Premium or Rental Payments: The Dimming light from the VIVO Energy Appeal

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By: CPA Charles Lutimba. CPA Lutimba is a Manager in Charge of Standards and Technical Support at the Institute of Certified Public Accountants of Uganda. He is a Professional Accountant and a Student of Law.

In the first quarter of 2019 the media was awash with commentaries around the Tax Appeals Tribunal (TAT) decision in VIVO Energy Uganda Limited (VIVO) v the Uganda Revenue Authority (URA). Spurts of responses and counter responses were equally evident on social media with a growing thread of comments from individuals interested in tax matters.

The facts of the matter at hand were that VIVO obtained leases for its service stations across the country. VIVO paid a premium for the leases and continuously made periodical payments to cover up the agreed total amount of the leases, which payments the company dubbed as rental payments. VIVO treated the premium and the rental payments as tax deductibles, a treatment the URA rejected firmly holding unto the provisions of the Income Tax Act (ITA) that treat expenditures of a capital nature as non-deductible expenses. In the end; the TAT, disagreeing with the submissions of VIVO held that the said leases conferred ownership of the land on VIVO for the periods specified and hence this demonstrated an acquisition of a capital asset. This literally put the payments of rent and premium (amounting to close Ugx. 4.6 Billion and 771 million respectively) by VIVO to the various landlords in the bracket of non deductable expenses.

However, on appeal, VIVO contended that the tribunal had erred in law in holding that rent and premium paid in respect of VIVO’s leases were not deductible expenses. This ground of appeal was technically re-dressed to specifically request the appellant court to make judgement on whether rent was a deductible expense or not. By principle; VIVO had conceded to the fact that premium payments were capital in nature and thus would not be claimed among allowable deductions.

The ultimate outcome was for Court to find that rent as an expenditure is a recurrent expenditure that is periodically paid to maintain occupancy of the leased facilities and that it was paid to maintain the revenue generating capacity derived from possession of the lease. Court further affirmed that lumpsum advance payment of rent did  not qualify rent into a capital expenditure since the interpretation section of the ITA defines rent as consideration for use or occupation, or right to use or occupy land or buildings BUT the definition does not confer title on the lessee beyond granting a license to use or occupy the land or building.

Whereas the ruling sheds light and gives some relief to entities that own significant leases, key issues which may be of concern for a proper functioning of the tax system arises as discussed in the foregoing paragraphs a proper functioning of the tax system.

  • The gist of contention was around what amounted to a revenue or capital expenditure. Court noted that, there was no statutory definition of the expenditure categorization into capital or revenue expenditure. As such resort is frequently sought from case law and this has substantially left the interpretation of whether an expenditure is revenue or of a capital nature a matter of law and fact basing on the surrounding circumstances of each case. The implication is that; the decision to differentiate between a capital and revenue expenditure will continue being based on Courts’ judgment based on appreciation of the facts at hand.
  • The definition of rent under the ITA was also cited as being unclear when it fuses rent and premium but fails to guide on whether payments of rent are revenue or capital in nature. The Court is of the opinion that if rent is a consideration for occupancy and or usage of rented premises then it cannot confer ownership. My opinion is that any efforts to delay clarification on the definition will likely draw more confusion on the matter. Remember as cited in Cape Brandy Syndicate v I.R.C.[1], “In a taxing statute one has to look merely at what is clearly said. There is no room for any intendment……..there is no scope for any inference or induction in constructing a taxing statute, there is no room for suppositions as to the spirit of the law, there is no room for speculation.”
  • Another key observation relates to the nature and form of lease agreements. In the instant case, the Court found it easy to split premiums from rent because the agreement made clear separation of the two. The essence of this is that the way the lease agreement is construed will be key in determining whether the parties thereto intended to create or acquire an asset basing on the nature of expenditure arising therefrom that is whether capital or revenue expenditure. The ultimate danger for Court to rely on form of a transaction rather than the substance is that it renders the ITA inoperative in respect to the mandate bestowed to URA in re-characterising transactions in whole or in part where parties to the transaction intend to avoid tax. This ruling may also encourage parties to construct their lease agreements strictly in manner that best serves their interests; hence the likely abuse of tax planning avenues.
  • Lastly, the International Accounting Standards Board issued IFRS 16 Leases in January 2016 with an effective implementation date of 1 January 2019. The standard that significantly changed the accounting of lessees by eliminating nearly all off balance sheet leases previously accounted for as operating leases. The standard now requires a lesee upon commencement of a lease to recognize a right of use asset (the underlying asset) and a liability (at the present value of future lease payments made). Lease payments made would reduce the lease liability as well as the Right of Use asset.  A depreciation on ROU asset and interest expense on the liability will be charged to the income statement instead of showing the operating lease payment as an expense.

Whereas the accounting approach to leases in respect to a lessee has changed the taxation approach seems not to have changed. The ITA remains intact in respect to what amounts to a finance lease. Section 59 of the ITA provides that a lease qualifies as a finance lease if the lease satisfies any of the conditions provided for under subsection 3. Otherwise a lease that fails to meet the definition of a finance lease under the ITA would be treated as an operating lease for tax purposes.

Accordingly, the tax implications of a finance lease will continue to apply as before. However, for operating leases, the lessee will not be entitled to claim capital allowances since the lessor claims allowances in respect of the leased asset. This seems to affirm the ruling in our instant case where Court is of the view that if a lessee does not own the asset, but only rents it (i.e makes a consideration for occupancy or usage of the rented premises) the lessee cannot claim capital deductions.

In order to allow deductions for expenses during any tax assessment process, the tax authority usually requires documents such as agreements, invoices and proof of payment to support claims; but there also has to be a clear provision of law to support such deductions.  Therefore, for tax purposes, the asset (ROU) will not qualify for any wear and tear allowances. The interest expense (based on the accounting standards but not actual interest on a debt obligation) and amortization of the lease asset (capital expenditure) will also not be tax deductible as they have no specific provision for deduction and the lessee will not have supporting documents to claim such expenses.

Based on the VIVO case however, the lease rental payments (based on lease contract) is a deductible revenue expenditure. As such for tax purposes, IFRS 16 will be ignored and the rent provided for in the contract will instead be allowed as a deduction.

On the sidelines, Other challenges that will arise from application of IFRS 16 include the classification for ROU assets (intangible assets) and therefore the rate of tax depreciation (applying over the period of benefit or right of use) and the applicability of the interest deduction restriction to not more than 30% of the tax earnings before interest, tax, depreciation/amortization (EBIDTA) rule with respect to the operating lease liability, if the lessor and lessee are related parties.

If the tax body considers the form of the transaction to take precedence over its substance, it would allow deductions for lease rental payments and disregard depreciation on ROU and interest on lease liability for tax purposes. This would give rise to temporary differences resulting into a deferred tax that would need to be recognised in accordance with IAS 12–Income Taxes.

The VIVO precedence sets a dimming light whose application going forward will largely anchor on the nature of contracts entered into between the lessee and lessor but also the extent to which the tax body’s unwithering mandate on recharacterization of transactions would be applied.  Otherwise as is; lease rental payments whether paid periodically or as a lumpsum in advance shall be treated as revenue expenditures and hence allowable deductions for tax purposes.


[1] (1 KB 64, 71):

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