Ardova Plc (“Ardova” or “the Company”) in the normal course of its business as a petroleum marketing and distribution company incurs product losses and shrinkages. The Company typically expenses these losses in its Statement of Profit or Loss and takes a tax deduction on the entire sums expensed. The Company filed its 2014 and 2015 financial year tax returns reflecting the above deductions.
The Company thereafter filed amended tax returns adjusting the capital allowances claimed to percentages lower than the maximum threshold of 66 ⅔% as prescribed by the 2nd Schedule of the Companies Income Tax Act (CITA). The Federal Inland Revenue Service (“FIRS) in conducting a tax audit on the said years disallowed part of the shrinkages and product losses on the ground that it exceeded the acceptable industry benchmark. It also disallowed the adjustments made to the capital allowance brought forward based on the refiled capital allowance claims.
The dispute on these items could not be resolved by the parties and was therefore escalated to the Tax Appeal Tribunal (‘TAT’ or the ‘Tribunal’) for determination During the Appeal, the FIRS also questioned the
validity of the appeal and the competence of the TAT to hear the appeal.
The Company’s arguments
PwC helps secure TAT ruling that petroleum product losses incurred in the course of business
are deductible and that a taxpayer may claim capital allowances below the maximum threshold
• Section 24 of CITA, entitles the Company to take tax deductions on expenses incurred wholly, reasonably, exclusively and necessarily (WREN) in the course of its business. The FIRS is not empowered under CITA to disallow WREN expenses on the basis of an industry average where such expenses are not attributable to activities between related parties. Irrespective of the foregoing, the actual product losses incurred were lower than the industry average communicated by the FIRS.
• CITA does not provide for a minimum threshold for capital allowance claims but a maximum threshold. Thus, a taxpayer is at liberty to claim a percentage lower than the maximum threshold and carry forward the remainder.
• Section 90 of CITA allows a taxpayer to make amendments to its tax returns when an error or mistake is discovered within six years.
• The operative date of the Notice of Refusal to Amend is the date of receipt by the taxpayer and not the date represented on the letter.
• The shrinkages and product losses claimed by the Company were above the industry average and thus, rightly disallowed.
• The amendment of the Company’s returns to claim capital allowances below the maximum threshold when it had sufficient assessable profit was unreasonable, unjust and a breach of paragraph 24(7) of the Second Schedule to CITA.
• The appeal was filed outside the 30-day timeframe.
1. On claim of shrinkage and product losses – The Tribunal held that where an expense has passed the WREN test under section 24 of CITA, it becomes deductible and CITA does not subject such expense to an industry average or benchmark. Also, CITA does not give the FIRS the discretion to allow only a quantum of the said expense. Thus, the Tribunal ruled that based on the evidence presented, the shrinkages and product losses incurred by the Company were wholly, exclusively, necessarily, and reasonably incurred for the purpose of producing its profits, and were deductible under section 24 of CITA.
2. On claim of capital allowance below the maximum threshold and ability to file an amended return by virtue of mistake or error under Section 90(1) – -The Tribunal agreed that claiming capital allowances below
the threshold of 662/3% does not offend CITA, because CITA does not make provision for a minimum percentage claim for capital allowances. However, to take benefit under Section 90 CITA and file an amended tax return, the mistake must have resulted in the taxpayer being assessed excessive tax. In the
instant case, excessive tax did not arise because Ardova had self-assessed itself to excess dividend tax and that did not change by virtue of the amended returns. Rather, the amendment sought to mitigate a future tax liability. The Tribunal in ruling, also stated that the filing of amended returns just to reduce the capital allowances claimed was not the mistake envisaged by Section 90(1) CITA.
3. On jurisdiction – The Tribunal held that the FIRS did not present contradicting evidence regarding the date of service of the NORA and in such absence, the Tribunal was left with the discretion to leverage the evidence provided by Ardova in determining that the appeal was filed within time.
Analysis and takeaway
This judgment re-emphasised the WREN principle enshrined in Section 24 which is the guiding principle for tax deductibility. The ruling affirmed that expenses established to have been incurred wholly, reasonably, exclusively and necessarily for the business, irrespective of whether they are within or higher than industry
standards, will be tax deductible.
This however excludes related party transactions where the arm’s length nature of the transaction needs to be demonstrated. The judgment also sets out a judicial precedent regarding the ability of companies to claim capital allowance lower than the maximum percentage (66 2/3%) of assessable profits as prescribed
under the law for all companies (excluding manufacturing and agro-allied companies). Although the TAT’s judgment states that claiming capital allowances below the maximum threshold does not offend CITA, it does not state whether there are any special circumstances under which capital allowances claims cannot be voluntarily restricted. Any company subsequently seeking to rely on the judgment to restrict their claim of capital allowances can do so on a case by case basis.
Another key insight from this judgment is the interpretation given to Section 90(1) of the CITA, which is to the effect that an amended return can only be filed where there has been a mistake or error in the computation and that mistake or error has resulted in the payment of excess tax for the same year. This interpretation leaves some room for further debate as Section 90 of CITA refers to excessive assessment” and not excessive tax payment. It thus begs the question: what exactly makes an assessment excessive? Is it when it results in immediate tax liability? Or can a consequential adverse position for a taxpayer, such as loss of tax assets (tax losses or capital allowance), be deemed to also qualify as an excessive assessment? This point was not addressed by the Tribunal.
In view of the above established precedents, taxpayers are encouraged to carefully evaluate their ability to file amended tax returns by virtue of an error or mistake therein. Also where possible, taxpayers may explore the judgment to restrict their claim of capital allowance and get the FIRS buy-in, if it would be optimal for tax purposes.