A taxpayer’s obligation as an upstanding citizen of a country is to pay all tax that is legally payable within the period that a tax act provides for. This implies that there is no obligation on a taxpayer to pay more tax than is legally payable or to pay tax earlier than when payment is legally due. Where a taxpayer has prior knowledge of future increases or decreases in the tax rate, it creates potential opportunities for tax arbitrage. In this article we deal with the potential opportunities presented by prepaid expenditure.
In his 2022 budget speech the Minister of Finance announced that the corporate tax rate will be reduced by 1% in the future.
This being the case, taxpayers should consider whether the accrual of any income can be deferred to years of assessments when the lower tax rate will apply, and expenses claimed in years of assessments where the higher tax rate is still applicable.
No this is not tax evasion – it is proper tax planning …
In this article we shall deal with prepaid expenditure and the year of assessment in which it is deductible.
The general principles
As a general principle an expense is regarded as having been incurred once it has been paid by a taxpayer. The expense would qualify to be deducted in the year of assessment that it is paid notwithstanding the fact that the benefit of the cost will only materialise in future years of assessment.
To utilise the opportunity that future reduced tax rates offer, a taxpayer could make a pre-payment of expenses in a year of assessment if it has prior knowledge that the tax rate will decrease in the future and deduct the expense in a year of assessment when the higher tax rate applies. Excellent tax planning!! But as we all know appearances can be deceiving …
Then enter section 23H …
Section 23H of the Income Tax Act effectively limits the amount of the deduction in respect of expenses that have been pre-paid to the extent that the taxpayer benefits from the expense in each respective year of assessment.
It achieves the above by limiting expenses incurred for the supply of goods to the extent that those goods have been supplied in a specific year of assessment.
When it comes to services it limits the deduction to the extent that the services have been physically supplied or rendered in a particular year of assessment.
The section also refers to any other benefits where the benefits are enjoyed in a year of assessment other than the year of the assessment in which the payment for the benefits has been made.
The above effectively means that the deduction for income tax purposes is limited to the extent to which the taxpayer benefits from the goods or services in a particular tax year of assessment irrespective of when payment for the goods or services was made.
But the back door is still slightly open …
Get out of jail free cards …
Section 23H contains certain exceptions where expenses may be claimed in full in the year of assessment that payment is made notwithstanding the fact that some of the benefits may only be enjoyed by the taxpayer in future years of assessment.
Where the benefit of expenses will be enjoyed within six months after the end of a taxpayer’s year of assessment, Section 23H will not apply and a full deduction may be claimed in the year of assessment that the payment is made.
The section also does not apply to prepaid expenses if the total of all prepaid expenses does not exceed R100 000 in a year of assessment. The section furthermore does not apply to expenditure in respect of which any unconditional liability exist to pay an amount imposed by legislation, as well as certain financial arrangements.
What if a taxpayer never receives the goods or services?
Where the taxpayer can prove to SARS that it will not receive any future benefits from the payments, the deduction may be made in the year of assessment in which the payments were made. This will be in circumstances where suppliers cannot perform against their contractual obligations.
It remains a taxpayer’s obligation to ensure that tax is not paid prematurely, and deductions are made in the correct year of assessment. Where arbitrage opportunities present themselves from time to time, careful consideration should be given to the impact of the opportunity and how it can best be utilised to minimise a taxpayer’s tax liability within the sphere of the law.
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