Chapter 2 (Paper 3.4 - Advanced Taxation)

CHAPTER 2CHAPTER 2

PERSONAL BUSINESS TAXATIONPERSONAL BUSINESS TAXATION

2.1 – AN EVALUATION OF THE BADGES OF TRADE

The Definition of TradeIncome Tax is charged on the ‘Annual Profits or gains arising or accruing to any person residing in the Republic of Zambia from any trade, profession or vocation.

A trade is defined as ‘Every manufacture, adventure or concern in the nature of trade. This is given by the UK Tax legislation at Section 832 (1) ICTA 1988.

A ‘trade’ is defined in the legislation as a ‘trade’, which is a circular definition and does not take us a great deal further. Therefore, the interpretation of what is meant by the term ‘trade’ has been left largely to the courts. The courts have developed a number of tests to determine whether somebody is trading. These tests are known as ‘The Badges of Trade’.

Profit seeking motive:When a person enters into a transaction, we need to identify whether there is a profit seeking motive. it is not the existence of a profit that is important, it is the motive to earn one. However, the ZRA will really be interested in this issue if a profit has actually been earned, because then they have something to tax.

A Taxpayer may argue that they are trading in order to utilize a loss to reduce their Tax bill. The taxpayer must however, demonstrate the motive rather than the existence of profit to establish that a trade is being carried on.

Summary:

Intention to trade clearly constitutes trading. Intention to make a profit may not necessarily be so.

L.3 – Advanced Taxation Amendment Act 2006/07

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LEARNING OBJECTIVES:After studying this chapter you should be able to:

Understand the Badges of trade Compute Tax Adjusted profits for Sole Traders and

partnerships Compute capital allowances Understand Basis Periods Understand the operation of Turnover Tax

In IRC Vs Reinhold (1953) the Tax- payer bought four houses admittedly for resale. He was held not to be trading.

Conversely, the intention not to make a profit will not necessarily mean that a trade is not being carried on.

In Grove Vs YMCA (1903) the canteen of YMCA made a surplus. The Organization was a non – commercial one. It was held that the profits were trading profits.

The subject matter of realizationIf the assets are normally held as trading stock, the presumption that the trade is taking place is higher. If the assets that have been sold are normally not held as trading stock it is unlikely that the transaction may be interpreted as trading.

In Rutledge Vs IRC (1929) the Tax- payer, whilst in Germany on business, purchased one and a quarter million toilet rolls. Shortly after his return to England he sold them making a profit of sterling Pounds Ten thousand. He was held to be trading.

In Martin Vs Lowry (1927) an Agricultural machinery merchant purchased from the Government its entire stock of aircraft linen amounting to almost 45 million yards. He had hoped to sell the linen to manufactures but instead was forced to sell it through an extensive retail operation direct to the public. He made a profit of almost Sterling Pound two million. He was held to be trading.

The length of period of ownershipIf a person sells an Asset that he has held for a long period of time it will be quite difficult to prove that the asset had been held as trading stock. This is because assets held for long periods of time are normally investments.

In Wisdom Vs Chamberlain (1969) the taxpayer had, with borrowed money, purchased silver bullion as a hedge against possible devaluation. After about a year he sold it making a profit, after expenses, of approximately forty eight thousand sterling pounds.

He was held to be trading. Harman J.J said:

Quote:“This was a transaction entered into on short term basis for purpose of making a profit… and if that is not an adventure in the nature of trade, I do not really know what it is”

The frequency of similar TransactionsThe more often that a taxpayer has entered into a particular transaction, the greater the presumption of trading. In the case J. Bolson & Sons Ltd Vs Farrell (1953), Harman J said:

“A deal done once is probably not trading. Done three or four times it usually is”


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In Pickford Vs Quirke (1927), the Taxpayer had entered into four transactions each resulting in a profit. He was held to be trading. In his judgment Rowlatt J remarked:

Quote “Now of course it is very well known that one transaction of buying and selling a thing does not make a man a trader, but if that is repeated and becomes systematic then he becomes a trader and the profits of the transaction, not taxable so long as they remain isolated, become taxable as item in trade as a whole, setting losses against profits, of course and combining them all into one trade”.

Supplementary Work

If an asset is acquired when it is in a poor state and supplementary work is carried out to improve it, then such an asset when sold will give rise to a trading profit.

In Cape Brandy Syndicate Vs IRC (1921), three individuals in the wine trade bought 10,000 gallons of South African Brandy. This was blended, bottled and sold to over 100 separate buyers over a period of about 18 months. Held to be trading. Per Rowlatt. J. They had “…bought it with a view to transport it, with a view to modify its character by skillful manipulation, by blending with a view to alter….”

In IRC Vs Livingstone (1972), a syndicate purchased a cargo vessel with a view to converting it into a steam drifter and selling it at a profit. They had never previously done this, but they were held to be trading!

Circumstances giving rise to the Realization If a taxpayer sells an asset in order to raise money to help solve some financial problems it will be difficult to prove that he is carrying on a trade. Incidentally, there have been few cases on this point.

In Page Vs Pogson (1954) the taxpayer built a house for himself and sold it six months later after completion. He then built another one but had to sell it when his employment moved to another part of the Country. He was held to be trading by the Commissioners of Taxes.

Upjohn .J felt unable to reverse the finding of the commissioners whilst doubting whether he would have reached that conclusion himself.

In addition to the six badges of trade there additional factors which have to be taken into account. These are:

Taxpayer’s other circumstances:


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If other circumstances of a taxpayer indicate the existence of a trade then even the current transaction is likely to be interpreted as an indication of the existence of a trade.

The Way in which the asset was acquired:If the asset was acquired by inheritance or by way of gift the transaction may not be considered to be a trading transaction.

Method of Finance:If the asset sold was acquired by use of borrowed funds the presumption that the asset was held as trading stock is high. The presumption is even greater if some interest was paid on the amount borrowed.

EXAM FOCUS

The question of whether a trade is being carried on or not, often in the minds of the Revenue Authority, will depend on the results of the substantive transactions. Investments by an Individual were not held to be carrying on of a trade, thus denying him loss relief against income.

2.2 – COMPUTATION OF TAXABLE TRADING PROFITS

The ZRA will normally accept profits which are determined in accordance with the accounting principles provided that there is no conflict between accounting principles and tax legislation. However, there is normally a conflict and the accounting profits require several adjustments to be made to them in order to determine the taxable profits.

Some Expenses that are charged in the Accounts are not recognized as expenses for tax purposes. We have so far recognized such expenses as Disallowable Expenditure. Similarly some Income that is usually credited to the profits is not taxed under Tax rules.


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The taxable Profit is computed as follows:

MS. KAUNDA MULENGAComputation of Taxable Trading Profit for the charge year 2006/ 2007

K’000Net profit as per Accounts XAdd: Disallowed Expenditure: Depreciation X Tax Penalty X Proprietor’s Wages X Private Telephones X

----- X

Less: Expenditure not charged in the P & L But which is Tax Allowable in the Act:

Capital Allowances (X)

Income Credited in the P & L but not Taxable: Profit on Asset disposal (X) Bank Interest (Taxed Separately) (X)

----------Adjusted Business Profit X

=====

Note:This computation is usually the first to be made. It is then carried forward into the Personal Income Tax Computation as a working under Earned Income.

The list under disallowable expenditure is not exhaustive. Other items that might be included are: Fines for illegal acts, Donations to non –approved charities, loans to employees, bad debts incurred before incorporation, costs of tax appeals, etc.

Allowable expenditure may include: Gross wages, Redundancy payments, compensation for loss of office, Normal business Losses and NAPSA Contributions.


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2.3 – COMPUTATION OF CAPITAL ALLOWANCES

Under Section 29 of the Income Tax Act, capital expenditure is not allowed as a deduction for tax purposes. However, under the fifth and sixth schedules of the same Act, relief is given for certain types of capital expenditure by granting Capital Allowances. These include buildings, implements, machinery, plant, etc.

Capital Expenditure

Such expenditure brings into existence an “Asset or Advantage” for the enduring benefit of the trade. “Asset or Advantage” can be Intangible, like Goodwill or the exclusive right to use a trade - mark or symbol. E.g. the Capital expenditure on acquiring the Master- Card symbol in Walker Vs Joint Credit Card Company Ltd in 1982.

The capital allowances system deals separately with different types of expenditure, with different rules both in terms of identifying which items qualify for capital allowances and in terms of the rates of capital allowances available.

Where a person carrying on a trade incurs capital expenditure on the provision of machinery or plant for the purposes of the trade, he may be allowed to claim capital allowances. But judging from reported tax cases, the meaning of ‘Machinery’ seems to cause few problems, but considerable difficulty has been experienced in determining whether or not expenditure has been incurred on the provision of ‘Plant’.

IMPLEMENTS, MACHINERY AND PLANT

The starting point for any consideration of the meaning of ‘Plant’ is of course supposed to be the available statutory legislation. But going through the Income Tax Act reveals that Section 2 of the Income Tax Act gives no precise definition of implements, Machinery and Plant. The words must therefore be given their Ordinary meaning as per the Rules of constructing the Taxing Acts. The phrase Implements, Machinery and Plant could be said to include all moveable and fixed items of equipment including:

Electrical devices such as X-Ray and Radar Equipment Desks and chairs Computers Moveable partitions Stationary Plant - Metal Tanks, Containers etc. Mechanical Transport – Railway, Steam, Petrol and Electric

motor vehicles Motor Power and Engines Pullies and fork lift trucks


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Actual running Machinery etc.

