Online Reporter
Nyashadzashe Ruimbe, [email protected]
The term “deemed” is often used in legal and formal contexts and it means to regard or consider in a specified way.
When something is “deemed”, it is treated as if it has a particular status or characteristic, even if that may not be the case in reality.
Likewise, the Zimbabwean tax system recognises some payments as taxable even though that is not their ordinary treatment. These dividends are triggered by payments between associated items, which are in excess of the allowable thresholds provided in Section 16 of the Income Tax Act.
Deemed dividends are charged a withholding tax rate of 15 percent and a reduced rate is not applicable as double tax agreements (DTAs) do not apply to these kinds of dividends. An example of a deemed provisions in the Income Tax Act, include the excess royalty payments through the application of Section 26(2) or Section 28(2) of the Income Tax Act.
The limit on deductible royalty payments was introduced by Finance Act (No. 2) No. 7 of 2024, effective January 1, 2025, where the royalty payments in excess of the lower of one and a half percent of annual turnover or the comparable value (benchmark) determined in terms of the Thirty-Fifth Schedule of the Income Tax Act, is treated as a deemed dividend.
The restriction applies to royalty payments for the use, or right of use of any literary, dramatic, musical, artistic, scientific or other work whatsoever, including cinematograph films or recordings in which any copyright subsists, or for the use of any patented article, trademark, design or model, plan, secret formula or process.
The provision is triggered when the royalty deduction is claimed by the taxpayer, or in favour of a company of which the taxpayer is an associated enterprise, or, where the company is a foreign company, the local branch.
This means there are three instances in which this legislative provision comes into play, the first being a deduction made by the taxpayer, or the second instance, where the taxpayer claims the royalty expenditure on behalf of another taxpayer, which is an associated enterprise; and the third instance, where the claim is made by a local branch on behalf of a foreign company.
The Income Tax Act does not define the term “associated enterprise”, but it’s defined in the OECD Model Tax Convention Article 9 to refer to an enterprise that participates directly or indirectly in the management, control or capital of another enterprise in another country or a situation where the same parties participate directly or indirectly in the management, control or capital of both enterprises.
Similarly, the Income Tax Act deems persons to be associated parties in section 2A of the Income Tax Act, where legislation notes that where a person, other than an employee, acts in accordance with the directions, requests, suggestions or wishes of another person, whether or not the persons are in a business relationship and whether or not those directions, requests, suggestions or wishes are communicated to the first-mentioned person, both persons shall be treated as associates of each other.
Section 2A of the Income Tax Act deems a person to control a company if the person, either alone or together with one or more associates or nominees, controls the majority of the voting rights attaching to all classes of shares in the company, whether directly or through one or more interposed companies, partnerships or trusts; or has any direct or indirect influence that, if exercised, results in him or her or his or her associates or nominees factually controlling the company.
This means that the taxpayer arrives at the same conclusion when interpreting the terms associated enterprise and associated party as the core elements of the relationship between the two parties is determined through ownership and control.
In line with section 26 and section 28 of the Income Tax Act, the excess royalty deduction is treated as a deemed dividend and charged Resident Shareholder Tax (RST) or Non-Resident
Shareholder Tax (NRST) depending on the source of the royalty.
If the royalty is from a source within Zimbabwe, then we apply Resident Shareholder Tax, and where the royalty is from a non-resident, then we apply Non-Resident Shareholder Tax. The deemed dividends are charged at a rate of 15 percent through sections 15 (RST) and section 17 (NRST) of the Finance Act.
This type of dividend does not qualify for a reduced rate through DTAs, hence the applicable rate remains at 15 percent. The RST is due within 10 days of the date of distribution while NRST is due to the commissioner within 30 days of the date of distribution.
It is worth noting that the determination of the excess royalties involves a benchmarking study to be made and a transfer pricing document will be required to serve as proof that the royalty payments were charged in a manner consistent with the arm’s length principle.
Taxpayers should take note that misclassification of expenditure may result in Zimra audits, especially in the case where a taxpayer wrongly classified royalty payments, hence deducting the expense in full, instead of subjecting the royalty payments to limits imposed by section 16(1)(t) of the Income Tax Act.
Through the application of section 16 of the Income Tax Act, excess royalty deductions are disallowed, resulting in increased tax liability and a further resident shareholder Tax or Non-Resident Shareholder Tax imposition at the rate of 15 percent. This means taxpayers have to benchmark the royalty rates being applied and compute the royalty expense against the set thresholds to avoid triggering deemed dividends.
l Nyashadzashe Ruimbe is a tax supervisor at Baker Tilly, overseeing all tax types and Zimra audit supports. He writes in his personal capacity.
