NATIONAL INSTITUTE OF PUBLIC ADMINISTRATION

LLB 405 – TAXATION LAW

STUDY MODULE

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 TABLE OF CONTENTS

PAGE

UNIT 1: INTRODUCTION TO TAX LAW 3

UNIT 2: TAXATION OF INCOME 9

UNIT 3: TAXATION SYSTEMS 27

UNIT 4: TAXATION OF EMOLUMENTS 34

UNIT 5: TAXATION OF BUSINESS INCOME 52

UNIT 6: ASSESSMENT AND COLLECTION OF TAXES 83

UNIT 7: INTERNATIONAL DOUBLE TAXATION RELIEF 90

UNIT 8: INTERPRETATION OF TAX STATUTES 105

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 UNIT1:
INTRODUCTION TO TAX LAW

1.1 WHAT IS TAX LAW?

Tax law is a body of rules, policies and laws that govern the tax process in a country. The power
to impose taxes is generally recognized as a right of governments. The tax law of a nation is
usually unique to it, although there are similarities and common elements in the laws of various
countries.

In general, tax law is concerned only with the legal aspects of taxation, not with its financial,
economic, or other aspects. The making of decisions as to the merits of various kinds of taxes, the
general level of taxation, and the rates of specific taxes, for example, does not fall into the
domain of tax law; it is a political, not a legal, process.

Tax law falls within the domain of public law - i.e., the rules that determine and limit the
activities and reciprocal interests of the political community and the members composing it—as
distinguished from relationships between individuals (the sphere of private law). International tax
law is concerned with the problems arising when an individual or corporation is taxed in several
countries. Tax law can also be divided into material tax law, which is the analysis of the legal
provisions giving rise to the charging of a tax; and formal tax law, which concerns the rules laid
down in the law as to assessment, enforcement, procedure, coercive measures, administrative and
judicial appeal, and other such matters.

The development of tax law as a comprehensive, general system is a recent phenomenon. One
reason for this is that no general system of taxation existed in any country before the middle of
the 19th century. In traditional, essentially agrarian, societies, government revenues were drawn
either from nontax sources (such as tribute, income from the royal domains, and land rent) or, to a
lesser extent, from taxes on various objects (land taxes, tolls, customs, and excises). Levies on
income or capital were not considered an ordinary means for financing government. They
appeared first as emergency measures. The British system of income taxation, for example, one
of the oldest in the world, originated in the act of 1799 as a temporary means for meeting the
increasing financial burden of the Napoleonic Wars. Another reason for the relatively recent
development of tax law is that the burden of taxation—and the problem of definite limits to the
taxing power of public authority—became substantial only with the broadening in the concept of
the proper sphere of government that has accompanied the growing intervention of modern states
in economic, social, cultural, and other matters. 1
The area of tax law is exceedingly complex and in constant flux largely due to two reasons. The
first is that the tax legislation has been used increasingly more often for objectives other than
raising revenue, such as meeting political, economic and social agendas. The second reason is the
manner in which the tax laws are amended.

1.2 THE TAXING POWER

1
Tax Law, 2016, Encyclopædia Britannica Online. Retrieved 28 February, 2016, from
http://www.britannica.com/topic/tax-law

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 Taxing power is the power of a government to impose and collect taxes within its jurisdiction.
The power to impose taxes is usually granted under the provisions of a country’s constitution. In
most democratic systems of government, this power is granted to the legislature, not the
executive or the judiciary.2The constitutions of some countries may allow the executive to impose
temporary quasi-legislative measures in time of emergency, however, and under certain
circumstances the executive may be given power to alter provisions within limits set by the
legislature.

In Zambia, for example, the power to impose taxes generally lies with Parliament. Prior to its
amendment in 2016, the Constitution of Zambia 3provided under Article 114 that: “taxation shall
not be imposed or altered except by or under an Act of Parliament.” The Constitution, however,
authorised Parliament to confer upon any local government authority, power to impose taxation
within the area for which that authority is established and to alter taxation so imposed.

The Constitution, as amended by Act No. 2 of 2016, now simply provides in section 199 that “a
tax shall not be imposed, except as prescribed.” The word ‘prescribed’ is defined in section 3 of
the Interpretation and General Provisions Act, 4to mean “prescribed by or under the written law in
which the word occurs.” Therefore, taxation can only be imposed in Zambia as prescribed by or
under the Constitution.

The legality of taxation has been asserted by constitutional texts in many countries, including the
United States, France, Brazil, and Sweden. In Great Britain, which has no written constitution,
taxation is also a prerogative of the legislature.

The historical origins of this principle are identical with those of political liberty and
representative government—the right of the citizens to take cognizance, either personally or
through their representatives, of the need for the public contributions, to agree to it freely, to
follow its use and to determine its proportion, basis, collection and duration (in the words of the
Declaration of the Rights of Man and the Citizen proclaimed in the first days of the French
Revolution, August 1789). Other precedents may be found in the English Bill of Rights of 1689
and the rule “no taxation without consent” laid down in the Declaration of Independence of the
United States. Under this principle all that is necessary is that the rights of the tax administration
and the corresponding obligations of the taxpayer be specified in the law; that is, in the text
adopted by the people’s representatives. The implementation of the tax laws is generally
regulated by the executive power (the government or the tax bureau). 5

1.3 WHAT IS TAX?

Tax is a compulsory monetary contribution to the state's revenue, assessed and imposed by a
government on the activities, enjoyment, expenditure, income, occupation, privilege, property,
etc., of individuals and organizations.

The duty of Zambian citizens to pay taxes is enshrined in the Constitution. Article 43(1) (b) of the
Constitution6provides that “a citizen shall…pay taxes and duties lawfully due and owing to the
State…”

1.4 SOURCES OF TAX LAW

2
Ibid.
3
Chapter 1 of the Laws of Zambia
4
Chapter 2 of the Laws of Zambia
5
Supra, note 1.
6
As amended by Act No. 2 of 2016.
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 The primary source of tax law is statutes. In Zambia, for example, the main statute laws for
taxation include:

(a) the Income Tax Act, Chapter 323 of the Laws of Zambia (for income tax);

(b) the Value Added Tax Act, Chapter 331 of the Laws of Zambia (for value added/sales
tax);

(c) the Customs and Excise Act, Chapter 318 of the Laws of Zambia (for customs and excise
duties); and

(d) the Property Transfer Tax Act, Chapter 340 of the Laws of Zambia (for tax on property
transfers).

Also included in the primary sources rules and regulations issued pursuant to statute laws.

Statutory provisions have, however, been the subject of extensive interpretation by the courts and
as such, case also forms an important source of tax law.

1.5 REASONS FOR IMPOSING TAXES

Governments around the world commonly raise money by imposing taxes on consumer spending,
investment and business activity. As in many other countries, tax revenue in Zambia generally
funds government operations. This includes all the facilities, salaries, and logistics involved in
running the country. According to the 2016 Budget Speech delivered by the Minister of Finance,
tax revenue estimated at a total of K30.4 billion was expected to finance 57.2 percent of the 2016
national budget. To ensure the flow of tax revenue, agencies such as the Zambia Revenue
Authority (ZRA) ensure that taxes are collected efficiently.

Government Services

One of the largest government expenses is providing services to people. For instance,
governments are generally responsible for education, health and social security services. These
services are commonly paid for by tax revenues. Similarly, local authorities are responsible for
emergency services such as fire brigade services, which are funded from taxes collected by the
local authority.

Infrastructure

Tax revenue allows government agencies to play a key role in developing infrastructure. At the
national level, the government funds programmes targeted at modernizing and improving areas of
national significance. For instance, the 2016 National Budget includes a K6.6 billion budget to
fund road infrastructure projects.

Public Goods

Taxes also generate revenue to fund public goods from which every citizen benefits. In economic
terms, public goods are consumed by everyone, and the production of public goods has no
competition. For instance, military and law enforcement officers are public goods. According to
the 2016 Budget Speech, for example, the 2016 defence budget stands at K3.1 billion, while the
budget for law enforcement stands at K1.8 billion.

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1.6 DIRECT AND INDIRECT TAXES

Taxes can be either direct or indirect.

A direct tax is one that the taxpayer pays directly to the government. These taxes cannot be
shifted to others. A land owner for example pays property taxes directly to the government upon
disposal of the land. Types of direct taxes include individual income tax, corporate tax and
property transfer tax.

An indirect tax is a tax whose effective incidence of tax falls on a person who does not himself
remit the tax to the government, i.e. the tax can be passed on to another person or group. A
business may recover the cost of the taxes it pays by charging higher prices to customers. A tax
shift occurs when the business shifts its taxes to others. Types of indirect taxes include value
added tax (VAT) and excise duty.

1.7 QUALITIES OF A GOOD TAX SYSTEM

A good tax system is said to be based on the following main principles:

(a) Neutrality;

(b) Efficiency;

(c) Certainty;

(d) Simplicity;

(e) Effectiveness and fairness; and

(f) Flexibility; and

(g) Equity.

Neutrality

Taxation should seek to be neutral and equitable between forms of business activities. A neutral
tax will contribute to efficiency by ensuring that optimal allocation of the means of production is
achieved. A distortion, and the corresponding deadweight loss, will occur when changes in price
trigger different changes in supply and demand than would occur in the absence of tax. In this
sense, neutrality also entails that the tax system raises revenue while minimising discrimination in
favour of, or against, any particular economic choice. This implies that the same principles of
taxation should apply to all forms of business, while addressing specific features that may
otherwise undermine an equal and neutral application of those principles.

Efficiency

The principle of efficiency entails that tax compliance costs to taxpayers and tax administration
costs for governments should be minimised as far as possible. In a good tax system, the costs of
complying with tax laws and the cost of administering tax laws will be minimal in comparison to
the taxes collected.

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Certainty and simplicity

Tax rules should be clear and simple to understand, so that taxpayers know where they stand. The
computations, tax compliance procedures and tax laws should not be ambiguous. A simple tax
system makes it easier for individuals and businesses to understand their obligations and
entitlements. As a result, businesses are more likely to make optimal decisions and respond to
intended policy choices. Complexity also favours aggressive tax planning, which may trigger
deadweight losses for the economy.

Effectiveness and fairness

Taxation should produce the right amount of tax at the right time, while avoiding both double
taxation and unintentional non-taxation. In addition, the potential for evasion and avoidance
should be minimised. For example, if there is a class of taxpayers that are by law subject to a tax,
but are never required to pay the tax due to inability to enforce it, then the taxpaying public may
view the tax as unfair and ineffective. As a result, the practical enforceability of tax rules is an
important consideration for policy makers. In addition, because it influences the collectability and
the administerability of taxes, enforceability is crucial to ensure efficiency of the tax system.

Flexibility

Taxation systems should be flexible and dynamic enough to ensure they keep pace with
technological and commercial developments. It is important that a tax system is dynamic and
flexible enough to meet the current revenue needs of governments while adapting to changing
needs on an ongoing basis. This means that the structural features of the system should be durable
in a changing policy context, yet flexible and dynamic enough to allow governments to respond
as required to keep pace with technological and commercial developments, taking into account
that future developments will often be difficult to predict.

Equity principle

The equity principle of taxation states that a taxpayer should pay according to his ability to pay in
terms of the income he has received and the capacity to derive benefits. A good tax system should
therefore be equitable in this sense. In a complex economic and social environment, it may not be
possible to design and administer a tax system that is equitable in an absolute sense. However, a
tax system that is generally perceived as equitable is a desirable and achievable goal.

Equity in taxation was the first canon of taxation on which Adam Smith laid a good deal of stress.
Adam Smith established “four maxims with regard to taxes,” one of which was the need for
equality in a tax system. Equity is traditionally delivered through the design of the personal taxes,
i.e. personal exemptions, deductions and graduated tax rates.

There are two prominent theories put forward to devise a fair or equitable tax system. They are:

(a) benefits received theory and

(b) ability to pay theory.

Benefits Received Theory

According to this theory of taxation, citizens should be asked to pay taxes in proportion to the
benefits they receive from the services rendered by the Government. This theory is based upon

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the assumption that there is an exchange relationship or quid pro quo between the tax payer and
Government.

The Government confers some benefits on the tax payers by performing various services or
providing them what are called social goods. In exchange for these benefits individuals pay taxes
to the Government. Further, according to this theory, equity or fairness in taxation demands that
an individual should be asked to pay a tax in proportion to the benefits he receives from the
services rendered by the Government.

However, there are some difficulties in application of this theory. The most crucial problem faced
by benefits received approach is that it is difficult to measure the benefits received by an
individual from the services rendered by the Government. For example, how much benefit an
individual tax payer derives from providing for national defence and education, and maintaining
law and order by the Government cannot be measured with any objective criterion. Secondly,
most of the Government expenditure is incurred on common indivisible benefits so that the
division of benefits of Government expenditure is not possible.

Further, benefits received theory militates against the very notion of a tax. A tax is defined as a
payment for general purposes of the State and not in return for a specific service. The benefit
theory can have meaning if the benefits of the Government services to the community as a whole
are considered. But this will only indicate how much total tax revenue the community should pay
to the Government. This will not help us in dividing the tax liability among various individuals
comprising the community. It may be noted that most important common benefits are peaceful
enjoyment of life, liberty and property. So far as life and liberty are concerned, Government’s
protection is the same for all. This will indicate levying of a toll tax. But toll tax has long been
discarded as it was found to be highly regressive and also a small yielder of revenue.

The benefit theory is applicable only in cases where the beneficiaries can be clearly
identified. Thus for example, the benefit theory is applied to the collection of road tax
from vehicle owners. This is also applied when local authorities collect special levies for the
services such as construction of sewers and roads they render to the people of their locality.

Ability to Pay Theory

The ability to pay is another criterion of equity in taxation. This theory requires that individuals
should be asked to pay taxes according to their ability to pay. The rich have greater ability to pay,
therefore they should pay more tax to the Government than the poor.

Essentially, the ability to pay approach to equity in taxation requires that burden of tax falling on
the various persons should be the same.

Horizontal and vertical equity

There are two concepts of equity, namely horizontal equity and vertical equity based on the
principle of ability to pay.

Horizontal equity suggests that equals should be treated equally, i.e. persons with the same
ability to pay should be made to bear the same amount of tax burden. This encourages tax
compliance as taxpayers will be confident with a tax system that treats taxpayers in similar
circumstances equally.

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Vertical equity, on the other hand, suggests that unequals should be treated unequally, i.e., how
the tax burden among people with different abilities to pay should be divided with taxpayers in
better circumstances than others bearing a larger part of the tax burden as a proportion of their
income. In practice, the interpretation of vertical equity depends on the extent to which countries
want to diminish income variation and whether it should be applied to income earned in a specific
period or to lifetime income.

In both these concepts of equity, what is exactly meant by ability to pay has been considered as a
subjective measure by some, and an objective measure by others.

In the subjective approach, the concept of sacrifice undergone by a person in paying a tax
occupies a crucial place. It is argued that in paying a tax, a person feels a pinch or suffers from
some disutility. This pinch or disutility felt by a tax payer is the sacrifice made by him. In this
subjective approach to ability to pay, tax burden is measured in terms of sacrifice of utility made
by the tax payers.

The objective approach considers what should be objective base of taxation which measures
ability to pay correctly. While there is no one agreed base of taxation which is said to measure
ability to pay, income is generally considered to be the best measure of ability to pay . This is
because a person’s income determines a person’s command over resources during a period to
consume or to add to his wealth. Justification of progressive income tax is based on this
understanding. Wealth of a person is another objective measure of ability to pay that has been
suggested as a tax base. The ownership of the property or wealth of an individual determines how
much resources he has accumulated. Saving from every year’s income adds to his wealth. The
wealth or property is therefore said to be a better index of taxable capacity.

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 UNIT 2:
TAXATION OF INCOME

2.1 DEFINITION OF INCOME

Income tax is, as its name implies, is a tax on a person’s income, not on transactions or things.
Since income tax is levied on the "income" of an entity, it is significant to know what income is
for tax purposes.

The term “income” is not really defined in legislation and has several meanings in daily usage of
the term. The term “income” has a very broad scope and it is not possible to define it
exhaustively. Therefore, for tax purposes, the Income Tax Act, Chapter 323 of the Laws of
Zambia provides a classification of what is included in the term “income”.

Section 17 of the Income Tax Act classifies “income” to include the following items:

(a) gains or profits from any business for whatever period of time carried on;

(b) emoluments;

(c) annuities;

(d) dividends;

(e) interest, charges and discounts;

(f) royalties, premiums or any like consideration for the use or occupation of any property;

(g) income from the letting of property; and

(h) the income as further classified in the First Schedule of the Income Tax Act.

The First Schedule of the Income Tax Act further classifies income to include the following:

(a) amounts received by way of maintenance or allowance under any judicial order or decree
in connection with matrimonial proceedings, or under a written separation agreement;

(b) the value of improvements effected on land or to the buildings thereon by any other
person pursuant to an agreement with the other person;

(c) any amount received in connection with the taking up of employment or by reason of the
cessation of any agreement for employment including compensation for loss of office or
employment;

(d) lump sum payments;

(e) capital recoveries;

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(f) the market value of any exotic timber that is on any land which is disposed of for
valuable consideration;

(g) any farm stock owned by a farmer at the beginning and end of each period for which he
makes up the accounts of his farming business;

(h) the gross sale proceeds or proceeds from sale of options in respect of shares allotted,
reserved or acquired by an individual in terms of an approved share option scheme net of
any amount paid for the acquisition or exercise of such shares or options by the
individual concerned; and

(i) amounts refunded to any person carrying on mining operations pursuant to the Mines and
Minerals Development Act.

The concept of income under the Zambian tax system therefore is wide to cover any form of
money or money’s worth that a person receives.

Read: Mohammad Hussein v Zambia Revenue Authority - 2001/RAT/36 where it was held that
money brought into Zambia for purposes of investment was not earned income within the
meaning of section 17 of the Income Tax Act and therefore was not taxable.

Capital is not income

The Zambian income tax system is a tax on income and not capital. While a receipt of money or
money’s worth assessed to be income is assessable for taxation purposes, capital is not assessed
for taxation purposed. It is thus very important to be able to differentiate between income and
capital; these have very different meanings as far as tax assessment is concerned.

Whether a receipt or an outgoing has the character of income or capital will usually be obvious
enough, even though we do well to remember that it is the context of the receipt or outgoing that
will usually be decisive to its character. For example, rent, interest, dividends, salaries, wages,
business profits and other receipts are easily classified as income. Money coming from the sale of
an asset is usually classed as capital. You do not usually pay tax on capital receipts as such,
though certain sales such as sales of land and shares may be taxable under property transfer tax
laws.

It is easy enough to understand most capital payments, for example if one buys an investment
asset for K100,000 and later sells it for K100,000, he/she won't be taxed on getting their own
money back and thus the K100,000 won't be assessable as income. In countries where capital
gains tax exists, if the person sold the asset for more than K100,000 there may be capital gains
tax on the gain itself, but nothing on the K100,000.

However, the difference between an income receipt and a capital receipt can sometimes be quite
difficult to determine and may at times be non-existent in economic outcome. Indeed, the
economic relationship between capital and income is sometimes so closely interwoven that in
economic terms the two are economically indistinguishable. Thus, for example, the capital value
of shares cum dividend will be affected by any dividend paid, payable or expected. The very price
of shares has a relationship to a company’s expected earnings, and the capital value of a business
(or of other income producing capital assets like many licences) is likely to reflect future
maintainable earnings. In short, Zambia has adopted a basis of taxation upon a distinction which
in some cases, and from some points of view, does not exist.

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 The exclusion of tax from capital receipts stems from the fact that when income tax was first
introduced, the conceptual idea behind an income tax was that tax should be paid upon a
taxpayer’s annual income: that is, from a taxpayer’s annual fruits, profit or labour, rather than
upon the capital or the means by which that income was produced. It was the accountant’s annual
period that was chosen for calculating the tax, and it was the accountant’s concept of a calculated
amount of revenue receipts less revenue outgoings that was chosen as the amount upon which to
levy tax. It was not a tax on wealth, or upon individual transactions; the tax was upon the regular,
recurrent and periodic returns to individual taxpayers, excluding capital receipts and after
allowing losses and outgoings properly referable to the derivation of the income over a twelve-
month accounting period. The system of taxation adopted as a tax upon income, therefore, took as
its target the accountant’s profit and loss statement (adjusted for tax) rather than the balance
sheet. The words “income” and “taxable income” were used as the statutory basis for the
exaction, but they referred to more fundamental general concepts found in commerce, business
and the ordinary world.

The distinction between capital and income is so fundamental to the structure of our taxing
system that it continues to have effect, even though in some respects the practical consequences
may have been blurred by the fact that an item may be taxed whether it be income or capital or
that in some cases an outgoing on capital account will be allowable as a deduction. A regularly
lamented problem, however, is that of determining a test to distinguish between items on revenue
account from those on capital account.

In Heather (Inspector of Taxes) v P.E.Consulting Group7Lord Denning MR said:

“The question – revenue expenditure or capital expenditure – is question which is being

repeatedly asked by men of business, by accountants and by lawyers. In many cases the
answer is easy, but in others it is difficult. The difficulty arises because of the nature of
the question. It assumes that all expenditure can be put correctly into one category or the
other. But this is simply not possible. Some cases lien the border between the two, and
this border is not a line clearly marked out. It is a blurred and undefined area in which
anyone can get lost. Different minds may come to different conclusions with equal
propriety. It is like the border between day and night, or between red and orange.
Everyone can tell the difference except in the marginal cases, and then everyone is in
doubt. Each can come down either way. When these marginal cases arise, then the
practitioners, be they accountants or lawyers, must of necessity put them into one
category or the other: and then, by custom or by law, by practice or by precept, the border
is staked out with more certainty. In this area, at least, where no decision can be said to
be right or wrong, the only safe rules to go by precedent. So the thing to do is to search
through the cases and see whether the instant problem has come up before. If so, go by it.
If not, go by the nearest you can find.”

In Commissioners of Inland Revenue v British Salmon Aero Engines Ltd 8Sir Wilfred Greene MR
put it more bluntly by saying that:

“in many cases it is almost true to say that the spin of a coin would decide the matter
almost as satisfactorily as an attempt to find reasons.” 9

However, difficult as it might be to articulate tests for the difference and to give reasons for the
conclusions reached, the difference and the reasons still matter. They matter not just because
7
[1973] 1 Ch. 189 at 216.
8
[1938] 2 KB 482.
9
Ibid at 498.
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 more or less tax may be paid, but because the difference reflects an underlying system adopted
for taxation that needs to be understood and applied consistently with principle and with the
underlying concepts. In other words, they matter not only because more or less tax will be paid or
gathered, but also because they need to reflect, and to give effect to, the underlying policy
objectives weaved into the fabric of the legislation.

The tests which have been developed over the years have varied as between receipts and
outgoings. In the case of receipts, the enquiry focused upon the occasion by which the receipt was
derived; in the case of outgoings the enquiry focused upon what the receipt secured. A moment’s
reflection will reveal how much these tests owe to the affairs of business: receipts should be taxed
if referableto the fruits of enterprise; outgoings should be deductible if expended in the process of
producing income but not if their expenditure is reflected as part of the continuing capital of the
enterprise and capable of subsequent disposal or exchange.

On the income side, it was said in Federal Commissioner of Taxation v Myer Emporium Ltd 10in
the joint judgment:

“Although it is well settled that a profit or gain made in the ordinary course of carrying
on a business constitutes income; it does not follow that a profit organ made in a
transaction entered into otherwise than in the ordinary course of carrying on the
taxpayer's business is not income. Because a business is carried on with a view to profit,
a gain made in the ordinary course of carrying on the business is invested with the profit-
making purpose, thereby stamping the profit with the character of income. But a gain
made otherwise than in the ordinary course of carrying on the business which
nevertheless arises from a transaction entered into by the taxpayer with the intention or
purpose of making a profit or gain may well constitute income. Whether it does depends
very much on the circumstances of the case. Generally speaking, however, it may be said
that if the circumstances are such as to give rise to the inference that the taxpayer's
intention or purpose in entering into the transaction was to make a profit or gain, the
profit or gain will be income, notwithstanding that the transaction was extraordinary
judged by reference to the ordinary course of the taxpayer's business. Nor does the fact
that a profit or gain is made as the result of an isolated venture or a “one-off" transaction
preclude it from being properly characterized as income: Federal Commissioner of
Taxation v Whit fords Beach Pty Ltd. The authorities establish that a profit or gain so
made will constitute income if the property generating the profit or gain was acquired in a
business operation or commercial transaction for the purpose of profit-making by the
means giving rise to the profit.”11

In the case Vodafone Cellular Limited and others v Shaw (Inspector of Taxes) 12the Court of
Appeal provided for a general test which may be applied to distinguish capital payment receipts
from revenue payment receipts. The Court found that the distinction is a question of law and that
a number of factors may be taken into account in making the distinction. The Court found that
among the factors to be considered include: (i) whether the payment is a lump sum or not; and (ii)
the purpose for which the payment is being made.In the Court’s view, where a lump sum
payment is made for the purpose of commuting or extinguishing a contractual obligation to make
recurring revenue payments this is prima facie a revenue payment. If however the lump sum
payment is made to reduce or bring to an end revenue payments by the modification or disposal
of an identifiable capital asset then the payment is a capital payment. 13 Millett L J in Vodafone

10
(1987) 163 CLR 199.
11
Ibid at 209-210.
12
[1997] STC 734.
13
Ibid at 739
13
 Cellular Limited and others v Shaw (Inspector of Taxes) drew attention in to an important
exception to the case of payments made to commute or extinguish recurring payments; stressing
that where the payment secured the modification or disposal of an identifiable capital asset then it
was a capital payment.

Aperusal of the legislation and of decided cases will reveal both how important the distinction
between income and capital continues to be and how difficult, and perhaps how controversial, its
application can still be to the facts. The legislation continues to maintain taxing differences for
receipts and outgoings depending upon their respective character as capital or revenue. The
decided cases continue to feature prominently disputes concerning the application of the
distinction between Capital and income.

2.2 SOURCE AND RESIDENCE PRINCIPLES OF TAXATION

The income or profits of a person may be taxed where the income is earned (the source country),
or where the person who receives it is normally based (the country of residence). There are
therefore two principles of taxation on income: the source principle and the residence principle.

Source principle

According to the source principle of income taxation, if a country considers certain income as
taxable income when such income arises within its jurisdiction, such income is taxed in that
country regardless of the residence of the taxpayer, i.e. residents and non-residents are taxed on
income derived from the country. Source taxation is justified by the view that the country which
provides the opportunity to generate income or profits should have the right to tax it.

Source principle under the Income Tax Act

In Zambia, section 14(1) (a) of the Income Tax Act imposes a charge of tax on income received
from a source within, or deemed to be within, Zambia. The provision reads:

“(1) Subject to the provisions of this Act, tax shall be charged at the rates set out in the
Charging Schedule for each charge year on the income received in that charge year-

(a) by every person from a source within or deemed to be within the Republic; and…”

This provision charges tax on income received in a charge year by a person (regardless of the
domicile or residency of that person) from a source within or deemed to be within Zambia. The
charge of tax on income in Zambia is therefore primarily based on the source principal – that is,
where the income is derived from.

Section 18 of the Income Tax Act provides for instances when certain types of income will be
deemed to be from a source within Zambia. According to section 18(1), income will be deemed to
be from a source within Zambia if that income:

(a) arises under any agreement made in Zambia for the sale of goods, irrespective of whether
those goods have been or are to be delivered in Zambia;

(b) is remuneration from employment exercised or office held in Zambia or if it is received

by virtue of any service rendered or work or labour done by a person or partnership in the
carrying on in Zambia of any business, irrespective of whether payment is made outside
Zambia, or by a person resident outside Zambia;

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(c) is remuneration for services rendered outside Zambia to the Government or any statutory
corporation if the person rendering the services is resident outside Zambia solely for that
purpose;

(d) is a pension granted by a person wherever resident, irrespective of where the funds from
which it is paid are situated, or where payment is made, except where the employment or
office for which the pension is granted was wholly outside Zambia, and the emoluments
were never charged to tax in Zambia;

(e) arises from interest incurred in the production of income or in the carrying on of a
business in Zambia or paid directly or indirectly out of funds derived from within
Zambia;

(f) arises from a royalty incurred in the production of income or in the carrying on of a
business in Zambia or paid directly or indirectly out of funds derived from within
Zambia;

(g) arises from the carriage, by a person who is not resident in Zambia, of passengers, mails,
livestock or goods embarked, shipped or loaded in Zambia other than passengers
embarking in transit through Zambia or mails, livestock or goods shipped or loaded on
transshipment through Zambia; or

(h) arises from a management or consultant fee incurred in the production of income or in the
carrying on of a business in Zambia and is received by a person or persons in partnership
for a service other than such part thereof as is rendered by the person or persons in
partnership in the carrying on of a business in Zambia.

According to section 18(2), where a person, being an individual ordinarily resident in Zambia or,
not being an individual, is a person who is resident in Zambia, receives a share of the profits of a
business or partnership carried on partly within and partly outside Zambia, the whole of the
person's share of the profits of the business or partnership is deemed to have been received from a
source within Zambia.

Residence principle

According to the residence principle of income taxation, residents of a country are subject to tax
on their worldwide (local and foreign) income and non-residents are only subject to tax on
domestic-source (local) income. Residence taxation is justified by the view that people and firms
should contribute towards the public services provided for them by the country where they live,
on all their income wherever it comes from.