Although there is no general Statutory Definition of Plant and Machinery, there is a great Volume of Case law around this issue. In a recent case of Benson Vs Yard Arm Club Ltd, 53 TC, Bucley L. J said:

QUOTE:“The Statutes have not contained a definition of the meaning of Plant. Consequently the question is what does the word mean? And how does it apply to the particular circumstances of the case? That is a case of Law - being one of interpretation, but never- the- less, it is a jury question in the sense that the word “Plant” is not a word of Art, it must be interpreted according to its ordinary meaning as a word in the English language in the context in which it has been construed; that is to say, the court of construction must Interpret it as a man who speaks English and understands English accurately ………”

In many UK Tax cases, including the one above, the courts have approved an 1887 description of Plant by Lindley L. J in the Case of Yarmouth Vs France. In this case the court held that a horse used by a tradesman in his business was part of his plant. And in so holding, Lord Justice Lindley said:

QUOTE: “There is no definition of plant in the Act (the Employers’ liability Act 1880): but, In its ordinary sense, it includes whatever apparatus is used by a business man for carrying on his business – not his stock in trade, which he buys or makes for sale, but all goods and chattels, fixed or moveable, live or dead, which he keeps for permanent employment in his business”.

Although the Yarmouth case was not a tax case, it has always been assumed to be equally applicable to the tax legislation. The case makes it clear that things such as horses may be plant for tax purposes even though they would not be so considered by a layman.

However, the following are examples of items of capital expenditure, which the courts have decided do not qualify for capital allowances:

Display or background lighting in a retail store – Cole Bros Vs Philips, 1982 – regarded as the setting in which the business was conducted rather than something used in carrying on the trade.

The canopy of a petrol station was also regarded as setting and did not qualify in the case of Dixon Vs Fitch Garages limited in 1975.

Floor and wall tiles and décor, shop front – Wimpy International and Pizza land Vs Warland, 1989 – again regarded as setting and part of the fabric of the building. Perversely, the lighting was allowed as it


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was regarded as necessary to create the required ‘ambience’ for the fast food business.

The distinction between Plant and Setting:

In practice most disputes between Tax authorities and the taxpayers seem to arise where the choice is between the expenditure being on Plant or on a structure which is merely a setting within which the business is carried on which would qualify for, at most, Industrial Buildings allowance. In coining this distinction, we will use some of the recent court cases which set out to make this distinction.

In the cases we are going to use below, you must observe that the courts have used two tests to determine whether an object qualifies as Plant or not. These are:

The function or business use test: - that is to say does the object fulfill the function of plant in the business? If so, it can qualify for capital allowances – even if it is a building or structure.

The premises test – that is to say is the object part of the premises? If so, capital allowances are not due, no matter what the function is – unless the premises themselves are plant.

Let us now have a critical look at some of the decided court cases bordering on the above two tests. I must confess that some of these cases are really funny and interesting.

CIR Versus Barclay, Curle& Co Ltd 45 TC 221Case Point – Whether a dry dock is Plant.----------------------------------------------------------------------------------------------------------A shipping company built a dry dock. This involved excavating the site, lining the dock with concrete and installing gates, pumping machinery, valves etc.

The company argued that the whole thing was a single entity performing the function of a large hydraulic lift- cum-vice. They claimed capital allowances on the whole of the expenditure including the cost of excavating and lining the site.

The Revenue’s case was that each item had to be considered separately. The revenue conceded that the pumping machinery qualified for capital allowances but argued that the dock itself was a structure and thus the setting in which the trade was carried on.-----------------------------------------------------------------------------------------------------------


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Ruling:The whole of the cost qualified for capital allowances. The dry dock was not merely the setting in which the trade was carried on. It played an essential part in getting a ship into the dock, holding it securely and returning it afterwards to the water.

Although the dock was a structure it performed the function of plant in the company’s trade. One judge said and I quote:

QUOTE:"….It seems to me that every part of this dry dock plays an essential part in getting large vessels into position where work on the outside of the hull can begin, and that it is wrong to regard either the concrete or any other part of the dock as a mere setting or part of the premises in which this operation takes place. The whole dock is, I think, the means by which, or plant with which, the operation is performed.”

The test referred to in the Barclay, Curle & Co case is of course supposed to be the function or business use test. Even a building or structure can qualify as Plant if it fulfils the function of plant in the trade. There was no doubt that the dry dock was a structure but it fulfilled the function of plant and therefore capital allowances were due and claimable.

Tax Planning Point:

Before embarking on any major capital expenditure, advice should be sought on whether capital allowances will be available. An alternative to buying an item of equipment on which capital allowances may not be available would be to lease it. Apart from the obvious cash flow advantages – not having to pay the full amount now – the annual leasing charges will normally be deducted in full in arriving at the taxable profit. The topic on leasing is covered in adequate detail in a later chapter.

Cooke versus Beach Station Caravans Ltd 49 TC 514Case Point – Swimming pool as Plant------------------------------------------------------------------------------------------------------------The taxpayer company owned a caravan park. It provided various amusements including swimming and paddling pools. Capital allowances were claimed on the whole of the costs of building the pools including excavation and terracing.

The Revenue accepted that the heating and pumping equipment qualified but argued that the pools themselves were part of the setting in which the business was carried on.------------------------------------------------------------------------------------------------------------


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Ruling:The judge said that the pools were part of the apparatus with which the company carried on its business. They were not merely ‘where it’s at’. They fulfilled the function of providing ‘safe and pleasurable buoyancy’. Thus the company got its capital allowances.

This does not mean that any trader can build a swimming pool and claim capital allowances on it. It all depends on the nature of the trade. In Beach Station Caravans Limited the trade was providing leisure services and the swimming pool was part of the plant with which the trade was carried on.

Benson versus Yard Arm Club Ltd 53 TC 67Case point – Floating restaurant

We revisit this case which we used earlier on.------------------------------------------------------------------------------------------------------------A company bought an old ferry boat and converted it into a floating restaurant. They claimed capital allowances on the grounds that it was plant.-----------------------------------------------------------------------------------------------------------

May be before we analyze this case think of what your decision might have been. Would you have accepted the claim? And what reasons would you have advanced for your particular decision?

Ruling:The claim was thrown out. The court decided and held that the boat was the place or settling in which the trade was carried on.

The judge commented on the difference between a structure which could be regarded as plant and one like this one which couldn’t. Here is what he said:

QUOTE:“The distinction, I think, is that in the one case the structure is something by means of which the business activities are in part carried on; in the other case the structure plays no part in the carrying on of the activities but is merely the place within which they are carried on. So in the case … of a subject matter which is a building or some other kind of structure, regard must be paid to the way in which it is used to discover whether it can or cannot be properly described as plant.”

The ferry boat was the setting within which the company carried on its business. It played no further part in the operations of the trade. It was no different in principle from restaurant premises on dry land.


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TUTORIAL NOTE:------------------------------------------------------------------------------------------------------------This case is undoubtedly a good illustration of how critical the nature of trade is in deciding whether an object is plant or not. If the company had been in the business of operating a ferry service it would no doubt have got its capital allowances.------------------------------------------------------------------------------------------------------------

2.29 - 5th Schedule Part II – Basic Details:

Wear and Tear Allowance:

Para.10 (1) – Where a person has used any Implements, Machinery or Plant belonging to him for the purposes of his Business a deduction known as a Wear and Tear allowance at the rate of 25 % per annum shall be allowed in ascertaining the profits of the business for each charge year.

For the purposes of the second Schedule, the Word Business is as contained in Section 2 but including employment and the letting of property.

The pooling basis for computing Wear and Tear allowance was abolished as from 1991/92. The straight-line basis for computing wear and tear allowance was introduced and is still in force.

Para. (8) – Provides that Wear and Tear Allowances are not to be given on Implements requiring frequent replacement e.g. Hand tools. The cost of any additional implements is capital expenditure and cannot be allowed as a deduction in the Tax Computation. For this reason, when a claim is made for the cost of replacing Implements during the year, the ZRA may find it necessary to verify that extra implements have not been included in the so called Replacements.

Implements, machinery or plant acquired under a Hire purchase agreement are regarded as the Property of the purchaser for the purposes of Wear and Tear allowance- Para. 10(2).

The Wear and Tear Allowance for any Implement, Machinery, or Plant exclusively used in Farming, Manufacturing or Tourism is given at the accelerated rate of 50 % Per annum– Para.10 (5).

The Wear and Tear Allowance on the Cost of any New Plant or Machinery acquired and used by any Soft Drinks Manufacturer in a Rural area is calculated on a Straight line Basis at 20 % per annum on cost – Para.10 (6).


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Capital Recoveries from Implements, Machinery and Plant.

A recovery from Capital expenditure on Implements, Machinery or Plant is deemed to have taken place when the Implements, Machinery or Plant:

Permanently cease to be used for the purposes of a business; or Cease to belong to the person carrying on a business.

The amount of the recovery from Capital expenditure is the amount which the Implements, Machinery or Plant would have realized in the Open Market at the time the event giving rise to the Recovery occurred.

For assets bought on hire purchase, capital allowances are claimed on the cash price, while the interest or fiancé charges are an allowable expense against trading profits.

