Contracts are an important aspect of taxation because they help guarantee that all parties involved in a transaction understand the terms and circumstances. Contracts can be used to outline both parties’ rights and obligations, establish payment arrangements, describe tax liabilities, stipulate how disputes will be settled if necessary. A contract in place before any transaction between two or more parties reduces uncertainty about expectations from each side while also provides legal protection for those involved if something goes wrong during contract term. When it comes to signing of contracts, the ancient adage “cavet subscriptor” is quite significant. Aside from economic problems that may emerge between the contracting parties, contracts are tools that, if improperly structured, might bring unwelcome taxes (tax penalties and interest). Where contracts and reality or behaviour differ, the latter prevails for tax purposes, and contracts become worthless paperwork in the eyes of the taxman. To that end, taxpayers are requested to be more cautious when signing contracts and to engage taxpayers in advance rather than as an afterthought, lest it be a case of closing the barn door after the horses have run.
Contract signing is more than just signing your name on paper; one must pay close attention to detail. A trite legal principle that loosely translates as “signatory beware” is caveat subscriptor. It implies documents must be thoroughly reviewed and understood in terms of their legal and fiscal implications before signing. Many times, businesses get into agreements with other parties without fully comprehending the consequences. In rare cases, a taxpayer may enter into an arrangement without fully understanding its tax ramifications. This frequently leads in the taxpayer being subject to penalties and interest. When entering into a contract, it should be at arm’s length, which means that the agreement should be at fair market value, regardless of whether the parties are related or unrelated. This means that, in terms of pricing, the negotiated charges should be at market rate, and the terms should not be bent in favour of either party just because of their relationship. Section 23 (1) of the Income Tax Act states that “where any person carrying on a trade in Zimbabwe purchases any property, whether movable or immovable, from any other person at a price greater than the fair market price, or where he sells any property, whether movable or immovable, to any other person at a price less than the fair market price, the Commissioner may, for the purpose of determining the taxable income or assessed loss establish the fair market price at which such acquisition or transaction shall be accounted for or returned for assessment.” This is buttressed by the case of: Elite Wholesale (Rhodesia) (Pvt) Ltd v COT (1955) 20 SATC 33 where court alleged that “if the transaction is perfectly innocent, if it is not fictitious or colorable, the mere fact that income has been reduced is not a sufficient justification for the exercise of the power…”. When there is something about the transaction that indicates a desire… to escape assessment or tax, something that shows a lack of good faith or the presence of (citing precedents), moral dishonesty in the taxpayer’s mind,’ it becomes an occasion for its application. Section 98 of the Act further empowers the Commissioner to rebuild contracts or refuse to enforce the provisions of a contract that he believes was written solely for the purpose of tax avoidance. The Commissioner will rebuild the contract in any way he considers suitable to prevent that avoidance. As such when taxpayers go on the other side of the road they find themselves in situations where they are obligated to pay taxes that they did not expect to pay. Contracts must be written with not only business commitments in mind, but also with tax obligations in mind.
In cases of contracts involving related parties when corporations get into agreements, they frequently undercharge or overcharge each other when comparison is done on transactions involving unrelated parties. Offering technical support services within group setups; financial assistance in the form of loans, guarantees, and extended credit terms; intangible transactions such as the use of brand, know-how, intellectual property and making available equipment for rental payments are examples of transactions between related parties. These types of transactions necessitate thorough examination because of the tax problems involved in terms of transfer pricing. Contracts must be structured with tax requirements as well as commercial commitments in mind. These types of transactions need a full assessment of the tax issues associated with them. Some businesses find themselves in a situation where they deal with a corporation whose controlling shareholding is also on the board of the company with which they are transacting, and they enter into unusual arrangements based on tax avoidance or evasion. When the taxman detects this type of agreement, he promptly invokes the provisions of section 2A(1) of the Income Tax Act. When section 2A is activated, the following section to be applied is section 98B, which deals with associate transactions. The consequences of such an arrangement are effectively represented in subsections (1) and (2) of section 98B thus penalties which could have been avoided.
Contracts with non-residents
Certain clauses in contracts with non-residents must be avoided by taxpayers. Non-residents frequently bargain for tax reductions on foreign lands and frequently bring about the provision “all taxes of the country to be borne by the payee.” This is a highly problematic clause since it places the tax burden on the payee, despite the fact that rules such as the 17th Schedule expressly say that non-resident tax on fees is the non-resident’s responsibility. Unfortunately, because taxpayers do not understand the terms of the contract, they are forced to gross up (pay tax on customers’ behalf) in order to comply with tax obligations.
Although businesses enjoy contract freedom, they should pay close attention to every detail to prevent problems with the taxman, especially when establishing the provisions that govern their contracts. When organizations enter into contracts, transfer price rules must be followed, and transfer pricing documents must be provided as a reference. A corporation should identify its associated parties and ensure that all transactions are conducted at arm’s length. When creating contracts, it is preferable to consult with a lawyer and a tax expert to ensure that all of the implications of the contract are clearly put out. In terms of agreements, multinationals, group corporations, family managed firms, and companies that entangle business transactions with their linked counterparts should be on the lookout. In a nutshell avoid excessive fines and interest by signing where the pricing is correct and the terms and conditions are fairly drafted.