Residence principle under the Income Tax Act

Section 14(1) (b) of the Income Tax Act imposes tax on foreign-source interest and dividend
income earned by Zambian residents. The provision reads:

“(1) Subject to the provisions of this Act, tax shall be charged at the rates set out in the
Charging Schedule for each charge year on the income received in that charge year-

15
 … (b) by any individual ordinarily resident in the Republic, or by every person, not being
an individual, who is resident in the Republic, by way of interest and dividends from a
source outside the Republic…”

This provision charges tax on income received in a charge year by an individual or artificial
person ordinarily resident or resident in Zambia, if that income is from interest or dividends from
a source outside of Zambia. In Zambia therefore the residence taxation principle only applies in
respect of interest and dividend income.

Section 4 of the Income Tax Act provides for the tax residency rule. An individual isfor tax
purposes treated as resident in Zambia if the individual has resided in Zambia for a continuous
period, or several periods, equal to183 days in any charge year. A person other than an individual
is resident in Zambia for any charge year if the person is incorporated or formed under the laws
of
Zambia; or the central management and control of the person's business or affairs are exercised in
Zambia for that year.

Conflicts of Residence and Source Taxation

Residence /Source Conflicts - Most commonly, double taxation arises through the combined
operation of the residence and source principles. Under the residence principle, residents of a
country are taxed on their worldwide income and, under the source principle, non- residents are
taxed on their domestic source income only. For example, suppose a person resident in the U.S.A.
has business or investment activities in Zambia. The U.S.A. adopts the residence principle and
taxes income at a rate of 40%, while Zambia adopts the source principle and taxes income at a
rate of 30%. If the person earns $1,000 from his activities in Zambia, he will be liable to $300
(i.e. 30% of $1,000) in taxes in Zambia on the income arising from the activities in Zambia under
the source principle and also liable to $280 (i.e. 40% of $700) in taxes in the U.S.A. under the
residence principle. So the person would be left with only ($1,000-300-400) = $300, paying an
effective tax rate of 70%.

Residence/Source conflicts can be avoided by requiring the residence country to give tax relief
for the source country tax. A double taxation agreement (DTA) between the two countries may
for example provide for residence country only taxation of the income, i.e. the DTA precludes the
source country from taxing the income earned by the non-resident from the source country. The
DTA may alternatively provide for source country only taxation of the income, i.e. the DTA
precludes the residence country from taxing the income earned by its resident from the source
country.

Source/Source Conflicts - Similarly, while it is the international norm that countries can tax non-
residents on income sourced within their jurisdiction, there is no internationally agreed set of
source rules for this purpose. Instances of source/source conflicts can be found for almost all
classes of income when more than one country claims that revenue was sourced from its territory.
Example 1: Some countries may regard business profits as sourced within the jurisdiction if the
profits are attributable to a permanent establishment in the jurisdiction, while other countries may
regard business profits as sourced in the jurisdiction if the place of contract is in the jurisdiction.
Example 2: some countries may regard royalties as sourced in the jurisdiction if the underlying
property giving rise to the royalty is used in the jurisdiction, while other countries may regard it
as sourced in the jurisdiction if the royalty is paid by a resident of the jurisdiction.

Source/source conflicts can be avoided by a DTA effectively setting out a uniform set of source
rules that are then applied by both countries overriding any conflicting domestic rules.

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 Residence/Residence Conflicts - Two or more countries may claim that a particular taxpayer is a
resident of their tax jurisdiction. While it is now the international norm for countries to tax
residents on worldwide income, there is not universal agreement as to how residence is defined.

For individuals, two common methods are used to determine residence: (a) the facts and
circumstances approach – having regard to all the facts and circumstances, a judgement is made
as to whether a taxpayer has a sufficiently strong personal connection to the jurisdiction as to be
regarded a fiscal resident of the jurisdiction; and (b) the days present approach – an individual is a
resident of a jurisdiction if they are physically present in the jurisdiction for a specified number of
days (usually 183 days) in the tax year or, alternatively, in any period of 12 months beginning or
ending during a tax year. Consequently, it is possible that an individual with sufficiently strong
personal connection to one country also spends the specified number of days in another country
and therefore making him resident of both countries for tax purposes.

For companies, there are also two common methods used to determine residence: (a) the place of
incorporation – a company is resident of the country in which it is incorporated; and (b) the
central management and control – a company is resident of the country in which its central
management and control is located. Consequently, it is possible that a company incorporated in
one country but with its central management and control in another country will be a resident of
both countries and therefore subject to tax in both countries. It is also possible that a company
may have its central management and control divided between two countries and, as a result, be
resident of both countries.

Residence/residence conflicts can be avoided by the residence provision in a DTA including

tiebreaker rules that treat a person who is resident of both countries under each country’s
domestic law as a resident of one only of the countries for the purposes of the DTA.

Thus, the main effect of DTAs is to reduce double taxation that may result from the conflicts of
the source and residence taxation principles. The degree to which this is done depends on each
DTA: capital-exporting richer countries prefer the OECD model convention, which is more
favourable to residence, while capital-importing developing countries tend to favour the UN
model convention, which is more favourable to source.

2.3 TAXABLE INCOME

Generally, all income received is taxable unless it is specifically exempted by law. Income that is
taxable must be reported on your return and is subject to tax. Income that is non-taxable may
have to be shown on your tax return but is not taxable.

The concept of taxable income effectively defines the income tax base. The taxable income of a
person for a tax period is commonly defined as the gross income of the person for the period less
the total deductions allowed to the person for the period. The gross income of a person for a tax
period is the total of amounts derived by the person during the period that are subject to tax. The
gross income of a person, therefore, will not include amounts that are exempt from tax. The total
deductions of a person for a tax period arethe total of expenses incurred by the person during the
period in deriving amounts subject to tax plus any capital allowances and other amounts allowed
as a deduction on a concessional basis (e.g., charitable donations).

Consequently, there are three key elements in the definition of the tax base: first, the inclusion of
amounts in gross income; second, the identification of amounts that are exempt income; and
third, the allowance of amounts as deductions.

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 The definition of key concepts related to the determination of taxable income, drawing on
commonly accepted understandings and notions in the jurisdiction will depend in part on the
structure of the income tax system to be adopted and in part on existing structures and concepts.
Even when general definitions are used, they are inevitably supplemented by specific definitions,
inclusion rules, exclusion rules, rules allowing deductions, and rules denying certain deductions.
Thus, any consideration of general definitions must be made in the context of plans for specific
rules.

Gross Income

Gross income is income received by a person from all sources, unless excluded by law. The
inclusion of amounts in gross income will often be specified by reference to particular categories
of income. For this purpose, income is commonly divided into employment, business, and
investment income. There are often supplementary definitions of each category of income and, in
the case of investment income, definitions of amounts included in investment income (e.g.
dividends, interest, rent, and royalties). However, not all amounts derived by a taxpayer will fit
neatly into one of these categories. An issue arises, therefore, as to the specification of other
amounts to be included in gross income. This is commonly done by separately listing out those
amounts. Such a definitional structure means that any amount that does not come within one of
the listed inclusions will not be included in gross income. This may be overcome by including a
residual category of income. The residual category may itself be a separate category.
Alternatively, the list of amounts included in gross income may be expressed to be inclusive only
so that a general formula may apply for including other amounts in gross income.

Exemptions

There will be amounts that are not to be included in gross income. These amounts are usually
identified as “exempt income.” While many different amounts may be treated as exempt income,
such amounts can be classified into several broad categories.

First, an amount or an entity may be exempt for social compassion reasons. Examples of amounts
that may be exempt on this basis are welfare payments, scholarships, and compensation
payments. Examples of entities that may be exempt on this basis are religious, charitable, or
education institutions of a public character.

Second, an amount may be exempt as a result of international convention, agreement, or practice.

For example, a country that is a signatory of the Vienna Convention on Diplomatic Relations is
obliged to exempt from tax the official employment income and foreign-source income of a
foreign diplomatic officer, consular officer, administrative or technical employee of a diplomatic
mission or consulate, consular employee, member of the service staff of a diplomatic mission or
consulate, or a private servant of a diplomatic mission. 14 The exemption also extends to the
foreign-source income of family members and consular staff. As a matter of practice (sometimes
only on a reciprocal basis), a similar exemption may be extended to other foreign government
representatives working in the country.

Third, an amount may be exempt for structural reasons. This is primarily to prevent double
taxation under the income tax or other tax legislation. For example, some amounts (e.g., interest)
may be subject to withholding of tax at source as a final tax on the income. It is necessary to
exempt such amounts from inclusion in gross income so as to avoid double counting. Another
example is gifts, which may be subject to gift duties or capital transfer taxes. While such amounts
14
See for example paragraph 3(a) and (b) of the Second Schedule to the Income Tax Act
18
need to be excluded from gross income, whether they are treated as exempt income for all the
purposes of the income tax legislation will depend on the circumstances in which the concept of
exempt income is relevant under the legislation.

Fourth, an amount may be exempt for political or administrative reasons. An example of such an
amount is a windfall gain. Finally, an amount may be exempt as an incentive toencourage a
particular activity. For example, the income of a retirement fund may be exempt from tax to
encourage retirement savings. As indicated above, the concept of exempt income may be relevant
for other purposes of the income tax law. For example, it is important in applying rules that deny
deductions for expenditures incurred to derive exempt income. Section 15 of the Income Tax Act
authorises the Minister of Finance, by statutory instrument, to exempt certain income or certain
persons from tax. The income and persons exempted from tax are listed in the Second Schedule
of the Income Tax Act and include the following:

(a) Exempt office holders: The emoluments of the President are exempt from tax.The income
of the Liwung of the Western Province as Liwung and the income of any Chief received
as a Chief from the Government are also exempt from tax.

(b) Foreign exemptions: the following are exempt from tax:

(i) the emoluments of any individual payable in respect of any office which he holds
in Zambia as an official of any foreign government, if such individual is resident
in Zambia solely for the purpose of carrying out the duties of his said office;

(ii) the emoluments of any domestic or private servant of any individual referred to
in sub-paragraph (i) payable in respect of domestic or private services rendered
or to be rendered by such servant to such individual, if such servant is not a
Zambian citizen and is resident in Zambia solely for the purpose of rendering the
said services;

(iii) the emoluments payable to any individual who is not a Zambian citizen and who
is temporarily employed in Zambia in connection with any technical assistance
scheme provided by any foreign country, any international organisation, or
agency, any foreign foundation or any foreign organisation, if the exemption of
such emoluments or such part of the emoluments as may be specified is
authorised under the terms of an agreement entered into by the government of
such foreign country, international organisation or agency, foreign foundation or
foreign organisation with the Government of Zambia;

(iv) the emoluments of any individual in respect of service with any international
organisation or any agency of a foreign government or any foreign foundation or
organisation, which organisation, agency or foundation is approved by the
Minister of Finance by order in the Gazette and such individual is not a Zambian
citizen and is resident in Zambia solely for the purpose of rendering the said
service or secondment to any Zambia organisation, agency, or foundation; (v) the
income of any international organisation, any agency of a foreign government, or
any foreign foundation or organisation; as is approved by the Minister of Finance
by statutory order in the Gazette.

(c) Exempt organisations: The incomes of the following organizations are exempt from tax:

(i) local authorities;

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 (ii) registered trade unions;

(iii) agricultural society, mining or commercial society (whether corporate or

unincorporated), or any other society having similar objects, not operating for the
private pecuniary gain or profits of its member;

(iv) a club, society or association organised and operated only for social welfare, civil
improvement, pleasure, recreation or like purposes, if its income, whether current
or accumulated, may not in any way be received by any member or shareholder;

(v) approved fund or medical aid society or approved share option scheme;

(vi) employees' savings scheme or fund, if approved by the Commissioner-General;

(vii) political party registered as a statutory society under the Societies Act;

(viii) a statutory body;

(ix) a collective investment scheme to the extent to which the income is distributed to
participants in the scheme;
(x) a non-resident person derived from the carrying on of the business of ship owner,
charterer or air transport operator, where the country in which such non-resident
person is resident extends a similar exemption to ship owners, charterers and air
transport operators who are not resident in such country but who are resident in
Zambia;

(xi) any organisation, partnership or body corporate, or such part of the income as is
specified, where the objects and activities within Zambia of such organisation,
partnership or body corporate are to assist in the development of Zambia and
such exemption of the income, or such part thereof as is specified is approved by
the Minister of Finance by Statutory Order;

(xii) any charitable institution or of any body of persons or trust established for the
promotion of religion or education, or for the relief of poverty or other distress,
if, in relation to the people of Zambia, the income may not be expended for any
other purpose;

(d) Exempt income: There following incomes are exempt from tax:

(i) income by way of lump sum payments withdrawn from an approved pension
fund at retirement age or death or on the beneficiary becoming permanently
incapable of engaging in an occupation or such sums withdrawn from an
approved fund which the Commissioner-General determines cannot be enjoyed
by the member until he attains retirement age;

(ii) income received as a war disability pension, or as a war widow's pension, or as

an old age pension paid out of public funds, or as a benefit paid under any written
law in respect of injury or disease suffered in employment;

(iii) income received in conjunction with the award of military, police, and fire
brigade decorations for distinguished or good conduct or long service;

20
(iv) income received by an individual or his dependants or heirs, being on account of
his injury or sickness, from any approved fund or registered trade union or
medical aid society or under any policy of insurance;

(v) income received as a local overseas allowance by any member of the Defence
Force of Zambia while on service officially declared to be active service;

(vi) income received as an allowance paid for service outside Zambia by the
Government or a statutory corporation in respect of an excess of living expenses
due to such service;

(vii) income in respect of a scholarship or bursary, for the purposes of education and
maintenance during such education;

(viii) income by way of alimony, maintenance or allowance under any judicial order or
decree in connection with matrimonial proceedings, or under any separation
agreement, to the extent of the amount of the alimony, maintenance or allowance
that has not been allowed as a deduction to another individual under the Income
Tax Act;

(ix) income prescribed under the Ministerial and Parliamentary Offices (Emoluments)
Act, and which, pursuant to the provisions of that Act, is exempt from tax;

(x) income by way of grant as compensation for loss of office or disturbance by an

officer admitted to the permanent and pensionable establishment of the
Government;

(xi) income by way of any education allowance or passage value payable to a public
officer or payable in respect of his wife and children or in respect of his wife or
children;

(xii) income received by a person designated as an enterprise under the Zambia

Development Agency Act, 2006 who has been granted the incentives provided
under that Act, to such extent and for such period as the Minister of Finance may
prescribe;

(xiii) income by way of pension received by an individual from an approved fund;

(xiv) incomeby way of a dividend declared from farming income for the first five
years the distributing company commences farming;

(xv) income received by an individual by way of sitting allowance for attending a

council meeting;

(xvi) ex-gratia payment made to a spouse or dependant on the death of an employee;

(xvii) income received by a person designated as a micro or small enterprise under the
Zambia Development Agency Act, 2006;

(xviii) income received by way of a dividend declared by a company listed on the

Lusaka Securities Exchange (LuSE) to an individual;

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(xix) income received by way of a lump sum payment paid to an employee on loss of
office or employment on medical grounds;

(xx) emoluments received by a former President of Zambia; and

(xxi) interest on any public loan raised by Government or a statutory corporation,

where the terms of the loan provide that the interest thereon shall be exempt from
tax; and interest on any bond issued under or in respect of a public loan raised by
the Government or a statutory corporation.

Personal exemptions

When calculating a taxpayer’s income tax liability, a taxpayer may under the income tax
legislation of a country be entitled to certain exemptions known as „personal exemptions‟
which are dependent on the personal circumstances of the taxpayer, as well as the
economic, social and political goals of a particular society. The whole structure of these
exemptions is linked to one’s ability to pay – when taxes are imposed they impose
different burdens on different sectors of society, e.g. a tax may impose a greater burden
on a taxpayer with a large extended family to support than on a taxpayer with a small
nuclear family. Personal exemptions usually take the form of a fixed amount given to a
qualifying taxpayer as tax free-income.

Personal exemptions are deducted from the taxpayer's income to arrive at the taxable
income, thereby providing some form of tax relief to the taxpayer.

Examples of personal exemptions include the following:

(a) Standard deductions: a standard deduction is a flat amount that a tax system
allows taxpayers to deduct from their taxable income. The idea of a standard
deduction is that a minimum amount of income is needed in order to sustain a
living and therefore this amount should not be subject to a direct tax. In Zambia,
the current standard deduction allowed for individuals is K3,000.

(b) Married allowance: a tax system may allow a married taxpayer to deduct from
their taxable income a certain amount as a married allowance. The justification
for a married allowance is that when one gets married, his/her living expenses
increase and therefore the allowance provides some tax relief in order to allow
such a person have a bit more income to spend.

(c) Child allowance: a tax system may allow a taxpayer to deduct from their taxable
income a certain amount as a child allowance in respect of each child that the
taxpayer has. Such an allowance is made available on the understanding that the
cost of raising children is high and therefore the allowance provides allows the
taxpayer to have a more income to spend on his/her children.

(d) Dependant allowance: similar to the child allowance, a deduction may be

allowed to a taxpayer who has dependants in his/her care. In countries where the
allowance is available, the tax laws usually define who is a dependant and an age
limit is usually set to prescribe who qualifies to be a dependant for purposes of
the allowance. In most cases, a dependant has to be an unmarried relative of the
taxpayer or of the taxpayer’s spouse.

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(e) Old age allowance: this is a personal exemption that may be given to a taxpayer
of old age and in receipt of an income. The rationale for such a tax relief is that
such a taxpayer is most likely drawing on his/her savings or that his/her ability to
earn income is relatively precarious compared to other taxpayers of younger age.

(f) Handicapped allowance: this is a personal exemption that may be given to a

handicapped taxpayer; the rationale being that such a taxpayer’s earning ability is
lesser than able-bodied individuals.

In certain instances, personal exemptions may be additive, i.e. a taxpayer may be entitled
to more than one personal exemption. For example, a person who is both handicapped
and aged may be entitled to three exemptions: the standard deduction, handicapped
allowance and old age allowance.

Example:

John Sangwapo is married to Mailesi. John has been blind since birth; and he and Mailesi
have four children, the oldest being 10 years old. John is a technician at Zamtel and his
gross salary is K10,000. If the tax system provided for a flat income tax rate of 25% for
individuals, a standard deduction of K3,000, married allowance of K1,500, child
allowance of K400 per child and a handicapped allowance of K800, John’s tax liability
would be determined as follows:

K8,000 (gross salary) - K3,000 (standard deduction) = K7,000

Personal exemptions:

Married allowance- K1,500

Total child allowance- K1,600
Handicapped allowance- K 800
Total K3,900

Taxable income = K7,000 – K3,900 = K3,100

Tax payable = 25% of K3,100 = K775

The determination of the nature and amount of personal exemptions that a government
may wish to extend to its taxpayers depends on many considerations. For example,
societies where large families are held desirable or where extended family systems
subsist, child and dependant allowances may be substantial. The other consideration for
the grant of personal exemptions may be from an administrative point of view. The cost
of taxing very little income may be proportionately high relative to the revenue yield and
therefore a government may find it much more practical to exempt a certain level of
income from tax in order to eliminate large numbers of taxpayers who earn little income
and pay little tax thereon.

There are essentially four functions that personal exemptions are said to perform:

(1) They keep the total number of taxpayers within manageable proportions and
particularly keeping out from the tax base, persons whose tax liabilities are lesser
than the cost of collecting taxes from such persons;

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 (2) Freeing from tax, income needed to maintain a minimum standard of living;

(3) They held achieve a smooth graduation of effective tax rates at the lower end of
the scale; and

(4) They differentiate tax liability according to personal circumstances such as

family size.

Prior to 1 April 1989, Zambian income tax laws provided for married allowance, family
allowance, single allowance, child allowance, insurance allowance and handicapped
allowance as personal exemptions. However, with the abolishment of the concept of the
family as a taxpaying unit in 1989, these married allowance, family allowance, single
allowance and child allowance were abolished leaving only a primary allowance,
insurance allowance and handicapped allowance as the provided personal exemptions.
With effect from 1 April 1993, the Income Tax Act only provided for an individual tax
credit, which is now provided under section 14(2) of the Income Tax Act. This provision
reads:

“(2) Subject to the other provisions of the Act, in the case of an individual, the
amount of tax which, apart from this subsection, would be charged in respect of
any income received by that person in that charge year shall be reduced by the
amount of the tax credit appropriate to such person for that charge year as
specified in the Charging Schedule and that person shall be liable to pay tax for
that charge year an amount equal to that reduced amount…”

Under Paragraph 1(b) of the Charging Schedule of the Income Tax Act, a tax credit is
provided for in respect of individuals with disabilities. Therefore, the only personal tax
relief currently provided under the Income Tax Act is the tax credit provided under the
Charging Schedule to persons with disabilities.

Deductions

The third element in the determination of the tax base is the allowance of amounts as a deduction.

A deduction is a reduction of income that is able to be taxed, and is commonly a result of

expenses, particularly those incurred to produce additional income. Deductions, like exemptions,
therefore reduce taxable income.

The general rule commonly allows a deduction for expenses to the extent to which they are
incurred in deriving amounts included in gross income. Therefore, while exemptions are
dependent on personal circumstances of the taxpayer as well as a particular society’s economic,
social and political goals, deductions on the other hand are dependent on amounts actually spent
by the taxpayer and may include items such as life insurance premiums, medical expenses,
charitable contributions, capital allowances (such as depreciation and amortization provisions)
etc. Therefore, a taxpayer who does not incur such expenses has no basis for claiming any such
deductions.

Deductions are said to be necessary for the following reasons:

(1) to relieve the hardship created by the impairment of ability to pay particularly through
heavy, unsought and unavoidable expenditure;

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 (2) to allow the deduction of certain items that are costs of obtaining non-business income or
that are hard to distinguish from such costs;

(3) to promote the achievement of social, economic objectives desirable by the government.

There are a number of deductions that various countries allow their taxpayers and the amount
depends on the policy objectives that a government attaches to each. Some of these include:

(a) Medical expenses – a deduction of expenses incurred in seeking medical treatment is

common in those countries where there are limited or no free medical services. It is
designed to take care of expenses that are usually high and represents a degree of
hardship that could seriously impair the ability to pay. The attitude appears to be that a
person has little control over the amount of his medical expenses and that these expenses
are unforeseeable and sometimes catastrophically large.

(b) Charitable contributions – the main argument in favour of the deduction of charitable
contributions is essentially that of a social and economic expediency in the achievement
of a ‘public good.’ Since these contributions finance education, religious, cultural and
welfare activities, the cost of which would otherwise be assumed by the government. In
other words, such contributions relieve the government of what ordinarily would be its
responsibilities. The deduction is therefore meant to be an incentive aimed at stimulating
philanthropic contributions.

(c) Savings – apart from relieving hardships, deductions can be used as an incentive
deliberately designed to encourage or stimulate certain kinds of economic behaviour
among taxpayers, such as savings. Many countries place great reliance on tax deduction
to influence saving schemes and cultures among its taxpayers.

(d) Home mortgage interest deduction – this allows taxpayers who own purchase homes
using a mortgage facility to reduce their taxable income by the amount of interest paid on
their mortgage loan. Such a deduction is meant to encourage home ownership. Most
developed countries do not allow a deduction for interest on personal loans, so countries
that allow a home mortgage interest deduction have created an exception to those rules.
The Netherlands, Switzerland, and the United States each allow the deduction.

While exemptions and deductions provide relief from tax that may be desirable, tax exemptions
and deductions may produce some undesirable results. Such reliefs erode or narrow the tax base
to a considerable extent and in an effort for the government to maintain a certain amount of
revenue from taxes, this erosion of the tax base could lead to the few taxpayers being subjected to
higher tax rates. Higher tax rates may lead to increased pressure for more tax relief.

2.4 GENERAL PRINCIPLES

In specifying the basic structural rules of the income tax, there are some general principles for
which provision may need to be made.

Apportionment

The categorization of income gives rise to the need for apportionment rules, particularly for
deductions. In general, deductions (e.g. expenses incurred in deriving income) must be
apportioned reasonably among the categories of income to which they relate.

25
 However, some deductions (such as deductions for charitable donations or contributions to
pension funds) do not relate to the derivation of any income. For such deductions, apportionment
rules may provide for the apportionment of such deductions rateably among each class of income
derived by the taxpayer.

Recouped Deductions

Tax laws generally have an inclusion rule in respect of recouped deductions (i.e., expenditure or
losses for which a deduction has been allowed that are subsequently recouped in whole or in
part). It is common to find such rules in specific contexts, such as the recovery of amounts written
off as bad debts or capital allowances recovered on disposal of the relevant asset; though a
general rule is considered preferable to ensure that all possible situations are covered.

Generally, expenditure or loss (including a bad debt) that has been allowed as a deduction in one
tax period but is recovered by the taxpayer in whole or in part in a later tax period must be
included in the gross income in that later period to the extent of the amount recovered. The
recouped amount normally takes the character of the income to which it relates. For example, the
recovery of a previously deducted bad debt incurred in carrying on a business would be treated as
business income.

Valuation

It will be necessary in some cases to take into account for tax purposes an amount in kind. This is
most commonly the case where income is derived as a benefit in kind (e.g., an employee fringe
benefit). However, there are other contexts under the income tax where this will also be the case.
For example, a deductible outgoing may be paid in kind, or an asset may be acquired or disposed
of for consideration given in kind. In each case, the in-kind item must be valued for the purposes
of determining the amount to be taken into account for tax purposes.

Tax laws normally provide for a rule for the valuation of such income received in-kind.It is
generally preferable that such a valuation rule be of general operation so that it can apply in all
circumstances where it is necessary to value an in-kind item.

UNIT3:
TAXATION SYSTEMS

3.1 SYSTEMS OF INCOME TAXATION

26
There are three main systems that are used for the computation of income tax – the schedular
system, the global system and the mixed system.

Schedular System

A schedular system of taxation is one in which separate taxes are imposed on different categories
of income. In the benchmark schedular system, gross income and deductible expenses are
determined separately for each type of income; in some cases, limited deductions or no
deductions may be allowed. The rates of tax applicable to each category of income are then
applied to the taxable amount of the income. The rates of tax may vary from category to category,
for example, salaries may be categorized under one schedule and taxed at certain rates, dividends
may also be categorized under a separate schedule and subjected to their own tax rates, etc.

Different procedures may apply to each category of income for the reporting, assessment, and
collection of tax. Some types of income may be taxable only through withholding; others may
involve the filing of returns. Schedular systems used to be more widespread; a few countries still
have such a system, or one with substantial schedular elements. For example, Burundi, the
People's Republic of China, Eritrea, Ethiopia, Lebanon, Romania, Rwanda, Somalia, Sudan, the
Republic of Yemen, the Democratic Republic of Congo and Zambia have a substantially
schedular system of income tax, in which different rate schedules apply to different major
categories of income.

The schedular system does not take into account personal circumstances of the taxpayer and
therefore is considered not to be a fair system of taxation.

Global System

A global (or unitary) system of taxation is one in which a single tax is imposed on all income,
whatever its nature. For example, income earned by a person in form of salary, interest, rentals
and royalties will be aggregated and subjected to a single tax rate. In the benchmark global
system, there is no matching of particular types of income to the expenses incurred to derive the
income. All income and expenses are considered together to arrive at a single net gain that is
subject to tax. Thus, under a pure global system, the category of income is irrelevant. The global
system is popular in developed countries. It is considered fairer and achieves equity in taxation as
it is possible to take into account the personal circumstances of each taxpayer. As such there is
more compliance by taxpayers in such a system.

Mixed System

The “mixed” or “composite” system combines the features of a global system and the schedular
system.

Comment
Many tax policy theoreticians consider the global system to be superior to the schedular system.
It is commonly suggested that schedular taxation suffers from the following disadvantages:

(a) The separation of a taxpayer’s income into more than one tax regime may make it
difficult or impossible to impose progressive taxation and to provide for personal tax
relief (in the form of exemptions, deductions, or rebates). Progressive taxation is
commonly seen as the most effective way of levying taxes on an ability-to-pay basis, and
to the extent that ability to pay is indicated by an increase in total economic capacity, the
tax should be levied on a taxpayer's total income. Under a schedular system, a

27
 progressive marginal rate structure may be applied to some categories of income only,
leading to inequities between taxpayers who earn different types of income. Similarly,
under a schedular system, personal tax relief must be either applied wholly against one
category of income, such as employment income - in which case the relief may not be
fully effective - or divided among various categories of income, which increases
complexity.

(b) The schedular system is potentially more difficult to administer. Scarce administrative
resources may be wasted on classification issues arising at the borders between the
various schedules. For example, if income from employment and income from business
are taxed under different schedules, then it becomes necessary to characterize a particular
income-earning activity as being one of employment or business (self- employment). The
border between an employer-employee and a customer-consultant relationship is difficult
to draw.

(c) Any differences in the final tax burdens imposed under a schedular system on income in
different categories will be exploited by taxpayers engaging in tax planning and
restructuring to ensure that their income fits within the most advantageous category. Tax-
planning activities of this sort not only impose economic dead-weight losses as resources
are diverted into unproductive planning activities, but may cause serious economic
inefficiency as taxpayers opt for income-earning activities that may be less efficient, but
more lightly taxed.

An advantage of the schedular system is tax rates can be adjusted to compensate for
underreporting and tax evasion. For example, rates can be higher on business profits and
professional earnings, than on salaries and wages because it is presumed that the former will be
less fully reported than the latter.