A Worked Example: - Capital allowances on Assets bought on hire purchase:

DORCAS MUTITI LIMITED

Dorcas Mutiti Ltd, a Company Incorporated in the Republic bought a Machine for K5, 500,000 from Dade Ltd on Hire Purchase. The terms and conditions of the Hire Purchase included the following:

Dorcas Mutiti Ltd was to make a deposit of K1, 500,000 and 4 Annual Instalment Payments of K1, 000,000 on 30 June each year.

The rate of interest chargeable is 10 % p.a.

Required:Compute Allowances to be claimed by Dorcas Mutiti Ltd.

Answer:Dorcas Mutiti Limited:

Dorcas Mutiti Limited has acquired a Machine. This falls within the applied definition of Implements, Machinery or Plant for the purposes of computing Wear and Tear allowance.

The Capital Cost of the Machine on which the Wear and Tear Allowance can be given is the Cash Price of K5.5 million. The Hire element, frequently described wrongly as Interest is not available for Wear and Tear Allowance but falls to be allowed as a Revenue Charge in the Profit and Loss Account. Therefore:


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KCost Price (Cash Price) 5,500,000W & T 25% on Cost (Yr.1) (1,375,000)

-------------Written Down Value 4,125,000W & T 25 % on cost (Yr.2) (1,375,000)

---------------WDV 2,750,000

=========

TUTORIAL NOTE:

The Interest Chargeable at the Rate of 10 % Per Annum is allowed as a Deduction for Tax Purposes and does not come in the Wear and Tear Allowance computation.

COMMERCIAL VEHICLES

Para.13 (3) defines a Commercial Vehicle as Meaning:----------------------------------------------------------------------------------------------------------- A road Vehicle of a type not commonly used as a private vehicle and unsuitable to be used as such but includes all types of road vehicles used solely for Hire or Carriage of the public for reward.------------------------------------------------------------------------------------------------------------

All other vehicles should be regarded as non-commercial. This in particular includes: private cars, station wagons, mini-buses, motor caravans etc but excludes Vans, Pick-up Trucks, Lorries, Buses and other Vehicles of similar type.

The Wear and Tear Allowance for Commercial Vehicles is given at the rate of 25 % Per Annum, while Non-Commercial Vehicles receive a 20 % p.a Wear and Tear Allowance.


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CHALI KALUMBA

Example:

Chali Kalumba Started in business on 1 April 2006 and prepares Accounts to 31 March each year. She acquired the following items of Plant for business use.

K1.04.06 Spinning Machine 6,050,0001.05.06 Lathing Machine 4,000,0001.12.06 Private Car 5,750,000

Required:Show the Capital Allowances Computation for the Charge years affected.

Answer:Computation of Capital allowances:

Spinning Lathing Private TotalMachine (25%) Machine (25%) Car (20%)

K K K KCost 6,050,000 4,000,000 5,750,000 -W & T 25% (1,512,000) (1,000,000) - 512,000

-------------- ------------- -------------31.03.07 4,538,000 3,000,000 -

======== ======== ------------- 5,750,000

W & T - - (1,150,000) 1,150,000 -------------- --------------

31.03.07 4,600,000 662,000 ========= ========

* Private Car is a non-commercial vehicle written down at the rate of 20% p.a on Cost as per Part V of the 5th Schedule to the Income Tax Act.

Note:Chali Kalumba will use the K3, 662,000 to reduce her Taxable trading Profits for the Charge year 2004 / 05 to arrive at Adjusted Profit for Tax purposes.


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Valuation in exceptional circumstances

Para.13 provides that in the calculation of any allowance, the Original Cost of any Implement, Machinery or Plant that has been:

Used outside the Republic by a person, and brought by him to the Republic for the purposes of his Business;

Used by him for a purpose other than the purpose of his business, and is then used for the purposes of his business; or

Acquired by him for no valuable consideration

Is according to the Commissioner –General’s determination.

The Notional write off is made of the Wear & Tear allowances which would have been due had it been used in a business. In Practice this will be done in the year of first business use and the net cost after Notional Wear & Tear will rank for Wear & Tear Allowances on Straight Line Basis.

MUMBA CHAMFYA

Example:

Mumba Chamfya bought a Shafting Machine locally for K781, 550,000 on 20 May 1994. Mugabe Constructions in Zimbabwe hired this Machine until 31.03.97, when it was brought back to Zambia. Mumba Chamfya immediately conceived the idea of setting up a construction business and his dream finally took off on 1.05.97, and he started using the Shafting Machine from that date.

Required:Compute the Capital Allowances.

ANSWERMUMBA CHAMFYA

Mumba Chamfya bought the Machine in 1994 but only engaged it in business in 1997. In General ZRA’s approach would be to value the Machine at 1.05.97, the time of first business use. But this is not what is usually done in Practice.

In Practice the Shafting Machine would be written down notionally by 25 % p.a for the years it was not in use, i.e., for the years 94/95, 95/96, and 96/97. During these years the Machine was being used in Zimbabwe.


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Notional Wear & Tear Allowance:

Notional write off is made of the Wear & Tear allowances which would have been due had the Machine been used in business, but are not deductible when computing taxable profits and any resulting balancing charge is restricted to the actual allowances given. Therefore:

K’000Cost 781,550W & T (Notional) 25% (195,388)

-----------WDV 31.03.95 586,162W & T (Notional) 25% (195,388)

-----------WDV 31.03.96 390,774W & T (Notional) 25% (195,388)

------------WDV 31.03.97 195,386*

=======

* Does not add up to K195, 388,000 due to rounding off. The Notional written down value as at 31.03.97 will be the net cost (K195, 388,000) for Capital allowances purposes.

2.33 – DIVIDED USE

Para.12 of Part II of the Fifth Schedule to the Income Tax Act provides for the Proportionate reduction of wear and tear allowance on Implements, Machinery or Plant, for non –business use. The type of Asset, which is most often used privately, is the Motor Car.

PETER CHOLA

Example:Peter Chola bought a Motor Car for K25 million on 1.04.98 and used it for both business and private purposes. He later sold the car on 01.03.01 for only K16 million. The proportion for private use is estimated at 30%. Compute the Capital Allowances.


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ANSWER:PETER CHOLA:

Peter Chola will claim Capital allowances for the Charge years beginning 31.03.99, 31.03.00 and 31.03.01 as follows:

Cost Private Use NetAdjustment- 30% Allowed.

K K K25,000,000 - -

W & T 20% (5,000,000) 1,500,000 3,500,000------------- ------------ ------------

31.03.99 20,000,000 - -W & T 20% (5,000,000) 1,500,000 3,500,000

-------------- ------------- ------------31.03.00 15,000,000 - -Sale Proceeds 16,000,000 - -

-------------Balancing Charge (1,000,000) 300,000 700,000*

======== ======= ======

The balancing charge arises when the Disposal Proceeds exceeds the WDV of the Asset at the time of Disposal. Where the Disposal Proceeds are less than the WDV, then a balancing allowance arises. In this case, the balancing charge of K700, 000 should be included in the Tax Computation. The rationale behind this is that an Asset has been sold at a profit and that profit is a taxable Income. This is provided for in Para.5 (1)(b) of the First Schedule, which stipulates that:

QUOTE:“Income of a person Includes any amount paid by which recoveries from capital expenditure exceed – in the case of Implements, Machinery or Plant, such residue of the expenditure ranking for Capital allowances incurred in respect of the Implement, Machinery or Plant as remains after deduction of any wear and tear or other Capital allowances or similar deduction whether allowed under the Income Tax Act or under any Provisions of the Previous Law for any Charge year”

Where the sales proceeds exceed the original cost, the proceeds are restricted to the original cost for the purpose of calculating the balancing charge.


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FIFTH SCHEDULE – PART III – PREMIUM ALLOWANCE.

Para.14 provides that a Deduction called “Premium Allowance” is allowed in arriving at the profits of a business. This allowance is equal to the amount of any premium or like consideration paid for the right to use the Machinery or Plant.

The amount of Deduction should not exceed the amount of the premium divided by the number of years for which the right of use is granted.

Where a person acquires Interest in the ownership of Property for payment of a premium for the right of use of which he has already been allowed a deduction, he ceases to be allowed that Deduction as from the date of such acquisition of interest.

WEZI BANDA LIMITED

Example:

Wezi Banda Limited has been trading for many years. Its expanding business has led to the adoption and implementation of new Asset acquisition strategies, aimed at relaxing and maintaining a buoyant cash flow position.

As an alternative to Outright Cash purchases of equipment, the Company acquired a Machine by Subscribing K13 million for the right to use Machinery. The right to use this Machinery was to last 20 years. The agreement was signed and entered into on 1.06.96. On 1.06.98, the Company paid additional funds amounting to K15 million for the complete ownership of the Machinery.

Required:Compute the Premium Allowance.


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ANSWER:WEZI BANDA

Where a premium has been paid for the use of Machinery, Plant, a Patent, etc. a premium allowance is allowed in arriving at the profits of the Business. This allowance is computed as follows:

KCost of Premium 13,000,000Allowance – 96/97 1/20th (650,000)

--------------- 12,350,000

Allowance – 97/98 1/20th (650,000) --------------- 11,700,000

Allowance – 98/99 1/20th (650,000) ---------------- 11,050,000 ========

Note: No apportionment of the allowance is made on time basis.

