environment such as that of Zimbabwe lenders would charge high interest rate because the risk of borrowers defaulting is very high and would to be compensated for taking this risk. Nevertheless, government may through the central bank regulate interest rate, again this a key input for both risk free interest and risk premium interest.  It is therefore expected that in commercial transactions between private players, the interest rate should exceed the base rate because some level of default will always exist.  Therefore as starting point, in fixing the interest rate for financial transactions related parties should consider the base since independent lenders to independent borrowers are more than willing to charge interest rate in excess of that charged to governments or States.   

Before concluding on this subject matter, whether or not a financial transaction is at arm’s length regard must have been made to quantum of the loan versus the capacity of the borrower. Any commercial lender would want to determine whether a prospective borrower is thinly capitalised, because this might indicate the capacity of the borrower to pay the debt. It is necessary to determine how much the borrower could have borrowed on a stand-alone basis. In testing this, the comparability factors for testing the credit worthiness of the borrower should be considered in order to determine how much debt would be appropriate and viable for the borrower if it were an independent company. Meanwhile, Zimbabwe has thin capitalisation rules for regulating intra group loans which provides for a debt to equity ratio of 3:1. Interest charge on excessive debt is disallowed when computing income tax. Although these rules are not transfer pricing rules per se, they constitute a key consideration in evaluating the capacity of the borrower to repay the loan.

In summary, related parties must consider factors highlighted in this document when fixing interest rate on intra group loan in order to stay within the arm’s length range. The interest rate and the quantum of the loan should be comparable to those in transactions between independent parties.  The analysis should be undertaken from both the lender’s and the borrower’s perspective. A two-sided analysis involves a review of risks borne by the lender when lending monies and requires consideration of the cost of obtaining these funds by the borrower. The analysis must also take into consideration the debt capacity of the borrower. A debt capacity analysis ascertains how much debt the borrower can service without defaulting on its obligations. This is important because any excess debt undertaken by the borrower will be considered at non-arm’s length, and interest deductions on that part of the debt could be denied for tax purposes. This analysis is generally undertaken by analyzing the liquidity and solvency ratios of the borrower. In light of the harsh penalties imposed by the government for failing to comply with the transfer pricing laws, related parties must exercise care when fixing the interest rate on intra group loans. Excessive interest could lead to non-deductible interest expense, double taxation, penalties or other more serious sanctions imposed on them by the government. On the other hand inadequate interest charge may result in the ZIMRA imputing income on the lender which action has almost the same implication as the charging of excessive interest rate.

Company cars have long been seen as a valuable perk because of the flexibility, prestige and convenience they provide to employees. The flexibility comes about because employees are able to embark on private travel; and prestige arises from travelling in personal cars as opposed to using public transport. However, the potential tax implications are rather less appealing because the use of company cars is regarded as a taxable benefit to the employee in terms of the law. The envisaged use includes travelling between home and place of work or vice versa or other personal errands of employees.  Choosing a more luxurious car can prove very expensive and disastrous to an employee because the bigger the car the more the taxable benefit. Thus the applicable tax depends on one’s earnings and the engine capacity of the car. Simply put, high earners driving expensive cars will pay the most.  Whilst the employee’s salary may remain fixed, higher taxes may be payable if one opts for a car with higher engine capacity. The recent announcement by the Minister of Finance and Economic Development, Professor Mthuli Ncube through the National Budget Speech of the new motoring of benefits commencing 1 January 2020 is a clear testimony. For instance, for a lower engine capacity of up to 1500cc and a higher engine capacity of above 3000cc the annual taxable benefit will be ZWL$54,000 and ZWL$144,000 respectively. Although the Minister has maintained the value of the taxable benefit this year compared to last year in real terms, the figures in Zimbabwe dollar are shocking and beyond reach for many since salaries and wages in functional currency have not been increased by that margin.  The implication is that some employees may give up company cars or are likely to go home with negative net pay. We do not envisage some employers affording to increase employees’ earnings to cater for the increase in motoring benefits. This is not the only scary point concerning luxury cars in Zimbabwe as discussed below.

