Note: this is the fifth part in a series of posts on Tax and, more specifically, the draft Zimbabwean Income Tax bill. The preceding posts:
- Tax-oh-no-mics 101: the Zimbabwean Lesson – in which Zimbabwe experiences hyperinflation, dollarises, engages in diamond trade, and the Government runs out of money.
- Tax-oh-no-mics 102: An Introduction To Expanding The Tax Base – in which Governments only have limited ways of financing themselves, and how most of those options are no longer options after economic collapse.
- Tax-oh-no-mics 103: Where Everyone Is A Zimbabwean Resident – in which some new residential definitions are made: definitions which may be difficult to enforce on the whole…
- Tax-oh-no-mics 104: Attention All Income Flights – in which best taxation practice suggests that “worldwide income based on where you’re tax resident” is a much larger pool of tax than “any income made in the source country in question”.
And here’s a reminder of that tax calculation:
less Allowable Deductions
equals Taxable Income
multiplied by Tax Rate
gives you Income Tax Payable
less any Foreign Tax Credits and Rebates
now you have Actual Tax Payable
So this post is about “allowable deductions” and the general idea behind them.
The profit map…
For the most part, if you just earn a salary, then the whole topic of allowable deductions won’t apply to you. The general idea behind taxation (I know I’m repeating myself) is that each person (natural or otherwise) must pay, according to their means, for the privileges of being a citizen and having public goods provided by a government.
So one way of looking at this:
- Employees – pay tax on their salaries, because they’re individuals.
- Shareholders – pay tax on their profits through the companies they own, then again through dividend tax.
What we sometimes forget (I think) is that the general morass of trusts, limited liability companies and public corporations are all just individuals at their root. When you tax a company’s profits, you are taxing the owners of those companies. The “company” itself is just a shell that protects the owner’s interest in that enterprise from all his other interests.
However, while an employee is going to spend his salary on himself, a company does not get to spend all of its incoming money on the owner. Most of that money will go towards “producing income”.
How Income Is Produced
Let’s take the example of a small shop. In order for a shop to make sales to customers (Gross Income), it’ll need to do some of the following:
- Buy stock from wholesalers to sell
- Pay rental and electricity on the shop
- Invest in tills and shelves
- Hire a person to work behind the till, and a cleaner to keep everything tidy
- Arrange for trucks to collect the stock and deliver it to the shop
- Find a bookkeeper to keep a record of all the above
Whatever is left at the end is the owner’s money (profits) to play with as he wishes – which makes that his “means” and he should be taxed according to them.
So What Is An Allowable Deduction
In principle, companies are generally allowed to deduct any expense that takes place “in the production of income”. But there’s usually a bit of a limit on this – because if you take the definition too far, you end up with companies that say “we bought this mine for billions of dollars, and that’s in the production of income, so…”
Most Tax Acts will therefore split expenditure into two types:
- normal expenses – being ones that you regularly during the year; and
- capital spending – being purchases of equipment or property that have value for longer periods of time.
If the Minister of Finance wants a really long and complicated Tax Code, they’ll list everything that they will allow to be deducted (eg. “utility bills from any Utility”, “Trading Stock calculated in accordance with the following formula…”, etc). My understanding is that this is what the US tax code looks like. Which totally explains why they need so many tax lawyers.
But if you want a simpler Income Tax Act, there will just be an overriding principle (like “any expense incurred in the production of income”), and the rest will be left up to the Revenue Authority’s interpretation…
The new Zimbabwean Income Tax Bill?
The draft of the new bill has gone with simplicity:
(1) For the purpose of ascertaining the taxable income derived by a taxpayer during a year of assessment, there shall be deducted –
(a) all expenditure and losses incurred in the production of income except to the extent to which they are expenditure or losses of a capital nature;
(b) amounts allowed in terms of… <insert capital allowances and other special deduction sections here>
So far, sounds reasonable.
But the problem with any new Tax Act, especially one that introduces a new principle, is that there is a crisis of transition. And often, there is a carry-over of old interpretations.
If you read the Current (soon-to-be Old) Income Tax Act…
The current “overriding principle” definition of an allowable deduction in Zimbabwean tax law reads:
(2) The deductions allowed shall be –
(a) expenditure and losses to the extent to which they are incurred for the purposes of trade or in the production of income except to the extent to which they are expenditure or losses of a capital nature;
You’ll notice that the new definition excludes the phrase “for the purposes of trade”?
This is where the panicked concerns have come from.
Because if I were a Revenue Authority, and my definition of an allowable deduction went from mentioning “deductions incurred for the purposes of trade” to not mentioning them at all, then the logical conclusion I would draw is that those deductions are no longer permitted.
My understanding is that the original interpretations went something like this:
- “In the production of income” – meant any direct expense (ie. direct manufacturing costs);
- “For the purposes of trade” – meant anything else (ie. overheads).
And here’s a list of what has traditionally been designated “deductions incurred for the purposes of trade”:
- administrative salaries
- marketing expenses
- head office expenses
- accountancy fees
- legal expenses
- auditing fees
- insurance premiums
- any other overhead cost (even bank charges!!)
Should the bill be enacted as is, the Zimbabwean business community is fully expecting those expenses to be disallowed.
And from the face of it, that expectation is fully justified. Especially when any Tax Authority is heavily incentivised to interpret that Tax Code in the most punitive/revenue-generating* way possible.
*depends on which side of the tax collection fence you sit.
But There Is Good Reason Not To Panic
The important point here is that this is an interpretational dispute. The bill itself does not specifically disallow those deductions – there is just a standing interpretation based on a different Income Tax Act.
Like every other country before it, the Zimbabwean Tax Act will have to have its interpretation defined by case law. And we can only have case law once the bill is enacted, and a ZIMRA interpretation challenged in court.
In other good news, the standing interpretation is inconsistent with other sections of the Act; as well as being inconsistent with South African case law (this particular section is remarkably similar to s11(a) of the South African Income Tax Act – and the Zimbabwean courts are often guided by South Africa case law). It’s also a bit discordant that Zimbabwean company law can require audits and the submission of accounting returns, but then disallow those expenses for tax…
So it will take a bit of time, and there are likely to be some heavy assessments in the interim – but the case in favour of “Deductions in the purposes of trade” actually being “deductions in the production of income” seems a pretty strong one.
It’s just a bit unfortunate if you’re the company that has to take the stand.
Sorry about that.