There will be no allowance after 98/99 because the Machinery was bought. The Company, as from 1.06.98 has acquired an interest in the ownership of the Machinery in respect of which the premium was earlier paid for the right of use.

Subsidies

Capital allowances are given only for Capital expenditure incurred or actually suffered by the taxpayer. If part of the expenditure has been covered by a government grant or subsidy, the amount of capital expenditure is reduced by the amount of subsidy. This, therefore, means that capital allowances will be calculated on the net amount.

ENOCK SIKAZWE

Example:Enock has been trading as a Brewer for 8 years now. His business has suffered a slump in recent years following technological advancement in the industry, which he cannot afford.

He has, in the charge year 2004/05 received a grant of K15 million from the Ministry of Commerce for the acquisition of additional and more advanced Machinery Costing K50 million.Required:What Capital Allowances might he claim?


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ANSWER:ENOCK SIKAZWE

Enock has in his possession an Asset, which is partly financed by Public funds, i.e., a government Grant. His claim of Capital allowances will, therefore, be restricted to the expenditure he has actually suffered.

KTotal Expenditure 50,000,000Less: Grant (15,000,000)

--------------- 35,000,000

W & T 25% (8,750,000) ---------------

WDV 31.03.01 26,250,000 ========

CONTROLLED SALES

Where Assets are sold for a sum, which the Commissioner General determines, is not at “Arms Length Price” then Capital allowances are calculated as if the assets had been sold for either:

The Open market Price; or The WDV, if the parties to the sale apply in writing for this basis. This

method is applied only where the buyer has control of the seller or the seller has control of the buyer or some third party has control of the both. This type of situation arises where s sole trader turns his business into a private Company or where sale of assets are made between private Companies, which are controlled by the same group of individuals.

NZALI KATILUNGU

Nzali Katilungu sold her transport Contractor’s business to a Limited Company on 1.04.96. She owned nearly all the shares in the Company and thus controlled it. The WDV of his vehicles at 31.03.96 was K4 million. The Original cost of these vehicles had been K6 million and W & T allowance of K2 million had been allowed before 1.04.96. On 1.10.97, the Company ceased trading and the vehicles were sold for K5, 200,000. The trader (Nzali) and the Company made an election in writing under Para.17 (3) of the Income Tax Act.

Required: Show the calculation of W & T Allowance and Recoupment for the Company.


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ANSWER:NZALI KATILUNGU

The calculation of W & T allowances and Recoupment for the Company will be as follows:

K1996 / 97Cost of Motor Vehicles to the Company 4,000,000W & T 25% (1,000,000)

--------------WDV 31.03.97 3,000,000Sales Proceeds 5,200,000

--------------Company to be taxed on Capital Recovery 2,200,000

========

CAPITAL ALLOWANCES ON INDUSTRIAL BUILDINGS AND OTHER ASSETS

Buildings

An Industrial Building means a building or Structure in use for the purposes of any electricity, gas, water, inland navigation, transport, hydraulic power, bridge or tunnel undertaking, or any like undertaking of public utility, or is in use for the purposes of any trade which:

Is carried on in a Mill, factory etc. Consists of the Manufacturing of Goods Consists of the Storage of goods to be used in Manufacturing Consists of the Storage of goods on Imports or for Export Consists in the working of a mine or well for the extraction of natural

deposits.

The statutory definition of “Industrial building or structure” concentrates on the business Activity rather than the premises as such. In general of course the type of activity required is that of manufacturer, i.e., subjection of goods and materials to any process: coupled with some wholesale rather than retail selling: (Kilmarnock Equitable Coop Vs CIR – 42 TC.675), made it clear that some Retail activity does not debar a claim where there is also selling wholesale.


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Kilmarnock Equitable Co-operative Society Ltd Vs CIR

The Society erected a building to park Coal into 28lb paper bags, which it sold to retail shops. The Coal was passed by conveyor belt from wagons in the yard into a hopper near the roof, fed down a chute through a vibrator screen where dross was removed, passed by conveyor belt to the weighing points, packed into the bags and deposited at floor level to await disposal.Held:That the Society was entitled to industrial building allowance.

Case Analysis:The success of the appellant’s contention depends on whether their building is in use for the purpose of a trade, which consists in the subjection of goods or materials to any process.

The material consideration is the purpose of the use of the premises, not the use to which the product is put. The Courts have amplified the definitions set out in the Statute and the following illustrate the views of the Court in setting limits to them.

Where claims are made for a building on the Grounds that it is used to subject goods to a process the nature of the “goods” is Important.

The Screening and packing of Coal into paper bags as we saw in the Kilmarnock case is subjecting goods to a process.

On the other hand a building used for the Cremation of human bodies does not qualify – Human Bodies are not Goods! Neither does a building used for packing wages into Envelopes – because notes and Coins are not goods.

A building for maintaining and repairing hired out Plant did not qualify because the Plant was not being subjected to a process.

Buildings used for Storage of Manufactured goods before delivery to a customer. Where a retailer or wholesaler stores goods the building does not qualify.

Excluded Buildings.Para.1 (2) of the 5th Schedule has specifically excluded certain buildings from being classified as industrial buildings. These are:

Dwelling Houses Retail Shops Show Rooms Hotels or offices.


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Qualifying Hotels – Para.1 (3)

Any building, which on first construction is an Hotel, or which is an extension made to a building first constructed as an Hotel and is certified by a relevant Government Ministry as conforming to the Standards of the Hotel Industry, qualifies as an industrial building for the purposes of the Income Tax Act.

“First Construction” means the building must have been planned and erected as a Hotel. Conversions of buildings, which were originally erected with some other purposes in, mind, e.g. A private House, will not qualify because they are not Hotels on first construction.

All Hotels in existence at 31.03.66 and beyond are excluded from the definition of Industrial buildings. Extension to any Hotel, old or new, on or after 1.04.66 qualifies to be classified as an industrial building unless the old Hotel was made out of a Converted building.

Qualifying Housing Units – Para.1 (4)

Any building constructed or acquired by a person to provide housing for Employees qualifies for Industrial building allowance, as long as it is a low cost housing unit. The cost for each housing unit should not exceed K2 million. The cost of a housing unit, which exceeds K2 million, will not qualify for Industrial building allowance.

Any housing unit acquired or constructed on or after 1.04.97 will qualify for IBA provided the cost does not exceed K2 million.

A housing unit may be a separate building complete in itself or a part of a larger building, e.g. a flat or dormitory accommodation. However, housing for domestic employees would not qualify because such employees are not usually employed for the purposes of the Employer’s Business.

Drawing office

If the drawing office is an integral part of the industrial premises and is devoted to the industrial operations carried on, it ceases to be classified as an office. For instance, a drawing office owned by a structural steel engineering company may not be excluded from the definition of an industrial building – CIR Vs Lambhill Ironworks Ltd – 31 TC.393.


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Building used for the welfare of employees

Any building in use for the welfare of employees engaged in the undertakings and trades mentioned in sub-paragraph (1) of the 5th Schedule, qualifies for industrial buildings allowance.

Sub-paragraph (4) – which deals with qualifying Housing units for employees, does not specify that the employees shall be employed in any particular type of business for their Houses to qualify, but sub-paragraph (5) states that for a building used for the welfare of the employees to qualify as an industrial building, the employees must be engaged in the trades mentioned in sub-paragraph (1) which includes: Works Canteens, Works sports pavilions and mine hospitals.

EXAM ALERT

Only buildings will qualify. No allowance is given on structures like Swimming Pools; Staff Tennis courts etc. because these structures are not Buildings!

WHERE PART OF A BUILDING IS AN INDUSTRIAL BUILDING AND THE OTHER PART IS NOT.

Sub-paragraph (7) states that where part of a building is an industrial building and a part is not, then the whole building shall be classified as an industrial building where the non-industrial part of the building does not exceed 10 % of the total cost. Thus if an office or showroom is housed in a factory building and costs 10 % of the entire cost of the building, then the whole building would qualify as an industrial building. If the office or showroom is housed in a separate building sub-paragraph (7) cannot apply.

If the non-industrial part of the building exceeds 10 % of the whole, then only the Industrial part must be treated as an industrial building.


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Commercial buildings

A commercial building means a building or structure which is not an industrial building; and is not a farm improvement or farm works; and is in use for business purposes; and was completed for first use on or after 1.04.69. Examples include retail shops, banks, office buildings, garages, showrooms or houses, which are used for business.

The definition also includes Structures and parts of a building. It is obvious therefore that a housing unit for employees which does not qualify as an industrial building only because it costs more than K2 million, will, provided it was constructed for first use on or after 1.04.69, qualify as a commercial building.

Cost of land

An industrial building or commercial building is a separate entity from the Land on which it stands, for the purposes of Capital Allowances.

Capital Allowances are to be restricted to the cost of the building or structure; they are not to be given on the cost of the land on which the building is erected.

CHRISPIN MUKUKA CHONTA

Example:Chrispin Mukuka, a long time serving Director at National Milling decided to resign and set up her own Company in 1995 at which time she was only 45 years old. She proceeded to acquire barren Land in the Woodlands area at a cost of K17 million, and proceeded with the Construction of an ultra modern milling facility complex. The Complex was finally completed and brought into use on 1.10.95 at a cost of K100 million. Included in the K100 million were Architects fees of K4 million, K2 million was paid in connection with the Land Purchase. Show how the qualifying cost for industrial building allowance will be arrived at.


