DISTRIBUTABLE (53)

Judgment No. SC 43/03

Civil Appeal No. 41/99

WET BLUE INDUSTRIES (PRIVATE) LIMITED

v THE COMMISSIONER OF TAXES

SUPREME COURT OF ZIMBABWE

CHIDYAUSIKU CJ, ZIYAMBI JA & MALABA JA

HARARE, OCTOBER 22, 2001 & NOVEMBER 28, 2003

J C Andersen SC, for the appellant

A P de Bourbon SC, for the respondent

MALABA JA: This is an appeal from a judgment of the Special Court for Income Tax Appeals (“the special court”) dismissing with costs an appeal against the decision of the respondent to disallow certain deductions from gross income as rebates and raising penalties for non-payment of tax in the years of assessment 1993, 1994 and 1995. I will refer to the parties as “Wet Blue Industries” and “the Commissioner” respectively.

The facts are as follows. In 1988 the Government imposed an embargo on the export of raw hides. The Cold Storage Commission (“CSC”), S.M. Lurie & Co (Pvt) Ltd (hereinafter referred to as “Lurie”) and Tirzah Investments (Pvt) Ltd (“Tirzah”) had been involved in the business of processing and exporting raw hides. After the embargo the “three parties” decided to form a company which would provide them with the services of wet blue tanning of their hides. The company formed was Wet Blue Industries. Whilst the three parties were Wet Blue Industries’ shareholders, they were also its partners.

In terms of the agreement reached by the three parties, Wet Blue Industries was to apply the wet blue tanning process exclusively to hides owned and forwarded to it by the three parties. It did not acquire ownership of the hides. Each partner was to send the hides it required treated and Wet Blue Industries would raise invoices for the tanning costs to each partner quarterly. To raise working capital Wet Blue Industries, which was run by a management committee from Tirzah, had to raise provisional invoices on a monthly basis.

Quarterly invoices were then raised, based on the actual costs of processing the hides. Added were interest and finance charges incurred and the cost of serving the capital portions of loan obligations. The amounts paid by the partners on the provisional monthly invoices would then be deducted from the quarterly invoices. It was understood by the parties that Wet Blue Industries was a service provider. The intention was that it would not make a profit. It was an express term of the agreement that Wet Blue Industries would not retain earnings to be carried over from one financial year to the next except such as might be required to meet loan capital repayment commitments.

The invoicing system set out in the agreement, and which would have ensured that no profit accrued to Wet Blue Industries, was not followed by the management committee. Invoices were instead raised for charges in respect of the tanning of raw hides on the completion of each batch. The charges for the services rendered were fixed by Wet Blue Industries. As a result of the money received by Wet Blue Industries from each of the three parties in payment of the charges for the processing of the hides, the company generated surplus funds or profits, after deducting all the necessary expenditure and meeting loan capital repayment commitments.

Initially Wet Blue Industries decided to distribute the surplus amount to the three parties as dividends. The CSC objected to this arrangement because it would have received an amount equal to that received by Tirzah and Lurie, notwithstanding the larger number of hides it would have forwarded to Wet Blue Industries for processing.

The parties then agreed that the money be paid out to them as rebates calculated by reference to each party’s throughput of raw hides. In 1993, 1994 and 1995 Wet Blue Industries paid the amounts of $3.5 million, $4.4 million and $6.2 million respectively as rebates. In Wet Blue Industries’ books of account the amounts paid out were reflected not as rebates but as costs of purchase of material used in the processing of the hides.

In examining Wet Blue Industries’ books of account in respect of the three years, the Commissioner assessed Wet Blue Industries’ taxable income on the basis that the amount paid out to the three parties formed part of its “gross income” and the rebates were not amounts allowed to be deducted in terms of s 15 of the Income Tax Act [Chapter 23:06] (“the Act”). The Commissioner took into account the fact that only a co-operative agricultural company or co-operative society had, under s 15(2)(y) of the Act, the right to deduct from gross income “any amount distributed during the year of assessment by way of discounts, rebates or bonuses granted by the company or society to shareholders, members or other persons in respect of amounts paid or payable by or to them on account of their transactions with the company or society”. Wet Blue Industries was not a “co-operative agricultural company” or a “co-operative society”.

The Commissioner also considered that in entering into the scheme whereby Wet Blue Industries paid the amounts of money to the three, CSC, Lurie and Tirzah, as rebates, the parties had entered into a scheme, the effect of which was the reduction or avoidance of tax liability by Wet Blue Industries, and that one of the main purposes of the scheme was the reduction or avoidance of tax liability on the part of Wet Blue Industries in contravention of s 98 of the Act. The Commissioner disallowed the amounts paid by Wet Blue Industries to the three parties in each of the three years of assessment and raised penalties for its failure to pay tax.

Wet Blue Industries appealed to the special court which held that the amounts of money paid out to the three parties as rebates were part of Wet Blue Industries’ “gross income” which the Commissioner had correctly taken into account in calculating its taxable income. The learned President of the special court also held that the Commissioner had correctly taken the view that the provisions of s 98 of the Act had been contravened.

