After more than a year of being slapped with a huge and what many say is an unjust tax bill last year, Cigarette Company of Jamaica (CCJ) a subsidiary of Carreras Group Ltd only recently learnt what was the basis of the charge. This they discovered only towards the end of the tax appeal hearing held in August. The charge is based on some $8.5 billion paid to the parent company by Cigarette Company of Jamaica, which the tax Authorities claim is subject to tax as a distribution. But the tax body is not relying on the section dealing with distribution to tag the company and instead leaned on section 16 subsection 1 that deals with artificial transactions as the foundation of their claim.
The information on the tax assessment was disclosed by the company last year and is reflected in a note to the audited financial statements but the Investor’s choice is informed that Carreras was sent the shocker in April last year. The note in the financial statements reported that “Cigarette Company of Jamaica Limited, has received income tax assessments in respect of the years 1997 to 2002 from the Commissioner, Taxpayer Audit & Assessment totalling $5,716 million, being income tax of $2,172 million and penalties of $3,544 million.
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assessments, which should therefore be discharged. The Directors are unanimously of the same view. No provision for this amount has been made in the financial statements.
Initial reaction|The initial reaction of the public to the assessment is that the amount on which the tax is based was being treated as a distribution under section 35 of the income tax act. A check on that section suggests that it is unlikely for the company to be caught under this section. In fact a reliable source told the Investor’s Choice that this is not the section that the tax authorities are relying on for the case and in fact they never contemplated using this section. This was further confirmed by another source as well, who indicated that section 16(1) is the applicable section used. Under section 35 see an extract of the section the loan is repaid within five years of the date of advance will not have to pay any taxes under the section if in fact they were taxable. Cigarette Company of Jamaica could only be taxable under the section if Carreras Group the recipient of the funds were a foreign based company and did not get any permission from the Minister of Finance to made the advances. This is a view agreed to by a noted tax practitioner. But this is clearly not the case.
Earlier this year the group put into liquidation all none operating subsidiaries including Cigarette Company which ceased to operate in December last year. This publication understands that the scheme to reorganise the group was determined by the overseas parent from very early in 2003 and the tax authorities were advised that the loans would be repaid, as they would be liquidating the company. Communication between the company and the tax authorities we understand confirms this and the authorities indicated thereafter the amount of transfer tax to be applied in the liquidation at the same time they advised them of the additional income tax assessment.
Inter-group advances cleared|All amounts advanced to the Group Company was cleared by the end of March by a combination of cash payment and a capital distribution of $4.67 billion that was made to the parent company net of transfer tax. The move helped to wipe out $9.7 billion shown as due to subsidiary, at the end of the previous year. At the end of the 2002 fiscal year, the amount owing to subsidiaries amounted to $8.5 billion and climbed further in 2003. The effect is that there is every reason to feel that an additional amount will be taxed based on the additional $1.2 billion advanced up 2003. Under section 35 the worse case scenario if that were the section under which the assessment is applied would remove $4.7 billion from being subject to taxation, the amount advanced to Carreras between 1998 and 2002. It is not clear how the capital distribution on which transfer tax was paid will be treated by the tax body if their claim succeeds.
Section 16 indicates that where the Tax Commissioner is of the opinion that any transaction which reduces or would reduce the amount of tax payable by any person is artificial or fictitious, or that full effect has not in fact been given to any disposition, the commissioner may disregard any such transaction or disposition, and the persons concerned shall be assessable accordingly.
The problem for the tax authorities if they were to succeed at the tax appeal stage is for them to prove a loss of tax revenues, further they are likely need to prove why it is that they allowed the company which is said to have advised the government from 1977 of the arrangement between the group companies to ensure compliance with foreign exchange controls that they never considered the advances then distributions.
Tax neutral|The funds transferred to the parent company does not affect the net tax position of the group as income earned on the funds by Carreras Group Ltd is taxed at standard tax rate putting the government in no worse a position than if the funds were in the hands of the subsidiaries. It is difficult to see the Government getting away with the taxing of CCJ for the funds advanced and not allowing Carreras Group Ltd to benefit from the an imputed expense. The other factor is that our understanding is that the Carreras Group never charged royalties and only recently, management fees which it could have charged to CCJ well within the norms of business practise.
The problem seems more complicated thought. If the Commissioner is claiming that Carreras transfer the funds to allow the parent company to earn income in its own right without adequately compensating CCJ thus allowing them to pay dividends to shareholders without further tax deductions, the group will need to prove that the government is not short changed with what was done, otherwise it appears difficult that the commissioner will be convinced that the move was not one of tax avoidance. The courts may well take another view entirely. But Carreras during the period of assessment made payment of dividends that were taxed in the main at the official tax rate hence the amount of taxes lost by the government from the group is at worse be minimized and at best left the government in no worse position than they currently are in. In fact this publication understands that the tax position for the group was essentially tax neutral.