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ANSWER:CHRISPIN MUKUKA CHONTA

Expenditure must be incurred in construction, thus the cost of the Land and the incidental costs associated with its acquisition do not rank for industrial buildings allowances. However, costs of work on the Land that is preliminary to construction do qualify. Such costs include: The preparation of the site in order to lay foundations, and cutting, tunneling and leveling the Land in connection with the construction.

Professional fees – Architects Fees, incurred as part of a construction project do qualify for industrial building allowances.

The Qualifying cost for industrial building allowances will therefore be computed as follows:

KTotal Cost 117,000,000Less: Non – Qualifying Expenditure: Cost of Land 17,000,000 Incidental Land acquisition costs 2,000,000

-------------- (19,000,000)

---------------- 98,000,000 =========

INITIAL ALLOWANCE FOR INDUSTRIAL BUILDINGS

An initial allowance of 10 % on an Industrial building is available.

This allowance is only available on brand new buildings. No initial allowance is given on an Industrial building which has been in existence for sometime and which the taxpayer has subsequently bought.

Initial allowance is granted on a new addition to an existing Industrial building. The allowance is granted in the year in which the building, addition or alteration is brought into use. This need not necessarily be for the same year as the year in which the building is completed.

There is no initial allowance for commercial buildings.


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WEAR AND TEAR ALLOWANCE

In ascertaining the business profits of any person who in any charge year has the use of an Industrial or Commercial Building which he acquired, constructed, added to or altered, a deduction known as a Wear and Tear allowance is granted.

Rates of Wear and Tear allowance:Rate

Low cost Housing Units 10 %Industrial Buildings (Others) 5 %Commercial Buildings 2 %Implements, Machinery and Plant 25 %Non –Commercial Vehicles 20 %Commercial Vehicles 25 %

The Wear and Tear allowance is calculated each year on the Original Cost of the Building, i.e., on a Straight-line basis or Equal Instalment basis.

Example:A factory building was constructed and completed on 30.10.94 at a cost of K200 million and was brought into first use on 1.01.95. Show how the allowances will be granted.

Answer: K’000

Cost 200,00094 /95 – Initial Allowance @ 10 % 20,000

Wear and Tear allowance @ 5 % 10,000 ---------

(30,000)-------------

31.03.95 WDV 170,00095 /96W & T @ 5 % (10,000)

-------------31.03.96 WDV 160,000

96 /97W & T @ 5 % (10,000)-------------

ITWDV 31.03.97 150,000 =======


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Note:A factory qualifies as an Industrial building (Others) upon which relief of 5 % p.a on cost is given.

Example - Commercial buildings.A block of offices was completed on 31.08.94 and was brought into first use on 1.12.94. It cost K1.2 billion.

Allowances will be given as follows for the first three years of its use: K’000

Cost 1,200,00094/95 W & T @ 2 % (24,000)

--------------WDV 31.03.95 1,176,00095/96W & T @ 2 % (24,000)

--------------WDV 31.03.96 1,152,00096/97W & T @ 2 % (24,000)

--------------ITWDV 31.03.97 1,128,000

========

Note:The initial allowance is not available on Commercial buildings. It is only given on Industrial Buildings.

Balancing allowance for buildings

Where a building, which has been used for business purposes, is sold, then a balancing allowance is given, calculated on the difference between the last WDV and the amount obtained on the sale of the building.

A balancing allowance is also given where a building is not sold but permanently ceases to be used for business purposes. The Commissioner General, under Par.5 (3) has the power to determine the market value of a building if no sale has taken place or if he is not satisfied that the sale has taken place in the open market.

The balancing allowance is given in the year in which the building ceases to belong to the taxpayer or in which he permanently ceases to use the building for business purposes.


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ABRAHAM MULOLANI

Example:

Abraham Mulolani erected a factory block for use in his manufacturing business. The total price of K370 million was apportioned as follows:

K’000Freehold Land (Including Cost of Conveyancing) 60,000Cutting and tunneling of site 2,000Construction of Building Comprising:Factory 267,000Employee’s Canteen 12,000General Offices 29,000

----------- 370,000 ======

The factory block was completed and paid for on 1.06.95 and taken into first use on 1.08.95. On 1.08.98 the factory was sold for K300 million (Including K100 million for the Land to Chanda Musonda.

Abraham Mulolani has always prepared his accounts to 31 March.

Required:Compute the IBA available to Abraham Mulolani for each of the years concerned.

ANSWER:ABRAHAM MULOLANI

Qualifying Expenditure: K’000

Total Cost 370,000Less: Land & associated costs (60,000)

-----------Cost of Construction 310,000

=======

Sub-Para.(7) of the Fifth Schedule provides that where part of a building is an Industrial building and a part is not, then the whole building shall be classified as an Industrial building where the Non-Industrial part of the building does not Exceed 10 % of the Total Cost. In this Case, General offices costing K29 million needs further investigation as follows:


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29 million X 100 %------------------------- = 7.8 (Say 8%). 370 million

The Non – Industrial part does not exceed 10 % of the total cost, so the Industrial building allowance is available on the Cost of the Whole structure, i.e., K310 million.

K’00031.03.96Cost 310,000Initial allowance @ 10 % 31,000W & T @ 5 % 15,500

---------(46,500)-----------263,500

Years ended 31.03.97 & 31.03.97W & T @ 5 % for 2 yrs (31,000)

-----------WDV Before Sale 232,500Qualifying Sale Proceeds (K300 – K100) (200,000)

------------32,500======

Total period of ownership from 95/96 to 98/99 = 4 yrs.W & T allowance given for 3 yrs.

Therefore:Balancing Allowance for 98/99 = 3/4 X K 32,500,000

= K24, 375,000.

Who owns the asset?

As a general rule, ownership, expenditure and claims for Capital allowances must reside in the same person or corporate body. There are however numerous exceptions to this. For Instance, we have seen that subsidies from Public sources normally reduce the amount on which Capital allowances can be claimed.

Subsidies from private sources will also reduce the amount on which allowances are due, where the provider of the subsidy can themselves obtain tax relief either as a business deduction or by way of capital allowances.

A trading tenant (possibly holding only a licence to occupy the premises, rather than a more formal tenancy) incurring expenditure on items, which become Land Lord’s fixtures once installed on the premises. In such circumstances the tenant may be permitted to claim the appropriate Capital allowances.


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Land and Buildings cause Particular problems because of the Legal possibility of a multiplicity of subordinate interests in the property. The legislation solves this problem by tying the right to allowances to ownership of the relevant interest; meaning the Interest (Freehold or Leasehold) owned by the person incurring the expenditure at the time when the expenditure was incurred.

2.4 - ACCOUNTING DATES

There is often an assumption for the newly set up businesses that accounts should be prepared for 12 months from the date of commencement. There is, however, no provision in our Zambian Income Tax Act, which prescribes such a practice. Taxpayers are free to choose whatever accounting date they wish. They may also change that chosen date as often as they like – although such changes may not always be effective for Tax purposes, as we shall see later in this Chapter.

In Zambia, the Tax year, or Charge year as it is commonly called runs from 1st April to the following 31 March. Income Tax therefore is charged by reference to the Tax payer’s Income received from a source within or deemed to be within Zambia in a charge year and the amount of business income assessable is the amount received in the charge year ended 31 March. We can deduce from the foregoing that for tax purposes business accounts, even though they do not add up to a period of 12 Months are required to be made up to 31 March of each charge year.

PROVISIONS OF SECTION 62 ITA

Section 62 ITA deals with Business Accounts. It provides as follows:

S.62 (1)A person may have an accounting date, which does not coincide with the end of the Charge year, that is, which ends on a date other than 31 March. This shows that even though the Law recognizes 31 March as the required end of year date, it does not make it the only accounting date to which accounts are supposed to be made.

The Commissioner General has the discretion to accept or reject a date, which does not coincide with 31 March. Students are advised to note that the acceptance of a non 31 March accounting date is discretionary and as per the provisions of Section 114 (1)(a) such discretionary acceptance cannot be questioned in any proceedings.

The Commissioner General also has the power to accept a Period, which is Less than 12 Months as though the accounts had been made up for a period of 12 Months.


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S.62 (2)When the Commissioner General accepts an accounting date, it becomes the standing and binding accounting date even in subsequent years. The accounting date can only be changed through an application to the Commissioner General.

S.62 (3)The Commissioner General is empowered to compute adjusted Income where the accounting date has been changed.

This power to compute adjusted Income is discretionary so the Taxpayer cannot question or appeal against such adjustment.

S.62 (3A)This section was introduced by the 1999 amendment Act. It provides that for a Tax payer whose accounting date straddles 31 March the provisional returns should not be based on the charge year, i.e., from April to March, but should be based on the accepted financial year.

S.62 (3B)States that relevant accounts must relate to the accepted accounting date.

BASIS OF ASSESSMENTS

Accounts that have been prepared to a Non 31 March accounting date may be assessed:

For the current charge year (CY). A current charge year is the charge year in which the accounts date falls. For Instance, the date 31 December1999 belongs to the charge year 99/2000 but 31 December 1999 falls in the year 1999 which will be taken as the current charge year.

For the previous charge year (PY). A previous charge year is the charge year ending before the accounts date.

