Residence basis of taxation: what to expect from the new Income Tax Act

The Income Tax Act (Chapter 23:06) which was first enacted in 1967 is to be replaced by a new Income Tax Act (Chapter 23:13) with effect from 1 January 2014. In this regard, Income Tax Bill, 2012 was gazetted on 30 November 2012. The need to study the Bill and raise what may appear to be problems with the new law cannot be over-emphasised.

The Zimbabwean income tax system is currently primarily based on what may be referred to as the source plus basis of taxation. All income which originates in Zimbabwe and certain types of income which are deemed to be from a source in Zimbabwe (i.e. foreign dividends and foreign interest) are taxable in terms of the Income Tax Act. The Bill proposes that a residence based tax system will be adopted with effect from 1 January 2014.

Several reasons must have motivated government to move to the residence based tax system.

Some such reasons are:-
-To place the income tax system on a sounder footing thereby protecting the Zimbabwean tax base from exploitation,
-To bring the Zimbabwean tax system more in line with international tax principles,
-The relaxation of exchange controls and the greater involvement of Zimbabwean companies offshore and
-To more effectively cater for the taxation of e-commerce.

To facilitate the implementation of the new proposals it has been necessary to re-define one of the most important building blocks on which the income tax system is based, namely what income is taxable. This is because income tax is levied on every person who has taxable income for the year of assessment. The gross income definition will therefore be amended to reflect the world-wide basis of taxation.

In short-
-All residents will be taxable on their Zimbabwean and foreign income
-Non-residents will be taxable on their Zimbabwean sourced income.
-Expatriates will be taxable on Zimbabwe sourced income and the income, if any which accrues during that year from all sources outside Zimbabwe and which is required to be remitted to Zimbabwe in terms of exchange control regulations.

As a world-wide tax system is based on residency, it is of crucial importance that there is certainty of what the term means. As far as individuals are concerned two rules will apply to define what a resident is. The first rule is a subjective rule based on ordinarily residence which will mean that a person is a resident of Zimbabwe if his or her permanent home, to which he or she will return (normal place of abode), is in Zimbabwe and he or she is present in Zimbabwe at any time during the year of assessment.

The second rule is based on physical presence in Zimbabwe and is therefore time based and more objective. A person will become a resident if he or she is present in Zimbabwe for one or more periods amounting in aggregate to at least one hundred and eighty-three days in any twelve-month period that ends during the year of assessment.

A company will be a resident if it is incorporated, effectively managed and controlled or undertakes the majority of its operations in Zimbabwe during the year of assessment. Control in this sense means where Zimbabwean residents hold more than 50 percent of the participation rights or votes in the entity or control the entity. The term "place of effective management" is not defined in the Act and the ordinary meaning of the words, taking into account international precedent and interpretation, may assist in ascribing a meaning to it.

UK legislation focuses effective management on the board of the foreign company with special attention given to the board composition, board powers, meeting and approval procedures and other administrative procedures. In South Africa the law defines the place of effective management to be where the day-to-day operational management and commercial decisions taken by the senior managers are actually implemented, i.e. the place where the business operations/activities are actually carried out or conducted. It will therefore be crucial for the Authorities to publish an interpretation note on the issue.

A branch in Zimbabwe of a non-resident company will be regarded as a separate person which is resident in Zimbabwe. To avoid the impact of double taxation where foreign income was taxed in the hands of a resident, the foreign tax paid will be allowed as a credit against the Zimbabwean tax liability subject to proof of payment being furnished.

The foreign income of any branch of a resident company or of a foreign company that is effectively managed and controlled in Zimbabwe will generally be subject to tax in Zimbabwe. However, such income might be ignored if it was subject to tax by the host country at a statutory rate of at least 25.75 per cent (i.e. the corporate tax rate in Zimbabwe) and the basis of taxation in that country is similar to that of Zimbabwe. If the same income was taxed at a lower rate in the host country, it will be taxable in Zimbabwe and a credit will be granted in respect of any foreign taxes which are proved to be payable in respect of such income. The tax liability in Zimbabwe will therefore be the difference between the Zimbabwean income tax and the host country's income tax.

The Authorities may consider certain transactions between a resident company and a non resident associate to be "diversionary transactions" which are aimed at exploiting the Zimbabwean tax base. Examples are transactions in respect of both goods and services where the income which should otherwise have been taxable in Zimbabwean is reduced or otherwise diverted to another country.

This could be achieved by a transaction whereby an abnormally high or low price for a purchase or sale is used to divert profits from Zimbabwe. The Bill empowers Zimra to so distribute, apportion or allocate income, deductions etc between the associates as they consider necessary to reflect the taxable income that would have accrued to them in an arm's length transaction.

It is therefore about time that executives review their group structures in view of the proposed legislation so as to fix them and ensure they remain tax efficient.

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Max Mangoro is a Partner at Ernst & Young in the Tax Advisory Service Line