Carreras Group’s executives indicated that they were unsure what exactly it is that they are being taxed for? Both the company and the tax authorities agreed that this was the case but that it now clear with the Tax Appeal hearing now completed. Reports are that the tax collection agency is very confident that they have an excellent case against the group, but it is also the view of the body that they see the reorganisation of the group this year as an attempt to avoid the liability. If so this appears less than fair not only from the stand point that group apparently took the decision before the assessment, but importantly that the Group has very good reasons to proceed to flatten the organisation. For one, the group now only operates a hotel and the cigarette production unlike previous years when they also owned and operated the Biscuit Company of Jamaica, Graphic Arts, Agricultural Products of Jamaica. The group faced a major problem with the inability to get to the profits of CCJ without paying additional taxes on any distribution that the company may have paid. With a bulging pocket filled with cash and needing no more as the operations continually threw off annual surplus cash, the Group company was constrained in how much it could pay to shareholders. In such a scenario, CCJ was a costly appendage to keep and worse a big irritant. The company took the logical approach to liquidate the unneeded subsidiaries cutting cost in the process and simply the operations as the group now operates out of one office at the factory site in Spanish Town except for San Souci which is located in Ocho Rios. The situation has only become relevant since government started to reduce the tax on dividends paid by listed companies. Before that dividends paid would be subject to tax but recoverable by the recipient or treated as prepaid taxes.
What now seems clear is that the tax is based on the distribution and not the interest that the funds could have earned. The problem for the tax authorities is that section 35 covers distributions relating to loans made to a corporation and not section 16. But one pleading is that Carreras low dividend payment amounted to a scheme to avoid tax. But that seems to hold no water, as the group is one of the highest dividend payers of all the stock exchange listed companies with only BNS and Cable & Wireless consistently paying out more profits than they.
The tax staffers have virtually been gagged and making little or no comments on the matter. The Investor’s Choice gleaned that if they succeed in winning the matter then Carreras Group would face an additional charge for 2003. Quite likely 2004 could well suffer the same fate. By liquidating CCJ the group has limited the liability as the subsidiary now has just about $5 billion in assets to play with and any interest that may be accrued thereon.
Wide Implications| Corporate Jamaica needs to take a very close look at this one as it has wide ranging implications for a wide cross section of companies operating in the country. It has always been accepted that companies within a group can lend to each other without interest being charged. More importantly, it is the accepted practise worldwide that the parent of Group is the one with the responsibility for treasury functions without worrying about taxes being applied to the amounts advanced. But this case is turning all of this on its head. But it appears that it is not just the matter of a loan to the parent that was at stake at Carreras but the amount of funds involved that attracted the authorities. The issue places the country in a bad light as it sends a message to the world that the country is not principled. And yet it goes well beyond this. If carried to its fullest, a lot of companies could find that they are slapped with taxes and may well face bankruptcy. Far worse than all of this, is that investors could take their assets over seas where it is not only welcomed but the rules are clear and applied consistently.
The Tax Appeal commissioner heard the presentation of both parties and is expected to hands down his decision by October or early November. The position as we understand it is that CCJ can appeal the decision but this is apparently not the case of the tax commissioner.
The entire matter has made a number of persons uneasy, including the auditors. Efforts are being made to get the Minister of Finance to actively intervene in the matter. The minister can intervene under the Income Tax Act the Investor’s Choice was reliably informed. Not all in the tax practise field thrilled with the move to get the Minister involved but it is unclear that he will. In fact the Minister was informally told that the tax assessment was a bad move shortly after the assessment was raised but it appears that nothing have happened. It is unclear if the Minister could possibly intervene at this late stage with the appeal process in place as it would set a bad precedent.
The group’s reorganisation and the capital distribution made to the local parent, places the group in a position to make a major dividend payment, however, the tax assessment is likely to delay any major move in this direction until after the matter is cleared up.
Investors hit with the news seems to have factored in the worse outcome for the company and marked the stock down with a spate of sell off. While the stock made headway earlier this year in the big market move up to April the stock has since fallen sharply on the back of lower than expected profits caused in some part by increased cost and additional tax flowing from the proposed distribution of revenue reserves of Cigarette Company. At the present price the stock offers double-digit dividend returns.
Note. The above article was published by the Investors’ Choice in 2004