The increase in motoring benefit as aforesaid has spill over effects on employers who are VAT registered operators. The motoring benefit is a deemed supply for VAT purposes. The employer will therefore be required to declare VAT based on the new values. This therefore adds to the cost of doing business in the hands of companies that are VAT registered as they will be required to foot more in terms of VAT on motoring benefit. Furthermore, Statutory Instrument 33 of 2019 declared that all values previously expressed in United States Dollar are converted to Zimbabwe dollar on 1:1 basis with effect from the 22nd of February 2019. This means that the cost base for tax purposes of amounts previously expressed in United States dollar remained fixed in absolute terms despite low purchasing power. This is also confirmed by s2 of the Finance Act no. 2 of 2019 which pronounced that values, figures or symbols contained in the Revenue Acts wherever stated as Untied States Dollar should be read Zimbabwean dollar, values, symbols or amounts. In this case the value for passenger motor vehicles (luxury cars) for purposes of claiming capital allowances was previously fixed at US$10,000 and this value was not changed and accordingly it now reads ZWL$10,000. In real terms the value has tumbled following increase in the foreign exchange rate, the Zimbabwe dollar to the United States dollar. Companies are therefore eligible to claim less capital allowances on luxury cars compared to last year and in actual fact; the capital allowances have become worthless as a tax incentive.

As if this is not enough the government has also restricted the value of duty free importation of luxury vehicles for returning residence to US$5000. Accordingly, returning residents who import motor vehicles in excess of this threshold will be required to pay import duty based on the stipulated rates.  This literally means that the government is banning the free importation of luxury vehicles. It is only making room for cheaper vehicles.

Last year the government introduced the law which designated certain products to be imported and duty paid for in foreign currency. Among this list are luxury motor vehicles. The implication is that importation of luxury motor vehicles now costs more considering that the Zimbabwe Dollar is not at par with the foreign currency charged for duty and they are now beyond the reach of many citizens.

In a nutshell the use of luxury cars is becoming unbearable to both employees and employers. This is further compounded by the rising motor vehicle running costs such as the cost of fuel. We envisage the number of drivers to fall as the luxury car taxes go up. Going forward more people are expected to use public transport under these circumstances. It is no longer cost effective to use luxury cars from both the perspective of employer and employee. Invariably the use of luxury cars has a negative impact on the fiscus in terms of importation bill (in terms of current deficit), the environmental and social impacts. That is; use of more cars may result in increased air pollution, traffic accidents, congestion and noise. Nevertheless; people may find it difficult to report for duty at work unless if a reliable, affordable and efficient transport system is in place. The government initiative on Zimbabwe Passenger Company (ZUPCO) needs upgrading through introducing reliable and efficient passenger trains especially in areas where we already have the railway system.

Restrictive covenants or agreements are often agreements entered into between the employers and top echelon, e.g. chief executives, directors, executive managers etc whereupon the employer pays an employee an amount in return for the latter agreeing not to compete with the employer on termination of employment.  The agreement may also take the form of a legal contract between a buyer and a seller of a business. Whichever form it takes the seller or the employee is restrained from engaging in a similar business or taking up employment within a specified geographical area and/or within a specified period of time. Of concern is how these payments are treated for income tax purposes from both the payer and the recipient perspectives.

To the payer of restraint of trade, the test for the deductibility is embodied in s15 (2) (a) of the Income Tax Act. The section stipulates that expenditure or losses are deducted if they are incurred in the production of income or for the purposes of trade of the taxpayer, except to the extent to which they are expenditure or losses of a capital nature. Of relevance to our discussion is whether a payment of restraint of trade is capital in nature or not, because as it fully appears the expenditure is incurred in the pursuance of trade or in the production of income. There is no definitive definition of capital nature expenditure. However it is widely accepted in the accounting profession that capital nature expenditure includes the cost of acquiring fixed assets, share capital or capital employed in business, an income-producing unit, goodwill, intellectual property (software, patents, trademarks etc.), and cost of improving or enhancing any of these items plus related expenses. By accepting a restraint of trade contract the payee (seller or employee) agrees to impair his/her future income production capacity, whilst the buyer or employer will be protecting his/her future business or income from being diminished. In other words the contract is meant to protect the future downsize risk of the buyer or employer, alternatively it impairs the employee or seller’s future income. For these reasons restraint of trade payments are viewed as capital nature. This is further confirmed by the decision in Tuck v CIR 1988 (3) SA 819 (A) which stated that a payment in consideration for agreeing to a restraint of trade is a receipt of a capital nature.  The payer of restraint of trade is therefore barred from deducting it in his/her income tax return, only recurrent or revenue expenditure is tax deductible.    

