Section 24C – Managing your tax liability – Enjoy now – pay later…

In the previous article we dealt with the general circumstances under which income tax on advance receipts can be deferred to subsequent years of assessment in terms of section 24C of the Income Tax Act. As promised, this article deals with some of the practical challenges presented by section 24C in practice.

Introduction

There are numerous issues that a taxpayer must consider establishing whether it is entitled to a section 24C allowance. Certain of these considerations may appear straightforward at first glance, but don’t lose sight of the ancient wisdom reminding us that appearances can often be deceiving.

The matters that we emphasise in this article serve to stress the importance of carefully considering the facts and contractual rights and obligations of each case before a final conclusion is reached.

So let’s dive in …

Contractual obligation to incur future expenditure

Before a taxpayer is entitled to a section 24C allowance against an amount received in advance, the taxpayer must have a legal/contractual obligation to incur future expenditure against the advance receipt.

The good news is that a taxpayer needs not have contracted with any third party for the incurral of the expenditure. If the original contract in terms of which the advance payment was made provides that future expenditure must be incurred, the requirement of section 24C will be met.

The easy hurdle …

Future expenditure must be deductible for income tax purposes

The expenditure that must be incurred in the future must be of such a nature that it will be deductible in terms of normal income tax rules.

For normal operating expenditure the above test is quite straightforward. However, when it comes to capital goods the rules should be carefully considered.

Where an obligation exists to incur future costs on the acquisition of capital goods specifically relating to the advance receipt, the full amount to be expended on the capital goods may be included in the section 24C deduction if the relevant capital goods have not yet been acquired at the end of the year of assessment in which the advance payment has been received.

Once the capital goods have been acquired, the normal capital allowances must be claimed against the cost of the capital goods and the goods can no longer be taken into consideration for the purposes of quantifying any future section 24C allowance. This is on the basis that no further future costs will be incurred.

Ceded contracts

And this is where it really gets messy …

If a taxpayer is in the process of ceding a contract in respect of which the taxpayer has received an upfront payment to a third person and as a result of the cessation the obligation to incur future expenditure will be transferred to the third person, the taxpayer will no longer have an obligation to incur future expenditure and section 24C will not apply to the amount received in advance.

The person that acquires the contract will also not be entitled to any section 24C relief as it will not have an obligation to incur future expenditure against an amount received in advance.

Talk about shooting yourself in both feet!

Warranties

Generally speaking, section 24C does not apply to amounts received in respect of goods subject to a warranty. This is on the basis that there is no legal obligation to incur future expenditure, but only a contingent uncertain future liability.

The criteria for the deduction furthermore fall short on the basis that it is often not possible to demonstrate which portion of the purchase price relates to the future warranty.

A minefield indeed …

Maintenance contracts

Maintenance contracts must be carefully considered to determine whether there an amount has been received in advance and whether a contractual liability exists to incur future expenditure against that amount.

In practice SARS allows a section 24C allowance against a motor vehicle maintenance plan on the basis that the expenditure is generally incurred on a regular and continuous basis and is not in that sense wholly contingent on an uncertain future event.

The above can however not be considered an umbrella rule fitting all sizes. Each case must be considered on its own facts and merits and an informed decision made accordingly.

Conclusion

While section 24C ensures some level of tax neutrality and equity, the application of the section is limited and should be considered prudently and carefully to ensure that all blocks are ticked.