While a global income tax may be preferable from a conceptual perspective, the purest form
remains a theoretical ideal only. In practice, all global income tax systems contain some
schedular elements and most existing income tax systems lie on the spectrum between schedular
and global. While some countries with a global income tax system define income without
breaking it down into categories, others have a schedular structure to the identification of taxable
amounts, whereby such amounts are defined according to categories of income. The global
systems of many countries have also become partially schedularized by the use of final
withholding taxes on certain types of income, particularly dividends and interest, and lower tax
rates on capital income.

3.2 PROGRESSIVE, REGRESSIVE AND PROPORTIONAL TAX SYSTEMS

There are three systems of tax computation that may be used in the world:

(a) progressive system;

(b) regressive system; and

(c) proportional tax computation.

In Zambia only two systems of tax computation are used: progressive tax computation and
proportional tax computation.

Progressive tax computation system

28
The progressive tax computation system essentially imposes more tax on more income, i.e. for
any extra band of taxable income, the rate at which tax will be calculated is increased.

For example, income of individuals may be taxed at the following rates:

0% on the first amount of up to K3,000 per month

25% on the next K800
30% on the next K2,100
35% on the balance

The progressive tax computation is used in Zambia for computation of income tax for individuals
e.g. salaries and sole traders.

For the progressive tax system to operate there are tax bands and tax rates introduced by law,
which may change from year to year depending on government policy.

Example:

Ms X is an employee of UNILUS Limited, a company based in Zambia, and gets salary of

K12,000 per month in 2013. For the charge year 2014/15 the applicable tax rates on emoluments
were as follows:

0% on the first amount of up to K3,000 per month

25% on the next K800
30% on the next K2,100
35% on the balance

Calculate the total tax payable on Ms X’s salary to the ZRA if the progressive tax computation
system is used (assuming there are no allowable deductions).

Solution:
Tax
Monthly salary 12,000
Taxable @ 0% 3,000 0
9,000
Taxable @ 25% 800 200
8,200
Taxable @ 30% 2,100 630
Taxable at 35% 6,100 2,135
Total tax 2,965

The progressive tax system is considered to be a fair tax system to taxpayers in that those that are
rich will pay more than those that are poor. This is because a bigger amount of their income will
be taxed at a higher rate of 35% while the small amount of money earned by the poor will be
taxed at lower rates.

Note: in actual practice tax is calculated after taking into account other rules of taxation such as
deductions and credits.

Regressive tax computation system

29
The regressive tax computation system is where any extra band of income of a taxpayer is taxed
at a lower rate than the earlier band.

For example, income of individuals may be taxed at:

35% on the first amount of up to K3,000 per month

30% on the next K800
25% on the next K2,100
0% on the balance

Example:

Ms X is an employee of UNILUS Limited and gets salary of K12,000 per month in 2013. For the
charge year 2013/14 the applicable tax rates on emoluments were as follows:

35% on the first amount of up to K3,000 per month

30% on the next K800
25% on the next K2,100
0% on the balance

Calculate the total tax payable on Ms X’s salary to the ZRA if the regressive tax computation
system is used (assuming there are no allowable deductions).

Solution:
Tax
Monthly salary 12,000
Taxable @ 35% 3,000 1,050
9,000
Taxable @ 30% 800 240
8,200
Taxable @ 25% 2,100 630
Taxable at 0% 6,100 0
Total tax 1,920

The regressive tax computation system is considered unfair to poor taxpayers because most of
their income is taxed at a higher rate, while the rich, though they pay more tax in terms of actual
amounts paid, in percentage form they pay less than the poor do. This system may therefore
discourage the poor from paying taxes.

Proportional tax computation system

This is a system of tax computation where the tax rate applied on all taxable income a taxpayer
has is the same for all taxpayers, regardless of the income bracket in which they fall. It is based
on benefits derived but can also be based on income earned. For example, under this system, a tax
rate of 30% may be applicable on all income earned by individuals.

This type of tax computation is used in Zambia for example to tax companies whose income is
less than K800,000 per annum (turnover tax) and for adjusted profit for some companies whose
income is over K800,000 per annum. For companies the tax rates in Zambia differ depending on
the type of company and its status. For example, the income of a company listed on the LuSE is
taxed at 33% in the first year of listing while all other unlisted companies generally pay tax at a
rate of 35%.

30
3.3 COMPANY TAX SYSTEMS

There are basically two schools of thought with regard to taxation of companies.

The first is that since companies have a legal existence of their own distinct from that of the
shareholders, the taxation of companies should be independent of the taxation of the shareholders
who own the company. A problem arising from separate entity concept is that company income
may be subject to double taxation – first at the corporate level when it is earned, and again at the
shareholder level when it is distributed as dividends.

The other school of thought suggests that since a company is a legal fiction, the corporate veil
should be lifted and all profits accruing, whether distributed or not, should be regarded as
belonging to the shareholders who should be taxed at their individual marginal tax rates.

The approach in most jurisdictions is a mixture in which taxes are levied at both the corporate and
shareholder levels in varying degrees. For example, in Zambia, tax at the corporate level is levied
at a standard rate of 35 percent while tax at the shareholder level in respect of dividends is at 15
percent.

There are four commonly used company tax systems. These are:

(a) the classical system;

(b) the imputation system;
(c) the split rate system; and
(d) the integrated system.

The type of system used influences the company structure of companies, i.e. whether equity or
debt.

The Classical System

This system embodies the principle that the tax liability of a company should be completely
independent from that of its shareholders i.e. since the company is treated as a distinct entity it
should bear its own tax. The company is subjected to a flat rate of corporate tax on its taxable
profits while the shareholders pay income tax on their respective dividends.

The major objection to this system is that dividends are subject to double taxation – first at the
corporate level, and then at the shareholder level. For example, if a company that has profits of
K100,000 in a particular year and makes a dividend distribution of its entire after-tax profits, the
following will be the tax consequences:

Corporate Profits K 100,000.00

Corporate Income Tax @ 35% K 35,000.00
Distributed Dividends K 65,000.00
Dividend Income Tax @ 15% K 9,750.00
Total After-Tax Income K 55,250.00
Total Tax Rate 44.75%

31
The two layers of tax create a significant tax burden on company income as illustrated above. Out
of profits of K100,000 the company needs to pay the corporate income tax of K35,000 (at the
standard rate of 35 percent), which leaves the company with K65,000 in after-tax profits. When
the company distributes these profits as a dividend, the income is taxed again at the shareholder
level. The shareholders then pay K9,750 in income taxes (at the standard rate of 15 percent). In
total, the K100,000 of company profits face a combined marginal tax rate of 44.75 percent (i.e.
44,750 / 100,000 x 100 = 44.75%).

The economic effects of the classical system are three-fold:

First, there is discrimination between dividends and retained profits because retained profits are
only subject to corporate tax. This may encourage companies to retain profits and channel them
out by way of high salaries, loans, non-taxable fringe benefits or generous pension schemes, etc.

Second, the classical system favours debt financing over equity financing due to the fact that
interest payments are deductible in ascertaining the business profits of the company for tax
purposes; while the cost of servicing capital raised from shareholders (i.e. through payment of
dividends) is not.

Third, from the revenue point of view, the classical system results in higher tax receipts because
tax is collected at the corporate level and at the shareholder level.

The Imputation System

The imputation system is where the company pays corporate tax on its profits, and any profits
which are subsequently distributed to shareholders as dividends bear not tax as it is assumed that
tax thereon has already been paid at a specified rate (known as the rate of imputation) by the
company. The shareholders therefore pay no tax on the dividends received as the tax paid by the
company is imputed to the shareholders.

The imputation system is therefore designed to mitigate the tax liability on dividends paid out by
a company to take into account the fact that the profits out of which they have been paid have
already bore corporate tax. This is achieved by crediting shareholders with the tax paid by the
company. This credit may be used to set-off the shareholders’ income tax liability on dividends,
i.e. part of the company’s tax liability is imputed to shareholders and is regarded as pre-payment
of their income tax on their dividends.

The main argument in favour of the imputation system is that it is more beneficial to the
shareholder and hence encourages capital formation from equity financing.

The Split-rate System

The split-rate system is where distributed profits i.e. dividends are taxed at a lower rate than
retained profits. Where it is desired to eliminate double taxation altogether, the tax on dividends
may, for example, be zero-rated.

The Integrated System

32
The integrated system is essentially a variation of either the imputation system or the split-rate
system which results in the integration of corporate and individual income taxes, the distinctive
feature being that there is a total alleviation of double taxation.

Integration may either be effected at the corporate level (split-rate system) or at the shareholder
level (imputation system).

At the corporate level, the profits of a company may only be subjected to corporate tax and the
dividends paid to shareholders may be exempt or zero-rated. At the shareholder level, integration
may be effected by allowing companies a deduction for dividends paid to shareholders in arriving
at the taxable profits of the company and then subjecting shareholders to tax on the dividends
received. Alternatively, shareholders and companies both pay tax on their income, but
shareholders can be given a credit to offset taxes the company has already paid. In either way, the
dividend is subjected to only one tax.

Many developed countries, such as Australia and Estonia, have integrated their corporate and
individual tax codes to reduce or eliminate the two layers of taxation on corporate income.

UNIT 4:
TAXATION OF EMOLUMENTS

33
4.1 CHARGE OF TAX ON EMOLUMENTS

Section 14 of the Income Tax Act charges tax on income received by a person and income as
classified in section 17 includes “emoluments.”

Receipt of income is defined in section 5 of the Income Tax Act.According to section 5, income
is received by a person

“…when, in money or money’s worth, or in the form of any advantage, whether or not
that advantage is capable of being turned into money or money’s worth, it is paid to him,
or it accrues to him or in his favour, or it is in any way due to him or held to his order or
on his behalf, or it is in any way disposed of according to his order or in his favour, and
the word "recipient" is construed accordingly.”

4.2 MEANING OF EMOLUMENTS

“Emoluments” are defined, in section 2 of the Income Tax Act as meaning-

“any salary, wage, overtime or leave pay, commission, fee, bonus, gratuity, benefit,
advantage(whether or not that advantage is capable of being turned into money or
money's worth), allowance, including inducement allowance, pension or annuity, paid,
given, or granted in respect of any employment or office, wherever engaged in or held”.

By this definition, therefore, tax is charged on “emoluments received in respect of office or

employment”. Let us first look at the terms ‘Office and Employment’. What do they mean? Well
as neither of these terms have been defined in the Income Tax Act, we will have to look
elsewhere to find out the meaning of these terms.

Meaning of Office

The shorter Oxford Dictionary gives the meaning of ‘office’ as, “A position to which certain
duties are attached, especially a place of trust, authority of service under constituted authority”.

The term has been judicially defined as a permanent substantive position that exists independent
of the person who fills it and which goes on and on and is filled in succession by successive
holders. Examples of office holders are Ministers of the Government of the Republic of Zambia,
Town Clerks and similar officers of Local Authorities, most Ministers of Religious
denominations and directors of limited companies. It is the judicial definition of office that will
be followed in interpreting tax laws.

Meaning of Employment

An employment is regarded as existing where there is a legal relationship of master and servant.
An employee will be under a “contract of service” whether written, verbal or implied. It is
important, at the outset to distinguish between an employee and an independent contractor, a
contract of service and a contract for service.

An employee would be liable to pay tax under PAYE scheme in respect of his emoluments where
as an independent contractor would be liable to tax on his income in respect of profits arising
from the trade or profession he carries on. This broad distinction has been expressed in different
ways, for example:

34
 (a) There would be a contract of service where the employer has the right to demand services
of the person specifically and direct the manner and the method of the work done. There
would be however, a contract for service where one of the parties agrees to have a desired
effect produced.

(b) In the case of Davies (Inspector of Taxes) v Braithwaite 15Rowlatt J considered that
employments were something like ‘offices’ and likened them to ‘posts’. He states that:

“Where one finds a method of earning a livelihood which does not contemplate the
obtaining of a post and staying in it but essentially contemplates a series of
engagements and moving from one to the other that each of those engagements could
not be considered an employment but a mere engagement in course of a profession”.

In the normal way it is not very difficult to establish whether an individual is (say) an electrician
in employment or an electrical contractor on his own account but in the field of professions it is
often very difficult to determine whether a person is carrying on a profession or holding an
employment – particularly as the circumstances which might determine the point may be complex
and may change frequently. For example, a doctor may have his own private practice and also
have a part-time appointment at the University Teaching Hospital as a consultant. Similarly, a
musician may have engagement with Zambia National Broadcasting Corporation, be an
instrumentalist in a band, give musical instructions to private pupils and teach music at the local
school. No hard and fast rule can be laid down in this respect, however, the distinction between a
profession or vocation on the one hand and an employment on the other is largely the same as
that between a contract for services, which is an incidence in carrying on of a profession or
vocation, and a contract of service involving the relationship of master and servant (see
Halsbury’s Laws 3rd edition, volume 25 pages 447-449).

In most cases the distinction does not cause any difficulty, however, one thing is clear, if a person
holds an office of an employment, the tax on emoluments from that office, or employment must
be collected under PAYE as for example will be the position in respect of our musician’s
engagement with Zambia National Broadcasting Corporation and the schools where he teaches
music as an employee; tax on any income he receives for services rendered otherwise than in the
performance of the duties of that office may or may not be collectible under that scheme.

Similarly, an accountant who prepares the accounts of a limited company may be a full time
employee of the company or he may carry on a profession; if the former applies, the tax on his
remuneration is collectible under PAYE and, if the latter applies, his remuneration is a receipt of
his profession the profits of which are chargeable under section 17(a). If he is a Director of the
company whichever may his remuneration in connection with the preparation of accounts is
taxed, any emoluments he receives as a Director, such as Director’s fee is chargeable under
section 17(b) and the tax collectible under the P.A.Y.E. scheme.

It should be noted further that the terms ‘employer’ and ‘employee’ are defined in section 2 as,
“an employer in relation of any employee means any person or any partnership which pays, gives
or grants any emoluments to the employee” and an employee in relation to any employer as, “an
individual who is paid, given or granted an emolument by that employer”.

Does the income arise from the office or employment?

Case reading: Mr. Justice M.M.S.W. Ngulube v Zambia Revenue Authority2003/RAT/29

15
18 TC 198
35
 This case considered, inter alia, whether payments made to a Chief Justice of Zambia in
the UK from government funds were payments made in connection with his office as
Chief Justice.

In the English case of Cooper v Blakiston,16the following dictum by the Lord Chancellor was
given:

“where a sum of money is given to an incumbent substantially in respect of his services

as incumbent, it accrues to him by reason of his office. Had it been a gift of an
exceptional kind such as a testimonial or a contribution for a specific purpose as to
provide a holiday or a subscription peculiarly due to the personal qualities of the
particular clergyman, it might not have been a voluntary payment for services, but a mere
present.”

The first part of this dictum sets out the rules that where a sum of money is received by a person
in respect of services performed by him by virtue of holding an office that sum is liable to tax in
his hands. The payment stems from that office.

The second part of the dictum states that if a person received a gift of an exceptional kind in
appreciation of his personal qualities then such a gift would be considered as a “present”’ and not
as a payment even though voluntary, for service performed. It was therefore, not liable to tax in
his hands.

It is very important to understand this distinction at the very outset since it forms the basis of
taxability of sums, advantage and benefits etc. – section 17(b).

The above case was concerned with the question “whether voluntary subscriptions made by a
congregation to a clergyman were assessable”. The Easter offerings were received by a vicar in
the normal way collection made at services in the church of England do not go to the vicar who
receive his stipend from other sources. In this instance, following long standing practice, the
Church wardens gave the collections made on Easter Sunday to the Vicar for his personal use as a
free will offering. The question was decided by the House of Lords, and the Easter Offerings
were held to be assessable in the hands of the Vicar.

Similarly in the case of Herbert v McQuade,17a grant made by a Clergy Sustentation Fund to a
Clergyman to augment the income of his benefices was held to be assessable because it accrues to
him by reason of the office which he holds.

However, in the case of Turner v Cuxson,18 a sum of money received by a curate from a religious
society in recognition of his faithful service as a Clergyman was not assessed. It was held that the
payment was not in respect of any particular curacy and could not therefore, be an emolument of
his office as curate. (Curate - a priest or deacon who assists a Rector or Vicar; curacy – the office
of a curate).

To recall, the principles established so far can be summarized as follows:

(a) The fact that there is no local obligation on the payer to pay money is irrelevant in
considering whether it is assessable under section 17(b);

16
5 TC 347
17
4 TC 489
18
2 TC 422
36
 (b) “A profit accrues by reason of an office when it comes to the holder of an office as
such in that capacity and without the fulfillment of any further or other condition on
his part”.

(Herbert v McQuade 4 TC 501).

Gifts of Exceptional Kind

The dictum of the Lord Chancellor in Cooper v Blakistonstated that gifts of exceptional kind
cannot be considered as payments made in connection with an office held. It would therefore be
necessary to consider what constitutes “gifts of exceptional kind.”

The case of Cowan v. Seymour19 concerned a secretary of a company who received no

remuneration for his services. The Company was then wound up and he was appointed as a
liquidator. The shareholders, at the final meeting of the company asked him to accept a sum of
money which would normally have been distributed to them. This was taxed in his hands and
Commissioners agreed that the sum was correctly assessed.

When the case came up before the court, it was admitted that the facts were not conclusive of the
point though, the Court placed a great weight on the fact that the office of Secretary had ended
sometime before and that the money was given by the shareholders and not by the natural
paymaster – the company. These facts indicated that it was a gift of an exceptional kind such as a
testimonial personal in character. “The personality of the appellant was everything”. The Court,
therefore reversed the Commissioner’s decision that the sum was assessable.

To some extent, however, the decision turned on the words “accruing by reason of the office” -
Young L.J. said that the office may have been a “causa sine qua non” but it was not a
“causacausans”.

It should be noted that the words “by reason of the office” do not appear in the definition of
emoluments in our Income Tax Act, but the distinction expressed by the dictum is very valid and
should be examined critically. It must also be remembered that the considerations applicable to
“employment”, as distinct from an “office”, are always not the same.

The case of Mudd v Collins20on the other hand involved an employee of a company who
negotiated the sale of a branch for which he received special payment from his employers. He
was assessed on the sum so received, and he unsuccessfully claimed that the sum did not arise by
virtue of his office. The court stated that:

“If an officer is willing to do something outside the duties of his office and his employer
gives him something in that respect, that is a profit it becomes a profit of his office which
is enlarged a little so as to receive it”

Receipts not assessable - Case I

Reed v. Seymour 11 TC 625

In this case the committee of a Cricket club exercising their absolute discretion, granted a benefit
match to a professional cricketer in their service. The proceeds of the match, together with
certain public subscription, were invested in the name of the trustees of the Club the income
19
7 TC 372
20
9 TC 297.
37
 therefrom paid to the beneficiary in accordance with the rules of the Club. Subsequently the
investments were realized and the proceeds were paid over to the beneficiary; who with that sum
purchased a farm with the approval of the trustees.

He was assessed on the proceeds of the benefit match (public subscription were excluded), and
the assessment was discharged by the General Commissioner.It was held that the award of
proceeds of the benefit match to the cricketer was not a profit accruing to him in respect of his
office or employment but was the nature of personal gifts and not assessable to Income Tax”.

Receipts assessable - Case 2.

Davis v Harrison 11 TC 707.

In this case the benefit money paid to a professional footballer by his old club after he had been
transferred to another club was held to be assessable remuneration and not as contended
compensation for loss of office. The rules of the Football League (in England) allowed a club to
agree to pay a player a money-benefit after five or ten years and if he was transferred before the
end of the period to pay him a percentage of the promised benefit as a reward for services.

4.3 PAY-AS-YOU-EARN

Under the Income Tax Act, tax in respect of emoluments is collected by means of arrangements
generally referred to as the Pay-As-You-Earn (P.A.Y.E.). Under this system, when an employer
pays any remuneration he is responsible for deducting tax by reference to tax tables and to a code
number supplied to him in respect of each employee by the Commissioner General.

The P.A.Y.E. mechanism is provided for under Part IV of the Income Tax Act, and is
administered in accordance with the Income Tax (Pay-As-You-Earn) Regulations, 2014 (the
“P.A.Y.E. Regulations”).

Scope of P.A.Y.E.

The P.A.Y.E. system of deducting tax from salaries and wages applies to all offices and
employments. Tax under P.A.Y.E. is to be deducted not only from monthly and weekly
payments, but also from daily, annual or other irregular payments – see Reg. 6 and 7 of the
P.A.Y.E Regulations. P.A.Y.E. applies to full time employees as well as casual employees (see
Reg. 5). Tax is to be deducted from all emoluments paid to an employee (Reg. 4(2)).

Employer’s Duty to Deduct Tax

Under section 71 of the Income Tax Act, it is the duty of the employers to deduct tax from
payments of emoluments to their employees, whether or not they have been directed to do so by
ZRA. All employers are under an obligation to operate P.A.Y.E. Section 71 reads:

“On the making of any payment of, or on account of, any emolument, tax shall, subject to
and in accordance with regulations made by the Minister, be deducted or repaid by the
person or partnership making the payment, notwithstanding that when the payment is
made no assessment has been made in respect of the emoluments, and notwithstanding
that the emoluments are in whole or in part emoluments for some charge year other than
the year during which the payment is made, and, for the purposes of this subsection,
payment shall be deemed to be made when the emolument is received as provided in
section five: or to income, for an individual, on which turnover tax has been assessed in

38
 accordance with subsection (2) of section sixty-four A ” after the words “ non-money
fringe benefits,

Provided that with reference to paragraph (1) of section forty-four the requirements of
this subsection shall not apply to emoluments provided to employees in the form of non-
money fringe benefits.”

Under the P.A.Y.E. system therefore, the employer is empowered to:

(a) calculate tax payable by every employee;

(b) deduct tax due from the emoluments, and

(c) remit tax deducted to ZRA

In terms of Regulation 17 of the P.A.Y.E. Regulations, an employer is required, within 14 days of

the end of the income tax month, send a monthly return and pay the tax due to the ZRA.

The employer is wholly liable for the payment of any tax not deducted or under deducted due to
non– a monthly return and pay the tax due to the ZRA. (Reg. 18). Penalties are chargeable under
the Income Tax Act on any employer who fails to comply with the P.A.Y.E. regulations. If tax is
not remitted on time, a penalty of 5% per month of the unpaid amount is chargeable under section
71(3) of the Income Tax Act

The undoubted importance of P.A.Y.E. in our scheme of taxation must not be allowed to obscure
the fact that it is merely a method of collecting tax. Although in most cases the total net tax
deducted during the year corresponds closely with the tax chargeable, the amount of an
individual’s liability depends not on the tax to be deducted under P.A.Y.E. but on the provisions
of the Income Tax Act which define the scope and measure of liability from these sources.

Before we consider the method of collecting tax, therefore, we must first consider the provisions
of the Income Tax Act under which tax is charged on emoluments, namely:

 Section 2 - definition of emoluments;

 Section 5 - receipt of income;
 Section 14 - charge of tax; and
 Section 17 - classification of income; and
 Section 71 - collection and payment of tax from emoluments

4.4 CHARGEABLE EMOLUMENTS

As an employer has to calculate tax to be deducted from an employee’s pay by reference to

“chargeable emoluments” it is important to know what is meant by the term “chargeable
emoluments means.”

Chargeable emolumentsfor P.A.Y.E. purposes mean emoluments from an employee’s

employment that are chargeable to income tax, but does not include any allowable pension
contribution or any amount which is exempt from income tax (Regulation 2 of the P.A.Y.E.
Regulations).

Chargeable emoluments include salaries, wages, overtime or leave pay, commission, fee, bonus,
gratuity, any benefit, advantage or allowance (excluding non-money fringe benefits), and

39
 payments on taking up or leaving employment. (Section 2, Income Tax Act). In addition, all
employee’s liabilities borne by the employer and all other payments made by the employer to the
employee in respect of that employment form part of his chargeable emoluments.

Benefits

The definition of emoluments under section 2 of the Income Tax Act includes benefits, which
may either be in monetary form or in kind.

Cash benefits

Cash benefits paid in the form of allowances are taxable on the employee under P.A.Y.E.
Examples of cash benefits are:

 Education allowance
 Housing allowance
 Transport or fuel allowance
 Domestic utility allowance
 Commuted car allowance
 Settling allowance

Benefits in kind

A benefit in kind generally means a benefit of some sort which is not money. It is, therefore,
obviously, from a commonsense view anyway, that if an employer gives an employee his salary
in the form of saving certificates, he is paying him his salary just as much as if he gives him a
cheque for that amount both can be cashed, the only difference is that the saving certificates are
not negotiable; they are not money. The difficulty arises however, where the reward is of a more
intangible nature.

The question whether a benefit in kind is assessable, on the employee was considered in the case
of Tennant v Smith21. In this case, a bank manager, was required as part of his duty to reside in
the “bank house adjoining the bank. He lived there rent free; he had no power to sublet and when
he retired or moved to another branch of the bank, he would be required to vacate the premises. It
was held that the benefit of the house did not constitute an emolument since it was not convertible
into money.The House of Lords indicated as a general principle that “benefits received in kind”
was a profit if it represented “money’s worth” and where a person receives substantial things of
money value capable of being turned into money, they represented money’s worth”. It might be
observed in passing that “substantial” in this context does not mean large; the term is used as an
antonym to insubstantial. The right to live in a house is not a “substantial thing” nor in this case
was it capable of being converted into money.

It must be noted that the test applied in Tennant v Smith was whether the benefit could be
lawfully converted into money; it is irrelevant whether the employee actually converts it into
money.The law as decided in Tennant v Smith therefore is that benefits in kind are only taxable if
they are of money value capable of being converted into money.

Value of convertible benefits

21
3 TC 158.
40
 If a benefit in kind is convertible into money, tax is levied on the value of the benefit to the
employee: this is taken to be the second-hand value. In the case of Wilkins v Rogerson,22 a
company arranged with a firm of tailors that each employee would be entitled to obtain clothes of
up to £15 in value. Under this arrangement Rogerson, an employee of the company, ordered a suit
costing £14.5 which his employer paid for directly to the tailors. It was held that Rogerson had
received a benefit that was convertible into money because he could sell the suit, but that he could
only be taxed on the second-hand value, estimated at £5. As Herman L.J. said at page 353 -

“The only controversy was whether he was to pay tax on the cost of that perquisite to his
employer or on the value of it to him, and it appears to me that this perquisite is a taxable
subject matter because it is money’s worth. It is money’s worth because it can be turned
into money and, when turned into money, the taxable subject matter is the value
received.”

Pecuniary liability of an employee met by the employer

If an employer defrays some expenditure which his employee was under a legal obligation to
meet, the employee receives a profit; and if it is a profit from his employment, it is assessable on
him. For example, where an employer pays for an employee’s bills or expenses such as rent,
electricity, telephone bill, water bill, school fees or similar payments, the employer is required to
add such payments to the employee’s emoluments and deduct tax under P.A.Y.E.

This point was made clear in Hartland v Diggins.23It was held in this case that the income tax
liability of an employee if paid by his employer, the amount assessable on the employee is the
remuneration which he actually receives plus the tax liability on the amount assessable. It should
also be noted that legal obligation need not be statutory, for it has been held that a premium paid
by an employer under an employee’s life assurance policy represented money’s worth.

In the case of Nicoll v Austin,24the Managing Director of a company owned and resided in a large
and imposing house but found difficulty in meeting the expenses connected therewith. The
company agreed in addition to paying a salary, to meet all the outgoings on the house (rates,
repairs gardener’s wages etc.), on condition that he agreed to continue to reside there. This was
rather different from the situation of the bank manager in Tennant v Smithbecause not only was
he required to live in the house as manager as a condition of his services, but when his
appointment was terminated or he was moved to another branch he would be required to give up
the house. Tennant’s occupation of the house was clearly “representative” and all outgoings on
such as rates were the legal liabilities of the bank and not of the tenant. In Austin’s case the
house was his own and liability for rates and repairs was his. The court took the view that the
only proper construction to be placed on his agreement with the company was that the terms of
his employment provided him with money as his salary, and money’s worth as the expenses of
the house were defrayed by the company.

Expense Reimbursements

It is a common practice among large companies to make expenses reimbursements to their

Directors and higher executives, that is, contribution towards expenses incurred by the employee in
connection with his work. In the normal circumstances such payments could not be regarded as
emolument since they are not reward for service or anything like it.

22
39 TC 344.
23
10 TC 247.
24
19 TC 531.
41
 On the other hand, an employer cannot relieve an employee of his liability to tax by calling
remuneration by some other name. Consider the case of Dingley v McNulty.25In this case the
taxpayer was Vice-President and a Director of a Benevolent Fund incorporated under special Acts
of parliament. He attended seventy-four director’s meetings and received one guinea in respect of
each meeting. On appeal against an assessment of income tax made upon him under schedule E in
respect of these sums less allowance of 25% for expenses, he contended that –

(a) his office of Director was not an office of employment of profit assessable under
schedule E; and
(b) the whole sum paid was simply an allowance for sums expended wholly exclusively
and necessarily in the performance of his duties.

The Special Commissioners decided that the sum paid to the taxpayer constituted remuneration as a
Director in respect of which he was assessable under schedule E, and in the absence of detailed
evidence which was not submitted, the allowance made in respect of expenses was adequate. On
appeal, the court held that the decision of the Special Commissioners was correct. The principle
established by this case was that:

“Where the employer reimburses a genuine expense incurred on the employer’s behalf
during the course of his work, the employee will not be taxed on “expenses payment”
received if expended fully. But where an employer reimburses an employee for an expense
that conferred some benefit on the employee that benefit would be assessable.