To the recipient, the concept of gross income excludes capital nature income. As alluded above a restraint of trade payment is capital in nature. It is therefore non-taxable to the recipient. In other words, where a person’s right to freely trade is restricted and the person is paid for that restriction, the payment is akin to compensation for loss or sterilization of a fixed asset. The recipient by means of such covenant surrenders a portion of his/her income-earning capacity in return for a payment of money. He is parting with a capital asset and the payment is of a capital nature which is excluded from gross income as propounded in the case of Taeuber & Corssen (Pty) Ltd v SIR, 1975 (3) SA 649 (A) (37 SATC 129).

Meanwhile, the ZIMRA may seek to discredit a contract in restraint of trade on the basis that it is a disguised agreement “to compensate the employee for services rendered/to be rendered and to retain such services of the employee”, that is, it is not a genuine restraint of trade contract.  In testing whether the restraint of trade is genuine or not the courts have applied some tests, among them; whether the recipient in fact surrendered a right of a capital nature i.e. there must be the sterilization of the recipient’s right to freely trade in some manner. Additionally, the recipient must be in a position to cause a loss to the payer’s business in the event that the restraint acts are not observed. The threat should emanate from the nature and scope of the recipient’s involvement with the payer. If no danger of such prejudice exists, the payment may be considered for tax purposes as additional income for services rendered or for services which are to be rendered and will be subject to tax.  The employer must be able to prove that it has a legitimate interest in imposing a restraint, and that the restraint is no wider than reasonably necessary. For example a restraint of trade cannot be as to the whole world or for an indefinite period. It must be reasonable geographically (in radius) and in duration. For example a restraint of trade in respect of a business in Harare cannot be regarded as genuine where it restrains the opening of business of a similar nature for instance in Lusaka. It was alluded to in Automotive Tooling Systems (Pty) Ltd v SJ Wilkens [2006] 128 (RSA) that a restraint of trade agreement is not legally enforceable unless it intends to protect an employer’s proprietary interests and that an agreement that merely seeks to prevent an erstwhile employee from utilising the skills and knowledge learned on the job in the service of someone else is not legally enforceable. In CSARS vs. McRae 64 SATC 1, 2001, lump sum payments were made by employer to employee in terms of certain Stock Unit Plan aimed at providing employees who make an important contribution to the company’s success before their retirement. The plan also restrained employees from going into competition with their employer on retirement or termination of employment. In deciding whether the payments were made in respect of services rendered or in respect of restraint, or both, the court held that the agreement contained element of both service and restraint and apportioned on the basis of 50% each.

In conclusion, the contracting parties should carefully examine the contracts they enter into. Clear words have to be used in the crafting of contracts. This will enable ease of characterisation of payments that will be made in terms of such contracts on whether it will be a payment for service or restraint of trade. This is critical due to the different tax implications they present to both the payer and the recipient. The fact that an amount is not a genuine restraint of trade (thus taxable to the employee) does not automatically follow that it will then be allowed as a deduction to the payer. In other words, the treatment of restraint of trade payment for employees’ tax does influence the revenue authority’s treatment of expenditure for income tax purposes in the hands of the payer (employer). It may be prudent to have your consultant look at the tax implications of your contract before signing.

Making a payment in return for you to have your video with your products and services played at an event, workshop or conference is undoubtedly in connection with production of income.  A payment to a football club, or towards a school event, for no exchange of immediate goods or services from the recipient of sponsorship or third parties sounds somewhat a donation. However the fact that sponsorship does not result in an immediate supply of goods, services or benefit to the sponsor should not be the reason for disallowing it as an expense for income tax purposes. The motive for the sponsorship and its connectivity to the business of the taxpayer matters much more as fully explained below.    

Expenditure is allowed for tax purposes if it has been incurred by the taxpayer in the production of income or for the purposes of the trade of the taxpayer. The case of Port Elizabeth Electric Tramway Co Ltd v Commissioner of Inland Revenue 8 SATC 13 (CPD) held that expenditure is for the production of income if its purpose is to produce income. In order for it to be viewed as such, the act to which it is attached should be performed in the production of income or performed bona fide for the purpose of carrying on trade which earns the income. The expenditure should be closely linked to such act that it can be regarded as part of the cost of performing it. It does not matter whether the expenditure in question is necessary for the performance of the act, attached to it by chance or bona fide incurred for the more efficient performance of business operations. The problem with sponsorship is that it is in the middle of the road between donation and advertisement. When viewed as a donation “in the production of income” motive becomes farfetched because of some element of philanthropy, hence disallowed for income tax purposes.  The taxpayer must prove that the sponsorship was necessary in bringing brand eminence, awareness, publicity and advance its standing or market in the area in which the sponsorship activity has been undertaken to qualify for deduction. For example sponsorship of a football tournament or a football team can bring brand awareness and prominence to the audience and advance the business of a taxpayer. 