On appeal to this Court, the parties agreed that the facts found by the learned President to have been proved on the evidence adduced by the parties are correct. They also agreed that the learned President had correctly set out the law as contained in s 8 of the Act, which defines “gross income” for purposes of calculation of the taxable income as:

“… the total amount received by or accrued to or in favour of a person or deemed to have been received by or to have accrued to or in favour of a person in any year of assessment from a source within or deemed to be within Zimbabwe excluding any amount so received or accrued which is proved by the taxpayer to be of a capital nature …”.

It appears to me that the amounts paid out to the three parties as rebates had been received by Wet Blue Industries as payment for the charges it had fixed for processing the hides. The amounts formed part of its “gross income” before they were paid out. Wet Blue Industries had not purchased any material with the money. The money was not part of expenditure of a capital nature.

The learned President cited with approval the case of Brookes Lemos Ltd v Commissioner for Inland Revenue 1947 (2) SA 976 (A), which decided that:

“… once the taxpayer receives an amount as his own during a tax year, the fact that in terms of his contract he may, in certain circumstances, have to repay the same later, does not have the effect of excluding these amounts from his ‘gross income’ for the year in which he received same”.

In respect of the legal principles to be applied in respect of the application of s 98 of the Act, the learned President cited with approval the case of Secretary for Inland Revenue v Geustyn, Forsyth & Joubert 1971 (3) SA 567 (A), where OGILVIE-THOMAS CJ paraphrased the provisions of s 103(1) of the South African Income Tax Act (similar in wording to s 98 of the Act) as follows:

“To warrant a determination by the Secretary of liability for tax in terms of s 103(1) there must be established –

(a) a transaction, operation or scheme entered into or carried out;

(b) which has the effect of avoiding or postponing liability for tax on income or reducing the amount thereof; and which

(c) in the opinion of the Secretary, having regard to the circumstances under which the transaction, operation or scheme was entered into or carried out –

(i) 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

(ii) 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 that

(d) the avoidance, postponement or reduction of the amount of such liability was, in the opinion of the Secretary, the sole or one of the main purposes of the transaction, operation or scheme.”

See also A v Commissioner of Taxes 1985 (2) ZLR 223 (H), ITC 1513 (1988), 54 SATC 56 (2), ITC 1518 (1989), 54 SATC 113 (T) and ITC 1554 (1990) 44 SATC 115 (Z).

It was common cause that the scheme had the effect of reducing Wet Blue Industries’ taxable income. The learned President found evidence of abnormality in the scheme in the manner the amounts paid to the three parties were reflected in the accounts as costs of purchase of processing material. He also found it in the decision not to pay the money as dividends and that the amounts were arbitrarily fixed by the management committee at Wet Blue Industries. Finally, he found that CSC, Lurie and Tirzah had no legal right to claim refunds or rebates from Wet Blue Industries. It was the finding of the learned President that one of the main purposes behind the scheme was to avoid taxation.

The heads of argument advanced by Mr Andersen, on behalf of Wet Blue Industries, were to the effect that the learned President erred in coming to the conclusion he did. Mr de Bourbon, for the respondent, raised a point in limine that the appeal was on a question of fact. Section 66(1)(a) of the Act provides that a taxpayer who is dissatisfied with the determination of an appeal by the special court may appeal to the Supreme Court without leave of the President of the special court on any ground which involves a question of law only.

I agree with Mr de Bourbon that the determination by the learned President of the special court, that the amounts of money paid by Wet Blue Industries to the three parties as rebates were part of the gross income it had received during each year of assessment, was a finding of fact which is not appealable unless it is so grossly unreasonable as to amount to a misdirection on the law.

There was, in my view, no misdirection in the findings of fact made by the learned President, because the parties were determined that the money which had accrued to, i.e. received by, Wet Blue Industries as gross income was to be taken out and that the effect of such a deduction was the reduction of Wet Blue Industries’ tax liability. The fact that the money was taken out before the taxable income had been determined by the Commissioner did not change the legal effect of the deduction. To form part of the gross income it was enough that the money was received by Wet Blue Industries from a source within Zimbabwe. It did not have to be a source of income itself, as Mr Andersen argued. The gross income could only be reduced by deductions effected in terms of s 15 of the Act.

I also agree that the determination that the scheme was abnormal and one of its main purposes was the avoidance of tax liability by Wet Blue Industries is a finding of fact.

If Wet Blue Industries wanted to appeal against the findings of fact, it should have applied for the leave of the President of the special court to appeal in terms of s 66(1)(b) of the Act. No such leave was applied for.

The appeal is accordingly dismissed with costs.

CHIDYAUSIKU  CJ: I agree.

ZIYAMBI JA: I agree.

Joel Pincus, Konson & Wolhuter, appellant's legal practitioners

Civil Division of the Attorney-General’s Office, respondent's legal practitioners