4.5 NON-CHARGEABLE EMOLUMENTS

The following emoluments are exempt or otherwise not chargeable to income tax and,
consequently need not be included in the chargeable emoluments from which P.A.Y.E. tax is to
be deducted: -

 Ex-gratia Payments – A voluntary, non–contractual, non–obligatory payment made by an

employer to a spouse, child or dependant of a deceased employee is exempt (Para.7(t),
Second Schedule of Income Tax Act).

 Medical Expenses - Medical expenses paid or incurred by an employer on behalf of an

employee or refunds of actual medical expenses incurred by an employee are exempt (The
Income Tax (Suspension of Tax) Order, S.I. No. 104 of 1996). Medical allowances,
however, are taxable and should be included in chargeable emoluments.

 Benefits not convertible into money or money’s worth – Benefits which cannot be
converted into money or money’s worth are not taxable to the employee. 26 See Tenant v
Smith, 3 TC 158.

 Accommodation provided by employer - Free residential accommodation provided by an

employer in a house owned or leased by the employer is not a taxable benefit to the
employee.27Payments for utilities such as electricity, telephones, water bills, security and
similar payments, however, are not included in the meaning of free residential
accommodation.
25
21 TC 152.
26
However, no deduction in respect of the cost of providing such benefit to the employee may be claimed by the
employer.
27
However, the cost to be disallowed in the employer’s tax computation for any rent paid by it for such employee
accommodation is limited to 30% of the taxable income paid to the employee.
42
 The issue of whether an employee occupies free residential accommodation provided by the
employer and its subsequent exemption from income tax has been a subject of litigation and
judicial decision. The earlier tax cases sought to decide this issue based on who the legal
occupier of the accommodation was for assessment purposes. In Bent v Roberts28for
example, it was held that the place authorities were the occupiers of a house in which they
compelled a constable to reside and accordingly the accommodation was not assessable
income to the constable. In the case of Reed v Cattermole,29it was held a Methodist Minister,
who lived in the manse supplied by his employers and required by them to live therein was
not the occupier under Schedule E of the U.K. Income Tax Act 1918, but that his employers
were.

From the study of these cases it becomes clear that where the employer is the actual or legal
occupier of a house in which an employee is accommodated, the occupation of the employee
is termed to be in “representative occupation” i.e. he merely represents the actual occupier,
the employer.The accommodation is not taxable income to the employee if he/she is in
representative occupation.

See also:Tennant v. Smith, 3 T.C. 158 and Gray v. Holmes, 30 T.C. 467.

 Personal to Holder Vehicles - The benefit arising out of the provision by an employer of a
motor vehicle to an employee on a personal to holder basis is a non–taxable, non–money
fringe benefit. A personal to holder means a vehicle provided to an employee for both
business and personal use and usually involves payment by the employer of all expenses
associated with the running and maintenance of the vehicle.

 Funeral Expenses - Funeral expenses paid or incurred by an employer on behalf of an

employee are exempt from tax (The Income Tax (Suspension of Tax) Order, S.I. No. 104 of
1996).

 Sitting Allowances for Councilors - Payments by Local Authorities to councilors as sitting

allowance are exempt (paragraph 7(s), Second Schedule of the Income Tax Act).

 Labour Day Awards – Labour Day awards paid to employees either in cash or in kind are
non-taxable

 Pension Contributions - Chargeable emoluments do not include allowable pension

contributions(paragraph 7(q), Second Schedule of the Income Tax Act. Where an employee
contributes to an approved Pension Fund or funds, including National Pensions Scheme
Authority (NAPSA), the amount contributed by the employee, within limits, is to be
deducted in calculating chargeable emoluments.

Currently the maximum pension contribution that may be deducted, including contributions
to NAPSA, is 15% of gross emoluments or K255 .00 per month, whichever is less.

4.6 TREATMENT OF TAX-FREE EMOLUMENTS

Sometimes an employer will enter into an agreement with an employee to pay the employee
emoluments that are “free of tax” or “net of tax”. This means, in effect, that the employer has
28
1 TC 199.
29
21 TC 35.
43
 agreed to bear on the employee’s behalf, any tax chargeable in respect of payments made under
the agreement.

Regulation 14 of the P.A.Y.E. Regulations provides that where such an agreement is made
between an employer and employee:

(a) The agreement is treated as an agreement by the employer to pay the employee such
gross emoluments as will, after deduction of tax will be equal to the net emoluments; and

(b) The employer shall calculate the amount of tax to be deducted from any payment of the
employee’s emoluments by reference to the gross emoluments of the employee and not
by reference to the employee’s net emoluments.

In other words, the employer must account for an amount of tax on a gross payment that would,
after the deduction of tax in accordance with the Regulations, leave a net amount equal to the
amount actually paid/payable to the employee under the agreement.

Any employer entering any such agreement with an employee is obliged to notify the
Commissioner General of the details of the agreement within 14 days of the beginning of the
charge year or the commencement of the employment in question (Reg. 14(2)).

4.7 COMPUTATION OF TAX

Tax Tables

Regulation 4(1) of the P.A.Y.E. Regulations requires an employer to deduct tax from emoluments
paid to an employee or repay tax to an employee in accordance with appropriate tax tables. Tax
tables are provided by ZRA for use by employers to work out how much P.A.Y.E. tax is to be
deducted or repaid from chargeable emoluments. There are two sets of tables:

(a) Monthly tables; and

(b) Daily tables

Monthly Tables - These are to be used for all employees who are paid at monthly intervals. The
Monthly Tables are divided into two parts. Table A shows the tax rates to be used in arriving at
the tax to be deducted or repaid. Table B shows how to calculate tax due before deducting the tax
credit by reference to chargeable emoluments paid. Table B assumes that the allowed deductions
have been deducted and what is reflected in the table is the chargeable amount.

Daily Tables - These are to be used for casual employees, that is, all employees who are paid at
intervals of less than 5 days. Where a worker is paid daily the tax payable is arrived at by simply
finding the tax payable for the particular amount paid. Where the payment period is 2, 3 or 4
days, the payment made is divided by 2, 3 or 4 respectively, the tax due calculated by reference to
the table and amount then multiplied by 2, 3 or 4, to arrive at the tax to be deducted.

Tax Rates

For the charge year 2016, the tax rates applicable to monthly emoluments are as follows:

First K3,000.00 @ 0%
Next K800 @ 25%

44
 Next K2,100 @ 30%
Balance over K5,900 @ 35%

Calculation of tax

Under the P.A.Y.E. system, the amount of tax which an employer deducts from emoluments
depends on:

(a) the employee’s total gross pay;

(b) the applicable tax rates; and

(c) statutory deductions (e.g. pension contributions).

Example:

An employee has a gross salary of K14,000 per month in January 2016. The tax liability of this
employee will be calculated as follows:

(a) calculation of taxable pay:

Gross Salary: K14,000

Less pension contribution: K 255
Taxable pay: K 13,745

(b) Calculation of tax using the tax rates:

Rate of Tax Tax Due (K)

Taxable income K13,745
@ 0% First 3,000 0.00
10,745
@ 25% Next 800 200.00
9,945
@ 30% Next 2,100 630.00
@ 35% Balance 7,845 2,745.75
Tax Due will be 3,575.75

(c) Calculation of net pay

Gross Salary: K14,000.00

Less tax: K 3,575.75
Employee’s net pay: K 10,424.25

Irregular Payments in Addition to Basic Salary

Employers will sometimes make payments in addition to an employee’s basic salary or wages on
a day that is not the employee’s regular pay day, for example, a quarterly bonus paid on a day
other than a regular pay day.

The tax to be deducted from such payments is to be calculated by:

45
  Working out how much tax will be deducted from the employee’s next payment of basic
salary or wages.

 Working out how much tax would be deducted from the next payment of basic salary or
wages if the additional payments were made added to the basic salary or wage.

 The tax deductible is the difference between the two figures.

Example

Suppose an employee is paid a regular salary of K14, 000 per month and a quarterly bonus of
K1,000 is paid on 5 March 2016. How much tax should be deducted from the bonus payment?

From the previous example above we have seen that K3,575.75 would be payablein taxes from
the basic salary of K14,000 at the end of March. If the K 1,000 bonus was also paid at the end of
March, the tax to be deducted would be:

Gross salary: K14,000

Plus bonus: K1,000
Total taxable pay K15,000
Less pension contribution: K 255
Taxable pay: K14,745

Using the tax rates:

Rate of Tax Tax Due (K)

Taxable income K14,745
@ 0% First 3,000 0.00
11,745
@ 25% Next 800 200.00
10,945
@ 30% Next 2,100 630.00
@ 35% Balance 8,845 3,095.75
Tax Due will be 3,925.75

Therefore, the tax to be deducted on the bonus payment made on 5 March is:

K3,925.75 – K3,575.75 = K350.00

4.8 MULTIPLE EMPLOYMENTS – PART-TIME EMPLOYEES

The term “part- time” has a special meaning for P.A.Y.E. purposes that is different from the
normal meaning of the phrase.

Where an employee has only one employment, that employment is not regarded as part–time,
whatever the number of hours of employment. However, where an employee obtains other
employment, the second and any subsequent employments are, for P.A.Y.E. purposes, regarded
as part–time (Reg. 18(5) and (6) of the PAYE Regulations).

This means, for instance, if an employee is employed as a barman, 5 days a week from 20:00hrs
to 24:00hrs, this employment is not regarded as part–time for P.A.Y.E. purposes. If, whilst
remaining employed as a barman in the evening, the employee also starts working as a driver, 6

46
 days a week, from 07:00hrs to 17:00hrs, this second employment is, for P.A.Y.E. purposes,
regarded as part – time.

The significance of part – time employment is that tax is to be deducted at the maximum tax rate,
that is, the highest marginal rate applicable to individuals for the charge year of payment (35%
for 2016). No deduction is to be given for any tax credit to which the employee may be entitled
and no regard is taken of cumulative tax (Reg. 18(1) of the PAYE Regulations.

4.9 PAYMENTS MADE ON CESSATION OF EMPLOYMENT

When an employment terminates through an employee leaving or on death, an employer may

make various payments, depending on the circumstances giving rise to the cessation. The
employment may cease due to resignation, early or normal retirement, dismissal, redundancy,
retirement or the completion of a fixed – term contract.

Payments on cessation of employment may be of various types and generally fall into the
following categories:

(a) payments made on dismissal or resignation;

(b) payments made to an employee at the end of a contract;

(c) payments made to an employee on redundancy;

(d) payments made to an employee on retirement; and

(e) payments made on the termination of employment due to the death of anemployee.

Payments on Dismissal or Resignation

Where an employee has been dismissed or resigns, the employee may receive thefollowing
payments:

(a) salary, wage, overtime, leave pay, commission, bonus, a fee;

(b) cash in lieu of leave (leave days due but not taken);
(c) salary in lieu of notice;
(d) severance pay; and
(e) gratuity

These payments are taxed as follows:

 Payments (a) to (c) above are taxable by reference to the PAYE Tax Tables applicable for
the month in which the payment accrued.

 Severance pay and gratuity are exempt as provided under the Constitution of Zambia
(Amendment) Act, No.2 of 2016.
Payments on Expiry of Employment Contract

Where employment ceases on the expiry of a contract, the following payments are usually made
to an employee:

47
(a) a final salary;
(b) gratuity;
(c) leave pay; and
(d) repatriation pay.

These payments are taxed as follows:

 Leave pay, repatriation pay and the salary are added and taxed under PAYEwith respect
to the tax table applicable for the month in which the paymentaccrues to the employee.

 Gratuity is exempt under the Constitution of Zambia (Amendment) Act, No.2 of 2016.

Payments on Redundancy/Retrenchment

The following payments may be made to an employee who has either been declared redundant or
has been retrenched:

(a) salary;
(b) leave pay;
(c) repatriation pay;
(d) salary in lieu of notice;
(e) severance pay;
(f) accrued service bonuses; and
(g) compensation for loss of office.

The above payments are taxed as follows:

 Salary, leave pay, salary in lieu of notice, accrued service bonuses aretaxed under PAYE
in the month in which they accrue to the employee;

 Severance pay and compensation for loss ofoffice areexempt under Constitution of
Zambia (Amendment) Act, No.2 of 2016

 Repatriation allowance is taxed as follows:

(a) The first K35,000 is exempt from tax under section21(5) of Income Tax Act; and

(b) the balance is taxed at 10%

Payments on Early, Normal or Late Retirement

Where an employee goes on early, normal or late retirement, the following payments may be
made:

(a) salary;
(b) leave pay;
(c) repatriation pay;
(d) pension from an approved pension fund;
(e) accrued service bonuses; and
(f) severance pay.

The above payments are taxed as follows:

48
  Salary, leave pay and accrued service bonuses are taxed under PAYE inthe month in
which payment accrues to the employee.

 Severance pay isexempt under Constitution of Zambia (Amendment) Act, No.2 of 2016

 Repatriation allowance is taxed in the same way as for redundancy/retrenchment as

described above.

 Pension from an approved fund is exempt from tax (Paragraph 7(q)of Second Schedule to
the Income Tax Act.

Payments on Termination of Employment Due to Death

The following payments may be made upon the death of an employee:

(a) salary;
(b) leave pay;
(c) gratuity;
(d) an ex-gratia payment;
(e) accrued service bonuses;
(f) pension;
(g) severance pay; and
(h) repatriation pay.

The above payments are taxed as follows:

 The salary up to the date of death, leave pay and accrued servicebonuses are taxed under
PAYE in the month in which the paymentsaccrued to the employee.

 Gratuity is exempt under the Constitution of Zambia (Amendment) Act, No.2 of 2016.

 Ex-gratia payments made to a spouse, child or dependent of a deceased employee are

exempt from tax under paragraph 7(t) of the Second Schedule to the Income Tax Act.

 The tax treatment of pension is the same as for early, normal or lateretirement as
described above.

 Repatriation allowance is taxed in the same way as for redundancy/retrenchment as

described above.

Tax Treatment of Leave Pay and Salary in Lieu of Notice

Leave pay and salary in Lieu of notice paid to an employee on resignation, dismissal, expiry of
contract, redundancy or retrenchment, earlyretirement, normal retirement, late retirement or on
termination of employment due todeathis subjectto tax under PAYE scheme in the normal way.
Such payments will not be classified as terminal benefits under Section 21(5) of the IncomeTax
Act and therefore do not qualify for the K35,000 exemption thereunder.

Tax Treatment of Lump Sum Payments Made On Medical Grounds

49
 Where the employer, on medical advice from a registered medical practitioner or medical
institution, determines that an employee is permanently incapable ofdischarging his/her duties
through infirmity of mind or body, the employer mayterminate the services of an employee.

A lump sum payment made to an employee on termination of employment on medical grounds is

exempt from tax.

Tax Treatment of Pension Benefits

The Constitution of Zambia (as amended by Act No. 2 of 2016) exempts from taxation any
amount paid to an employee as a “pension benefit.” Articles 188 and 189 of the Constitution
provide as follows:

188. (1) A pension benefit shall be reviewed periodically to take into account
actuarialassessments.

(2) A pension benefit shall be exempt from tax.

189. (1) A pension benefit shall be paid promptly and regularly.

(2) Where a pension benefit is not paid on a person's last working day, that person shall
stop work but the person's name shall be retained on the payroll, until payment of the
pension benefit based on the last salary received by that person while on the payroll.

The Constitution defines “pension benefit” under Article 266 as follows:

“Pension Benefit includes a pension, compensation, gratuity or similar allowance in

respect of a person's service.”

The Constitution therefore exempts from taxation any amount of compensation, gratuity,
severance pay, repatriation and other similar allowances received in respect of aperson's services
at cessation of employment or expiry of contract.

4.10 REMITTANCE OF TAX

P.A.Y.E. tax deducted by an employer, less any refunds, must be remitted to ZRA together within
14 days of the end of the income tax month (Reg. 17 of PAYE Regulations).

Where an employer fails to make a return or to remit tax, ZRA may estimate the tax the employer
is required to remit and issue a notice requiring payment of that amount or issue a notice
requiring the employer to submit a default return (Reg. 18).

Further, where an employer fails to remit tax deducted to ZRA within the required period, section
71(3) of the Income Tax Act imposes a penalty of 5% of the tax unpaid for each month, or part
thereof that tax remains unpaid. In addition, interest under section 78A accrues on the unpaid
taxes from the due date to the date of payment at the Bank of Zambia discount rate plus 2% per
annum.

50
 UNIT5:
TAXATION OF BUSINESS INCOME

5.1 SCOPE OF LIABILITY

Section 17 of the Income Tax Act classifies income to include gains or profits from any
business, emoluments, dividends, interest, royalties, etc. The charge of tax on income under
section 14(1) of the Income Tax Act therefore extends to imposing a tax on income from a
business. It is therefore necessary to look at what constitutes a “business” and “gains and profits”
for purposes of the Income Tax Act.

51
5.2 MEANING OF BUSINESS

The starting point in determining whether an item of income is business income is to determine
whether the activity giving rise to the income is properly characterized as a business.

In broad terms, a business is a commercial or industrial activity of an independent nature

undertaken for profit. While the word business is commonly used in income tax laws, some
countries use other expressions, such as “entrepreneurship”, to identify independent economic
activity. Some systems have distinguished a trade from a profession or vocation.

Section 2 of the Zambian Income Tax Act provides an inclusive definition of the term ‘business.’
Business is defined to include:

(a) any profession, vocation or trade;

(b) any adventure in the nature of trade whether singular or otherwise;
(c) manufacturing;
(d) farming;
(e) agro-processing; and
(f) hedging.

Whether a person is carrying on manufacturing, farming, agro-processing or hedging activities

would normally be clear. However, the carrying on of a profession, vocation or trade or of any
adventure in the nature of a trade may not always be clear. These terms are considered below to
have a fuller understanding of the word business.

Profession

The term ‘profession’ is not defined under the Income Tax Act. However, ‘profession’ has been
judicially described as ‘involving the idea of an occupation requiring either purely intellectual
skill or manual skill controlled by the intellectual skill of the operator.’ 30 In its ordinary sense, the
term profession means an ordinary handicraft depending on the personal skills of the practitioner,
often, though not necessarily, requiring a qualification obtained by examination. A profession
differs from a trade as it involves an element of continuity. The courts have expressed the view
that the distinction between a profession and a trade is one of degree and therefore, of fact.

Vocation

The term ‘vocation’ has been judicially defined by Denman J in Partridge v Mallandaine31as ‘…
the way in which a man passes his life.’ This definition is somewhat unhelpful as it would
embrace a very wide variety of activities not all of which would be vocations. The term wide
definition of the term can be used to bring within the scope of income tax any form of regular and
continuous profit earning, which does not fall within the categories of trade, profession or
employment.

Trade

‘Trade’ has equally not been defined in the Income Tax Act. However, there is ample case law
which gives guidance as to the meaning of this word. Lord Atkin said in, Fry v Burma
Corporation Limited32stated that:

30
See Scrutton LJ in IRC V Maxse [1919] 12 TC 41
31
[1886] 18 QBD 276.
32
15 TC 144.
52
 “Trade refers to the various activities of commerce – the wining and using the products of
the earth, or multiplying the products of the earth and selling them or manufacturing them
and selling them, the purchase and sale of commodities or the offering of services for a
reward such as conveyance and the like”.

In Ransom v Higgs,33 Lord Wilberforce stated that:

“Trade normally involves the exchange of goods or services for reward…there must be
something which the trade offers to provide by way of business. Trade, moreover
presupposes a customer.’

In Smith Berry v Cordy,34 the appellant bought endowment policies taken out by other people on
their own lives and maturing at various dates to provide himself with regular income. Scott LJ
said:

“the learned judge held that it was not an operation within meaning of “trade” because
there was no “dealing” in the policies in sense of their being bought and sold again ….
this interpretation of schedule D is now too narrow…”

He further pointed out that the word trade must be used in its ordinary dictionary sense and went
on to note from the Oxford dictionary showing how very wide the meaning of the term is
including “anything practised for a livelihood.”He stated:

‘We think Lord Wright had the Oxford dictionary in mind when in National Association
of Local Government Officers v Bolton Corporation (19430 AC 166 at page 184 he was
discussing the meaning of the “trade” in the Industrial Courts Act, 1919. He then had the
occasion to consider its ordinary meaning in English language. After pointing out that in
that statute the word was used as including “industry”, he said indeed trade is not only in
the etymological or dictionary sense but in legal … a term of the widest scope. It is
connected originally with the word tread and indicates a way of life or an occupation. In
ordinary usage it may mean the occupation of a small shopkeeper equally with that of a
commercial magnate. It may also be a skilled craft. It is true that it is often used … with a
profession. A professional worker would not ordinarily be called a tradesman, but the
word “trade” is used in the widest application to the appellation trade unions.”

It would follow from the foregoing that when construing the meaning of the word trade regard
must be to its ordinary meaning in English language as well as the judicial meaning. Whether or
not an activity is an adventure or concern in the nature of trade is mixed question of law and fact.
A person does not trade if he simply procures others to trade; he must be involved in the buying
and selling or rendering of service – Ransom v Higgs. If there is a regular buying and selling or
rendering of service it is clearly trading and the gains or profits therefore are taxable, but an
isolated or casual transaction may be ‘an adventure, or concern in the nature of trade” if it is of
commercial nature. In Erichsen v Last,35 The Master of the Rolls said,

“there is not I think, any principle of law which lays down what carrying on a trade is.
There are a multitude of things which together make up the carrying on of a trade: but I
know no one distinguishing incident for it is a compound of fact made up of a variety of
things.”

Adventure in the nature of trade

33
[1974] 3 All ER 964.
34
28 TC257.
35
4 TC 422.
53
 A person may claim that he is not carrying on a trade, but he may nevertheless be carrying on an
adventure or concern in the nature of trade. The meaning of the words “adventure or concern” in
the nature of trade has also been subject of judicial interpretation. The courts have tended to
support the view that the word ‘adventure” is unqualified by the attributes of the nature of trade
but it is clear from the context that the word cannot be dissociated from the notion of trading, as
Lord McMillan said in Leeming v Jones36:

“…adventure in this context must plainly be a “trading adventure”.

Similarly, the words “in the nature of trade” are clearly meant to bring within the scope of the
charge an activity which has some but not all of the characteristics of a trade.

In Rutledge v IRC,37 the taxpayer was a businessman connected with the film industry. Whilst in
Berlin he purchased 1 million toilet rolls for £1,000 that he resold in the UK at a profit of
approximately £11,000. The Court of Session held that the taxpayer had engaged in an adventure
in the nature of a trade so that the profits were assessable. The Court stressed that such a quantity
of goods must have been intended for resale.

Similarly, in Martin v Lowry,38 a sale and purchase of 44 million yards of government surplus
linen at a profit of £1,600,000 amounted to a trade largely because of the nature of the subject
matter and the commercial methods employed to sell it.

Is there a business being carried on?

From the above, it can be seen that a ‘business,’ excluding profession and vocation, is generally
characterised by one primary activity – “something is sold”. That which is sold may consist of
goods or services or both.

However, it should be noted that a sale of goods or services does not, ipso facto amount to the
carrying on of a business. This point can be illustrated by the hypothetical case of Mr. Bambo:

Mr. Bambo is a civil servant. Ten years ago he bought a house in Lusaka and lived in it
with his family up to the present time. He now sells it and buys another house in which
he and his family are living. He sold the previous house for K100, 000 more than he paid
for it. He has therefore made a profit on the transaction. He may have changed his
residence for a variety of personal reasons. Does the purchase and sale of his residence
amount to carrying on a business such as business of property dealing? The answer
appears to be no, yet it should be noted that such a transaction has much in common with
transactions which amount to the carrying on of a business. Buying and selling is one of
the characteristics of a business, seeking to make profit is another. We may assume that
in our example, Mr Bambo would have tried to sell his house for as much as he could
obtain it.

What exactly is the difference between him and a property dealer? What characteristics are to be
found in the activities of a property dealer which are absent in the case of Mr. Bambo?

In seeking to answer to answer these and similar questions, it becomes necessary to consider what
constitutes carrying on a business. This is because a sale of goods or services that does not
constitute carrying on of a business does not give rise to business income. Only a sale of goods or
services that is conducted while carrying on a business will give rise to business income.

36
15 TC 366.
37
14 TC 490 [1929].
38
[1926] 1 KB 550.
54
 The question of whether or not there is a business may arise in two sets of circumstances:

(a) where no business is admitted;

(b) where a business is admitted but the item in question cannot be included in computing the
profits or gains of that business in which case it may be possible to show that it in itself
constitutes a separate trade.

There is no single test for the determination of whether a business is carried on. However, certain
objective tests (‘badges of trade’) have been suggested by case law as tests to be taken into
account in dealing with this question. The problem has occurred most often in transactions of
purchase and sale, though it can arise in providing a service. The following ten factors have been
considered as helpful in determining whether or not a sale of goods or services is a business
transaction:

(a) profit seeking motive;

(b) the way in which the asset is acquired;

(c) the nature of the asset;

(d) modification of the asset to make it saleable;

(e) the interval of time between purchase and sale;

(f) the existence of a sales organisation;

(g) the frequency of transactions;

(h) the existence of a trading interest in the same field;

(i) the existence of financing arrangements; and

(j) the destination of the sale proceeds.

 Profit seeking motive. If a transaction is done in order to realise a profit this is usually
prima facie evidence of trading activity. Purchase with a view to resale at a profit however, is
not necessarily sufficient evidence in itself but must be weighed along with other relevant
factors in a given situation. Often, however, the subject matter involved will be decisive. In
Wisdom v Chamberlain39the taxpayer, a comedian, who bought £200,000 of silver bullion as
a hedge against an expected devaluation of the sterling pound and three months later sold it
realising a profit of £50,000 was held to be trading. His claim that he had made no profit, but
rather that the pound had fallen in value, was rejected.

It should be noted that the absence of a profit motive does not necessarily prevent a
commercial operation from amounting to a trade. Certain concerns may be regarded as
trading even in the strict sense. The surplus made by a public utility board, for example may
not be destined for the benefit of a group of individual shareholders in a company.
Nevertheless, it is perhaps true to say that the profit-seeking motive still exists. These boards
are expected to cover expenses and may be required to raise sufficient surplus by their

39
[1968] 1 All ER 332.
55
 activities to pay off loans. In order to cover their commitments, they may be said to aim at
making profit.

It may be noted that a profit seeking motive as evidence of trade is more easily assigned to a
company than to an individual, because the reasons for the company’s existence is normally
that it is a profit making concern. An individual, on the other hand, may buy and sell at a
profit and particularly if the transaction is isolated, he may be regarded as merely realising
the profit on a capital investment.

 The way in which the asset is acquired. If it is by gift or inheritance, it will be difficult if
not impossible to show that a subsequent sale is by way of trade. If the asset is acquired by
purchase the circumstances (e.g. the market in which it is bought or the correspondence
leading up to the purchase), may tend to show either that it was being bought for resale or
that it was wanted for the private use or as an investment.

 The nature of the asset acquired. This may also be important. The commodity purchased
may be something like whisky, which can be regarded as for personal use or for use as
trading stock, but it may be fairly clear that if bought in large quantity it can only be used for
purposes of trading. If by its nature it might have been acquired for personal enjoyment or
use or to produce income whilst held, e.g. a painting or jewellery or shares, the difficulties in
the way of showing that a trade was being carried on are formidable or if a trade is already
carried on, it may have the appearance of a capital asset in that trade e.g. plant or machinery.
See Rutledge v IRC,14 TC 490 [1929]

 Modification of the asset to make it saleable. There may be modifications of the asset by
way of processing or manufacture of some kind of adoption to secure that it is readily
marketable. Thus the blending of brandy before sale or the refitting of a ship between
purchase and sale could be a pointer to the conclusion that the whole activity was in the
nature of trade.

 The interval of time between purchase and sale. A man who buys land and holds it for
many years before selling it may be in stronger position to argue that he is realising an
investment than if he sells very soon after he has bought it. This kind of evidence, however,
cannot be regarded conclusively either way, and the reason for sale could rebut the
presumption that a quick sale is more consistent with a business activity (see Wisdom v
Chamberlain [1969] 1 All ER 332).

 The existence of a sales organisation.Any form of organised activity designed to promote a

sale is evidence in favour of deciding that a trade is carried on, e.g. a sale by advertisement
or the use of a selling agency or sales staff. In the case of Cape Brandy Syndicate v CIR,40 a
syndicate of chartered accountants distilled brandy. They distilled more than they could
actually drink themselves and sold the surplus. HMRC sought to tax them as trading income.
They argued that they were simply selling what they could not physically drink themselves.
However, as they had set up a special phone line and information desk and published
brochures and adverts advertising their brandy, HMRC successfully argued that they had
commenced a trade.

 The frequency of transactions. If any particular transaction is found to be one of a series,

and there is evidence of methodical activity then the transaction tends to fall into the general
pattern which in a whole constitutes a trade. The case is much stronger than if there is only

40
12 TC 358.
56
 one transaction to be judged on its merits. In Pickford v Quirke41 for example, the court held
that although a single purchase and sale by a syndicate of four cotton mills did not amount to
trading, the series viewed as a whole did. On the other hand, a line is to be drawn between a
number of desultory (unstable) haphazard transactions perhaps spread over years, which it
may be argued, do not constitute a series at all and transaction related to each other occurring
at not too great intervals of one time, and presenting appearances of habitual and continuous
activity.

 Existence of a trading interest in the same field. If the man has an admitted trade or
connection between the transaction in question and that trade, it may indicate that it was
entered into as a matter of trade. Such finding may affect the decision.