In a nutshell, a close connection should exist between the sponsorship and the taxpayer’s business. It does not matter whether a third party is also to benefit out of the sponsorship. What matters is that the business is being promoted by incurring the sponsorship expenditure. Put differently, a nexus must exist between the sponsorship being incurred and the production of income in the year of assessment. As an example, a deduction may be allowed of the cost of reimbursing a sporting team for its purchased bus that displays the sponsor’s name or for sponsoring a sporting competition named after the sponsor. However, a deduction may not be allowed for a gift to a school attended by the donor’s child where the school is in another district away from where business activities are conducted or where the business proprietor sponsors a sporting activity which is part of his/her hobby. There must exist a relationship of the potential market to the taxpayer’s business and the relationship between expenditure and the ultimate income derived. For example, a sale of bulls at an agricultural show by a farmer sponsoring the event in return for being able to display the bulls shows a direct relationship between the sponsorship expenditure and the resultant income. A deduction may also be allowed for sponsoring a sporting team where the business name is displayed on players’ jerseys.  Nevertheless, an up-front sponsorship payment covering more than a year advertising period may be subject to the rules on prepayments .These rules provide that expenditure is allowed in the year to which it relates.

Notwithstanding sponsorship expenditure being incurred in the production of income, capital nature sponsorship is disallowed. Capital nature sponsorship has its main object of creating an image or goodwill (e.g. promoting name of the company) or bringing an enduring benefit to the taxpayer. In the caseof Shell Rhodesia (Pvt) Limited v COT. J.273 (I.T.C. 1129, 31 S.A.T.C. 144); the taxpayer awarded bursaries to Rhodesian citizens and also paid certain sums to the Rhodesian College of Music to enable that college to assist its students. There was no obligation on any of the recipients of the bursaries to enter the taxpayer’s employment on completing his education. An attempt by the taxpayer to deduct the amounts as advertising expenditure, incurred wholly and exclusively for purpose of its trade was denied on the basis the expenditure was held to be of a capital nature because the object of the expenditure was not immediately and directly to increase taxpayer’s sales but to improve its public image and so to build up goodwill. The case of; Rothmans of Pall Mall (Rhod) Limited v COT. J. 336. (1973) was however distinguished. Over a period of four tax years, the taxpayer, a cigarette company, paid certain amounts in sponsoring the National Sports Foundation. It was common cause that the payments were made to secure an advantage over its competitors in the advertisement of its name and in marketing research. The Commissioner had contended that the expenditure was meant to create goodwill, but the court ruled that the taxpayer’s main object was not to create an image or goodwill but to provide an opportunity for advertisement and also to conduct market research. The advantage or benefit obtained was not long term or enduring. The expenditure was of a recurrent nature and was more closely related to the performance of the income producing operations than to the income producing machine and hence tax deductible.

The burden of proof that the sponsorship expenditure is deductible lies with the taxpayer. This can be strengthened by instituting proper internal control systems. For example when committing to a sponsorship agreement, it is important to spell out the benefits to be derived by the sponsor from the sponsorship. In turn the sponsorship agreement and supporting documents e.g. a letter of approach from the organisation, tax invoices for the sponsorship, written evidence of all contributions made, contract of terms and conditions for the sponsorship must be retained as evidence in support of the claim.  The sponsorship agreement should be a specific requirement in the promotion of a taxpayer’s business. It should also reflect the extent and prominence of the business exposure. Making the sponsorship arrangement part of a coherent marketing strategy bolsters chances of the sponsorship expenditure being deducted.

Disputes are a part of humanity, they are inevitable, and most of us will someday need a lawyer to defend us. When you are thinking of getting a divorce, writing or entering into a lease agreement, fighting a tax dispute or you were involved in an accident and want to sue the other driver you will definitely need the services of an attorney where upon legal fees may be payable. Legal fees broadly cover fees for services of legal practitioners, expenses incurred in procuring evidence or expert advice, court fees, witness fees and expenses, taxing fees, the fees and expenses of sheriffs or messengers of court and other litigation expenses etc.  Whether all these expenses are tax deductible or not, it depends on the underlying claim.

