Companies tend to make prepayments because suppliers may insist on receiving payments before they make a supply. This is often a custom in the insurance industry, where they request for premiums before the insurer covers the insured against a risk. For the purposes of renting out commercial premises, licenses are often paid for in advance before granting right of use to the tenant. Prepayments can be made by customers who may want to benefit from discounts and economies of scale. Prepayments constitute a very popular expenditure for most entities, but most tax payers often wonder the tax status of these expenses, especially considering amendments done towards the tax status of prepayments in Zimbabwe. In this article we look at the tax status of prepayments in our legislation, highlighting amendments implemented.
Prior to 1 January 2018, there were no clear legislative rules dealing with prepaid expenses. Basically, the deductibility of prepayments was merely dependent on the general deduction rule. The rule allows for deduction of expenses that are made in the production of income or for the purposes of trade not being capital in nature. This was the basis the ZIMRA used in determining the deductibility status of prepayment incurred by entities. This was necessary in determining whether expenditure meets the deduction criteria provided by the above legislation.
A prepayment would be tested to evaluate when the expenditure was actually incurred for the production of income and not just incurred. Prepayments of a revenue nature were deductible only if they had been incurred. Thus where money had been laid out without necessarily the existence of a liability to pay, the ZIMRA would insist that the taxpayer was under no legal obligation to effect the payment and would disallow it. The term incurred was defined in ITC 542, 13 SATC 116 to mean “an actual payment or an obligation undertaken”. In Sub-Nigel Ltd v CIR 15 (1948) SATC 381 (A) it was held that the Court is not concerned whether a particular item of expenditure produced any part of the income but with whether that item of expenditure was incurred for the purpose of earning income. Matters that have been mind boggling on prepayments was whether the prepayment was to be matched with actual income generated. The production of trade income derived from the definition of “gross income” does not limit such income to a particular year of assessment but encompasses the production of income in “any year of assessment”. This position is buttressed in the case of SZ v ZIMRA.
However, some payments like insurance premiums and license renewals, an insurance cover or licensing cannot commence until full payment has been received. Such an insurance cover or licensing may span into another financial year. An unconditional obligation to pay for premium arises prior to cover. Premium is due prior to cover. A policy will only be issued upon the insured paying the insurance premium, therefore the unconditional obligation to pay arises prior to cover. The court had an opportunity to deal with insurance premium in the case of DEB v ZIMRA but the court lumped up the concept together with that of prepayment of excise without actually dissecting how an insurance operates, which leaves the areas still subject to debate. Generally such expenditure is allowable as a deduction as long as it complied with the requirements of s15 (2) (a). Furthermore, it was the practice of the ZIMRA to disallow prepayments for goods and only to allow prepayments for services when a taxpayer is under contractual obligation to make the payment. This was regardless of the fact that all revenue nature amounts received in advance by a person would constitute gross in terms of section 8 (1) of the Income Tax Act. This meant that a taxpayer would include prepayments received in advance in its gross income in the year they are received and deduct prepayments paid for goods in advance in the following year.
With effect from 1 January 2018, the Finance Tax Act of 2018 clarified the position regarding prepayments. The new law provided for the apportionment of prepaid expenses in the determination of taxable income over the years of assessments in which the goods, services or benefits are used up. The amendment ensured expenditure in respect of income to be received or accrued in the future years of assessment is reported when income accrued or was received. This change aligned the Zimbabwean legislation in line with the South African practice and accounting practice. Meanwhile, a similar change was effected to income received in advance and this is no longer taxed in the year of receipt with effect from 1 January 2018 but in the year in which it relates.
In conclusion, our courts have reinstated that prepayments have always been disallowed. The coming in of the Finance Act amendment of 2018 gave clarity to the deductibility of prepayments by entities. This is so because the new amendment aligned the treatment of the expense in accounting and tax terms, and this made it easier for tax payers who struggled with implementing tax rules, being more comfortable with the accounting rules. In essence, the International Accounting Standard number 1 (IAS 1) is the basis for a prepayment being recorded as a current asset in the period of payment, and being later on recognised as an expense when the obligation to pay the expense falls due. Hence no adjustment is needed for tax if a prepayment is not recognised as an expense in the year of payment.