 Financing arrangements. If the purchaser especially borrows money in such circumstances

it would be clear from the first that he would have to sell to repay the loan. He may
undertake the purchase in the expectation that he will pay for it out of the proceeds of a trade
which he is already carrying on. All these situations would on the whole favour the
conclusion that he was trading. On the other hand, the evidence may be that the money for
purchase is merely changing investments. See Wisdom v Chamberlain [1969] 1 All ER 332.

 The destination of the proceeds.If the proceeds of the sale of the asset are retained for the
use in a similar transaction when the opportunity arises, this may indicate that the sale
transaction was entered into as a matter of trade as opposed to when the proceeds of the sale
are invested or used for a different purpose.

5.3 GAINS AND PROFITS

We have seen from the above discussion that the broad effect of the statutory provisions
regarding the scope of tax liability in relation income from a business may be stated as follows:

(a) a ‘business’ is the subject matter of assessment; and

(b) only profits or gains of the business can be taxed.

In a particular situation, therefore it is necessary to consider not only whether a business is carried
on, but also whether that which is brought to be taxed represents ‘profits’ or ‘gains’ of that
business.

The expression “gains or profits” is frequently encountered in the Income Tax Act but it is
nowhere defined. The words must accordingly be construed in their ordinary dictionary meaning.

In its ordinary dictionary meaning, the word profit means the surplus remaining after total costs
are deducted from total revenue. Taxation on business income is therefore only effected on the
surplus after certain costs of the business are deducted from the total revenue of the business.

5.4 ALLOWABLE DEDUCTIONS

In computing gains or profit of a business for income tax purposes, the Income Tax Act in section
29(1)(a) allows for the deduction of “losses and expenditure, other than of a capital nature,
wholly and exclusively incurred for the purposes of the business”.

 Deductible expenditure – in terms of section 29 of the Income Tax Act, expenditure of a

business will be deductible in arriving at the gains or profits of the business only if:
41
13 TC 251 [1927].
57
 (a) it is a revenue and not capital expenditure; and

(b) it is incurred wholly and exclusively for business purposes.

A distinction is drawn between expenses incurred in earning the profits (which are
deductible) and expenses incurred after the profits have been earned, which are not
deductible. For example, the payment of income tax is an application of profit which has
been earned and is, therefore, not deductible.42

Expenditure must be revenue not capital expenditure

Expenditure is only deductible if it is revenue and not capital expenditure.It is therefore

necessary to understand what constitutes capital expenditure.

Capital is not defined in the statute and there is no single test to be applied in
distinguishing capital from revenue expenditure. There are various tests for whether
expenditure is of a capital nature, and the determination must depend upon the facts of the
particular case. No single test applies in making that determination. Lord Denning in
Heather v P E Consulting Group Ltd43 made the following still very pertinent
observations at page 321A:

“The question - revenue expenditure or capital expenditure - is a question which

is being repeatedly asked by men of business, by accountants and by lawyers. In
many cases the answer is easy: but in others it is difficult. The difficulty arises
because of the nature of the question. It assumes that all expenditure can be put
correctly into one category or the other: but this is simply not possible. Some
cases lie on the border between the two: and this border is not a line clearly
marked out; it is a blurred and undefined area in which anyone can get lost.
Different minds may come to different conclusions with equal propriety. It is like
the border between day and night, or between red and orange. Everyone can tell
the difference except in marginal cases; and then everyone is in doubt. Each can
come down either way. When these marginal cases arise, then the practitioners -
be they accountants or lawyers - must of necessity put them in one category or
another. And then, by custom or by law, by practice or by precept, the border is
staked out with more certainty. In this area at least, where no decision can be said
to be right or wrong, the only safe rule is to go by precedent. So the thing to do is
to search through the cases and see whether the instant problem has come up
before. If so, go by it. If not, go by the nearest you can find.”

And in the case ofB.P. Australia Ltd. v. Commissioner of Taxation of the Commonwealth
of Australia,44Lord Pearce in referring to the matter of determining whether expenditure
was of a capital or an income nature said:

“The solution to the problem is not to be found by any rigid test or description. It
has to be derived from many aspects of the whole set of circumstances some of
which may point in one direction, some in the other. One consideration may point
so clearly that it dominates other and vaguer indications in the contrary direction.

42
See Ashton Gas Co. v A-G [1906] AC 10.
43
[1972] 48 TC 293.
44
[1966] A.C. 224, [1965] 3 All E.R. 209
58
 It is a common sense appreciation of all the guiding features which must provide
the ultimate answer.”

In Strick v Regent Oil Co Ltd,45 Lord Reid described the difficulties in making sense of
the large number of decisions on this topic:

“It may be possible to reconcile all the decisions, but it is certainly not possible to
reconcile all the reasons given for them. I think that much of the difficulty has
arisen from taking too literally general statements made in earlier cases and
seeking to apply them to a different kind of case which their authors almost
certainly did not have in mind - in seeking to treat expressions of judicial opinion
as if they were words in an Act of Parliament.’

The tests that have been applied by the courts in classifying expenditure as revenue or
capital include the following:

 the object of the expenditure;

 whether the expenditure was made from fixed or circulating capital;
 whether the expenditure is recurring or once-off;
 whether the expenditure produces, improves or disposes of an asset; and
 how the expenditure would be treated on ordinary principles of commercial
accounting.

(a) The object of the expenditure

This test, set out in the case of Athertonv British Insulation Helsby Cables
Limited,46 arguably looks to the purpose or motive of expenditure (‘...with a view
to...') - expenditure is of a capital nature if it is made for the purpose of bringing
into existence an asset for the enduring advantage of the business. In Atherton,
Viscount Cave said at p. 192:

“Where an expenditure is made with a view to bringing into existence an

advantage for the enduring benefit of a trade, I think there is very good
reason (in the absence of special circumstances leading to opposite
conclusion) for treating such an expenditure as properly attributable not
to revenue but to capital”

The modern authorities, however, reject that approach. Instead, they argue that
you should seek to identify on what the expenditure was incurred or what was
obtained for it (or would have been obtained if the expenditure had not proved to
be abortive). Thus, in Tucker v Granada Motorway Services Ltd 47 expenditure for
the purpose of reducing a revenue outgoing (rentals due over a period of years
under a lease of land) was nevertheless capital because it was incurred on a
capital asset (the lease of land).

See also Lawson v Johnson Matthey Plc [1992] 65TC39.

(b) Whether expenditure was from fixed or circulating capital

45
[1965] 43 TC 1 at 29
46
[1925] 10 TC 155
47
[1979] 53 TC 92
59
 In his classic definition, Adam Smith distinguished between capital and revenue
expenditure by reference to fixed and circulating capital. According to this test,
expenditure will be revenue expenditure if made out of circulating capital and
capital expenditure if made out of fixed capital of the business.In income tax law
the distinction has been recognised repeatedly, and in discussing it the courts
have had recourse to the economists (Adam Smith, Marshall, Mill etc.) and to
company law.48A defect with this test is that the classification of the asset as fixed
or circulating depends upon the particular business.

The question that follows is what is ‘fixed’ and ‘circulating’ capital?

In his 'Wealth of Nations', Adam Smith described ‘fixed capital’ as “what the
owner turns to profit by keeping it in his own possession”, and ‘circulating
capital’ as “what he makes profit of by parting with it and letting it change
masters.”

The courts have not always found this oft quoted definition to be helpful.

In Van den Berghs Ltd v Clark49 the distinction between fixed and circulating
capital played some part in the Court of Appeal finding for the Revenue. In the
circumstances and for the reasons he gives at page 432 Lord Macmillan did not
find the Adam Smith definition helpful:

“…I confess that I have not found it very helpful. Circulating capital is
capital which is turned over and in the process of being turned over yields
profit or loss. Fixed capital is not involved directly in that process, and
remains unaffected by it. If this is to be the test, I fail to see how the
appellants could be said to have been engaged in turning over the asset
which the agreements in question constituted. The agreements formed the
fixed framework within which their circulating capital operated; they
were not incidental to the working of their profit-making machine but
were essential parts of the mechanism itself. They provided the means of
making profits, but they themselves did not yield profits. The profits of
the Appellants arose from manufacturing and dealing in margarine.”

Lord Macmillan’s strictures are but one of many examples where judges have
warned against taking a particular method of identifying the capital/revenue
divide and applying it to all and sundry cases.

In the case of J & R O’Kane and Co. v Commissioner of Inland Revenue50 Roland
L.J. quotes from ‘Buckley on Companies’ at p. 336 as follows:

“The author would define fixed capital as property acquired and intended
for retention employment with a view to profit, as distinguished from
circulating capital, meaning property acquired or produced with a view to
resale or sale at a profit”.

A definition of difference is suggested again by Rowlatt J., in Rees Roturbo

Development Syndicate Ltd v Ducker & CIR51at p.379:
48
See Viscount Haldane’s judgment in John Smith and Son v Moore [1921] 12 TC 266
49
[1935] 19 TC 390
50
[1922] 12 TC 303
51
[1928] 13 TC 366
60
 “In one sense the words “capital assets” are not words of art because you
do not have one set of assets representing income. Of course, but what is
meant by the phrase “capital assets” is that this is an asset which
represents fixed capital as opposed to circulating capital, that is to say
that this is an article which is possessed by an individual in question, not
that he may turn it over and make a profit by the sale of it to his
advantage, but that he may keep it and use it and make a profit by its use.
Then if an article of that sort is sold at a profit, that profit is not a profit of
trade.”

Very briefly, ‘Carter’s Advanced Accounts’ defines fixed and floating capital as
follows:

 Fixed capital comprises all the fixed assets

 Circulating (or floating) capital consists of the floating or circulating

assets.

These terms mark a distinction which constantly occurs in commercial practice.

There appears to be little difference between circulating and floating capital,
except that the word circulating emphasises the liquidity of the capital and the
case of converting it into cash. Sometimes the fixed capital is referred to as
capital assets of the concern.

Thus premises, plant, leases and goodwill are fixed capital retained and used in
the business; while stock, book debts and cash are circulating capital, turned over
in order to make a profit.

The courts, however, are naturally concerned with arguable items and have
repeatedly affirmed that the distinction is not easy to apply in the borderline
example. There are two reasons why this should be so, first, the same kind of
asset may either be fixed or circulating according to the nature of the business.
Thus “investments” would be circulating to a stockbroker but fixed capital to an
ordinary trader. Similarly, plant would be fixed capital to an ordinary
manufacturer but circulating capital to a company which manufactures or deals in
plant. Secondly, the existence of arguable items in a particular case shows that
although the distinction can be said to be real one there is no hard and fast line to
be drawn. The one kind of capital shades off into another. The point made is by
Lord Hanworth, MR in The European Investment Trust Co. Ltd v Jackson 18
TCat page 13 –

“The question whether or not a sum is fixed capital is one of degree; and
he goes on to say, therefore, a question of fact.”

Sometimes the question arises in regard to something that does not appear as an
asset in the balance sheet at all e.g. the right secured by a contract may be very
valuable and consideration often entering into or cancelling the contract may be
capital expenditure or a capital receipt.

The distinction being clear in principle between fixed and circulating capital it
follows from what has been so far discussed, its application in practice to a
disputed item requires a close examination of various factors including:

(i) the nature of the trade;

61
 (ii) the relation of the asset to ordinary trading operations;
(iii) the purpose for which the asset was acquired;
(iv) the circumstances in which it was acquired and sold.

It is only when the full facts are known that a decision can be taken whether the
particular receipt is to be included in computing the gains or profits of the
business. It may be noted incidentally that it is difficult to show that fixed capital
has changed its nature into circulating capital. One or two judges in obiter dicta
have suggested that such a change is possible but so far has been decided on the
basis of a change having taken place.

(c) Whether expenditure is recurring or once-off

A once and for all expenditure, even though it brings no enduring asset into
existence, is more likely to be of a capital nature than a recurring expense. In
Watney Combe Reid & Co. Ltd v Pike, 52for example, ex gratia payments made by
Watneys (the brewers) to tenants of tied houses to compensate them for the
termination of their tenancies were held to be capital, because their purpose was
to tender capital assets (the premises) more valuable.

Expenditure which is not once-off (i.e. recurring expenditure) may nevertheless

be capital. Expenditure of a recurring nature on the acquisition of assets which
are clearly fixed rather than circulating capital (for example a fleet of vehicles
used by a concern's sales representatives), for example, remains capital
expenditure. Moreover, an outgoing does not cease to be of a capital nature
merely because it is payable by instalments. 53 But there can sometimes be a fine
line between the payment of a capital sum by instalments and revenue payments
for the use of an asset, particularly finance lease rental payments. But a ‘once and
for all’ payment may not necessarily be capital (for example, paying off an
unsatisfactory employee).

(d) Whether the expenditure produces, improves or disposes of an asset

One of the tests in determining whether expenditure is of a capital nature is

whether the expenditure produces an asset or at least an advantage to the
permanent and enduring benefit of a trade. If so, the expenditure is a capital
expenditure - Sampson v The Commissioner of Taxes.54

Expenditure will also be capital if it spent for the improvement 55 or disposal56 of

a capital asset. It is not sufficient that it was paid in connection with (or on the
occasion of) the acquisition, improvement or disposal of the asset. For example,
the goodwill of customers may be a valuable capital asset. But that is not enough
to make expenditure such as the pay of staff (who, by serving customers well,
may have helped create the goodwill) a capital outgoing. See also Lawson
v Johnson Matthey Plc [1992] 65TC39.

There is no simple yardstick of the length of time for which an asset or advantage
must endure before it may be regarded as capital. There are other important
52
[1982] 57 TC 372
53
See CIR v Adam[1928] 14 TC 34
54
[1966] Z.R. 51 See also Rolfe v Wimpey Waste Management Ltd [1989] 62 TC 399
55
See Tucker v Granada Motorway Services Ltd [1979] 53 TC 92
56
See Mallet v The Staveley Coal & Iron Co Ltd [1928] 13 TC 772
62
 considerations such as: how the asset or advantage functions in the context of that
particular trade; how it benefits the business, and whether it is obtained by a lump
sum or by periodical payments.

It is necessary to identify a specific capital asset for which the expenditure is

incurred. See Tucker v Granada Motorway Services Ltd.57 The asset may be
tangible or intangible.

Where the asset is tangible the question will usually be straightforward - either
the asset is held as a current (revenue) asset such as trading stock (or otherwise
for resale at a profit) or it is held as a fixed (capital) asset. (See below for
intangible assets.)

Where the expenditure is on an intangible benefit or advantage (for example,

trading agreements, licences or other intangibles) it will be necessary to ask
whether the identifiable asset is of a sufficiently substantial and enduring nature
to count as capital. See for example:

Heather v P E Consulting Group Ltd[1972] 48 TC 293

Anglo-Persian Oil Company Ltd v Dale[1931] 16 TC 253

CIR v Carron Company[1968] 45 TC 18

In Walker v Joint Credit Card Co. Ltd58 for example, a payment by a credit card
company to preserve its goodwill was held to be a capital expenditure.

(e) How payment would be treated under ordinary accounting principles

For determining profits for accounting purposes, the important issue is whether
expenditure is ‘consumed’, i.e. used up, and, therefore, when it must be charged
to the profit and loss account, or whether it the expenditure brings into existence
an asset or advantage for the enduring benefit of the trade. See: Athertonv British
Insulation Helsby Cables Limited.

Expenditure must be ‘wholly and exclusively’ incurred for business purposes

A taxpayer must justify any given deduction so as to show that it relates to an expenditure
incurred wholly and exclusively for the purposes of its trade or in the production of its
income, otherwise the deduction will be disallowed.

Read: Commissioner of Taxes v Basil Stores Limited (1973) Z.R. 107, where the High
Court upheld the disallowance of excessive amounts indicated as directors’ fees
which the Responded claimed as deductible amounts from its income on the basis
of "expenditure incurred wholly and exclusively for the purposes of its trade or
for the production of its income". The court held that the services rendered by the
directors in question were largely nominal and the remuneration paid to them
could not be regarded as expenditure incurred wholly and exclusively for the
purpose of its trade or in the production of its income.

Part IV of the Income Tax Act sets out other specific allowable deductions and these include:

57
[1979] 53TC92
58
[1982] 55 TC 617
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 Foreign currency exchange gains and losses – section 29A - any foreign currency
exchange losses, other than those of a capital nature, shall be deductible in the charge
year in which such losses are realised, that is, in the charge year in which the person or
partnership concerned is required to pay the additional kwacha or is allowed a rebate or a
reduction in settlement of a foreign of a foreign debt or liability.

While foreign exchange losses of a capital nature are generally not deductible, foreign
exchange losses of a capital nature incurred on borrowing used for the building and
construction of an industrial or commercial building shall be deductible.

The deduction of foreign currency exchange losses does not apply to banks.

 Losses – section 30 - Any loss incurred in a charge year by a person from:

(a) a source other than a mining operation, shall be deducted from that person’s
income from the same source on which the loss was incurred; and

(b) a mining operation, shall be deducted from 50 percent of the income of the
person from the mining operation.

Where a loss in respect of operations other than a mining operation exceeds the income
of a person for a charge year, the excess shall, as far as possible, be deducted from that
person’s income from the same source on which the loss was incurred in the following
charge year.

Where a loss in respect of mining operations exceeds 50 percent of the income from
mining operations for a charge year, the excess shall, as far as possible, be deducted from
50 percent of that person’s income from the mining operation in the following charge
year.

The carry-over of losses to the subsequent charge year is subject to the following
limitations:

(a) a loss incurred by a person carrying on mining operations or hydro and thermo
power generation shall not be carried forward beyond 10 subsequent charge years
after the charge year in which the loss was incurred; and

(b) in any other case, the loss incurred shall not be carried forward beyond 5
subsequent charge years after the charge year in which the loss is incurred.

 Capital allowances – section 33 - Capital allowances are deductible in ascertaining the

gains or profits of a business and the emoluments of any employment or office for each
charge year-

(a) for buildings, implements, machinery and plant, and premiums, according to the
provisions of Parts I to V of the Fifth Schedule;

(b) for capital expenditure in relation to mining operations, according to the

provisions of Parts I to VI inclusive of the Fifth Schedule; and

(c) for farm improvements and works, according to the provisions of the Sixth
Schedule.

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Capital allowances for buildings, implements, machinery and plant, and premiums

Under the Fifth Schedule of the Income Tax Act, the following are the capital allowances
permitted:

(i) initial allowance for industrial buildings;

(ii) wear and tear allowance;
(iii) balancing allowance;
(iv) premium allowance; and
(v) improvement allowance.
Initial allowance for industrial buildings

Under paragraph 3 of the Fifth Schedule, a deduction known as an initial allowance is

allowed in respect of capital expenditure incurred on the construction of a building
intended to be used as an industrial building, or on an addition to or an alteration of an
industrial building.

An ‘industrial building’ is defined in paragraph 1 of the Fifth Schedule as:

(a) 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: (i) is carried on in a mill, factory or like premises; (ii) consists of the
manufacture of goods or materials, or their subjection to any process; (iii)
consists of the storage of goods or materials to be used in the manufacture or
processing of other goods; (iv) consists of the storage of goods on import or for
export; or (v) consists in the working of a mine or well for the extraction of
natural deposits;

(b) any building constructed as a hotel which the Minister of Tourism has certified as
such;

(c) any building constructed or acquired to provide housing for the purposes of that
person's business; and

(d) any building in use for the welfare of employees engaged in the undertakings and
trades referred to in paragraph (a) above e.g. a cafeteria, recreational facility,
health centre etc.

The allowance is calculated as a percentage of the expenditure incurred – currently 10

percent – and is deductible only once in the charge year in which the said building,
addition to or alteration is brought into use as an industrial building.

The initial allowance is deductible from the cost of the building in determining its
written-down value.

The initial allowance is also available to a person who acquires the industrial building
from another person who constructed it in the course of his trade and is the first user of
that building. In such case the capital expenditure is the cost of acquisition.

Wear and tear allowance for buildings

Under paragraph 4 of the Fifth Schedule, a wear and tear allowance (also known as
‘writing down allowance’) is allowed as a deduction in ascertaining the business profits
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of any person in a charge year. The wear and tear allowance is available to a person who
uses for the purposes of his business an industrial or commercial building which he
acquired, constructed, added to or altered.

A ‘commercial building’ is defined in paragraph 2 of the Fifth Schedule as ‘a building or

structure, or part thereof, which is not an industrial building as defined in paragraph 1, or
farm improvement or farm works as defined in the Sixth Schedule, and which is in use
for the purposes of any business.’

The wear and tear allowance is also calculated as a percentage of the original cost of the
building to such person, provided that in no case shall the total of all the deductions
allowed to such person exceed the cost to such person of such acquisition, construction,
addition or alteration, as the case may be.

Currently, wear and tear allowance for industrial buildings is 10 percent in the case of
low cost housing that qualifies as industrial buildings, and 5 percent for other industrial
buildings. Wear and tear allowance for commercial buildings is 2 percent.

Where a building is used by a person as an industrial building for part of a charge year
and as a commercial building for another part of the same charge year, that building shall
be regarded as used by that person solely as an industrial building for that charge year.

No wear and tear allowance shall be deductible for any charge year in respect of any
building if at any time during the said charge year that building is used as his usual
dwelling place by-

(a) any individual who uses such building for the purposes of the business, or by any
individual partner in such business;

(b) any individual who, by reason of his shareholdings, or of his control of

shareholdings, in any company or by reason of any partnership interest, is in a
position to exercise control, directly or indirectly, over the person or persons
using the building for the purposes of the business;

(c) a director of a company using the building for the purposes of its business, who is
not a whole time service director thereof.

Wear and tear allowance for implements, machinery and plant

Under paragraph 10 of the Fifth Schedule, a wear and tear allowance is allowed as a
deduction in ascertaining the business profits of the business for each charge year of any
person who has used any implements, machinery or plant belonging to him for the
purposes of his business.

Where a person holds any implements, machinery or plant under a hire-purchase

agreement as defined in the Hire-Purchase Act, then the implement, machinery or plant
shall be deemed to belong to that person for the purposes of this paragraph.

The wear and tear allowance for any charge year is also calculated as a percentage of the
original cost of the implement, machinery or plant; provided that in the charge year in
which the business ceases the allowance shall be the amount of the residue of the original
cost.

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The wear and tear allowance for implements, machinery and plant is calculated on a
straight line basis of the original cost of the implements, machinery and plant. However,
in the case of any implements, machinery or plant which were acquired by a person other
than for the purpose of a business, the original cost shall be the current market value of
such implements, machinery or plant as determined by the Commissioner-General in the
charge year that they are first used for the purpose of a business.

Currently, wear and tear allowance for implements, machinery and plant (including
commercial vehicles) is 25 percent, while the wear and tear allowance for non-
commercial vehicles is 20 percent.

The wear and tear allowance on any implement, machinery or plant which is proved to
the satisfaction of the Commissioner-General to be exclusively and directly used in
farming, mineral processing, manufacturing, tourism or leased out under an operating
lease for any charge year, is calculated on a straight line basis at the rate of 50 percent of
the cost.

The wear and tear allowance on the cost of any new plant or machinery acquired and
used by any soft drinks manufacturer in respect of such business carried on by him in a
rural area, shall, in any charge year, be calculated on a straight-line basis at the rate of 20
percent of the cost of such plant and machinery.

Balancing allowance

This is provided for under paragraph 5 of the Fifth Schedule. It is available where any
building in respect of which an initial or wear and tear allowance has been or could have
been deducted ceases to belong to a person or permanently ceases to be used by him for
the purposes of any business. It is the difference between the written down value and
disposal price or market value of the building. If the amount realised on disposal is less
than the written down value of the building, the difference is granted as a balancing
allowance and is deductible from the income of the income of the business in respect of
which the said building was last used in order to arrive at the taxable profits of that
business for the charge year of such cessation.

Example

The balancing allowance on the disposal of a commercial building developed at a cost of

K2,000,000 with total wear and tear allowances of K200,000 over 2 years and disposed
of at a price of K1,500,000 can be calculated as follows:

Cost of building: K2,000,000

Less wear and tear allowances: K 200,000

Written down value: K1,800,000

Less amount realised on disposal: K1,500,000

Balancing allowance: K 300,000

The amount of K300,000 can be deducted from the income of the business in arriving at
the taxable profits of the business in that charge year.

If, however, the amount realised on disposal of the building is greater than the written
down value of the building, the difference becomes capital recovery which constitutes

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taxable income. Thus, in the above example, if the amount realised on disposal was
K1,900,000, the K100,000 difference would be added to the profits of the business in
arriving at taxable income.

Where wear and tear allowance has been deducted for part only of the entire period of
ownership or possession of the building, the allowance deductible shall be determined by
multiplying the balancing allowance as above calculated by the number of years in
respect of which wear and tear allowance has been deducted and dividing the result by
the number of years of the said ownership or possession.

Thus, if in the above example, the K200,000 wear and tear allowance was only deducted
for a period of 2 years but the building was owned for a period of 4 years the deductible
allowance would be calculated as follows:

Cost of building: K2,000,000

Less wear and tear allowances: K 200,000

Written down value: K1,800,000

Less amount realised on disposal: K1,500,000

Balancing allowance: K 300,000

K300,000 x 2 years = K600,000

K600,000 ÷ 4 years = K150,000

Therefore, the deductible balancing allowance will be K150,000.

Premium allowance

Under paragraph 14 of the Fifth Schedule, a deduction is allowed (called a premium

allowance) in ascertaining the profits of a person's business equal to the amount of any
premium or like consideration paid by him for the right of use of machinery or plant, or
for the use of any patent, design, trade mark or copyright, or for the use of other property
which the Commissioner-General determines is of a like nature, where such right is used
by that person for the purposes of his business.

The amount of any premium allowance allowed as a deduction for any charge year shall
not exceed the amount of the premium or like consideration divided by the number of
years for which the right of use is granted. In other words, the allowance is pro-rated over
the period of years for which the right of use the particular item has been granted.

For example, if a company pays K10,000 for the right to use a patent for 5 years, the
premium allowance is:

K10,0000 / 5 years = K2,000 per year

Where a person acquires any interest in the ownership of property for payment of a
premium or like consideration for the right of use of which he has been allowed a
deduction, he ceases to be allowed that deduction as from the date of such acquisition.

Improvement Allowance

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Under paragraph 4A of the Fifth Schedule, a person operating in a priority sector or in
respect of a priority product and operating in multi-facility economic zone or industrial
park designated as such under the Zambia Development Agency Act, 2006 who in that
year uses for business, an industrial or commercial building which that person has
constructed, or altered, a deduction shall be allowed (called improvement allowance) for
that charge year.

The improvement allowance is calculated as a percentage of the original cost of such

industrial or commercial building to such person, currently at 100 percent.

Capital allowances for farm improvements and works

Under the Sixth Schedule of the Income Tax Act, the following are the capital allowances
permitted:

(i) a farm improvement allowance; and

(ii) a farm works allowance.

Farm improvement allowance

Under paragraph 2 of the Sixth Schedule, an allowance (known as a farm improvement

allowance) is allowed in determining the profits of a farming business for any
expenditure incurred in a charge year on farm improvements.

A "farm improvement" is defined under paragraph 1 of the Sixth Schedule as ‘any

permanent work, including a farm dwelling and fencing appropriate to farming and any
building constructed for and used for the welfare of, employees, and in relation to
farming land owned or occupied by the farmer…’.

Read: Enviro-Flor Limited v Zambia Revenue Authority 2001/RAT/36

A farm improvement allowance is calculated at 100 percent of the expense incurred on

the farm improvement.

Where the expenditure on farm improvements is partly in respect of a farm improvement,

and partly in respect of some other purposes, only such proportion of that expenditure as
the Commissioner-General may determine will be taken into account for the purposes of
the allowance.

Farm works allowance

Under paragraph 5, a deduction (called the farm works allowance) is allowed to a farmer
in respect of expenditure on farming land in his ownership or occupation and for the
purposes of farming, on stumping and clearing, works for the prevention of soil erosion,
boreholes, wells, aerial and geophysical surveys, and water conservation (collectively
referred to as "farm works").

The expenditure incurred in respect of any farm works is allowed as a deduction in

ascertaining the profits of his farming business for that year, provided that where the
person incurs the expenditure in a charge year prior to the charge year in which he
commences farming operations the expenditure shall be allowed as a deduction in the
charge year in which he commences farming operations.

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 A farm works allowance is calculated at 100 percent of the expense incurred on the farm
improvement.

In terms of paragraph 8 of the Sixth Schedule, the amount of any capital expenditure
incurred in respect of farm improvement or in respect of farm works will be reduced by
the amount of any subsidy or grant received by the farmer from public funds towards or
in aid or in recognition of such expenditure.

 Investment allowance – section 34 - Where a person incurs capital expenditure on the

construction of, addition to, or alteration of any industrial building, as defined in
paragraph 1 of the Fifth Schedule, to be used by him for the purposes of his business as a
manufacturer, an investment allowance of 10 percent of such expenditure shall be
deducted in ascertaining the gains or profits of that business for the year in which the said
building, addition or alteration is first used for the said purposes. However, unlike the
initial allowance, the investment allowance is not deductible from the cost of the building
to arrive at its written down value.

 Development allowance – section 34A - Where a person incurs expenditure on the

growing of rose flowers, tea, coffee, or banana plant or citrus fruit trees, or other similar
plants or trees, a development allowance of 10 percent of such expenditure is deductible
in ascertaining the gains or profits of that business for the charge year. In the case of a
person growing for the first time the aforementioned plants or trees, the development
allowance may be carried forward to the following charge years up to the first year of
production, but in no case shall the development allowance in respect of more than three
consecutive years be carried forward.