An expenditure or loss is deductible for tax purposes if it is incurred for purposes of trade or in the production of income other than expenditure or losses of a capital nature. Accordingly legal expenses must meet this test to be deductible. The claim, dispute or action at law should arise in the ordinary course of or by any reason of the taxpayer’s trade or during the course of producing income. Exceptions are with regard to legal costs of a capital, domestic or private nature, those incurred in earning exempt and non-taxable income or legal costs that are contrary to the public policy doctrine.

Capital in nature legal costs are those incurred for the purposes of acquiring or improving a capital asset for the enduring benefit of business, costs incurred in defending an act which is meant to protect a capital asset, amending the corporate charter, incorporation, amalgamation, corporate reorganization, share issue, initially listing or increase in capital stock etc. Fees paid for advice or in litigation to establish an exclusive right to a trade name are also capital in nature since the benefit is of indefinite duration. The cost of preserving asset or copyright is also capital in nature. It was however held in ITC 1528, 54 SATC 243,that capital in nature legal costs do not include the cost of removing a business obstacle since this is not designed to bring an asset into existence. All is not lost with regards to legal costs incurred in relation to assets ranking for capital allowances such as factory buildings, commercial buildings, intangible assets in the nature of acquired or developed computer software, movable assets to be used in business etc. These may have to be added to the cost of an asset and written off over the useful life of the asset through a method of capital allowance. If the asset does not rank for capital allowances, the fee becomes deductible only for purposes of capital gains tax when the asset is sold or disposed.

Any legal fees associated with production of income save for those which are of a capital nature are tax deductible. This covers legal expenses incurred by a landlord in an appeal to the rent board regarding rental increase. The same applies to cost of evicting a tenant to seeking more rentals as opposed to those incurred when contemplating change of use of property. Legal expenses for employee related dispute are also deemed incurred in the production of income.  On the other hand, legal costs incurred in order to protect impairment of right or preventing total or partial extinction of the business (see African Greyhound Racing association Ltd v CIR) are disallowed on the pretext that they are deemed connected to the protection of an asset or right. So are legal costs incurred in resisting an order of ejectment from business premises because this is linked to the business more than the impairment of current year income.

A long established rule is that expenditure contrary to the public policy doctrine should never be allowed for tax purposes. This doctrine is against promoting activities which are against the national or state policies or interests. Simply put expenditure or expenses resulting from unlawful or undesirable conduct cannot be considered incurred in the production of income or for purposes of trade. The same applies to legal expenses incurred by the taxpayer seeking advice on tax matters or in fighting a tax bill. However, the Income Tax Act provides for deduction of income tax appeal costs in the High or Supreme Court on a tax case successfully won by the taxpayer and if the case is partially won, partial deduction is granted. In practice legal costs incurred in the collection of outstanding debts are deemed incurred in the production of income and are tax deductible.

No deduction is allowed for payments for legal services in primarily personal matters, for example legal costs for the preparation of wills; the prosecution or defense of actions to recover damages for personal injuries, or the prosecution or defense of actions for separation or divorce etc. Personal or domestic expenses broadly covers cost of maintaining taxpayer and his family, household expenses e.g. food, clothing and shelter etc., medical expenses and clothing, other than protective clothing or compulsory work clothing and those worn by television presenters and related cleaning cost. Therefore related legal costs are accordingly disallowed. A lawyer fees that is incurred in respect of exempt or income not from a source within Zimbabwe is non-deductible.

In conclusion legal expenses take their tax nature from that of the underlying claim. If the claim is about damage to a capital asset like goodwill, the legal costs will not be deductible. If it involves loss of earnings, for example, the legal costs will be deductible. Meanwhile, you should scrutinize legal expenses to ensure that they are deductible in terms of the law in order to avoid penalty implications and any business reputation.

Expenditure is deducted in the computation of income tax if it has been incurred in the production of income or for the purposes of trade. Expenditure on acquisition or construction of fixed assets, known as property, plant and equipment (PPE) is not deducted but is written off against taxable income over the tax life of the PPE by way of capital allowances. Assets ranking for capital allowances include Commercial buildings; Industrial buildings; Staff houses; Farm improvements; Implements, machinery or utensils; Motor Vehicles; Computer software among others. Capital allowances are available to all persons deriving income from trade and investment namely sole traders, independent contractors, non-executive directors, partners, companies, and trusts with taxable income etc irrespective of the type of business undertaken. However miners and petroleum operators, have their own methods of claiming capital expenditure. 

