Enjoy now – pay later – Managing your tax liability

In the previous article we dealt with the tax arbitrage opportunities presented by increases or decreases in the corporate tax rate with regards to expenditure. In this article we explore the opportunities relating to income received in advance.

Introduction

In his 2022 budget speech the Minister of Finance announced that the corporate tax rate will be reduced by 1% in the future.

We can state with reasonable confidence that a taxpayer would prefer to pay income tax at a lower rate than at a higher rate. A taxpayer should therefore explore opportunities to avoid the accrual of income in a higher tax rate year of assessment and defer the accrual to years of assessment with a lower rate.

This article deals with some of the requirements of section 24C of the income tax act which effectively allows for amounts to be taxed in future tax periods. In the next article we shall deal with how the principles are applied to specific transactions.

The general principles

As a general principle, income is taxable in the year of assessment that an amount is received or in which an amount accrues to a taxpayer, whichever event takes place first.

In practice income and expenditure to generate a specific income stream are generally closely linked resulting in profits being realised and taxed in a single year of assessment. Challenges arise in circumstances where amounts are received and taxed in advance and expenses will only be incurred in the future.

This challenge is largely overcome by the requirements of section 24C. The application of section 24C is however limited to specific circumstances and cannot be assumed to be applicable to all advance receipts.

This article deals with the basic requirements of section 24C. In the next article we shall deal with specific applications.

Section 24C of the Income Tax Act

Section 24C is a relatively short section essentially determining that a taxpayer who has received an amount in advance and is required to incur expenditure in the future in relation to the income received, may make a deduction in respect of such future expenditure against the advance receipt.

While the above may seem simple and straightforward, the devil is definitely in the detail in this case.

Don’t forget that the onus is on the taxpayer to prove that it is entitled to a deduction. The taxpayer is therefore on the back foot before the fight begins. SARS’ interpretation of the relevant principles are contained in a lengthy and complex interpretation note (IN78). The length and complexity of the interpretation note give an advance warning that applying this section in practice is never going to be a walk in the park.

The stumbling blocks

Is there a contract?

Section 24C requires that the amount received in advance must be received in terms of a contract and the future expenditure must also be incurred in respect of a contractual obligation.

The Law of Contracts allows for contracts either be in writing or not. SARS indicates in the IN that it agrees with this interpretation and that a contract does not need to be in writing. However, if the contract is not in writing, the onus of proving that the contract exists may be challenging to dispose of. Best practice when anticipating claiming a deduction in terms of section 24C is therefore to ensure that the contract is in writing.

Will there be future expenditure?

The commissioner must be satisfied that there will be future expenditure, that it will be incurred in a subsequent year of assessment, and that the expenditure will be incurred in performing the taxpayer’s obligations under the contract.

The IN stresses that the obligation must be in terms of the contract between the contracting parties. There must therefore be a contractual obligation to incur expenditure although the expenditure will only be incurred in future years of assessment.

The expenditure must furthermore be of such a nature that it would qualify in future years of assessment as deductible expenditure based on normal tax rules. When it comes to capital expenditure, the nature of the expenditure must be such that it would qualify for capital allowances provided for in the income tax act.

Merry-go-round

Any allowance allowed by the Commissioner for SARS in any year of assessment must be reversed in the subsequent year of assessment and be replaced by a new computation.

Conclusion

The above explains the basic requirements to claim a section 24C allowance. In the next article we shall deal with specific transactions to demonstrate how the principles are applied in practice. The learning from this article is that the devil is in the detail, and that the detail must be in the contract.