 Preliminary business expenses: section 35 – expenses incurred within 18 months before

the commencement of a business are regarded as deductible preliminary business
expenses so long as they are of non-capital nature i.e. they should not be expenses on
capital assets. This deduction is allowed in the first year of business.

 Post-cessation expenses – section 36 – expenses incurred by any person after the

cessation of his business which, if incurred prior to the cessation, would have been
deductible in computing his gains or profits from the business, are deductible from his
income for the charge year to the extent to which the said expenses have not already been
deducted in computing the gains or profits of the ceased business. The deduction is only
allowed the charge year in which the expenses are incurred or, if he has no income in that
charge year, from his income for the charge year in which the business ceased.

 Payments to approved funds – section 37 - A deduction is allowed in ascertaining the

gains or profits of a business in a charge year, any amount paid by the business by way of
contribution to an approved fund, such as the National Pension Scheme Authority,
established for the benefit of the employees of the business.

However, no deduction is allowed under section 37 in respect of any contribution other

than a contribution-

(a) which is not a contribution in arrear; or

(b) which is a special lump sum contribution allowed to be deducted under and in
accordance with section 37(2).

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 The deduction to be allowed for a charge year in respect of current contributions to an
approved fund shall not exceed 20 percent of the emoluments liable to tax received from
the employer in that charge year by each employee in respect of whom the contributions
are paid.

 Deduction for share option scheme – section 37A - A deduction is allowed in

ascertaining the gains or profits of an employer for a charge year of any amount incurred
by the employer in the establishment or in the administration of an approved share option
scheme for that year.

 Technical education - section 38 - A deduction is allowed in ascertaining the gains or

profits of a business for any payment made for the purposes of technical education
relating to that business or for the purposes of obtaining further experience, training or
qualifications, relating to that business; provided that no deduction will be allowed under
section 38 in respect of any payment made-

(a) on behalf of an individual who is related by blood or marriage to the person

making the payment, or to a person who is able to control directly or indirectly
the person making the payment;

(b) in pursuance of an agreement or undertaking to the effect that the person making
the payment will receive any reciprocal benefit for such payment where made on
behalf of an individual who is related by blood or marriage to any other party to
that agreement or undertaking.

 Subscriptions – section 39 - A deduction is allowed in ascertaining the gains or profits of

a business for any subscription paid by a person in respect of his membership of a trade,
technical or professional association which is related to his business, employment or
office. For example, a payment made by a legal practitioner to the Law Association of
Zambia as membership fee for the issuance of a practicing certificate will be deductible
from the business income of such legal practitioner.

 Donations to public benefit organisations – section 41 - Any amount paid by a person

during a charge year to a public benefit organisation shall be deducted from the income
of that person for that charge year if-

(a) the payments are in money or money's worth;

(b) the payments are made for no consideration;

(c) the public benefit organisation to which the payment is made is one approved by
the Minister of Finance; and

(d) the payment is made to a public benefit organisation that is owned by the
Government.
A deduction under section 41 may not exceed 50 percent of the assessable income of the
person for that charge year.

 Deductions for research – section 43 - A deduction is allowed in ascertaining the gains

or profits of a business of any expenditure, not being expenditure of a capital nature,
incurred by the business during a charge year on experiments or research relating to the

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 business. A deduction is also allowed for any contribution to a scientific or
educational society or institution or other like body of a public character approved by the
Commissioner-General where a condition of the contribution is that it must be utilised by
the society, institution or body, as the case may be, solely for the purposes of industrial
research or scientific experimental work connected with the business.

 Deduction for bad and doubtful debts - section 43A - A deduction is allowed in
ascertaining the gains or profits of a business for debts to the extent that the debts have
been included in the income of that business and to the extent that they are proved to the
satisfaction of the Commissioner-General to be bad or likely to become bad i.e. not likely
to be paid. Where there is no income from that business for the charge year for which
such deduction is due that deduction will be deemed to be a loss under section 30.

Section 43A does not stipulate what means should be used to satisfy the Commissioner
General that debts have become bad or are likely to become bad. The determination of
whether satisfactory proof has been given by the taxpayer is therefore the discretion of
the Commissioner-General. You will note in section 114 of the Income Tax Act that
when it is provided in the Income Tax Act that a particular matter is subject or according
to the Commissioner-General’s discretion, an exercise of such discretion shall not be
questioned in any proceedings.

Read: Lusaka Water and Sewerage Company v Zambia Revenue Authority -

1999/RAT/36

Where a deduction has been allowed for a bad or doubtful debts and in the subsequent
charge year part or all the debt is recovered, the amount of the recovery or, where less,
the total deductions allowed in one or more charge years in respect of that debt, shall be
assessable in the charge year in which the recovery is received (section 43A(2)). Where
recoveries are effected in more than one charge year, the total amount assessable in each
charge year after the first such charge year shall not exceed the amount of the recovery in
that later year or, where less, the total of the deductions previously allowed less any
recoveries assessable in previous charge years.

 Deduction of mineral royalty – section 43B. - A deduction shall be allowed in

ascertaining gains or profits of a business of any mineral royalty payable and paid for a
charge year in pursuance of the provisions of the Mines and Minerals Development Act
2008.

 Deduction for employing handicapped person - section 43D - A deduction shall be

allowed in ascertaining the gains or profits of a business in respect of each person with
disability who has been employed full-time by such business for the whole or substantial
part of the charge year for which the deduction is claimed. The amount of the deduction
allowed under section 43D is K1,000.

5.5 NON-PERMITTED DEDUCTIONS

Section 44 enumerates certain items of expenditure that may not be deducted. No deduction is
made in respect of any of the following matters:

(a) the cost incurred by an individual in the maintenance of himself, his family or
establishment, or which is a domestic or personal expense;

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 (b) any loss or expense which is recoverable under any insurance contract or indemnity;

(c) capital expenditure or loss of capital, other than loss of stock in trade, unless specifically
permitted under the Income Tax Act (See Zamcell Limited v Zambia Revenue Authority,
1999/RAT/36);

(d) any payment to a pension or superannuation fund or scheme or premium payable under
an annuity contract, except such payments as are allowed under section 37;

(e) any tax or penalty chargeable under the Income Tax Act;

(f) any amount which would be deductible in ascertaining the income from a source or from
income which the Commissioner-General is prohibited from including in any assessment
under the provisos to section 63(1);

(g) any expenditure incurred or capital asset employed, whether directly or indirectly, in the
provision of entertainment, hospitality or gifts of any kind, provided that this paragraph
shall not apply to-

(i) any expenditure incurred or capital asset employed in the provision of anything
which it is the purpose of a person's business to provide and which is provided in
the ordinary course of that business for payment or for the purpose of advertising
to the public generally without payment;

(iii) any expenditure incurred in the provision of a gift to any person consisting of an
article incorporating a conspicuous advertisement for the donor the cost of which
to the donor, taken together with the cost to him of any other such articles given
by him to that person in the same charge year, does not exceed K100;

(h) any amount incurred by the employer in the establishment or administration of a share
option scheme, except such amounts as are allowed under section 37A;

(i) the cost of any benefit or advantage not capable of being turned into money or money's
worth that is provided to employees, subject to such directions as shall be issued by the
Commissioner-General; see Chempro (Zambia) Limited v Zambia Revenue Authority,
2000/RAT/57.

(j) any copper price participation payment or cobalt price participation payment; and

(k) incidental costs of obtaining finance such as commitment and guarantee fees,
commissions and any other incidental cost of a similar nature.

5.6 DEPRECIATION

With time, capital assets used in a business either wear out or become obsolescent and have to be
replaced. Depreciation is an income tax deduction that allows a taxpayer to recover the cost of
certain capital assets which are subject to wear and tear or obsolescence. It is an annual allowance
for the wear and tear, deterioration, or obsolescence of the asset, even though in reality the asset
may durable for a longer period of time or gain market value.

As we have noted above, the Income Tax Act under the Fifth Schedule provides for a wear and
tear allowances in respect of industrial and commercial buildings as well as implements,

73
machinery and plant used for business purposes. These are depreciable assets in respect of which
the Income Tax Act allows a deduction in ascertaining the gains and profits of a business.

Since the purchase of a capital asset constitutes the single costliest aspect of a business, the laws
pertaining to depreciation are likely to play a significant role in an investors’ decision of whether
or not to invest on the grounds that they have a major impact on the net income and tax liability
of the business. Because of this, accelerated depreciation is an important incentive often offered
as a way of attracting foreign investment and stimulating domestic investment. The sooner the
deduction is allowed the more attractive a given investment will be to an investor.

Accelerated depreciation is a practice whereby for tax purposes, a business is permitted to write
off an asset over a period shorter than its actual service life. This is achieved by having the
amount of depreciation taken each year being higher during the earlier years of an asset’s life. For
financial accounting purposes, accelerated depreciation is expected to be much more productive
during its early years, so that depreciation expense will more accurately represent how much of
an asset’s usefulness is being used up each year. For tax purposes, accelerated depreciation
provides a way of deferring income taxes by reducing taxable income in current years, in
exchange for increased taxable income in future years. This is a valuable tax incentive that
encourages businesses to purchase new assets.

In order for a taxpayer to be allowed a depreciation deduction for an asset, the following
requirements usually must be met:

 the taxpayer must own the asset. Taxpayers may also be allowed to depreciate any capital
asset which the taxpayer leases;

 the taxpayer must use the asset in business or in an income-producing activity. If the
taxpayer uses an asset for business and for personal purposes, the taxpayer can only deduct
depreciation based only on the business use of that asset; and

 the asset must have a determinable useful life of more than one year.

There are various methods used for computing depreciation and the choice of one or the other by
a tax system is very likely to have a substantial impact on the level of investment any given
country. Some common methods are:

(a) declining balance method;

(b) straight line method;

(c) sum-of-the-years’ digit method; and

(d) units of productions method.

Thedouble declining balance method and the sum-of-the-years’ digits method are popular
methods for achieving accelerated depreciation. For tax purposes, the allowable methods of
depreciation depend on the tax law that the taxpayer is subject to. In the Zambia, the currently
allowable depreciation method is straight line method.

Declining balance method

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Under this method the asset is depreciated at a constant proportion of the balance outstanding on
the original cost of the asset.

For example, if the asset originally cost K10,000 and the rate of depreciation is 10 percent, then
depreciation would be computed as follows using the declining balance method:

Year Depreciation Allowance Value of Asset

0 0 K10,000
1 10% of K10,000 = K1,000 K10,000 – K1,000 = K9,000
2 10% of K9,000 = K900 K9,000 – K900 = K8,100
3 10% of K8,100 = K810 K8,100 – K810 = K7,290
4 10% of K7,290 = K729 K7,290 – K729 = K6,561

5 10% of K6,561 = K656 K6,561 – K656 = K5,905

In order to absorb 100 percent of the original cost of the asset within the designated period, a
larger sum has to be deducted as depreciation allowance.

Straight line method

Under this method, the depreciation allowed each year is a constant amount (the annual constant).

For example, an asset may cost K10,000 and the tax law may stipulate that the annual constant is
20 percent of the initial cost of the asset. Depreciation using the straight line method would be
calculated as follows:

20% of K10,000 = K2,000 depreciation allowance each year

Year Depreciation Allowance Value of Asset

0 0 K10,000
1 K2,000 K10,000 – K2,000 = K8,000
2 K2,000 K 8,000 – K2,000 = K6,000
3 K2,000 K 6,000 – K2,000 = K4,000
4 K2,000 K 4,000 – K2,000 = K2,000
5 K2,000 K 2,000 – K2,000 = K 0

The straight line method is more simplified and the rate of depreciation is much faster as can be
seen from the above example.

Units of production method

This method is used in the case of businesses that are seasonal, e.g. fishing. Depreciation of assets
used in such businesses will vary from period to period in a particular year and therefore the
depreciation allowance will vary from one accounting period to another. A piece of equipment
may be used much more intensely for say 3 months and not used for the next 5 months or so.

Since use and contribution to revenue may not be uniform from period to period, the amount of
depreciation is determined in accordance with intensity of use, i.e. the determinant is the actual
usage of an asset instead of the passage of time. Thus under the units of production method,
depreciation during a given year will be very high when the asset is more intensely used (and

75
thereby generating more units of production), and it will be very low when the asset is little used
(and thereby generating only a few units of production).

To compute the depreciation, the depreciable value of the asset (which is equal to the cost of the
asset less its salvage value) is divided by the estimated units that the asset will produce during its
entire service life. The result is the depreciation per unit of production.

Example

Let's assume that a production machine has a cost of K50,000 and its useful life is expected to
end after producing 24,000 units of a component part. The salvage value at that point is expected
to be K2,000. Under the units of production method, depreciation will be computed as follows:

Machine's depreciable value: K50,000 - K2,000 = K48,000

K 48,000/ 24,000 units = K2 per unit

If the machine produces 1,000 parts in the first year, the depreciation for the year will be K2 x
1,000 units = K2,000. If the machine produces 5,000 parts in the next year, its depreciation will
be K2 x 5,000 units = K10,000, etc. The depreciation will be calculated similarly each year until
the asset's accumulated depreciation reaches K48,000.

The units of production method is also referred to as the units of activity method, since the
method can be used for depreciating airplanes based on air miles, cars on miles driven,
photocopiers on copies made, DVDs on number of times rented, and so on.

Depreciation is an allocation technique and the units of production method might do a better job
of allocating/matching an asset's cost to the proper period than the straight-line method, which is
based solely on the passage of time.

Sum-of-the-years’ digit method

The sum-of-the-years’ digit method is an accelerated method for calculating an asset's

depreciation. This method takes the asset's expected life and adds together the digits for each
year. For example, if the assetwas expected to last for 5 years, the sum of the years' digits would
be obtained by adding: 5 + 4 + 3 + 2 + 1 to get a total of 15. Each digit is then divided by this
sum to determine the percentage by which the asset should be depreciated each year, starting with
the highest number in year 1.

Example

An asset with an original cost of K50,000 which is expected to last for 5 years would yield the
following depreciation schedule using the sum-of-years’ digit method:

5 + 4 + 3 + 2 + 1 = 15

Year Depreciation Allowance Value of Asset

0 0 K50,000

1 5/15 x 100 = 33% K50,000 – K16,500 = K33,500

33% of K50,000 = K16,500

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 2 4/15 x 100 = 27% K33,500 – K 9,045 = K24,455
27% of K33,500 = K9,045

3 3/15 x 100 = 20% K24,455 – K 4,891 = K19,564

20% of K24,455 = K4,891

4 2/15 x 100 = 13% K19,564 – K 2,543 = K17,021

13% of K19,564 = K2,543

5 1/15 x 100 = 7% K17,021 – K1,191 = K15,830

7% of K17,021 = K1,191

Note: The total percentages for each year should add up to 100%.

It makes sense to use an accelerated depreciation method such as the sum-of-the years’ digit
method when an asset will lose most of its value toward the beginning of its useful life - as is the
case with vehicles.

General comment

As already pointed out, the effect of depreciation is the deferral of income. Depreciation
allowance therefore is a rather attractive tax incentive in comparison with other tax incentives
such as tax holidays for both the treasury and the investor. For the investor depreciation
allowance allows greater cash flow for the business, especially during the sunrise phase of the
business venture. In essence the deferred taxes can be equated to an interest-free loan in the sense
that (i) the taxpayer enjoys a tax saving earlier than it otherwise would have arisen, and (ii) the
amount of the tax when it is paid in the future is the same as the earlier savings (i.e. the tax
liability does not accrue interest or compound). For the Treasury, the allowance is no more than a
loan (though interest-free) which has to be paid at some point in the future.

The various methods of depreciation may be used for different assets. For example, the declining
balance method is most often applied to machinery and equipment and not so much for buildings.
This is because the wear and tear on a building is not so digressive in practice. The straight-line
method is more appropriate for buildings and other fixtures. The same business may therefore
apply different methods for different assets it owns.

One disadvantage of depreciation allowance is that it encourages the use of capital-intensive

methods of production. For industrialized countries where the capital markets are sufficiently
well developed, this does not present any serious problem. However, for developing countries
where the capital markets are relatively underdeveloped and the supply of labour is abundant (i.e.
there is high unemployment) it is sometimes argued that greater emphasis should be placed on the
labor-intensive methods of production. The arguments against capital-intensive methods of
production are, first, that they encourage substitution of capital for labour which aggravates the
problem of unemployment; and second, that the importation of machinery and service parts uses
up scarce foreign exchange.

Capital-intensive methods, on the other hand, are justified on the grounds that (i) capital may be a
substitute for skilled labour; (ii) the quality of machine-produced goods may be better than the
quality of goods produced by labour using simple tools; (iii) capital-intensive methods take a
lesser time to perform a given amount of work; (iv) the employment of capital-intensive methods

77
 provides relief from high statutory wages, trade union militancy and the unsatisfactory
mechanisms for the settlement of labour disputes.

5.7 TAX TREATMENT OF TRADING STOCK

Trading stock is anything produced, manufactured or acquired by a business that is held for the
purpose of manufacture, sale or exchange in the ordinary course of a business. An item can only
be trading stock if it is capable of sale or exchange as part of a business, or if it is goods, property
or services in the process of production but not yet completed (i.e. work in progress). For
example, biscuits for sale in a convenience store would constitute trading stock, while the shelves
on which those biscuits are displayed would not, as the shelves are not available for sale or
exchange to customers.

General tax treatment

Three rules generally apply to trading stock:

(a) a deduction is allowed for the cost of purchasing trading stock

(b) if closing stock exceeds opening stock, the difference is assessable, and

(c) if opening stock exceeds closing stock, the difference (known as the valuation discount)
is deductible.

The value of closing stock on hand at the end of the income year is deducted from purchases and
opening stock to determine the cost of stock sold. The higher the value of closing stock on hand,
the higher the taxable income and vice versa.

Under the laws of some jurisdictions, businesses generally cannot deduct the cost of closing stock
when they purchase them. Instead, businesses are required to deduct the cost of closing stock
when they are sold.Requiring businesses to delay deductions of business expenses, such as
closing stock, tends to understate the true costs of the expenses of a business, overstates the
businesses’ income, and leads to a higher tax burden.

Valuation of closing stock

Closing stock (inventory) means goods or merchandise that remain unsold at the end of the
financial year of a business. In order to determine the gross trading profit of the business it is
necessary to evaluate the stock that a firm uses during the accounting period, as well as the
closing stock. The major objective for accounting for inventories is the proper determination of
income through the process of matching appropriate costs against revenues. The process of
assigning a cost to the closing stock is also a means of determining the cost of the goods sold.

There are four commonly used methods of evaluating inventories as they flow through a business.
These are:

(a) Specific invoice prices;

(b) First in, first out (FIFO);

(c) Last in, first out (LIFO); and

78
(d) Weighted-average cost.

Specific invoice prices method

When it is possible to identify each item in an inventory with a specific purchase and its invoice,
specific invoice prices may be used. Simply add up the invoices to get the total value of the
inventory.

First in, first out (FIFO) method

Under this method, the inventory is valued under the assumption that the first items received were
the first items sold.

For example, an enterprise may have made the following purchases of cell phones in 2015:

January 1 Opening stock: 20 units @ K1,000 = K20,000

March 1 Purchased: 20 units @ K1,200 = K24,000
June 21 Purchased: 3 units @ K1,500 = K 4,500
September 6 Purchased: 15 units @ K2,000 = K 30,000
December 6 Purchased: 10 units @ K4,000 = K40,000
Total purchases: 68 units for K118,500

If 55 units were sold, the closing stock would be computed as follows:

Total units available for sale: 68 units @ K118,500

Ending inventory: 3 units (September) @ K2,000 = K 6,000
10 units (December) @ K4,000 = K40,000

Closing stock is therefore 13 units @ K6,000 + K40,000 = K46,000

Valuation discount is therefore K118,500 – K46,000 = K72,500

Similarly, in the above example, if 27 units were sold, the closing stock would be computed as
follows:

Total units available for sale: 68 units @ K118,500

Ending inventory: 13 units (March) @ K1,200 = K15,600
3 units (June) @ K1,500 = K4,500
15 units (September) @ K2,000 = K30,000
10 units (December) @ K4,000 = K40,000

Closing stock is therefore 41 units @ K15,600 + K4,500 + K30,000 + K40,000 =

K90,100

Valuation discount is therefore K118,500 – K96,100 = K28,400

From these two examples, it can be seen that the more items sold the larger the valuation discount
and the less items sold the lesser the valuation discount. The valuation discount therefore
increases when the closing stock is low and decreases when the closing stock is high. This means
that there is greater tax relief when a business sells more of its products and remains with a low
inventory than when it sells less and ends with a huge inventory.

79
Since tax is imposed on the net profits and net profits are computed by subtracting expenses and
allowable deductions from the gross trading profits (i.e. net profit = gross trading profit –
[expenses + allowable deductions]), a business would prefer to diminish the gross trading profit
as much as possible so that the net profit and hence taxable income is reduced. The lower the
valuation discount the higher the net profit that a business remains with and hence more tax it
pays; but the higher the valuation discount the lower the net profit and hence less tax.

Last in, first out (LIFO) method

Under this method, the closing stock is valued under the assumption that the last items purchased
were sold first.

For example, an enterprise may have made the following purchases of cell phones in 2015:

January 1 Opening stock: 20 units @ K1,000 = K 20,000

March 1 Purchased: 20 units @ K1,200 = K 24,000
June 21 Purchased: 3 units @ K1,500 = K 4,500
September 6 Purchased: 15 units @ K2,000 = K 30,000
December 6 Purchased: 10 units @ K4,000 = K40,000
Total purchases: 68 units for K118,500

If 27 units were sold, the closing stock would be computed as follows:

Total units available for sale: 68 units @ K118,500

Ending inventory: 1 unit (June) @ K1,500 = K1,500
20 units (March) @ K1,200 = K24,000
20 units (January) @ K1,000 = K20,000

Closing stock is therefore 41 units @ K1,500 + K24,000 + K20,000 = K45,500

Valuation discount is therefore K118,500 – K45,500 = K73,000

When prices of stock are rising, a business that uses the LIFO method has lesser taxableincome
than a business that uses other methods of evaluating their inventory. This is because valuation
discount is higher under LIFO as prices rise. The opposite is the case when prices fall – the
valuation discountis lesser under LIFO as prices fall and therefore more taxable income.

Weighted-average cost method

Under this method, prices for the units in the opening stock and in each purchase are weighted by
the number of units in the opening stock and in each purchase; and are averaged to find the
weighted average cost per unit.

For example, an enterprise may have made the following purchases of cell phones in 2015:

January 1 Opening stock: 20 units @ K1,000 = K 20,000

March 1 Purchased: 20 units @ K1,200 = K 24,000
June 21 Purchased: 3 units @ K1,500 = K 4,500
September 6 Purchased: 15 units @ K2,000 = K 30,000
December 6 Purchased: 10 units @ K4,000 = K40,000
Total purchases: 68 units for K118,500

80
 If 27 units were sold, the closing stock would be computed as follows:

Step 1: The average cost per unit is:

K118,500 = K1,742.65 per unit

68

Step 2: The closing stock is calculated by multiplying K1,742.65 by 41:

K1,742.65 x 41 = K71,448.65

The valuation discount is therefore K118,500 – K71,448.65 = K47,051.35.

A country has a choice in deciding which system of computing the valuation discount would be
more effective in stimulating investment or raising more revenue from the business sector.

5.8 TURNOVER TAX

Turnover tax is a tax that is charged on gross sales/turnover (i.e. earnings, income, revenue,
takings, yield and proceeds).

Turnover tax is provided for under section 64A (2) of the Income Tax Act which states that:

“The Commissioner-General may make a standard assessment requiring any person carrying
on any business, other than the business referred to in subsection (1), with an annual turnover
of eight hundred thousand kwacha or less to pay tax on turnover at the rate set out in Part II
of the Ninth Schedule;

Provided that the provisions of this subsection shall not apply to income earned from the
provision of consultancy services or from mining operations or to income earned from a
business that qualifies for voluntary registration under the Value Added Tax Act and is
issued with a value added tax registration certificate.”

According to section 64A, therefore, turnover tax is applicable to a

ny person carrying on any business, other than a business referred to in section 64A (1), with an
annual turnover of K800,000 or less. The business referred to in section 64A (1) is the business of
operating a public service vehicle for the carriage of persons.

Turnover tax is calculated as a percentage of the turnover (gross sales) of the business, which rate
is prescribed in Part II of the Ninth Schedule of the Income Tax Act. The current rate of turnover
tax is 3 percent.

Inapplicability of turnover tax

According to section 64A (2), turnover tax does not apply to the following:

 any person carrying on a business with an annual turnover of more than K800,000;

81
  any individual or partnership carrying on business of public service vehicle for the
carriage of persons;

 any person providing consultancy services;

 any person carrying on a business who has voluntarily registered for VAT under the
Value Added Tax Act, Cap 331 of the Laws of Zambia; and

 any person who is involved in mining operations as provided under the Mines and
Minerals Development Act.

Turnover tax returns and payments

Turnover tax remittance cards must be submitted by the 14 th of the month following the month in
which the transactions occurred.

Remittance for turnover tax is due by the 14 th of the month following the month in which the
sales are made.

No Provisional tax returns are required for turnover tax. Provisional tax returns are only required
for taxpayers whose gross sales/turnover is above K800,000.

Change in Annual Turnover

Where a taxpayer whose turnover is below the threshold discovers that his annual turnover will
exceed K800,000 during the course of the year, he must notify the Commissioner General
immediately. However, he shall continue to pay turnover tax till the end of that particular charge
year and shall be assessed under the income tax system thereafter.

When a taxpayer who has been paying Provisional Income Tax discovers that his annual turnover
will not exceed K800,000 during the year, he must notify the Commissioner General
immediately. However, he shall continue to pay provisional income tax till the end of that
particular charge year and shall be assessed under the income tax system. At the end of the year,
the taxpayer will be required to submit a turnover tax return and a set of accounts with supporting
documents covering the whole year.

Any change from turnover tax to income tax and vice versa shall take effect only at the beginning
of a charge year. No change will be effected during the course of the charge year.

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 UNIT6:
ASSESSMENT AND COLLECTIONOF TAXES

6.1 ASSESSMENT

Assessment is the statutorily required recording of the tax liability. The Zambian tax system is
generally based on the principle that the collector of taxes (i.e. ZRA) has the right to assess the
tax liability, and demand the assessed amount from the taxpayer. The tax administration system,
however, works on a self-assessment system whereby the primary responsibility for making
assessment of tax liability falls on the individual taxpayer and not ZRA. This approach could be
described as a ‘process now – check later’; it is only after receipt and processing of the taxpayer’s
return that ZRA may make enquiries into its accuracy.

Annual Returns

Assessment is made by recording the taxpayer’s taxpayer identification number (TPIN), name,
address, and tax liability on a tax return. The tax return operates as a source of information and is
the basis of a debt payable by the taxpayer.

83
 Section 46(1) of the Income Tax Act requires every person liable to tax for any charge year, other
than an individual whose income consists entirely of emoluments within the provisions of Part VI
(which relates to Pay-As-You-Earn), to furnish to the Commissioner-General a return of income
and such particulars as may be required for the purposes of ascertaining the income chargeable, if
any, and the tax liability due, if any of such person.

The return required must:

(e) contain a statement of the person's income liable to tax, including income deemed under
the Income Tax Act to be the income of the person in respect of whom the return is
submitted;

(f) contain a computation, by or on behalf of the person liable to tax, of the amount of tax
due based on rates of tax applicable for such charge year and, in the case of an individual,
any deductions, and tax credit to which he is entitled;

(g) include a declaration by such person, or by the person in whose name he is assessable,
that such return includes a full statement of income liable to tax and a proper computation
of tax due for such charge year; and

(h) be designated in kwacha.

Every return filed pursuant to section 46 must be accompanied by such accounts and other
documents, in kwacha, as are necessary to support the return and must be signed by the person
filing the return.59

Returns must be furnished to the Commissioner-General not later than 30 thJune following the end
of the charge year. If a person fails to submit a return on or before this date, that person shall be
charged a penalty of: (i) in the case of an individual, 1,000 penalty units per month or part
thereof; or (ii) in the case of a company, 2,000 penalty units per month or part thereof.

Provisional Returns

Section 46A of the Income Tax Act requires every person who is required to file a tax return
under section 46 tofile with the Commissioner-General a provisional income tax return for each
charge year. The exception to this requirement is where the person is an individual who does not
expect to receive assessable income (other than emoluments) in excess of K1,000 for such charge
year. The provisional income tax return must:

(a) contain an estimate (based on information reasonably believed to be true) of the person's
income liable to tax, including income deemed under the Act to be the income of the
person;

(b) contain a computation of tax based on rates of tax applicable for such charge year and, in
the case of an individual, deducting any tax credit to which the individual is entitled, and
any such computation shall exclude tax on income falling within Part VI (Pay-As-You-
Earn) and any tax deducted from any other income;

(c) include a declaration by such person or by the person in whose name he/it is assessable,
that such provisional return includes a full and reasonable estimate of his income for such
charge year; and

59
Section 56(1), Income Tax Act.
84
 (d) be designated in kwacha.

A provisional income tax return must be lodged filed not later than the 30 thJune of the charge year
to which such return relates.60

Where during the course of the charge year, aperson who has filed a provisional income tax
return discovers that the filed return is likely to be substantially incorrect because of changed
circumstances, such person is required to file a revised provisional return and in such a case, any
alteration in the amount of estimated tax payable shall be taken into account in the next
instalment immediately following the date of such revised return.