Capital allowances is the practice of allowing a taxpayer to get a tax relief on capital expenditure by allowing it to be expensed against its annual pre-tax income. Assets must be used in the production of income or for the purposes of trade and also held at the end of the year of assessment. If an asset is constructed or acquired in one tax year then put into use in the following year, capital allowances are only claimed in the year the asset is put into use. Capital expenditure includes the cost of acquiring or construction of the asset itself, initial set up, installation, programming, travel cost to purchase the asset, freight charges, transit insurance, irrecoverable VAT, borrowing cost, foreign exchange losses in respect of the asset etc. There are two methods of claiming capital expenditure, namely Special Initial Allowance (SIA) and Wear & Tear (W&T).

SIA is an investment allowance granted upon election on constructed buildings (other than commercial), additions, alterations or improvement to the said buildings (other commercial buildings) and movable purchased. The Act provides for 90% de minimis use rule, meaning the property must be used at least 90 percent in the production of income or for purposes of trade to be granted SIA. The current rate for SIA is 25% for big businesses and 50% for SMEs in the first year. After the first year, accelerated wear & tear is 25% per annum for three years in the case of big businesses and 25% per annum for 2 years for SMEs. SIA is never apportioned, either the taxpayer qualifies or does not qualify for SIA at all. It is also computed based on cost. Assets under a finance lease qualify for SIA in the hands of the lessee.

Wear and tear is granted in all cases where SIA has not been granted. It is computed on cost of immovable assets purchased or constructed by the taxpayer, additions, alterations and improvements made to immovable properties and on movable property (including on computer software acquired or developed). Wear and Tear is computed on the written down value (tax value) of the asset for movable assets. Wear and tear is not an elective allowance, taxpayers automatically qualifies it in cases where SIA has not been granted. Unlike SIA, wear and tear can also be given on inherited or assets acquired through donation. The rate of wear and tear on immovable property is 5% per annum (2.5% on cost for commercial buildings) and is never apportioned. The general rate of wear and tear on movable property and computer software is 10% on written down value, exceptional cases include motor vehicles where the rate is 20% on written down value. Wear and tear is apportioned in the case of movable property used partly for business and private by the owners of the business. Accelerating capital allowances allows taxpayers to minimise their tax liabilities, making SIA a favourable method to claim wherever possible. However, it is not beneficial for a taxpayer with assessed losses which are about to expire to choose special initial allowance because it will result in increased assessed loss which may not be recovered.

Because certain expenditure also benefits employees among them passenger motor vehicles and employee houses (staff housing), cost ceilings are imposed on it qualifying for capital allowances.  Income Tax Act defines ‘staff housing’  inter alia, as any ‘permanent building’ used by the taxpayer for the purposes of his trade wholly or mainly for the housing of his employees, but does not include a residential unit the erection of which commenced on or after 1 January 2009 whose cost exceeds ZWL25,000. A “residential unit” means an apartment, flat, house whether detached, semi-detached or terraced, or similar unit of residential accommodation. A unit that exceeds the said threshold is qualified for purposes of capital allowances. A passenger motor vehicle is a motor vehicle propelled by mechanical or electrical power and intended or adapted for use or capable of being used on roads mainly for the conveyance of passengers. These are luxury type of motor vehicles namely station wagons, estate cars, vans, 4×4 double cabs excluding vehicles used for conveying passengers for gain, used by hotel operators to convey their guests, carrying 15 or more passengers excluding the driver, a vehicle purchased by a taxpayer for leasing under a finance lease, caravans and ambulances.  Taxpayers are free to buy passenger motor vehicles of their choice at any cost however, for purpose of capital allowances expenditure in excess of ZWL10,000 per passenger motor is disregarded. 

The caps for both staff housing and passenger motor vehicle as above were not reviewed along with other adjustments made through Finance Act no 2 of 2019, thereby have lost meaning as tax incentives. They were previously expressed in United States Dollar but with the gazetting of Statutory Instrument 33 and the amendment in the Finance Act no 2 of 2019, these figures were converted into Zimbabwe dollar on one to one basis.    Capital allowances are incentives on capital expenditure which taxpayers must take advantage of, but it is difficult to claim these when you are not a registered taxpayer or have no internal system for tracking your capital expenditure.