Accounts for less than 12 Moths may be assessed as if they were for 12 Months – S.62 (1).

DATE BETWEEN 1 JULY AND 31 MARCH

For any accounting date, which falls between 1 July and 31 March, we use the current charge year basis (CYB).

Example:For a set of accounts with a year-end of 31/07/01. This is the charge year 2001/02. Since 31/07/01 falls between 1 July and 31 March, we will use the CYB.

For a set of accounts ending on 30.09.98. This is the charge year 98/99. And 30.09.98 falls between 1 July and 31 March, therefore the CYB rules will be applied.


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DATE BETWEEN 1 APRIL AND 30 JUNE

For any accounting date, which falls between April and June the Previous, year basis (PYB) is used.

Examples: For a set of accounts to 15 June 1997. This is the charge year 97/98 but since 15

June 1997 falls between April and June, the PYB rules will apply. So this is the charge year 97/97!

For a set of accounts to 31 May 2001. This is the charge year 2001/02 but since it falls between April and June, the PYB rules will apply so this is the charge year 2000/01.

FIRST ACCOUNTS AFTER COMMENCEMENT

Period more than 12 Months but less than 18 Months

Where the first accounts to 31 March are for more than 12 Months but not more than 18 Months they may be accepted and apportioned on a time basis. The proportion from the date of commencement to the following 31 March will be assessed for the charge year ending on that date and the balance of 12 Months for the charge year ending on the next 31 March.

Capital allowances are due for the full year in both years. There is no apportionment.

Example:A trader commences business on 1 November 1995 and adopts 31 March as the accounting date. His trading profits for the 17 Months to 31 March 1197 are K20, 000,000. How will these profits be assessed?

Answer:

This is a period of 17 Months, which is less than 18 months but more than 12 Months. The period will be apportioned on a time basis.

The proportion from 1/11/95 to 31 March 1996 will be assessed for the charge year ending on 31/03/96, which is 95/96:5/17 X K20, 000,000 = K K5, 882,353.

The remaining 12 Months will be assessed on the period ending on the next 31 March, ie, 31 March 1997, as follows:12/17 X K20, 000,000 = K 14,117,647This is the charge year 1996/97 (CYB).


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Period More than 18 Months

Where the first accounts to 31 March are for more than 18 Months, separate accounts from the date of commencement up to the following 31 March and for 12 Months to the following 31 March are required.

CHANGE OF ACCOUNTING DATE

Provided certain conditions are met, a self employed person or legal person is allowed to change his/her accounting date. This provision is to be found in Section 62 (1) of the ITA. In doing so, there may be tax advantages; hence there are conditions that must be fulfilled before the change is effected.

Conditions to be met: Where a Company is a member of a group, it might change its accounting

date to that of other group members. For individuals who are required by law to submit accounts on a particular

date, they might be allowed to change their accounting date to that required by law.

For farming businesses a date that falls when there is no growing of crops is more appropriate. In Zambia most farming businesses prepare their accounts to 30 September, thus if a farmer wishes to have his accounting date changed to 30 September, this will be allowed.

Where the Tax- payer has provided Sound Commercial reasons for wanting to change the accounting date. For example, it may be easier to take stock at certain times of the year.

Assessment Basis:

Where a Non 31 March accounting date has been accepted the accounts will be assessed on a “current year basis” or “previous year basis” depending on the new accounting date:

If the new accounting date falls between 1 July and 31 March, the CYB will apply.

If the new accounting date falls between 1 April and 30 June, the PYB will apply.

Where a change of accounting date has been effected, the action to be taken will depend on two things:

Are the accounts to the new accounting date for less than 12 Months?; and

Do the results show a profit or loss?


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Accounts less than 12 Months with a Profit

Example:Agreed Accounting date is 30 June, now changed to 31 December.Accounts to 30.06.95 (12 Months) Profits K15 millionAccounts to 31.12.95 (6 Months) Profits K8 million.Accounts to 31.12.96 (12 Months) Profits K14 million.

Assessments:30 June 1995:

As far as this assessment is concerned this is the last Normal charge year before the change. And since June falls between April and June, the previous charge year basis will apply. Hence this is the charge year 1994/95.

The K15 million will be assessed in 1994/95.

31 December 1995: The accounting date has been shifted to this date. From 30 June 1995 to

this date is a total period of 6 months. This is known as the charge year of change (CYC).

Where the change results in a CYC, which is less than 12 Months, the Taxpayer has an inherent opportunity of making Tax savings. In order to minimize the levels of abuse, the ZRA does expand the profits of this narrowed CYC since it is a potential source of unfavorable Tax engineering. Thus the profits of the 6 Months to 31 December 1995 will be expanded as follows:

Profits = 8,000,000 X 12

------------------- = K16, 000,0006

The new date of 31 December falls between 1 July and 31 March thus the CYB will apply. It follows therefore that this is the charge year 1995/96. The Expanded profits of K16 million will be assessed in this charge year.

The profit expansion gives rise to the issue of Double Assessment of profits. This profit, which has been doubly assessed, is recorded in the Taxpayer’s Permanent Notes File at ZRA and is given as a relief on cessation of business. The amount doubly assessed is computed as follows:

1995/96 K16, 000,000 – K8, 000,000 = K8, 000,000.

31 December 1996

This is the subsequent Charge year after the CYC. The profit assessable is K 14 million.


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ACCOUNTS LESS THAN 12 MONTHS WITH A LOSS

The loss is to be regarded as a loss for the charge year of change based on the new accounting date.

The loss is not expanded to 12 months.

Example:Agreed Accounts date 30th June changed to 31 December.Accounts to 30.06.94 (12 Months) Profit K1 million.Accounts to 31.12.95 (6 Months) Loss K0.5 million.Accounts to 31.12.96 (12 Months) Profit K15 million.

Assessments The last Normal charge year ending 30.06.94 will be assessed on the PYB.

Thus the K1 million will be assessed in 1993/94 The CYC falls in the charge year 95/96 (CYB). The assessable Loss is K0.5

million. The subsequent charge year after the year of change ending on the next 31

December will be for 12 Months. Thus the K15 million will be assessed in the charge year 1996/97 under the current charge year rules.

Comment on the LossThere is no need to record it in the Permanent Notes File since there is no double assessment or Loss Expansion.

ACCOUNTS MORE THAN 12 MONTHS WITH A PROFIT.

The profit is expanded to 24 months and then half assessed in the CYC.

Example:Agreed Accounting date 30 June changed to 31 July.Accounts to 30.06.95 (12 Months) Profit K10 million.Accounts to 31.07.96 (13 Months) Profit K13 millionAccounts to 31.07.97 (12 Months) Profit K14 million.


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Assessments:30 June 1995:This is the Last Normal year assessed under PYB rules. This is the charge year 94/95. The profit of K10 million will be assessed in 1994/95.

31 July 1996 (13 Months):Profits expanded to 24 Months as follows:

13,000,000 X 24-------------------- = K24, 000,000.

13

The Amount will be half assessed in the CYC. Thus it is not the Whole K24 million that will be assessed in this CYC. 31 July falls between July and March with current charge year rules applying. However, this is a 13 Months period, which straddles two charge years as follows:

Charge year 1 = 95/96 K12 million.Charge year 2 = 96/97 K12 million.

One half assessable charge year of change is the 96/97 with K12 million.

A note in the Permanent Notes File of the doubly assessed profits of K24, 000,000 – K13, 000,000 = K11, 000,000 has to be made and adjusted on cessation.

ACCOUNTS WITH MORE THAN 12 MONTHS WITH A LOSS

The loss is apportioned 12 Months to the charge year of change (1) and the balance to charge year of change (2). The loss is not expanded to 24 Months.

YEAR OF CESSATION

S.62 (6) Provides that:------------------------------------------------------------------------------------------------------------ Where the period is in excess of 12 months, the Income is deemed to be for the charge year succeeding that in which the Income based on accounts for the immediately preceding charge year was assessed, and Income for the remaining period is deemed to be Income of the following charge year.-----------------------------------------------------------------------------------------------------------

Example:A Company prepared its accounts to 31.12.98 and on 31.05.99 it ceased to trade.

Assessments: In every case, irrespective of the accounting date, accounts for the

last Normal charge year to the date of cessation are required.


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In this case the LNCY is the period from 1.01.98 to 31.12.98, which will be assessed on CYB. This is the charge year 98/99.

The period from 1.01.99 to 31.05.99 (5 Months) falls in the charge year 98/99 under the previous year basis.

The succeeding or following charge year is the charge year 99/00. This means that the Income of the 12 Months to 31.12.98 (98/99) will be deemed to be Income of the succeeding year which is the period ending 31.05.99, but this period has already been assessed!!!

The Balance is deemed to be Income of the following charge year, which is 99/00.

S.62 (7) Provides That: Where Income has been taxed twice and the business ceases, an

overlap relief is given. The overlap relief only reduces profits of the year of cessation and if

the profits are not sufficient, the profits of the penultimate year.

Example:Accepted Profits for 12 Months to 31.01.97 is K20 million (96/97)Accounting date changed to 31 August.Accounts for 7 Months to 31.08.97 Profit K9.5 million (97/98)Accounts to 31.08.98 (12 Months) Profit K15 million (98/99)

Answer:

1997/98Profit = 9.5 X 12

---------- = K16.3 7

Doubly assessed profits = K16.3 million – K9.5 million = K6.8 million.

