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Last updated on January 5th, 2023 at 10:04 am
The High Court delivered its Judgement on 9th March 2020 to the effect that rent expenditure incurred by VIVO Energy is a deductible expenditure, contrary to the decision of the Tax Appeals Tribunal (TAT) which concluded that the premiums and rent payments were capital in nature and therefore non-deductible.
VIVO Energy has been proportionately amortising and claiming these rent and premium payments as deductible recurrent revenue expenditures in its books of accounts.
Uganda Revenue Authority (URA) conducted an audit and disallowed the premium and rent expenses as not being deductible expenses because the expenses are capital in nature. VIVO appealed to TAT arguing that a lease is not an acquisition of land and therefore not a capital expenditure.
The Tribunal held that the rent and premiums are costs incurred in acquiring a long term interest in land and therefore the expenditure was capital in nature.
So what transpired at the High Court and what was its decision?
- VIVO conceded that the amounts hitherto charged as premium payments were indeed capital in nature and therefore non-deductible. I concur.
- VIVO maintained their argument that the payment of rent is a revenue expenditure and therefore deductible. I concur, as a matter of fact and law.
- The High Court agreed with VIVO’s argument primarily on the grounds that the definition of rent in the Act limits its meaning to consideration for occupancy and usage of rented property, and is therefore incurred to produce income included in gross income, thus making it revenue in nature since it is a recurrent expenditure incurred that is periodically paid to maintain occupancy of the leased property and by extension to maintain the revenue generating capacity derived from possession of the lease.
The court arrived at this conclusion having perused the Lease Agreements and guided that where the issue of contention is founded on a contract, it is helpful to look at the terms of the contract in order to determine the intent of the parties regarding the expenditure and thus determine the tax consequence!
I have reservations on this reasoning, especially in the context of taxation. This is where I have #AlternativeFacts.
The court ought to have considered the “substance over form” doctrine provided for under section 91 of the Income Act and which grants URA the power to re-characterise a transaction or an element of a transaction that was entered into as part of a tax avoidance scheme; or to re-characterise a transaction the form of which does not reflect the substance.
I can only conclude that URA failed to make their case for a tax avoidance scheme evident in cleverly crafted Lease Agreements!
4. Court also ruled that payment of rent several months in advance and in a lumpsum does not make the outlay capital in nature. I concur.
It is my contention that the Lease Agreements that the court relied on for its decision were in form legally structured as an operating lease, but in substance, have the same economic effect as a sale on credit for the duration of the lease.
Just because an expenditure is structured as a recurrent expenditure does not necessarily make it a revenue expenditure.
In substance, the lessors or land owners have effectively transferred the benefits and risks associated with ownership of the leased asset to the lessee while retaining legal title in the asset.
Substantially therefore, the entire leased asset effectively passes from the lessor to the lessee. In other words, the lessors transferred economic ownership of the asset to VIVO (the lessee) but retained legal ownership of the asset.
For tax purposes, the substance of the transaction gives rise to a capital expenditure which the court rightly stated would be treated as capital if the expenditure gave rise to an enduring benefit.
Just because legal title remains with the lessor does not, for tax purposes, preclude URA from recharacterising the transaction as a tax avoidance scheme!
On an unfortunate note (but good for tax avoidance planners) reliance by the Court on the form of a transaction which may be used to disguise the true nature of a transaction and thus alter its tax consequences opens up a pandoras box for abusive tax planning opportunities.
The general principles from other Jurisdictions, that have emerged for considering a transaction under the substance over form doctrine, prescribe the following:
a) That if the substance of a transaction agrees with its form, and no alternative exists for re-characterizing the transaction, the form of the transaction should be respected.
b) That if the substance of a transaction cannot be reconciled with its form, the form of the transaction should be disregarded.
c) That if the substance of a transaction agrees with its form, but the transaction could, with equal or less force, be re-characterized as having another substance, the form of the transaction should be respected.
d) That if the substance of a transaction arguably agrees with its form, but more reasonably does not agree with its form, the form of the transaction should be disregarded if challenged by the tax administration, unless the taxpayer has a business purpose to support the form of the transaction.
However, the form of the transaction should not be ignored if challenged by the taxpayer, unless there is proof to the contrary.
Just my #AlternativeFacts