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Home Columns & Comment TAX MATTERS: How Zimbabwe’s tax system operates

TAX MATTERS: How Zimbabwe’s tax system operates

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ZIMBABWE presently operates on a source-based tax system. This means that income from a source within, or deemed to be within Zimbabwe will be subject to tax in Zimbabwe unless a specific exemption is available.

The specific circumstances of a transaction should always be considered to determine whether the transaction gives rise to taxation in Zimbabwe.
Section 8 of the Companies Act provides for the registration of a company limited by shares. In essence, a company limited by shares is formed when the members thereof subscribe to the memorandum of association.

The effect of registration of a company is that the liability of the members of the company is limited in terms of the Companies Act. Further, the registration of a company creates a separate legal personality as between the company and its shareholders. The Companies Act provides that a company shall have the capacity and powers of a natural person of full capacity in so far as a body corporate is capable of exercising such powers.

It is in this context of a company’s separate legal personality that it is individually liable for corporate tax. Corporate income is initially taxed in the name of the company as tax on profits and then subject to withholding tax when distributed to shareholders. This is the hallmark of income earned through a corporate and probably the biggest disadvantage of a company compared to a sole trader or a partnership. Sole traders and partners only suffer tax once at individual level, whilst shareholders suffer tax on profits and dividend. Also, company losses are non-transferable to a shareholder, but can be inherited by a company which is under the same control with that company.

A company pays tax on its profits, while its shareholder is subject to tax on dividend distributed to him. This “double taxation” of profits once at the corporate level and then again on distribution to shareholders is the hallmark of company tax. Why then are so many businesses operated through companies? There are a number of non-tax advantages to the corporate form, though not all of the advantages are unique to corporates. One very important factor is the relative ease of raising capital through the sale of stock.

Shares of stock are freely transferable, unlike partnership interests, which generally require the other partners’ consent for changes in the composition of the partnership. Because a corporate entity survives transfer of its interests, the price of its shares reflects the present value of future prospects. Multiple classes of stock are possible in a corporation, so it may be easier to align the structure of the business with underlying interests than it is with a partnership.

The corporate form also provides limited liability to investors, as does the limited liability company. Corporate shareholders can also be employees, unlike partners in a partnership, so they are eligible for employee fringe benefits that are excluded from income but deductible by the corporation. It is also easier to carry out certain mergers and acquisitions tax-free with a corporation.
Nonetheless, double taxation that accompanies the corporate form in small companies can be avoided by having the shareholder also playing the role of an employee or a creditor. Dividend can therefore be substituted by a salary, rent or interest, subject to transfer pricing rules and thin capitalisation rules.

A partnership is an association of individuals or entities in pursuance of some business venture. A common feature of a partnership is that it is formed through a Deed of Partnership ― an agreement to form partnership. It is this deed of partnership that spells out the name of the partners, business of the partnership, share of profits and losses, the relationship between partners as well as of partners and third parties. The deed also provides for other matters like dissolution of partnership etc. It is important to note that a partnership cannot be formed by more than 20 persons.

A partnership is not a separate legal persona for income tax purposes (Value Added Tax Act is an exception). It is not assessed for income tax as a company, but each partner is liable to income tax in his individual capacity on his/her share of taxable income. It constitutes a fiscal transparent entity (flow-through vehicle) in the sense that it is not in itself liable to tax on its profits but rather the individual partners are individually liable to tax on their respective proportionate shares in the partnership. This “flow-through” approach results in a single layer of taxation ― at the partner level.

An advantage of using a partnership as an investment vehicle is that assessed loss is not trapped in partnership as this immediately flows to partners. Also, a partnership does not distribute a dividend and once the partners are taxed there is no further tax on their income. A joint venture is treated in the same manner unless constituted as a company. Each participating company/individual is subject to income tax on its share of the joint venture’s taxable income.

A sole proprietorship or sole trader is a business that is run by its owner by himself. A sole proprietorship is not an entity separate from the individuals who own them, so they are not subject to separate taxation. The tax liability therefore falls upon the individual and treatment is similar to that of a partner in a partnership.

A trust is an entity formed by one person called a founder, donor or settlor with its administration entrusted to trustees for the benefit of named beneficiaries. The beneficiaries may be specific or a group or class of persons. A trust is a common law institution in Zimbabwe i.e. it is not established through the provisions of a specific Act of Parliament. It is formed through a deed of trust executed by the founder and the trustees. The deed of trust is a form of an agreement wherein the parties spell out, inter alia the name of the trust, the main objectives behind its formation, the first trustees and how they retain or lose office, duties and powers of trustees, the entitlements of beneficiaries, and amendment of the deed and dissolution of the trust. Trusts are taxed differently. However, public trusts are exempt from income tax.

Non-resident companies ― with effect from January 1, 2017, permanent establishment rules normally contained in a tax treaty (double taxation agreement) are domesticated by inserting section 19A in the Income Tax Act. This has the effect of making a non-resident company carrying on business in Zimbabwe through permanent establishment (PE) liable to pay income tax in Zimbabwe. Where the PE is deemed, all taxable income attributable to such PE wherever arising shall be subject to income tax in Zimbabwe.

In conclusion it is important to understand the tax implications of each juristic person before registering with the authorities. Meanwhile Matrix Tax School invites you to take part in the upcoming Conversion for Tax Preparers seminar on July 21 to 23 at Kadoma Rainbow Hotel and Chengeta Safari Lodge.

Tapera is the founder of Tax Matrix (Pvt) Ltd and chief executive of Matrix Tax School. He writes in his personal capacity.

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