If in the year of cessation the Company has profits of K4.5 million and K6.2 million in the year before, the relief will be applied as follows:

Year Before Cessation Year of(Penultimate Year) Cessation

K’m K’mIncome (Profit) 6.2 4.5Less: Double Assessment relief (2.3)* (4.5)

------- -------3.9 -=== ====

* K6.8 – K4.5 (Balance).


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2.5 - TURNOVER TAX

In a bid to broaden the Tax Base, the Income Tax Amendment Act of 2004 introduced Turnover Tax for the very first time in Zambia. The successful implementation of the Turnover Tax Regime is going to expand the Tax base and indeed provide Government with a buoyant Tax instrument for future Revenue collection. The potential to raise revenue in future is further enhanced by improving the institutional capacity within the Zambia Revenue Authority to collect this Tax. So far, it seems that this institutional capacity within the ZRA has been created. This coupled with sound legislative base, public acceptance and adequate financing will most likely lead to the desired goal.

Meaning of Turnover:For the purposes of Income Tax, Turnover includes Gross:

Earnings Income Revenue Takings Yield, and Proceeds

Liability to Turnover TaxThe following are liable to pay Turnover Tax:(a) Any Person carrying on any business with an Annual Turnover of K200

Million or Less.(b) Any Person whose Business earnings are subject to Withholding Tax and it is

not the Final Tax. Examples include the following: Rental Income Commissions Interest Earned by Companies Royalties Earned by Residents

Persons not Liable to Turnover TaxThe following Persons are not liable to Turnover Tax:

Any Person carrying on any Business with an Annual Turnover of more than K200 Million.

Any Individual or Partnership carrying on Business of Public Service Vehicle for carriage of Persons.

Partnerships carrying on any Business irrespective of whether the Annual Turnover is K200 Million or Less.

Partner’s Income from the Partnership is also excluded from Turnover Tax. This is because it is the Partnership that carried on Business and not the Partners.

Any Person whose Business earnings are subject to withholding Tax and it is the Final tax. These Include the following:(a) Bank Interest for Individuals(b) Dividends


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(c) Interest on Government bonds(d) Interest earned on Treasury bills for Charitable Institutions and

other Exempt Persons.(e) Management and consultancy Fees paid to Non – Residents(f) Payments made to Non –Resident Contractors(g) Public Entertainment Fees paid to Non – Residents(h) Royalties Paid to Non - Residents

Registration for Turnover TaxTaxpayers will be required to notify the ZRA within 30 days of commencement of Business. They will be registered and given a Tax Payer Identification Number (TPIN), Individual or Company Account number and a Pay As You Earn (PAYE) Scheme number where applicable.

Month – End Procedures:At the Month end a Taxpayer is required to add up his Turnover for the month, compute the Turnover tax and Remit the Tax due by the 14th of the Following month.

Taxpayers under the Turnover tax threshold will not be required to submit Provisional Income Tax Returns, as they will be expected to make monthly or quarterly remittances through the Monthly Turnover Tax Remittance Card.

But where a Taxpayer discovers during the year that his Turnover is going to exceed K200 Million, he should notify the ZRA immediately.

Year End procedures:Taxpayers who would have suffered withholding Tax Deductions during the year shall be refunded upon submission of withholding Tax certificates at the end of the charge year. The Refund will be determined through standard assessment issued by the ZRA at the end of the charge year.

Where no declaration is received the ZRA may issue a standard assessment at the maximum rate of 3% of K200 Million.


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EXAMINATION TYPE QUESTIONS WITH ANSWERSEXAMINATION TYPE QUESTIONS WITH ANSWERS


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QUESTION IIREEN MAPULANGA

Ireen Mapulanga is the proprietor of Zamiga Airports Ltd which she took over from the Government of the Republic of Zambia 13 years ago. So far, the company’s turnover has largely been represented by the invoiced value of navigation, landing, over flights, ground handling and parking fees relating to aircraft traffic, passenger service fees relating to passenger traffic, rentals and concessions relating to accommodation facilities provided at airport terminals and warehouses. The company’s auditors have recommended the use of historic cost convention in the preparation of financial and statutory accounts.

For the year ended 31 March 2005 the company accountant has prepared the following Fixed Asset Schedules.

Airport, terminal Leased MotorRunway & Aprons Building VehiclesK’000 K’000 K’000

COST:1.04.2004 19,933,072 32,905 2,820,488Additions 9,515,322 - 1,667,622Transfers 913,680 - 315,345Reclassifications - - -Disposals - - (82,739)

----------------- -------------- -----------------31.03.2005 30,362,074 32,905 4,720,716

========== ======== ========== Depreciation:1.04.2004 1,730,778 9,556 1,630,993Charge for the year 759,874 680 857,511Disposals - - (81,429)

--------------- -------------- ---------------31.03.2005 2,490,652 10,236 2,407,075

========= ======== =========Net Book Value@ 31.03.2005 27,871,422 22,669 2,313,641

---------------- -------------- ---------------Net Book [email protected] 18,202,294 23,349 1,189,495

---------------- --------------- ----------------


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The following additional schedules are also available including the overall totals:

Furniture Capital Work Total& Fittings In ProgressK’000 K’000 K’000

COST:1.04.2004 15,558,922 9,549,397 47,894,784Additions 3,907,800 57,661,562 72,752,306Transfers 53,454,078 (54,683,103) -Reclassifications - (3,932,026) (3,932,026)Disposals - - (82,739)

-------------- ------------------ -----------------

31.03.2005 72,920,800 8,595,830 116,632,325======== ========== ==========

Depreciation:1.04.2004 5,255,409 - 8,626,736Charge for the year 7,994,043 - 9,612,108Disposals - - (81,429)

------------- ------------------ ------------------31.03.2005 13,249,452 - 18,157,415

======== =========== ==========Net Book Value:@ 31.03.2005 59,671,348 8,595,830 98,474,910

--------------- ------------------- -----------------@ 31.03.2004 10,303,513 9,549,397 39,268,048

--------------- -------------------- ------------------Note:The leasehold building is encumbered as security for overdraft facility at a named commercial bank where the company has a facility of up to K100 million secured by a first legal mortgage of K45million and a lien for US $ 10,000 over the company’s foreign currency accounts.

Note 1: Motor Vehicle Disposals :( K’000)The total figure of K82, 739,416 is made of the following figures:

COST ITV b/f PROCEEDSNissan 190,459 - 6,000,000Nissan Van 652,607 - 5,000,000Hyundai Sonata 6,610,000 - 5,000,000Fire tender 26,000,000 - 3,500,000Hilux 16,500,000 - 8,000,000Corona 10,500,000 - 5,100,000Mark II 8,300,000 - 8,900,000Micro Bus 13,986,350 - 6,000,000

--------------- -------------- ---------------82,739,416 - 47,500,000--------------- -------------- ----------------

The accountant has estimated that a total of K35,239,416 will be claimable as a balancing allowance in the tax computation.


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Note 2 – Commercial Buildings:The buildings were bought as follows:

Cost ITV – B/F1990 38,051 28,1581990 32,141,000 23,784,3401991 726,000 566,2801994 9,971,964 8,177,0131995 1,240,000 1,042,6811996 447,438,586 393,745,9541997 127,839,386 115,055,4492001 15,000,000 14,400,000

------------------- ------------------634,394,987 556,799,875=========== ==========

Note 3 – Industrial Buildings:Cost ITV – B/F

1990 963,859,000 337,351,6502001 469,699,306 375,759,445

----------------- ------------------ 1,433,558,306 713,111,095

========== ==========

Note 4 – Airport Terminals, Runways & Aprons – industrial buildings: Cost ITV – B/F

2003 12,897,809,714 11,352,271,5732004 4,967,307,710 4,222,211, 5572005 10,429,002,000 Nil

--------------------- ---------------------28,294,119,424 15,578,483,130--------------------- ---------------------

Required:From the foregoing information you are required to compute the capital allowances that are claimable by Zamiga Airports Limited. Assume that the company has a policy to claim capital allowances as far as possible and at the earliest. This information is being required for the Finalization of the 2004/2005 Income Tax Assessment. Work to the nearest million Kwacha.


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ANSWER:IREEN MAPULANGA

This question looks a bit too long, and yes, you’ve got to get used to this type of questions. It is far much better to revise and practice with long questions and if you are a bit lucky encounter a short question in the actual examinations.

Although the question is long, its demands and requirements are relatively straight forward, i.e. to simply compute the various capital allowances that are claimable. Just looking at the Asset schedule alone should be enough to tell you what allowances are applicable. We can tell for sure that the following Capital allowances are likely to be computed from the available information:

Industrial Buildings Allowances From the information in Note 4 we observe that during the current

year the company has constructed new Airport Terminals, Runways and Aprons at the cost of K10, 429 Million. Since these new constructions are classified as Industrial Buildings, an Initial Allowance at the rate of 10% shall arise! Did you see that? If you did, I’m tempted to admire your mental alertness.

Capital allowances on Commercial buildings. Capital allowances on Motor Vehicles From the information given in Note 1 we can tell that since there

were disposals of fixed assets, either a balancing charge or allowance will arise and needs to be computed. In the question we have been told that the accountant has anticipated a balancing allowance of K35, 239 Million but we can not take this literally. We need to verify from the available information whether or not the accountant’s estimate is accurate and above all if it is in agreement with the Income Tax Law.

