TAT Decisions On Leases And Their Characterisation – The Ratio Decidendi In VIVO Energy & Mukwano Properties Cases


In both cases, the taxpayer had amortised lease rental expenses for land that had been paid in advance for the term of the lease.

In both cases, Uganda Revenue Authority (URA) disallowed expenses of rent and premium for leased land as being non-deductible capital expenditures under the Income Tax Act (The Act).

In the VIVO Energy case, the Tax Appeals Tribunal (TAT) held that the rent and premium payments were expenses of a capital nature and noted that there is a difference between a short lease and a tenancy with a long term lease that granted the applicant the exclusive right to use and occupy the property in exchange for consideration over a period of time.

They concluded that during that time the applicant has rights of ownership and it cannot be said that the taxpayer is not the owner of the land during the term of the lease.

The expenses were therefore capital in nature since they were incurred to benefit future periods; since they create a benefit of an enduring nature, since they increase the earning capacity of a company and since they are considered as money spent for the purchase of long term assets that have the effect of increasing the capacity, efficiency, lifespan of a fixed asset.

The High Court, on appeal, held that based on the terms in the lease agreements, the rent payments were revenue in nature and therefore deductible; and by concession of the taxpayer, the premiums were capital in nature and therefore non-deductible.

In the Mukwano Properties case, TAT answered the question whether the taxpayer should be allowed to deduct the expenses incurred in acquiring and holding its properties by examining the nature of trade in which the asset was employed; and concluded that the land in which a dealer in real estate carries on their business is part of their circulating capital or stock in trade.

Accordingly, any expenses incurred by the taxpayer in acquiring leases to the land i.e. the rent and premium, should be considered as revenue expenditure and therefore allowable deductions.

TAT also ruled, (strangely though, since the amounts were paid in advance), that the taxpayer is not entitled to have the said expenses amortised since the Act is silent and does not provide for amortisation of rent and premium paid over the lease period.

My Alternative Facts

No matter the reason, a lease is simply a contract to rent an asset for a given period of time and for agreed payment terms.

The lease grants a person the right to use an asset for a specified period of time in exchange for periodic rental payments.

Determining whether an arrangement is a lease therefore requires an evaluation of whether the arrangement conveys the right to use an underlying tangible asset to a lessee.

Leasing, in effect, separates the legal ownership of an asset from the economic use of that asset.

From both an accounting and tax perspective, leases typically fall into two main categories, operating leases and capital or finance leases.

For classification purposes, if the lease terms meet certain criteria, the lease will be considered capital in nature and the rules require that the leased assets are recorded as a fixed asset in the lessee’s financial statements and the lease obligation also recorded as a liability.

Over time, the value of the asset is amortised and the lease obligation decreases.

For tax purposes, whether a lease is a capital lease or an operating lease depends on the substance of the transaction rather than the form of the contract.

In other words, where property rights are obtained under leases and the substance of those leases cannot be distinguished from buying a property, the taxman can legitimately assert that the lease is a capital lease.

However, as a general rule, lease payments made by a lessee for the use of leased property may be deductible in computing taxable income to the extent they are incurred for the purpose of earning income from a business or property.

The Tax Man’s Challenge

The question of whether leased land is capital or revenue is a matter of concern in countries like Uganda where property rights can be obtained under long-term leases and the substance of those leases differs little from someone who actually buys a property.

The controversy over the treatment of such long-term leases of land emanates from the fact that, generally speaking, a leased transaction of land which does not result in transfer of the title to the lessee is out of scope for capture under the definition of finance leases in the Income Tax Act since a critical characteristic of land is that it normally has an indefinite economic life and therefore no residual value.

Above all, if title is not expected to pass to the lessee by the end of the lease term, the lessee normally does not receive substantially all of the risks and rewards incidental to ownership, in which case the lease of land would be an operating lease since the lessee cannot be in a position economically similar to the owner of the land.

Consequently, many tax planners would argue that for a lease of land, only ownership transfer or existence of a bargain purchase option would qualify the lease as a finance or capital lease.

This dilemma leaves Uganda Revenue Authority with no option but to create fairness in taxation by recharacterizing the transaction on the basis of substance of the transaction rather than the form of the contract.

In other words, where property rights are obtained under long-term leases and the substance of those leases cannot be distinguished from buying a property, the taxman can legitimately assert that the lease is a finance lease or an expenditure of a capital nature within the meaning of the terms in the Act.

Moreover, long term leases confer benefits of an enduring nature to a lessee and, consequently, the taxman is tempted to treat the rental payments or premiums as being in the nature of capital expenditure and not deductible in computing taxable income.

The uphill task that URA faces in the face of an objection by a taxpayer is to convince a judge about the substance of a transaction that is embodied in a written document.

This requires that they carefully ascertain the legal rights and obligations of the parties by construing the document as a whole and establishing a prima facie case of a tax avoidance scheme by the parties.

While the general anti-avoidance rules under the tax laws do not identify the details of transactions or circumstances that would qualify as a tax avoidance arrangement, and therefore would appear to give URA sweeping powers to recharacterise income and deductions as they deem fit, there are limits on the ability of URA to reconstruct the legal form of a transaction to reflect its substance.

In the absence of limits, URA actions would produce unintended consequences to the detriment of taxpayers who undertake bona-fide transactions without intention to defraud revenue.

Consequently, a number of factors must be taken into account by URA when deciding whether to re-characterise a taxpayer’s incomes and deductions.

As observed by Lord Denning in one of his judgements,

“…in order to bring [an] arrangement within the [anti-avoidance] section, you must be able to predicate – by looking at the overt acts by which it was implemented – that it was implemented in that particular way so as to avoid tax.

If you cannot so predicate, but have to acknowledge that the transactions are capable of explanation by reference to ordinary business or family dealing, without necessarily being labelled as means to avoid tax, then the arrangement does not come within the section”.

Anti-avoidance provisions exist to protect the integrity of the tax system against aggressive tax planning. How can we strike a balance? This is a question the Justices must contend with!


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