Ensuring that a taxpayer does not pay a single cent more tax than is legally required is a critical part of good corporate governance. Saving tax should however never be divorced from sensible commercial considerations. Never cut your nose to spite SARS. In this and the next few articles we shall deal with basic planning techniques without losing focus on what the business is about.
Taxpayers are often so obsessed with reducing the amount of income tax payable that they commit the cardinal tax sin of losing focus of what the business is actually about; making sound commercial decisions to create value for shareholders and other stakeholders.
In this article we explore the impact of paying expenses in advance to accelerate a deduction for income tax purposes.
Not always a good idea …
The basic principles
Expenses are deductible in the year of assessment that it is actually incurred. Actually incurred would normally include expenditure actually paid for during a year of assessment.
Where the benefit of goods or services acquired will only come to fruition in years of assessment subsequent to the year of assessment in which it was actually paid, the expenses would normally be reflected as prepaid expenses in the balance sheet of the taxpayer and would be claimed as an income tax deduction in the year of assessment that it was actually paid.
Then came section 23H of the Income Tax Act in 2000 …
The (not so) new rules
The rules contained in section 23H of the Income Tax Act link the payment for goods and services to the actual time that the goods or services are physically supplied or rendered. In short, the cheque-book (for those that still know what a cheque-book is) no longer determines the year of assessment in which a deduction can be made.
Where payments are made for goods or services partially supplied before and partially after the end of any year of assessment, an apportionment on a time or other reasonable basis must be done to determine in which tax period the deductions may be made.
The above essentially means that the accounting convention is aligned with the tax treatment of payments in advance.
Is there a get-out-of-jail-free card?
In fact, there are four get-out-of-jail-free cards.
If the goods or services will be supplied or rendered within six months after the end of the year of assessment in which payment for the goods or services is made, a full deduction may be claimed in the year of assessment that the payment is made.
You can also dodge jail if the total amount of pre-paid expenditure at the end of a year of assessment does not exceed R100 000.
The rules furthermore do not apply to interest-rate agreements and option contracts. This is however only a reprieve from jail as there are specific rules that apply to these categories of arrangements that must be considered.
The last card up your sleeve is where the payment relates to an unconditional liability to make a payment in terms of legislation. An example of this would be where property taxes have to be paid yearly in advance.
So where is the planning opportunity?
First and foremost, one should ensure that where prepaid expenditure has been incurred, the income tax deduction is maximised.
The above is done by firstly enquiring whether any apportionment is necessary i.e. whether you have one of the get-out-of-jail cards up your sleeve. If you have no cards to play, ensure that the formula to apportion the amounts between years of assessment is the most beneficial to maximise the income tax deduction.
Where does the commercial considerations come in?
Anybody that knows the song “Don’t pay the ferry man [until he gets you to the other side]” will know that this is excellent advice by Chris de Burgh.
Unless there is a significant benefit in paying amounts in advance, for example better rates, prices, last orders, etc. it normally makes no sense to pay amounts in advance. To simply pay amount in advance to obtain an earlier income tax deduction normally makes no sense at all.
In good old consulting terms; each case must be considered based on its own facts and merits.
This article deals with the issue of prepaid expenditure at a high level. Hopefully it provides you with some insight and a reminder of the existence of the prepaid rules in the Income Tax Act and the potential impact it could have on your organisation.
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