We can now get started by tackling the easier capital allowances first:

Initial Allowance on New Industrial Buildings:New AirPort Terminals, Runways and Aprons were constructed in the current charge year. All other Industrial buildings were bought years ago, some as far back as 1990! Thus Initial allowance will be computed as follows:

K10, 429 Million X 10% = K1, 043 Million.

Industrial Buildings Allowance:The industrial Buildings Allowance (IBA) is computed at the Rate of 5% per annum on cost, i.e. to say straight line method.


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Verifying the accountant’s computation of Balancing Allowance of K35 Million:

COST ITV b/f Proceeds AllowanceNissan 190,459 - 6,000,000 5,809,541Nissan Van 652,607 - 5,000,000 4,347,393Hyundai Sonata 6,610,000 - 5,000,000 (1,610,000)Fire tender 26,000,000 - 3,500,000 (22,500,000)Hilux 16,500,000 - 8,000,000 (8,500,000)Corona 10,500,000 - 5,100,000 (5,400,000)Mark II 8,300,000 - 8,900,000 600,000Micro Bus 13,986,350 - 6,000,000 (7,986,350)

--------------- --------- --------------- ----------------82,739,416 - 47,500,000 (35,239,416)--------------- --------- ---------------- ----------------

** When the total allowance is rounded off to the nearest Million Kwacha we get K 35 million. This is how the accountant computed and arrived at a balancing allowance, but this computation is against the requirements of the Income Tax Act as we shall see shortly. This mistake is quite common in practice and you need to get straight on top of things and never be caught off guard by the Zambia Revenue Authority. So, what does the law say? Let’s have a look at Para.5 (1) (b) of the First Schedule to the Income Tax Act again, which states that:


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Year Cost ITV b/f W & T ITV- C/F1990 964 337 (48) 2892001 470 378 (24) 3542003 2,898 11,352 (645) 10,7072004 4,967 4,222 (248) 3,9742005 10,429 0 (521)2005 Initial Allowance (1,043) 8,865

----------2,529======

QUOTE:“Income of a person Includes any amount paid by which recoveries from capital expenditure exceed – in the case of Implements, Machinery or Plant, such residue of the expenditure ranking for Capital allowances incurred in respect of the Implement, Machinery or Plant as remains after deduction of any wear and tear or other Capital allowances or similar deduction whether allowed under the Income Tax Act or under any Provisions of the Previous Law for any Charge year”

The key words are ‘as remains after the deduction of any wear and tear’ this effectively means that the figure to compare our disposal proceeds with is not the cost of the disposed asset but rather, it’s WDV or ITV (Income Tax Value). As can be seen the accountant was matching Disposal proceeds with Original cost rather than ITV to arrive at the balancing allowance of K35 Million. When we match disposal proceeds with ITV the scenario looks like this:

ITV b/f Proceeds Charge

Nissan - 6,000,000 6,000,000Nissan Van - 5,000,000 5,000,000Hyundai Sonata - 5,000,000 5,000,000Fire tender - 3,500,000 3,500,000Hilux - 8,000,000 8,000,000Corona - 5,100,000 5,100,000Mark II - 8,900,000 8,900,000Micro Bus - 6,000,000 6,000,000

--------------- --------------- ----------------- 47,500,000 47,500,000

-------------- ---------------- ----------------

Watch out! What was predicted to be a balancing allowance has in fact turned out to be a balancing charge. The Zambia Revenue Authority would start by first and foremost reversing the earlier claim of a balancing allowance and then disallowing K 47.5 Million in the Tax Computation. Note that balancing charge is the excess of Disposal Proceeds over the Income Tax Value of an asset.


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Capital Allowances on Commercial Buildings:Capital allowances on commercial buildings are computed at the rate of 2% per annum.

Year Cost ITV – B/F W & T ITV c/f1991 38,051 28,158 761 27,3971992 32,141,000 23,784,340 642,820 23,141,520

1993 726,000 566,280 14,520 551,760

1998 9,971,964 8,177,013 199,439 7,977,5741999 1,240,000 1,042,681 24,800 1,017,8812000 447,438,586 393,745,954 8,948,772 384,797,1822001 127,839,386 115,055,449 2,556,788 112,498,6612002 15,000,000 14,400,000 300,000 14,100,000

634,394,987 556,799,875 12,687,900 544,111,975

Capital Allowances on Motor Vehicles:

We have not been told whether or not the motor vehicles acquired during the year were Commercial or Non- Commercial Vehicles. For the purposes of this question, we will assume that all vehicles are commercial vehicles in which case they will be allowed a 25% Wear and Tear allowance on straight line basis:

Additions: 2005: - K1, 667 Million X 25% = K417 Million.Cost on 1.04.2004: - K2, 820 Million X 25% = K705 Million per annum for each year from date of acquisition which is not given in the question.

Capital allowances on Furniture and Fittings:Furniture and fitting are allowed a 25% Wear and Tear Allowance on cost. We have not been given the date of acquisition of the furniture and fittings so we can not accurately determine the ITV of these assets to ascertain the amount remaining for the assets to be completely written down. We can do a simple estimate as we did for motor vehicles to just show the annual wear and tear allowance on cost and the wear and tear relating to the current charge year, i.e. Additions to the asset register.

W & T on Additions for the year 2005:K3, 908 X 25% = K977 Million.

Cost on 1.04.2004: K 15,559 X 25% = K3, 890 Million per annum for each year from date of acquisition.


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QUESTION II

CHIBWE MATILDAH BITIPWATA

Matildah is involved in the manufacturing of farming equipment for small-scale farmers. Her business has been expanding steadily following the numerous tax incentives in agriculture announced by government; and now she needs an additional factory. She has three alternative options as follows:

Option 1

She can contract Dana constructions Ltd to construct a new factory. This will take 8 months and will cost her a total of K439, 630,000.

K’000VAT on building materials 18,555Cost of land 20,000Architects fees 15,000Ventilation and heating systems 5,000Fire alarm 2,775Concrete floor to support machinery 28,300General offices 40,000Factory 310,000

---------- 439,630

=====

Option 2

Buy an existing factory building from Mumba Chamfya at an estimated cost of K375, 555,000

Option 3

Obtain a medium sized factory on an arranged lease for 20 years. This arrangement will entail a monthly rental of K1, 000,000 and the lease premium will be K300, 000,000.

Required

Advise Matildah of the tax implications arising from the three options above. Include appropriate computations to support your answer.


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ANSWER

MATILDAH CHIBWE BITIPWATA

The question does in fact concern the tax implications of three alternative for Matildah who at the moment needs extra factory space as she is expanding following favourable tax incentives given by government to the farming community.

Option 1 – Construction of the factory through Dana Construction Limited

The factory will be new and will be brought into the business for the first time after construction and will accordingly qualify and rank for the Initial allowance at the rate of 10 % as well as the 5 % industrial building allowance on cost. This will be as follows:

Qualifying Expenditure

K’000

Total cost 439, 630Less: Cost of land (20,000)

VAT (18,555)Ventilation & Heating system (5,000)Fire alarm (2,775)

------------ 393,300

=====

Sub – Para (7) of the fifth schedule provides that where part of a building is an industrial building and a part is not, then the whole building shall be classified as an industrial building where the non industrial part of the building, in this case the general offices, does not exceed 10 % of the total cost. This can be computed as follows: K40, 000,000 / 439,630,000 = 9%. Since this is below 10 % the whole building will qualify. The industrial building allowance will accordingly be based on the cost of the whole structure, i.e. K 393,300,000.

The allowance will be claimed as follows:

(10% X 393,300,000) = K39, 330,000 as initial allowance, as this is a brand new building. An additional industrial building allowance will be claimed at the rate of 5 % on cost as follows: (5 % X 393,330,000) = K19, 665,000. Thus a total of K58, 995,000 will be deducted from the taxable trading profits in the current charge year in respect of industrial buildings alone.


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The Input VAT of K18, 555,000 will be reclaimed in full assuming that Matildah is making standard rated supplies.

The cost of the ventilation and heating systems (K5 million) and the fire alarm (K2, 775,000) will qualify as plant and machinery and will accordingly rank for Wear and tear allowances at the rate of 50 % on cost on a straight line basis. Thus K7, 775,000 X 50 % = K 3, 887, 500. The 50 % accelerated rate applies to plant and machinery that is used directly in farming and this is what we have assumed to be the case for Matildah.

Option 2 – Buy an existing factory building

If Matildah opts for this option, she will only be entitled to the industrial buildings allowance at the rate of 5 %. The 10 % initial allowance is only available on brand new buildings upon their first construction. Her total tax benefit will only amount to K375, 555,000 X 5% = K18, 777,750.

Option 3 – Lease of the factory

Under this option the owner of the factory will be entitled to claim the capital allowances as title of ownership remains with the lessor. Matildah can only claim the lease rentals as a deduction in her tax computation. Thus the K1 million monthly rentals will be an allowable expense and this will total K12 million at the end of the year.

The proportion of the premium assessed on the owner will also be deductible over the period of the lease as follows:

K’000 Premium paid 300,000Less: 300,000 X 2 % X (20 – 1) (114,000)

------------- 186,000========

K186, 000,000 / 20 years = K9, 300,000 per annum.

********************************************************************************************


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Documents

Chapter 2 (Paper 3.4 - Advanced Taxation)