Input tax is tax incurred by a VAT registered operator on goods or services acquired for use, consumption or supply in the production of taxable supplies including that incurred on imports for use, consumption or supply in the production of taxable supplies. Only persons who are registered for VAT, known as registered operators are permitted to claim input tax. They may either offset it against output VAT or recover it as a refund from the ZIMRA. Taxable supplies are supplies which are charged to VAT at 15 percent, known as standard rate supplies and those charged to tax at zero percent are called zero-rated supplies. A third category of supplies is called exempt supplies and a person supplying 100% exempt  supplies does not charge VAT on his sales nor claim input tax. An operator making both taxable and exempt supplies (non-taxable supplies) during an accounting period can claim input tax in proportion to the taxable element only as more fully explained below.

Theoretically it is easy to account for input tax when an operator only makes taxable supplies or exempt supplies. In practice an operator will make purely taxable supplies or purely exempt supplies only in exceptional circumstances. Such a mixture of supplies gives rise to one of the most problematic areas in any VAT system, namely the question of apportionment of input tax. Apportionment refers to the fact that only a portion of input tax that was paid is claimable – the portion not claimable will be added to the expense and will be deductible for income tax purposes when the business is assessed for income tax. Where possible, input tax suffered should be attributable directly to related supplies based on the actual or intended use of goods or services when they are received. Where input tax is exclusively attributable to taxable supplies, a trader is entitled to deduct it in full from the output tax due on his taxable supplies. In contrast, where input tax is exclusively attributable to exempt supplies, none of it is claimable. This means that the use to which an input is put is important. Input tax can only be attributable if the whole of the supply to which the input tax relates is used for either exclusively taxable or wholly exempt supplies, and there is a direct or an immediate link. Where this is not possible, the input tax becomes residual input tax which must be allocated by way of apportionment.  

Therefore in the event of input tax being incurred for mixed purposes, claimable portion is calculated according to the apportionment percentage by using an approved method of the Commissioner of the Zimbabwe Revenue Authority (ZIMRA). The only approved method which may be used to apportion input tax in terms of the Act without prior written approval from the Commissioner is the turnover-based method. The guidance on how the turnover-based method should be applied is taxable supplies exclusive of VAT divided by the total supplies (taxable plus non-taxable supplies exclusive of VAT) multiplied by total input tax incurred. When computing the income or turnover certain elements such as the cash value of goods supplied under an instalment credit agreement, supplies of capital goods or services which have been used for trade purposes and the value of any goods or services supplied for which input tax deduction is always denied e.g. income from sale of passenger motor vehicle are excluded

A registered operator who wants to use some other method which is not the turnover based should seek the prior approval of the Commissioner. The Commissioner would need to be satisfied that such other method fairly and reasonably represents the extent to which goods or services are used or are to be used by the registered operator in making taxable supplies. In other words the method must suit the special circumstances of individual registered businesses or reflect the use made by the taxable person of the relevant goods or services in making taxable supplies. The courts have held that in order for a method to be regarded as fair and reasonable it should be “sensible”, “sane”, and “not asking for too much”.. For example what may be considered fair and reasonable basis for apportioning the rent could be the floor space. “Taxable floor space” for this purpose means areas of the building used for making taxable supplies of building space to customers. Meanwhile, taxpayers are warned that methods which are not turnover based should be used or applied with caution, because they often change with time. Use of multiple methods notwithstanding the behaviour pattern of the applicable expenses should also be avoided. Further, the method so selected should be based on the information that is in possession of the taxpayer without having to resort to hiring expensive third parties, such as valuators.

The Act provides for de minimis apportionment rules. This means if the proportion of an input tax claim exceeds a given amount or ratio the registered person would be allowed full or 100 percent input tax or refund. The main purpose of these rules is to simplify VAT administration and compliance for tax officers and taxpayers. The VAT Act makes provision for such rule and provides that where the goods or services so acquired are used at least 90 percent for the purposes of making taxable supplies, full input tax credit may be granted. This indicates that input tax should be apportioned when the intended use of goods and services in the course of making taxable supplies is less than 90% of the total intended use of such goods and services. There are tax ramifications for not apportioning input tax where goods or services are acquired for use, consumption or supply in the making of mixed supplies. ZIMRA will disallow the undue input tax and levy penalties and interest.