Where, upon the receipt of an annual income tax return pursuant to section 46, it is discovered
that a person underestimated their income in the provisional income tax returnsuch that the tax on
such estimate has been underpaid by at least one-third, then such person shall be liable to a
penalty of 25 percent of the tax which has been underpaid. 61

Failure to submit a provisional income tax return in accordance with section 46A attracts a
penalty of:

(a) in the case of an individual, 1,000 penalty units per month or part thereof during which
such failure continues; or

(b) in the case of a company, 2,000 penalty units per month or part thereof during which such
failure continues:

Where a person has failed to file a provisional income tax return or revised provisional return
under section 46A, section 46B allows the Commissioner-General to:

(a) estimate such person's income liable to tax; and

(b) compute the provisional liability to tax of that person on that estimated income; and

Notice must be given to the person specifying the amount of income so estimated and the
provisional tax liability so computed.

Partnership returns

Section 61 of the Income Tax Act requires persons carrying on any business in partnership to file
a joint return of the income of the partnership for a charge year declaring therein the names and
addresses of all the partners and the amount of the share of the income to which each partner is
entitled for that year, together with such other particulars as the Commissioner-General may, in
writing, require.

Commissioner-General's power to assess

Section 63(1) of the Income Tax Act generally grants the Commissioner-General the power to
assess every person who is liable to tax under the Income Tax Act. However, any such
assessment must take into account the provisions of any double taxation agreement made under
section 74, if applicable, and may not include the following types of incomes:

(a) dividends from which tax in respect of that charge year has been deducted under section
81;

60
Section 46A (3), Income Tax Act.
61
Section 46A (5), Income Tax Act.
85
(b) a lump sum payment from which tax in respect of that charge year has been deducted
under section 82;

(c) interest, public entertainment fee royalties or any management or consultancy fee paid to
a non-resident person and from which tax has been deducted under section 82A;

(d) interest paid to a resident and from which taxhas been deducted under section 82A and
such tax deducted is the final tax for such person;

(e) income of an individual from which tax in respect of that charge year has been paid under
section 64A;

(f) interest paid to a person exempted under paragraph 5(1) and paragraph 6(1) of the Second
Schedule and from which tax in respect of that charge year has been deducted under
section 82A;

(g) income from gaming, lotteries and betting from which tax in respect of that charge year
has been deducted under section 82A; and

(h) income from letting of property from which tax in respect of that charge year has been
deducted under section 82A.

Where a person has made payments of tax or provisional tax in respect of any charge year under
sections 46 or 46A and the Commissioner-General is satisfied that the person has no outstanding
tax liability for that year, the Commissioner-General is not required to assess that person under
section 63, unless the person makes a request in writing for an assessment. However, if the
Commissioner-General is not satisfied that the person has no outstanding tax liability, the
Commissioner-General is required to make an assessment in respect of that charge year and the
person shall be liable to pay any amount determined to be in excess of the amount of tax or
provisional tax paid.

Estimated Assessments

Section 64 allows the Commissioner-General to make an assessment in any amount according to

the best of his judgement in respect of any person:

(a) who has not delivered a return as required by the Income Tax Act, or on whose behalf no
return has been so delivered; or

(b) whose return does not satisfy the Commissioner-General; or

(c) who the Commissioner-General has reason to believe is about to leave Zambia.

Standard Assessments

Section 64A (1) allows the Commissioner-General to make a standard assessment requiring any
individual or partnership carrying on the business of operating a public service vehicle or a
mining operations vehicle for the carriage of persons to pay a presumptive tax as set out in Part I
of the Ninth Schedule of the Income Tax Act.

Under section 64A (2), the Commissioner-General may make a standard assessment requiring
any person carrying on any business, other than the business of operating a public service vehicle
or a mining operations vehicle for the carriage of persons, and whose annual turnover does not
exceed K800,000, to pay tax on turnover (known as ‘turnover tax’) at the rate set out in Part II of
86
 the Ninth Schedule of the Income Tax Act. Section 64A (2) does not apply to income earned from
the provision of a consultancy service or from mining operations or from a business that is
voluntarily registered for VAT under the Value Added Tax Act.

Assessment Rules

Section 65 of the Income Tax Act provides for rules relating to assessments.

Every person who has been charged tax must be given a notice of assessment by ZRA. 62

No assessment of tax may be made for any charge year after the expiry of six years from the end
of that year.63 The exception to this rule is in cases of fraud or wilful default or for the purposes of
sections 21 (relating to apportionment of gratuities etc.), 87 (relating to general tax refunds), 88
(relating to tax refunds in cases of accumulated income), 91 (relating to error or mistake relief) or
113 (relating to adjustments on successful objection/appeal), or Part VII (relating to double
taxation relief), or paragraph 25 of the Fifth Schedule (relating to change of ownership of a
mine), or granting tax credits as provided in the Charging Schedule.

Assessments in respect of the income of any deceased person can only be made within a period of
three years after the end of the charge year in which such deceased person died. 64

According to section 65(4), any assessment made in accordance with generally prevailing
practice is not affected by any change in that practice after the time for objection to the
assessment has expired.

6.2 PAYMENT OF TAX

Tax for any charge year payable by any person required to submit an income tax return under
section 46 is due and payable on 30thJuneimmediately following the end of the charge year. 65

When paying tax, deductions may be made from the amount due:

(a) the amount of any payment of provisional tax which the person has made for that charge
year; and

(b) any amount of tax or provisional tax agreed by the Commissioner-General to have been
overpaid and which has not been refunded to that person or otherwise taken into account.

Payment of provisional tax for any charge year must be made during the charge year in four
instalments, each one of which must be equal to one-quarter of the amount of provisional tax
shown in the return, and must be paid as follows:

(a) 1st instalment –31st March;

(b) 2nd instalment - 30thJune;

(c) 3rdinstalment - 30thSeptember; and

(d) 4th instalment – 31st December;

of the charge year to which such return of provisional income relates.

62
Section 65(1), Income Tax Act.
63
Section 65(2), Income Tax Act.
64
Section 65(3), Income Tax Act.
65
Section 77(1), Income Tax Act.
87
6.3 PENALTIES AND INTEREST

Penalties for non-payment of tax

Non-payment of tax when due and payable attracts penalties. According to section 78(1) of the
Income Tax Act, any person who fails to pay any amount of tax within one month of the due date
or within the period specified for payment in a notice of assessment shall be liable to a monthly
penalty of 5 percent of the amount unpaid. 66 This penalty is due and payable on the date of issue
by the Commissioner-General of a notice to that effect. 67

Section 78(7) allows the Commissioner-General, in his discretion, to remit the whole or part of
any penalties payable for non-payment of tax.

Interest on overdue payments

Any payment of tax which is overdue attracts interest at the Bank of Zambia discount rate plus 2
percent per annum. The interest continues to accrue until such time as the payment of the tax has
been remitted. The Commissioner-General may remit the whole or part of any interest due on
overdue payments.68

6.4 COLLECTION OF TAXES

Tax is a debt due to Government

According to section 79 of the Income Tax Act, tax is a debt due to the Government and may be
recovered by the Commissioner-General either by distress or by suit in any court of competent
jurisdiction.

Where tax is found to be owing from any person under the Income Tax Act, the Commissioner-
General may, by notice in writing issued to such person, fix a date (or different dates in the case
of instalment payments) for the payment of such tax. 69

Recovery of tax by distress

Section 79A of the Income Tax Act allows any officer appointed for the purpose of carrying out
the provisions of the Income Tax Act, under warrant by the Commissioner-General, to levy
distress upon the goods and chattels of any person or partnership from whom tax is recoverable.

For the purposes of levying any such distress, the officer, together with such servants or agents as
the officer may consider necessary, may break open at any time between sunrise and sunset, any
premises; and the officer so authorised may require any police officer to be present while such
distress is being levied and any police officer so required shall comply with such requirement.

Where distress is levied, the goods and chattels upon which distress has been leviedmust be kept
for ten days either at the premises at which such distress is levied or at such other place as the
person authorised under warrant may consider appropriate at the cost of the person or partnership
from whom such tax is recoverable. If the person or partnership from whom such tax is
recoverable does not pay the tax due together with the costs incurred in levying the distress and
all other costs incidental thereto within the said period of ten days, the goods and chattels will be
sold by public auction and the proceeds realised from such sale will be applied, firstly, towards
the payment of the said costs and all further costs incurred in completing such sale and, secondly,
66
Section 78(2), Income Tax Act.
67
Section 78(5), Income Tax Act.
68
Section 78A, Income Tax Act.
69
Section 79(2), Income Tax Act.
88
the surplus, if any, will be applied in the payment of the tax and, thirdly, the balance, if any, shall
be paid to such person or partnership after deducting any further tax liable to be paid by such
person or partnership.

In the event that the full amount of the tax due and all the costs of distress and sale are not
recovered from the sale of the goods and chattels, the Commissioner-General may recover the
deficiency either in through court or accordance with or any other provisions of the Income Tax
Act.

No civil or criminal proceedings may be instituted against any officer for any act or omission
arising out of the levying of distress.

Recovery through court

Section 79B of the Income Tax Act allows the Commissioner-General to institute proceedings in
any subordinate court of the first or second class for the recovery of any tax or other amount
recoverable under the Income Tax Act. According to section 79B (4), a person cannot question
any assessment in any proceedings commenced for the recovery of tax. Further, the mere
production of an assessment or any document under the Commissioner-General's hand or the
hand of any officer duly authorised by him is conclusive evidence as to the contents of the
assessment or document.

Charge on land

Section 79C of the Income Tax Act allows the Commissioner-General to create a charge over
land owned by any person or partnership from whom tax is due by giving notice in writing to
such person. The charge will be effective from the date of service of the notice and for so long as
such land remains in the ownership of such person or partnership or until the notice is withdrawn.

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 UNIT7:
INTERNATIONAL DOUBLE TAXATION RELIEF

7.1 WHAT IS DOUBLE TAXATION?

Double taxation occurs when tax is paid more than once on the same taxable income or asset.

Double taxation may be economic or juridical.Double taxation is economic if more than one
taxpayer is taxed on the same income. For example, the profits of a company may be subject to
corporate tax in the hands of the company and to withholding tax in the hands of the shareholders
when the after-tax profits are distributed as dividends.Economically, the corporate profits and the
dividends are the same income, however taxed in the hands of two different taxpayers – the
company paying the corporate income tax and the shareholder – subject to the taxation on the
distributed profits. Double taxation is juridical when the same taxpayer is taxed twice on the same
income. For example, a resident of country A may earn dividend income from country B and this
dividend income may be taxed, first, in country B (based on the source principle) by a way of
withholding tax and then one more time in country A (based on the residence principle) by a way
of tax assessment.

Double taxation may occur in both domestic and international (cross-border) situations. We will
only be concerned with international juridical double taxation in this course.

International juridical double taxation

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 International juridical double taxation may arise where:

(a) two States each subject the same person to tax on his worldwide income or capital; or

(b) a person is a resident of one State (R) and derives income from, or owns capital in, the
another State (S or E) and both States impose tax on that income or capital; or

(c) two Stateseach subject the same person, not being a resident of either State to tax on
income derived from, or capital owned in, one of the States. This may result, for instance,
in the case where a non-resident person has a permanent establishment in one State (E)
through which he derives income from, or owns capital in, the other State (S).

7.2 METHODS FOR ELIMINATION OFINTERNATIONAL DOUBLE TAXATION

In general, there are two principal methods for elimination of international double taxation:

(a) the exemption method, i.e. exempting foreign income from domestic taxation; and

(b) the credit method, i.e. granting a credit for foreign taxes.

These two methods are set out in Articles 23A (exemption method) and 23B (Credit method) of
the UN and OECD Model Conventions.

Exemption method

Under the exemption method, the State of residence R does not tax the income which may be
taxed in State E or S. With the exemption method therefore, the country of residence leaves the
taxing right solely with the source country, giving that country the responsibility to tax the source
income according to its own tax rules and rates.

The principle of exemption may be applied by two main methods:

(a) the income which may be taxed in State E or S is not taken into account at all by State R
for the purposes of its tax; State R is not entitled to take the income so exempted into
consideration when determining the tax to be imposed on the rest of the income; this
method is called “full exemption”;

(b) the income which may be taxed in State E or S is not taxed by State R, but State R retains
the right to take that income into consideration when determining the tax to be imposed
on the rest of the income; this method is called “exemption with progression”.

Credit method

Under the credit method, the State of residence R calculates its tax on the basis of the taxpayer's
total income including the income from the other State E or S which may be taxed in that other
State. It then allows a deduction from its own tax for the tax paid in the other State. With the
credit method therefore, the residence country gets a subsidiary tax right which will have its
effect when the source country levies a lower tax than the country of residence, because then an
additional amount of tax needs to be paid on the worldwide income.

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The principle of credit may be applied by two main methods:

(a) State R allows the deduction of the total amount of tax paid in the other State on income
which may be taxed in that State, this method is called “full credit”;

(b) the deduction given by State R for the tax paid in the other State is restricted to that part
of its own tax which is appropriate to the income which may be taxed in the other State;
this method is called “ordinary credit”.

Fundamentally, the difference between the exemption method and the credit method is that the
exemption methods look at income, while the credit methods look at tax.

Countries using the exemption method reserve this mainly for “active income” such as business
profits (through permanent establishments) and employment income, while they use the credit
method for “passive income” such as interest, dividends and royalties.

Example

An artiste earns $80,000 at home in State R (State of residence) and $20,000 abroad in State S
(State of source) = worldwide income of $100,000.

In State R the tax rates are progressive, namely 35% (average) on an income of $100,000 (=
$35,000) and 30% (average) on an income of $80,000 (= $24,000).

In State S the tax rate is 20% leading to $4,000 source tax.

(a) Initial tax liability

Without any relief for double taxation, the total initial tax liability of the artist would be:

Tax in state R, 35 % of $100,000 $35,000

+ tax in State S $4,000

Total taxes in State R and State S $39,000

(b) Full Exemption

With the “full exemption”, the State R, State R, simply omits the foreign income from its
own taxation and only imposes tax on the domestic income of 80,000, at 30%:

Tax in state R, 30 % of $80,000 $24,000

+ tax in State S $ 4,000

Total taxes $28,000

Tax relief given by State R = $11,000 (i.e. $39,000 - $28,000)

(c) Exemption with progression

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 With the “exemption with progression”, domestic income is taxed at the tax rate for
worldwide income, i.e. 35%:

Tax in state R, 35 % of $80,000 $28,000

+ tax in State S $ 4,000

Total taxes $32,000

Tax relief given by State R = $7,000 (i.e. $39,000 - $32,000)

(d) Full Credit

With the “full credit”, the home country, State R, simply allows the deduction of the
foreign-source tax from the tax calculated on worldwide income:

Tax in state R, 35 % of 100,000 $35,000

less full tax in State S $ 4,000

Tax due $31,000

Total taxes in State R and State S $35,000

Tax relief given in State R = $4,000 (i.e. $39,000 - $35,000)

(e) Ordinary credit

With the “ordinary credit”, the home country, State R, also allows a deduction of the
foreign-source tax from the tax calculated on the worldwide income, but not more than
the proportion of tax that would be attributable to the income from State S (maximum
deduction). This limitation to the average tax rate is a maximum of 35% x $20,000 =
$7,000:

Tax in state R, 35 % of $100,000 $35,000

Less tax in State S - $ 4,000

Tax due in state R $31,000

Total taxes in State R and State S $35,000

Tax relief given by State R = $4,000 (i.e. $39,000 - $35,000)

In the above computation, the tax of $4,000 paid in State S is less than the $7,000
maximum deduction and therefore the entire $4,000 tax paid in State S will be allowed as
a deduction from the tax calculated on the worldwide income in State R.

If, however, State S had a tax rate of 40% this would lead to $8,000 source tax, and total
taxes in State R and State S would be $43,000 (i.e. $35,000 + $8,000). In such case, State
R would only allow a deduction of up to $7,000 foreign-source tax from the tax

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 calculated on the artist’s worldwide income. The computation of tax due in State R would
be as follows:

Tax in state R, 35 % of $100,000 35,000

Less maximum foreign-source tax - 7,000

Tax due in state R 28,000

Total taxes in State R and State S 36,000

Tax relief given by State R = $7,000 (i.e. $43,000 - $36,000)

Conclusions from Example

Of the two exemption methods, the “full exemption” is usually the most advantageous method for
eliminating double taxation for the artiste in this example. The “full exemption” will be given
against the marginal, highest applicable tax rate, while the “exemption with progression” allows
the exemption against the average tax rate on the income in the country of residence. This makes
a big difference in a country with steep progressive tax rates.

In any case, in both situations the tax relief can be more than the foreign-source tax, but can also
be lower. This will happen sooner with the “exemption with progression” method than with the
“full exemption” method, as the examples in (b) and (c) above show.

The “full exemption” method is regularly used for exemption in source States, but almost never
for elimination of double taxation in the country of residence. Article 23A of the OECD Model
Tax Treaty recommends the use of the “exemption with progression” method for countries that
want to apply this to active foreign income.

An important difference in favour of the “exemption with progression” method is the treatment of
foreign losses. They can be offset against other, domestic, positive income items and therefore
bring down the taxable income in the country of residence. This is more profitable than under the
“full exemption” method, where these foreign losses are included in the exemption.

From the two tax credit methods, the “full credit” gives the best result for the taxpayer. The tax
relief from this method seems to be closest to the theory of “capital export neutrality”, because
the total tax burden after the full tax credit is equal to the tax that would be due if the income
were earned in the home country only. At first sight, it is a nicely balanced credit system, with the
same overall tax burden regardless of whether the income had a domestic or foreign source.

But problems can arise for state budgeters when the foreign-source tax rate is higher than the tax
rate in the country of residence. This was already recognized in 1921 in the United States, a mere
3 years after the foreign tax credit was introduced in the Revenue Act. The limitation to “ordinary
credit” was enacted to prevent taxes from countries with income tax higher than that in the United
States from reducing US tax liability on US-source income. The reason was that the income tax
rates in the United Kingdom in those post-war years were so high that the United States was
afraid that all domestic tax revenue would be wiped out by a full foreign tax credit. The United
States stated the opinion that at least it wanted to collect the taxes that fairly belonged it. This

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 provision still constitutes a fundamental basis of US law for taxing income earned abroad by US
residents.

The United Kingdom also limits the tax credit to a maximum, which is the amount of UK tax
attributable to the income which has been subject to foreign tax. This is the same for other
countries using the tax credit system.

Article 23B of the OECD Model Tax Treaty follows the views of the United States and the
United Kingdom and recommends in general the use of the “ordinary credit” method for
countries wanting to apply the credit system to all types of foreign income, both active and
passive. But the conclusion from the example is that this might lead to insufficient compensation
for the foreign artiste tax, as shown in the example (e) above when the artist’s foreign-source tax
was $8,000.

Deduction method

The deduction method allows residents/citizens to deduct foreign taxes paid treating them as a
current expense so it becomes the effective means of providing relief when there is no DTA.

Anyone in the United States with unlimited tax liability on his full worldwide income can choose
not to take a tax credit for foreign tax, but to deduct the foreign tax as a business expense, so that
the tax base will become considerably lower.

Germany also gives its residents with unlimited tax liability the option of choosing the deduction
of the foreign tax from worldwide income as a business expense.

Deduction of foreign-source tax as an expense is allowable in the Netherlands when no DTA is

applicable and the unilateral rules for elimination of double taxation apply, giving residents the
option to choose between either an ordinary tax credit or the deduction of foreign tax from
taxable income

When the foreign-source tax is high or domestic income is low or negative, the choice of a
deduction as an expense might become advantageous.

7.3 UNILATERAL AND BILATERAL DOUBLE TAXATION RELIEF

Relief from double taxation can be provided in mainly two ways: (i) bilateral relief; and (ii)
unilateral relief.

Bilateral Relief

Under this method, the Governments of two countries can enter into an agreement (known as a
double taxation agreement (DTA) or double taxation treaty (DTT)) to provide relief against
double taxation by mutually working out the basis on which the relief is to be granted. Zambia,
for example, has entered into agreements for relief against or avoidance of double taxation with
more than 10 countries which include the United Kingdom, Ireland, Switzerland, Sweden,
Mauritius, South Africa etc.

Bilateral Relief may be granted by either the exemption method or credit method. In Zambia,
double taxation relief is provided by a combination of the two methods.

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 Unilateral Relief

This method provides for relief of some kind by the country of residence where no DTA has been
entered into with the country of source. Unilateral relief is normally allowed as a credit of the
foreign tax against the income tax chargeable in the country of residence.

7.4 DOUBLE TAXATION RELIEF PROVISIONS UNDER THE INCOME TAX ACT

Sections 74, 75 and 76 of the Income Tax Act provide for international double taxation relief in
Zambia.

Bilateral relief [Sections 74 and 75]

Section 74(1) of the Income Tax Act provides that the President may enter into a double taxation
agreementwith the Government of any other country:

(a) for the granting of relief of tax or the prevention of double taxation in respect of income
on which income-tax is payable in both Zambia and the foreign countryhas been paid
both in Zambia and in that country or specified territory; or

(b) for the rendering of reciprocal assistance in the administration of and collection of taxes
under the income tax laws o Zamia and of such foreign country.

Following the President’s entry into such an agreement with a Government of a foreign country,
the agreement must be presented before Cabinet by the Minister of Finance for ratification and
soon after ratification, the President is required, by statutory instrument, to notify the public of
terms of the agreement. The agreement will have effect until such statutory instrument is revoked
and for so long as the agreement has the effect of law in the other contracting country.

Double taxation agreements permitted under section 74(1) are intended to provide relief to the
taxpayer, who is a resident of either Zambia or of the other contracting country to the agreement.
Such taxpayer can claim relief by applying the beneficial provisions of either the agreement or
the domestic law.

Section 75(1) provides that where a double taxation agreement applies to a Zambian-resident in
respect of income earned in a foreign country and such agreement entitles the taxpayer to a credit
of foreign taxes against Zambian taxes, the taxpayer will be allowed a credit of the foreign tax
paid in respect of the foreign income against Zambian tax payable in respect of the foreign
income. The amount of foreign tax allowed as a credit is, however, limited to the amount of
Zambian tax that would be payable in respect of the foreign income (essentially relief is by way
of an ordinary credit).

Unilateral Relief [Section 76]

In the case of income arising to a Zambian-resident taxpayerin countries with which Zambia does
not have any double taxation agreement, relief would be granted under section 76 provided all the
following conditions are fulfilled:

(a) the taxpayer is a resident in Zambia;

(b) the income accrues or arises to him outside Zambia;

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 (c) the income in question has been subjected to income-tax in the foreign country in the
hands of the taxpayer;

(d) the taxpayer has paid tax on the income in the foreign country.; and

(e) there is no double taxation agreement between Zambia and the foreign country.

In such a case, the taxpayer shall be entitled to a deduction of the foreign taxes paid from the
Zambian income-tax payable by him. The deduction allowed, however, is limited to the amount
of Zambian tax that would be payable in respect of the foreign income (essentially relief is by
way of an ordinary credit).

7.5 DOUBLE TAXATION AGREEMENTS

A double taxation agreement (DTA), also known as a ‘tax treaty’ or ‘tax convention’is an
agreement entered into by the Governments of two countries with the broad objective of
facilitatingcross-border trade and investment by eliminating the tax impediments to these cross-
border flows. This broad objective is supplemented by several more specific, operational
objectives; the most important operational objective being the elimination of international double
taxation. If income from cross-border trade and investment is taxed by two or more countries
without any relief, such double taxation would obviously discourage such trade and investment.
Many of the substantive provisions of the typical DTAs are directed at the achievement of this
goal.

DTAs are generally based on certain models. The most common ones are:

(a) the Organisation of Economic Co-operation and Development (OECD) Model

Conventionon Income and on Capital (the “OECD Model Convention”); and

(b) the United Nations (UN) Model Double Taxation Convention between Developed and
Developing Countries (the “UN Model Convention”).

In addition, many countries have their own model tax treaties, which are often not published but
are provided to other countries for the purpose of negotiating tax treaties. The UN Model
Convention draws heavily on the OECD Model Convention.

The OECD Model Convention

The OECD Model Tax Treaty is an accord reached between member states of the Organization
for Economic Cooperation and Development (OECD) that serves as a guideline for establishing
tax agreements. The convention consists of articles, commentaries, position statements and
special reports on evolving tax issues. Its primary application is in guiding the negotiation of
bilateral treaties between two or more countries.

Currently, the OECD has 34 members, consisting of many of the major industrialized countries.
The OECD Model Convention was first published, in draft form, in 1963. It was revised in 1977
and again in 1992, at which time it was converted to a loose-leaf format in order to facilitate more
frequent revisions. Since then, revisions have been made every few years, on nine occasions,
most recently in 2014. The Committee on Fiscal Affairs (CFA), which consists of senior tax
officials from the member countries, has responsibility for the OECD Model Convention as well

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as other aspects of international tax cooperation. CFA operates through several working parties
and the Centre for Tax Policy and Administration, which contains the permanent secretariat for
CFA. The working parties consist of delegates from the member countries. Working Party No. 1
on Tax Conventions and Related Questions is responsible for the Model Convention, and it
examines issues related to it on an ongoing basis.

A detailed Commentary, organized on an article-by-article basis, accompanies the OECD Model

Convention. The OECD Commentaries have become increasingly important with respect to the
interpretation and the application of tax treaties, including some treaties between countries that
are not members of the OECD. To take account of the positions of some non-member states, the
OECD opened up the Commentaries in 1997 to many of them, including Argentina, Brazil,
China, India, Russia and South Africa.

The OECD Model Convention favours capital-exporting countries over capital-importing

countries. Often it eliminates or mitigates double taxation by requiring the source country to give
up some or all of its tax on certain categories of income earned by residents of the other treaty
country. This feature of the OECD Model Convention is appropriate if the flow of trade and
investment between the two countries is reasonably equal and the residence country taxes any
income exempted by the source country. However, the OECD Model Convention may not be
appropriate for treaties entered into by net capital-importing countries. As a result, developing
countries devised their own model treaty under the auspices of the United Nations.

The UN Model Convention

The UN Model Convention forms part of the continuing international efforts aimed at eliminating
double taxation. These efforts were begun by the League of Nations and pursued in the
Organisation for European Economic Co-operation (OEEC) (now known as the OECD) and in
regional forums, as well as in the United Nations, and have in general found concrete expression
in a series of model or draft model bilateral tax conventions.

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 The work of the United Nations on a model treaty commenced in 1968 with the establishment by

the United Nations Economic and Social Council (ECOSOC) of the United Nations Ad Hoc

Group of Experts on Tax Treaties between Developed

and Developing Countries pursuant to its

resolution 1273 (XLIII).70The Group of Experts produced a Manual for the Negotiation of
Bilateral Tax treaties between Developed and Developing Countries which led to the publication
of the UN Model Convention in 1980.71The Model Convention was revised in 2001 and again in
2011. In 2004, the Group of Experts became the Committee of Experts on International
Cooperation in Tax Matters.72The Committee maintains detailed Commentaries on the UN Model
Convention; it is also responsible for the publication of several useful manuals on tax issues
important for developing countries, such as transfer pricing and the administration of tax treaties.
The members of the Committee are tax officials nominated by their governments and appointed
by the Secretary-General of the United Nations, who serve in their individual capacity. A small

70
Economic and Social Council resolution 1273 (XLIII) of 4 August 1967.
71
UN Model Taxation Convention between Developed and Developing Countries (New York: 1980).
72
Economic and Social Council resolution 2004/69 of 11 November 2004.
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 majority of the members of the Committee are from developing countries and countries with
economies in transition. The UN Model Convention follows the pattern set by the OECD Model
Convention and many of its provisions are identical, or nearly so, to those in that Model
Convention. In general, therefore, it makes sense not to view the UN Model Convention as an
entirely separate one but rather as making important, but limited, modifications to the OECD
Model Convention.

The main difference between the two model Conventions is that the UN Model Convention
imposes fewer restrictions on the taxing rights of the source country; source countries, therefore,
have greater taxing rights under it compared to the OECD Model Convention. For example,
unlike Article 12 (Royalties) of the OECD Model Convention, Article 12 of the UN Model
Convention does not prevent the source country from imposing tax on royalties paid by a resident
of the source country to a resident of the other country. The UN Model Convention also gives the
source country increased taxing rights over the business income of non-residents compared to the
OECD Model Convention. For example, the time threshold for a construction site permanent
establishment under the UN Model Convention is only 6 months, compared to 12 months under
the OECD Model Convention. In addition, furnishing services in a country for 183 days or more
constitutes a permanent establishment under the UN Model Convention, whereas under the
OECD Model Convention furnishing services is a permanent establishment only if the services
are provided through a fixed place of business which, according to the OECD Commentary
thereon, must generally exist for more than 6 months.

Comment on the UN and OECD Model Conventions

The success of the UN and OECD Model Conventions has been astounding. Virtually all existing
bilateral tax treaties are based on them. Their wide acceptance and the resulting standardization of
many international tax rules have been important factors in reducing international double
taxation.