A leasehold improvement is expenditure which adds something new to the leased property and which should ordinarily be treated as capital expenditure. Because the land or building on which they are effected belongs to the landlord, the improvement will become the property of the landlord upon termination of the lease through accession. For this reason they are treated as additional rental income to him and additional rental paid by the tenant. They have income tax and VAT implications to both the landlord and tenant, but discussion in this article is only concerned with income tax implications as fully explained below.

A tenant is permitted in each year of assessment to deduct the value of lease improvement divided by the shorter of the remaining lease period in years (unexpired lease period) and 10 years. The unexpired lease period is calculated from the date improvements are first used or occupied by the tenant for purposes of his trade or in the production of income. However deduction is not granted to a tenant in respect of improvements effected on property not used or occupied by him for purposes of trade or which does not produce income. If the property is used or occupied by him partly for purpose of trade or in the production of income and for some other purposes, the Commissioner is given the discretion to reduce the allowance by such amount as he, in the circumstances, considers fair and reasonable. To the landlord, the lease improvements represent taxable income which should be spread in equal instalment over the shorter of unexpired period of the lease or 10 years commencing the date improvements are completed. If the tenant is entitled to such use or occupation for an indefinite period or the agreement is silent regarding the lease period, a period of 10 years is deemed and where the lease term is renewable or extended for a further period or periods, the extended period is not counted.

The tenant should ensure that there is a lease agreement which obligates him to effect improvements and that the expenditure is incurred by him in pursuance of such obligation in respect of a property used or occupied by him for purposes of trade or in the production of income. Otherwise an allowance cannot be granted to him if these conditions are not satisfied. Although it is possible at law to conclude an enforceable oral lease agreement, a written agreement serves as a burden of proof in the event of a dispute with the ZIMRA. Des Kruger Tax Strategy 4th Edition on page 94 observed that a contract imposing an obligation on a tenant to effect improvements should constitute an agreement granting the right of use or occupation of property. It provides further that the lease agreement should include a clause on the obligation to effect the lease improvements. This obligation must not be left to the discretion of the tenant to effect the improvements rather it must be compulsory for him to do so. If he fails to do so the landlord should be empowered to demand that the improvements are effected and to sue for specific performance.

Having to stipulate the value of improvement to be effected helps as burden of proof for a tenant seeking to claim the expenditure. However, where none has been stipulated, the Commissioner is given the discretion to determine the value. There are times when the parties due to economic factors such as inflation may want to vary the value of the improvements. In order to cater for such variation they must incorporate a clause in the agreement. This enables acceptance of the amended value of improvements provided such variation is agreed upon prior to completion of construction. If the variation is made after completion of construction, only the agreed original figure is recognised and the excess treated as voluntary improvements. If the improvements are required to meet certain specifications, with certain minimum value, the value of improvements shall be the fair and reasonable value and not merely the minimum amount stated. The case of ITC 1036 (1963) 26 SATC 84 noted that, in such cases the landlord is not simply asking for improvements to be erected, he is requesting for specific improvements, and the tenant must meet his requirements even if the cost exceeds the stated minimum value in the lease. If the value is below the minimum stated value, the improvements are disregarded. Meanwhile, any improvements which are meant to brand the tenant’s business or not required for purposes of the business of the lessor are considered not effected under an obligation under lease.  

If a lease agreement is cancelled, ceded or assigned, or the land or buildings on which the improvements were effected is disposed of or sold or the landlord is deceased or declared insolvent, before the improvements are fully taxed to the lessor, the outstanding balance is deemed to have accrued to the landlord immediately. A tenant who acquires the ownership of improvements in respect of which a lease improvement allowance has been granted, shall cease to qualify for deduction of lease improvement from the year of assessment following that in which he acquires such ownership.

In conclusion, when entering into a new lease agreement, both tenants and landlords need to be careful as to who will be paying for the leasehold improvements. If the landlord bears the cost, in which case he would own the improvements and he would be permitted to claim capital allowances on these improvements over the statutorily prescribed life. There would be no tax consequences for the tenant in this scenario unless he also contributes to the cost of improvements. If the improvements are effected in terms of the agreement, the landlord will be taxable on the improvements and the tenant permitted to deduct the expenditure, as outlined above. In a third scenario, where a tenant is permitted to set off the improvements against rent, the improvements will be taxable and deducted in the hands of the landlord and tenant respectively. The taxable or deductible portion of the improvements must be equal to rent that accrues under the agreement at each taxing period.