Changing the UN and OECD Model Conventions to correct flaws and respond to new
developments is extremely difficult. One source of difficulty is that countries can bring their
existing tax treaty networks into line with a revision to the UN or OECD Model Conventions
only by renegotiating virtually all of their existing treaties. In contrast, the Commentaries to the
UN or OECD Model Conventions are much easier to change than the Model Convention itself.
Therefore, if a Commentary is revised, it may be possible for the tax authorities of countries to
interpret existing treaties in accordance with it without the need to renegotiate existing treaties. 73

Unlike the UN Model Convention, the OECD Model Convention reflects the positions of the
member countries of the OECD. Member countries that disagree with any aspect of the OECD
Model Convention can register a reservation on the particular provision. These reservations are
found in the Commentaries to the Model Convention. A reservation indicates that the country
does not intend to adopt the particular provision of the OECD Model Convention in its tax
treaties. Most countries have entered reservations on some aspects of the Model Convention. For
example, several countries have entered reservations on Article 12, dealing with royalties, by
asserting their intention to levy withholding taxes on them.

The Commentaries on the OECD Model Convention also contain observations by particular
countries on specific aspects of them. Countries register observations to indicate that they

73
The country’s courts may take a different position and refuse to interpret the treaty in accordance with the revised
Commentary.

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disagree with the interpretation of the treaty provided in the Commentary. A country making an
observation does not reject the particular provision of the OECD Model Convention (in other
words, it has not registered a reservation on the provision). The purpose of an observation is to
indicate that the country may include the provision in its treaties but it will interpret and apply it
in a manner different from the interpretation espoused in the Commentary.

Contents of a typical DTA

A typical DTA based on the UN or OECD Model Conventions will have the following basic
structure and major provisions:

 Chapter I – Scope of Treaty: Chapter I consists of Article 1, which identifies the

persons whose tax obligations are affected by the treaty, generally residents of the
contracting States, and Article 2, which describes the taxes covered by the treaty,
generally income and capital taxes imposed by the contracting States and their political
subdivisions.

 Chapter II – Definitions:Chapter II provides definitions of important terms used in the

treaty including general definitions in Article 3, a definition of the term “resident” in
Article 4 and “permanent establishment” in Article 5.

 Chapter III – Taxation of Income: Chapter III contains what are often referred to as the
distributive rules of the treaty. Articles 6-21 deal with various types of income derived by
a resident of one or both of the States. In general, these provisions determine whether
only one or both of the contracting States — the State in which the taxpayer is resident
(the residence country) and the State in which the income arises or has its source (the
source country) — or whether both of them can tax the income and whether the rate of
tax imposed is limited. The Articles and the types of income are as follows:

Article 6 — Income from immovable property;

Article 7 — Business profits;

Article 8 — Income from the operation of ships or aircraft in international traffic and
boats in inland waterways transport;

Article 9 — Profits of associated enterprises and transfer pricing;

Article 10 — Dividends;

Article 11 — Interest;

Article 12 — Royalties;

Article 13 — Capital gains;

Article 14 — Income derived from professional and independent services;

Article 15 — Income from employment;

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 Article 16 — Directors’ fees and remuneration of top-level managerial officials;

Article 17 — Income derived by artistes (entertainers) and athletes;

Article 18 — Pensions and social security payments;

Article 19 — Income derived by government employees;

Article 20 — Income derived by students, business trainees and apprentices;

Article 21 — Other income; in other words, income not dealt with in Articles 6-20.

 Chapter IV – Taxation of Capital:Chapter IV deals with the taxation of capital (not

income from capital).

 Chapter V – Elimination of Double Taxation:Chapter V provides two alternative

methods for eliminating double taxation: (i) Article 23A (Exemption method) and Article
23B (Credit method). In general, if the contracting State in which income arises is entitled
by the rules in Article 6-21 to tax the income, the contracting State in which the taxpayer
is resident is obligated to provide relief from double taxation. Under the exemption
method, the residence country excludes or exempts the income from residence country
tax. Under the credit method, the residence country taxes the income but provides a
deduction from that tax for the tax paid to the source country on the income.

 Chapter VI - Special provisions: Chapter VI provides for certain special provisions.

Article 24 provides protection against various forms of discriminatory taxation by the
source and residence countries. Articles 25, 26 and 27 provide for important types of
administrative cooperation between the contracting States. Article 25 provides a mutual
agreement procedure (MAP) to resolve disputes concerning the application of the treaty;
Article 26 deals with exchanges of information between the States; and Article 27
provides rules for the contracting States to assist in collecting one another’s taxes. Article
28 simply provides that nothing in the treaty affects the “fiscal privileges” enjoyed by
diplomats and consular officials under international law or other international agreements.

 Chapter VII – Final Provisions: Chapter VII provides rules to govern the entry into
force and termination of the treaty.

7.6 THE CONCEPT OF PERMANENT ESTABLISHMENT

Where two countries have entered into a DTA that provides for the avoidance of double taxation,
usually the business activities of an enterprise that is resident in one of the countries (State R) are
protected from taxation in the other country (State S) as long as those activities do not create what
is known as a ‘permanent establishment’ (PE) in State S. Typically, a DTA defines a PE using the
following two general tests:

(a) whether the enterprise has a fixed place of business within the other country, as defined
under the language of a specific treat; and

(b) whether the enterprise operates in the State S through a dependent agent that habitually
exercises the authority to conclude contracts on behalf of the establishment in the State S.

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The definition of a PE is typically similar under both the OECD Model Convention and the UN
Model Convention. However, a specific treaty should always be examined for exceptions or
differences from standard language. In general, the UN Model Convention preserves greater
source country taxation rights in Article 5, which addresses the economic nexus required before
source country taxing rights may be exercised under the DTA.

Fixed place of business

Under the first prong of the PE test outlined above, anestablishment must operate in State S
through a fixed place of business to create a PE. A fixed place of business is typically defined to
include the following types of physical locations:

(a) a place of management;

(b) a branch or an office;

(c) a factory;

(d) a workshop; and

(e) a mine, oil, or gas well, quarry, or any other place where natural resources are extracted.

However, there are exceptions to these general types of locations that do not constitute a PE for
treaty purposes. The exceptions usually include:

(a) the use of a facility solely for the purpose of storage, display, or delivery of goods or
merchandise owned by the establishment;

(b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for
the purposes of storage, display, or delivery;

(c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for
the purpose of processing by another enterprise;

(d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or
merchandise (or collecting information) for the enterprise;

(e) the maintenance of a fixed place of business solely for the purpose of carrying on, for the
enterprise, any other preparatory or auxiliary activity;

(f) the maintenance of a fixed place of business solely for any combination of the activities
listed above.

Based upon the foregoing, an establishment has many options for doing business in State S
without triggering a PE for treaty purposes. The analysis is highly fact-specific for each case, and
the treaty language may vary depending upon the two countries involved in the analysis.

Using State S sales agent

A PE may also be created in State S if anestablishment operates in that country through a

dependent agent. Typically, tax treaties will provide the following general language addressing
the use of agents in a State S:

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 An enterprise of a contracting state shall not be deemed to have a permanent
establishment in the other contracting state merely because it carries on business in that
other contracting state through a broker, general commission agent, or any other agent of
an independent status, provided that such persons are acting in the ordinary course of
their business. However, when the activities of such an agent are devoted wholly or
almost wholly on behalf of that enterprise, he/she will not be considered an agent of an
independent status within the meaning of this paragraph if it is shown that the
transactions between the agent and the enterprise were not made under arm’s-length
conditions.

Typically, the analysis to determine whether an agent is working as an independent agent can be
determined by examining whether the agent is:

(a) acting in the ordinary course of their business;

(b) economically independent from the State Restablishment that has contracted for their
services; or

(c) legally independent from the State Restablishment that has contracted for their services.

Further, when examining the agency relationship, it is helpful to also identify the category of the
agent that has been hired by the State Restablishment. For example, agents can be considered any
one of the following:

(a) an importer or distributing agent;

(b) a general sales commission agent; or

(c) consignment agent.

Each type of agent must always be operating in the ordinary course of their business – and must
meet the economic and legal independence tests to protect the State Restablishment from being
considered as operating a business through a permanent establishment in the State S. In all cases,
consideration of the issues discussed above must be made when any enterprise is expanding their
operations into a foreign country.

7.7 RELATIONSHIP BETWEEN TAX TREATIES AND DOMESTIC LAW

The relationship between tax treaties and domestic tax legislation is a complex one in many
countries. The basic principle is that the treaty should prevail in the event of a conflict between
the provisions of domestic law and a treaty. In some countries — France is an example — this
principle has constitutional status. In many other countries, the government clearly has the
authority under domestic law to override the provisions of a DTA. For example, legislative
supremacy is a fundamental rule of law in many parliamentary democracies. As a result, it is
clear in these countries that domestic tax legislation may override their tax treaties. However, the
courts in these countries may require that the legislature explicitly indicate its intention to
override a treaty before giving effect to a conflicting domestic law. Courts may also strain to find
some ground for reconciling an apparent conflict between a treaty and domestic legislation.

In general, tax treaties apply to all income and capital taxes imposed by the contracting States,
including taxes imposed by provincial (state), local, and other subnational governments. In some
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federal States, however, the central government is constrained by constitutional mandate or
established tradition from entering into tax treaties that limit the taxing powers of their
subnational governments. Accordingly, the tax treaties of such federal States apply only to
national taxes. This is the situation for both Canada and the United States of America. In such
circumstances, a subnational government may impose taxes in a manner that would not be
permitted for its central government.

In general, tax treaties do not impose tax. Tax is imposed by domestic law; therefore, tax treaties
limit the taxes otherwise imposed by a State. In effect, tax treaties are primarily relieving in
nature. Similarly, tax treaties do not allocate taxing rights, although it is often claimed that they
do. In light of this fundamental principle, it is usually appropriate before applying the provisions
of a DTA to determine whether the amount in question is subject to domestic tax. If the amount is
not subject to tax under domestic law, it is unnecessary to consider the treaty. For example,
assume that under the provisions of a treaty between country A and country B, interest paid by a
resident of one State to a resident of the other State is subject to a maximum rate of withholding
tax of 15 per cent. If, under the law of country A, interest paid by a corporation resident in that
country to an arm’s-length lender resident in country B is exempt from tax by country A, the
treaty does not give country A the right to impose a 15 per cent withholding tax on the interest.

However, whether tax treaties give a right to tax independent of domestic law is a question of
domestic law. The internal law of a few countries — France is an example —provides that they
have the right to tax under domestic law any amount that they are not prevented from taxing
under the terms of the treaty.

The provisions of tax treaties do not displace the provisions of domestic law entirely. Consider,
for example, a situation in which a person is considered to be a resident of country A under its
domestic law and is also considered to be a resident of country B under its domestic law. If the
person is deemed to be a resident of country A pursuant to the tie-breaker rule in the treaty
between country A and country B (Article 4 (2) (Resident) of both the UN and OECD Model
Conventions provides a series of rules to make a person who is resident in both countries a
resident of only one country for purposes of the treaty), the person is a resident of country A for
purposes of the treaty but remains a resident of country B for purposes of its domestic law for all
purposes not affected by the treaty. Thus, for example, if the person makes payments of
dividends, interest or royalties to non-residents of country B, the person will be subject to any
withholding obligations imposed by country B on such payments because the person remains a
resident of country B.

Occasionally, some countries have passed legislation to modify or overturn the interpretation of a
DTA given by a domestic court. Such legislation, adopted in good faith, may not violate a
country’s obligations under its tax treaties. Often the country overriding its tax treaties in this way
will consult with its treaty partners to demonstrate good faith and to prevent misunderstandings.

Some countries may seek to prevent court challenges to certain domestic tax legislation on the
basis of the country’s tax treaties by providing that the new legislation prevails over any
conflicting provisions of a DTA. The most well-known and controversial treaty overrides are
probably those adopted by the United States; however, other countries have also done so on
occasion. Treaties are solemn obligations that should not be disregarded except in extraordinary
circumstances. At the same time, countries must have the ability to amend the provisions of their
domestic tax legislation to keep it current and to clarify interpretative difficulties.

Many of the provisions of tax treaties do not operate independently of domestic law because they
include explicit references to the meaning of terms under domestic law. For example, under
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 Article 6 (Income from immovable property), income from immovable property located in a
country is taxable by that country. For this purpose, the term “immovable property” has the
meaning that it has under the domestic law of the country in which the property is located. In
addition, Article 3 (2) (General definitions), which is discussed below, provides that any
undefined terms in the treaty should be interpreted to mean what they mean under the law of the
country applying the treaty. Conversely, in some countries where domestic law uses terms that
are also used in the treaty, the meaning of those terms for purposes of domestic law may be
interpreted in accordance with the meaning of the terms for purposes of the treaty.

UNIT8:
INTERPRETATION OF TAX STATUTES

8.1 THE TRADITIONAL RULE

The traditional approach taken by the English and Zambian courts to the interpretation of tax
statutes is reflected in the following extract from the opinion of Lord Cairns in the Partington v.
The Attorney General:

I am not at all sure that, in a case of this kind—a fiscal case—form is not amply sufficient;
because, as I understand the principle of all fiscal legislation, it is this: If the person sought
to be taxed comes within the letter of the law he must be taxed, however great the hardship
may appear to the judicial mind to be. On the other hand, if the Crown, seeking to recover
the tax, cannot bring the subject within the letter of the law, the subject is free, however
apparently within the spirit of the law the case might otherwise appear to be. In other words,
if there be admissible, in any statute, what is called an equitable construction, certainly such
a construction is not admissible in a taxing statute, where you can simply adhere to the

106
 words of the statute.74

Lord Cairns’ statement of the strict and literal approach, and the refinements developed by the
courts in other cases, coalesced into the following principles:

1. Tax legislation is to be construed strictly

Tax legislation is to be construed strictly on the basis of the words chosen by the legislator in
drafting the legislation, and with no assumptions about any legislative purpose or spirit other
than the raising of tax.

The Legislature must be assumed to have said what it intended, and its intentions can only be
ascertained from the words of the tax legislation.

In the case of Tenant v. Smith, the court said:

This is an Income Tax Act, and what is intended to be taxed is income”. And when I say
‘what is intended to be taxed’ I mean what is the intention of the Act as expressed in its
provisions, because in a Taxing Act it is impossible to assume any intention, any
governing purpose in the Act, to do more than take such tax as the statute imposes…75

The legislature is therefore presumed to be an almost perfect author and accordingly:

(a) construction should have regard to all the words used;

(b) no additions may be made to the word; and

(c) alteration of language in an Act suggests alteration of intention.

The court will not assume that the legislature has made a mistake. If the wording brings the
subject within the tax, the subject is liable no matter how much a case may be said to be
within the spirit of the tax, if the wording does not suffice to bring the subject within the
charge, the subject is free.

In Vestey v IRC, Lord Wilberforce stated that:

A citizen is not to be taxed unless he is designated in clear terms by the taxing Act as a
tax payer and the amount of his liability is clearly defined... 76

This principle of strict construction was also stated by Rowlatt J in Cape Brandy Syndicate v
IRC:

In a taxing Act one has to look merely at what is clearly said. There is no equity about
tax. There is no presumption as to tax. Nothing is to be read in, nothing is to be implied.
One can only look fairly at the language used.... 77

74
[1869] 4 LRHL 100 at 122.
75
3 TC 158 at 163.
76
[1980] STC 10 at 18.
77
[1921] 1 KB 64 at 71 - 12TC 358 at 366.

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 The words ‘there is no equity about a tax” do not of course mean that a tax is necessarily
unfair but that equitable considerations must not enter into interpretation of the words of a
taxing Act.
The principle of strict interpretation of tax legislation has been followed in Zambia, for
example in the case of Zambia Revenue Authority v Agro-Fuel Investments Ltd78 and OJ
Kalunga (Practicing as Kalunga & Cameron Smith) v Zambia Revenue Authority. 79

In the case of OJ Kalunga v Zambia Revenue Authority the Revenue Appeals Tribunal further
observed that the principle of strict interpretation of tax legislation gives rise to two
consequences:

(a) Firstly, it is for the Zambia Revenue Authority to establish that a subject falls
within the charge to be taxed. But this does not open the door for the subject to
have the "benefit of any argument that ingenuity can suggest." But only in the
event that after careful and balanced examination the judicial mind still entertains
reasonable doubt. If there is no ambiguity the words must take then natural
meaning;

(b) Secondly, the consequence of strict interpretation applies equally to the taxpayer as
much as to the Revenue Authority. So whether or not the literal interpretation
produces a construction whereby hardship falls on innocent beneficiaries...that
interpretation must be adhered to.

2. Tax legislation is to be construed as a whole

A taxing Act must be construed as a whole, i.e. in construing particular sections of the Act, it
is necessary to consider other sections of the same Act, or even other Acts dealing with the
same subject matter. If the wording of a section lends itself to two or more possible
interpretations, it is proper to adopt that interpretation which is consistent with other sections
of the Act.

In COR v. Wilsons Executors it was held that:

When we come to matter of doubtful construction, when it is possible without any

perversion or staining, to place either the one construction or the other upon a
provision;in such circumstances I consider it to be our duty to prefer the construction
which harmonises with the general intention of the Legislature as we gather it from the
whole statute.80

Further, Lord Herschell, in the case of Colquhoun v. Brooks said:

It is beyond doubt, too, that we are entitled, and, indeed, bound, when construing the
terms of any provision found in a statute, to consider any other parts of the Act which
throw light upon the intention of the Legislature, and which may serve to show that the
particular provision ought not to be construed as it would be if considered alone and apart
from the rest of the Act.81

The Zambian Revenue Appeals Tribunal in the case of OJ Kalunga v Zambia Revenue
78
SCZ Judgment No. 26 of 2008
79
1999/RAT/36
80
18 TC 465 at 476.
81
2 TC 500 at 500.

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 Authority expressed similar views when it held that a taxing Act must be read as a whole and
that where there is an ambiguity the scheme of the Act may dissolve (citing Lord Halsbury in
IRC v Priestley (190) AC 2208). The Tribunal further stated that the words of the legislature
must be consumed in their context. Until a person has read the whole document or statute he
is not entitled to say that it, or any part of it, is clear and unambiguous.

The History of a taxing Act may, in some instances, also be helpful in construing a provision
of a taxing Act – see Pepper (Inspector of Taxes) v Hart,82 a landmark decision of the House
of Lords on the use of legislative history in statutory interpretation. The court established the
principle that when primary legislation is ambiguous then, in certain circumstances, the court
may refer to statements made in the House of Commons or House of Lords in an attempt to
interpret the meaning of the legislation.

3. Ambiguity of a taxing provision should be construed in favour of the taxpayer

Tax laws are in derogation of personal rights and property interests and are, therefore, subject
to strict construction. Further, any ambiguity in the taxing provisions of an Act must be
resolved in favour of the taxpayer.

In Billings v. U.S., the U.S. Supreme Court clearly acknowledged this basic and long-standing
rule of statutory construction:

Tax statutes . . . should be strictly construed, and, if any ambiguity be found to exist,
it must be resolved in favour of the citizen. 83

Again, in United States v. Merriam, the U.S. Supreme Court clearly stated that:

On behalf of the Government it is urged that taxation is a practical matter and

concerns itself with the substance of the thing upon which the tax is imposed rather
than with legal forms or expressions. But in statutes levying taxes the literal meaning
of the words employed is most important, for such statutes are not to be extended by
implication beyond the clear import of the language used. If the words are doubtful,
the doubt must be resolved against the Government and in favour of the
taxpayer.84

4. Ambiguity in respect of an exemption from tax should be resolved in favour of the

taxing authority

Exemptions from taxation are highly disfavoured in law, and he who claims an exemption
must be able to justify his claim by showing the clearest intent of the legislature to exempt
him by plain words.

Laws granting tax exemptions are therefore strictly construed against the taxpayer and
liberally in favour of the taxing authority. Any ambiguity in a taxing Act relating to an
exemption from tax will be resolved in favour of the taxing authority the common burden
cannot be permitted to exist upon vague implications. It is a well settled principle of taxation
that “taxation is the rule, and tax exemption is the exception”. Therefore, the one who claims
an exemption from his or its share of the common burden in taxation must justify his or its

82
[1992] UKHL 3.
83
232 U.S. 261, 34 S.Ct. 421 [1914] at 265.
84
263 U.S. 179, 44 S.Ct. 69 [1923], at 187-88.

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 claim by showing that the legislature intended to exempt him by words was too plain to be
mistaken.

Similarly, a claim for tax refunds or the issuance of tax credits partakes of the nature of an
exemption, which cannot be allowed unless granted in the most explicit and categorical
language. Being in the nature of an exemption from taxation, a claim of refund is strictly
construed against the claimant, and the failure to discharge this burden is fatal to the claim.

8.2 RATIONALE FOR THE STRICT INTERPRETATION RULE

The courts have offered several rationales for the traditional approach to the interpretation of tax
legislation. In Pryce v. Monmouthshire Canal and Railway Companies, Lord Cairns stated that:

In as much as there was not any a priori liability in a subject to pay any particular tax,
nor any antecedent relationship between the taxpayer and the taxing authority, no
reasoning founded upon any supposed relationship of the taxpayer and the taxing
authority could be brought to bear upon the construction of the Act, and therefore the
taxpayer had a right to stand upon a literal construction of the words used, whatever
might be the consequence.85

This reflected the traditional view that tax legislation had no purpose other than the raising of
taxes, and therefore even if the statutory context and purpose were relevant to statutory
interpretation generally (itself a disputed point), there was in fact no broader context or statutory
purpose relevant to the interpretation of tax legislation.

In other cases, the courts characterized tax legislation as depriving taxpayers of the use and
enjoyment of their property and for this reason applied the same restrictive approach that was
traditionally applied to criminal statutes, expropriation acts, and other burdensome legislation
infringing individual rights, privileges, and property.86

While that position dominated the judicial approach to tax legislation for many decades, the
courts from time to time recognized specific exceptions (more often implicitly and without
expressly rejecting the strict and literal approach), and on occasion expressly dissented from the
traditional view.

8.3 THE MINORITY VIEW

In an 1899 House of Lords decision, Lord Russell CJ described the duty of a court in the case of
any statute, including a tax statute, as the duty “to give effect to the intention of the Legislature as
that intention is to be gathered from the language employed having regard to the context in
connection with which it is employed.”87 His Lordship rejected the use of any special canons of
construction specific to tax legislation. Similarly, in the Canadian case of Cartwright v. City of
Toronto, DuffJ held that tax statutes “must be construed according to the usual rule, that is to say,
with reasonable regard to the manifest object of them as disclosed by the enactment as a whole.” 88

8.4 EXCEPTIONS TO THE TRADITIONAL RULE

85
[1879], 4 AC 197 at 202-3 (HL).
86
See, for example, the comments of Brodeur J in The Canadian Northern Ry. Co. v.The King [1922], 64 SCR 264, at 275, aff’d.
[1923] AC 714 (PC) for a general discussion of the jurisprudence supporting the presumption that statutes are not to be construed
as taking property without compensation in the absence of clear language to that effect.
87
Attorney-General v. Carlton Bank, [1899] 2 QB 158, at 164 (CA).
88
[1914], 50 SCR 215, at 219.

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 On occasion, courts adopted a more purposive approach when confronted with legislative
provisions that, on their face, gave rise to “strangely anomalous” or absurd results. This principle,
enshrined among the canons of statutory construction as the “golden rule,” allows the courts to
depart from the literal wording of a statute to avoid anomalous or absurd results. The application
of this principle in practice required the courts to recognize the results, and often the purposes, of
the legislation, and therefore it is not surprising that it was rarely applied while the traditional
strict and literal approach was in its ascendancy, when the courts strongly preferred legislative
solutions to legislative problems.

In Astor v. Perry,89 the House of Lords applied this principle in a tax case to avoid what was
perceived to be an inappropriate result by reading extra words into the relevant statutory
provision. The golden rule was also applied by Lord Reid in another tax case in the following
terms:

[I]n order to avoid imputing to Parliament an intention to produce an unreasonable result,

we are entitled and indeed bound to discard the ordinary meaning of any provision and
adopt some other possible meaning which will avoid that result. 90

The courts were also inclined to depart from the traditional strict and literal approach in cases
where technological change required old statutes to be applied to new circumstances. In Simpson
v. Teignmouth and ShaldonBridge Company,91the English Court of Appeal considered whether
abicycle ridden over a bridge was subject to tolls applicable to “every coach, chariot, hearse,
chaise, berlin, landau and phaeton, gig, whiskey, car, chair, or coburg, and for every other
carriage hung on springs.” The legislation imposing the toll was passed before bicycles were
invented. Although the court held that a bicycle was not subject to tolls, the Earl of Halsbury LC
held that:

[t]he broad principle of construction put shortly must be this: What would, in an ordinary
sense, be considered to be a carriage (by whatever specific name it might be called) in
the contemplation of the Legislature at the time the Act was passed? If the thing so
sought to be brought within the Act would substantially correspond to what the
Legislature meant by a carriage (called by whatever name you please), I think that the
tax would apply; but if not, it is not for the Court to make an effort by ingenious
subtleties to bring within the grasp of the tax something which was not intended in
substance by the Legislature at that time to be the subject of taxation. 92

8.5 THE PLACE OF TAX AVOIDANCE

In the IRC v. Duke of Westminster,93 the House of Lords confirmed that taxpayers were entitled to
arrange their affairs to minimize their tax obligations. Their Lordships rejected arguments
suggesting that somehow tax liabilities could be determined through the application of a
“substance over form” doctrine, which would impose results based on a characterization of
documents, events, or transactions different from the legal relationships and consequences
established by the parties.

The Duke ofWestminster principle, which is focused primarily on characterization ofthe facts
89
[1935] AC 398 (HL).
90
Commissioners of Inland Revenue v. Luke (1963), 40 TC 630, at 648 (HL).
91
[1903] 1 KB 405 (CA).
92
Ibid. at 413-14. See also Powell Lane Manufacturing Co., Ld. v. Putnam, [1931] 2 KB 305 (CA).
93
[1936] AC 1 (HL).

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 rather than on interpretation of the law, is entirely consistent with the restrictive approach to
statutory interpretation traditionally espoused by the courts in tax cases. Indeed, one would not
have expected the courts to apply a strict and literal approach to statutory interpretation while
characterizing, and re-characterising, the actual legal relationships of the parties in a manner that
resulted in the imposition of tax by reference to economic results or the parties’ tax motivations.

8.6 GENERAL OBSERVATIONS

The traditional approach is characterized by the use of presumptions of general application.

Specific circumstances and the objectives of any particular legislative provision are usually
ignored unless absurd results force the courts to apply a more purposive approach under the
authority of the “golden rule.”

By virtue of the courts’ focusing solely on the statutory language and applying restrictive general
rules, the dice may be loaded against one side or the other (but usually against the tax authority).
Not only does this keep tax liabilities to a minimum, but it is generally felt that a higher degree of
certainty and predictability is achieved than would be the case if a more flexible and purposive
approach is taken. Yet if we consider the income attribution rules, where courts have applied
restrictive principles and held, for example, that a transfer did not include a loan, or that the
words “property or . . . property substituted therefor” did not include property substituted for
substituted property, or that income from “the property” did not include income from “the
property” if the property was used to generate income from a source that was a business. 94 Such
results have had the effect of minimizing taxpayer obligations, but were perhaps not entirely
predictable by a person attempting to read the sections and determine the manner in which they
would apply in practice.

Moreover, the consistently restrictive approach to legislation adopted by the English courts
historically has contributed to a detailed and complex style of legislative drafting in the common
law countries. Detailed legislative provisions invite the courts to conclude that the treatment of
the subject is exhaustive, and that the legislation is meant to say exactly what it says and does not
mean to say anything that it omits. Gaps are uncovered. The drafters have introduced legislation
with increasing frequency to plug the gaps exposed by restrictive interpretations by the courts.
The process becomes self-perpetuating. The result is the creation over time of increasingly wide
areas of law where even experienced practitioners must defer to specialists who are able to devote
substantial time and energy to mastering the provisions.

Will the purposive approach reverse this trend? Certainly it has not done so yet, and perhaps it
never will. For example, no one would say the US Internal Revenue Code is a simple statute,
although it has been interpreted using purposive principles for many years. The problem lies in
the inability of any legislation to anticipate every circumstance to which it may be relevant. A
purposive approach cannot, of course, be expected to solve the problem, because the problem has
more fundamental causes than the particular way in which courts approach legislative
interpretation. Nevertheless, the purposive approach may in some instances result in greater
conformity of judicial results to legislative purposes.

Some may be concerned that the purposive approach will undermine predictability by giving
judges a licence to “make law” by judicially rewriting legislation in order to carry out some
perceived legislative purpose that is not apparent to the taxpayers who are affected by the
legislation. This should not be a problem if the courts, in their application of the purposive
approach, remain firmly anchored by the plain meaning of the statutory language. In doing so the
94
See Dunkelman v. MNR, 59 DTC 1242 (Ex. Ct.); MNR v. MacInnes, 54 DTC 1031 (Ex. Ct.); and Robins v. MNR, 63 DTC
1012 (Ex. Ct.), respectively.

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application of the purposive approach will be confined to those areas where genuine ambiguity
exists. Judicial creativity has always been exercised in those areas because it is the work of the
judiciary to decide cases, and that involves sorting out ambiguities in legislation. All that the
purposive approach should do, as compared with the traditional strict and literal approach, is
ensure that the resolution of those ambiguities is achieved with proper regard for the purposes of
the legislation rather than through the application of arbitrary rules.

Put another way, statutory interpretation cases get to court because the parties cannot agree on
what the legislation means. Purposive rules of interpretation will not make hard cases easy, but no
matter what approach it adopts, the court must ultimately resolve the ambiguity in favour of one
party or the other. The traditional approach simply determines the contest by reference to rigid
rules and presumptions rather than by reference to the statutory purpose. It hardly seems
objectionable for the court to resolve the issues by reference to what the legislature intended.

113