Section 24C of the Income Tax Act, No. 58 of 1962 (“Act”) provides for an allowance in relation to moneys received upfront in terms of a contract where expenditure will be incurred at a future stage.
More specifically, the section applies if the income of any taxpayer in any year of assessment includes or consists of an amount received by or accrued to him in terms of any contract, and the Commissioner is satisfied that such amount will be utilised in whole or in part to finance future expenditure which will be incurred by the taxpayer in the performance of his obligations under such contract. In these circumstances, the taxpayer is entitled to deduct an allowance in the determination of his taxable income for the relevant year of assessment. The allowance may not exceed the amount received and must relate to the future expenditure to be incurred. The amount of the allowance claimed in any year of assessment is deemed to be income in the following year of assessment.
For purposes of section 24C of the Act, “future expenditure” in relation to any year of assessment is defined as an amount of expenditure which the Commissioner is satisfied will be incurred after the end of such year – (a) in such a manner that such amount will be allowed as a deduction from income in a subsequent year of assessment, or (b) in respect of the acquisition of any asset in respect of which any deduction will be admissible under the provisions of the Act.
In practical terms, the effect is that the amount of the expenses to be incurred in the following tax year could be deducted from related taxable income of the present year and held over to the following year (when it would effectively be cancelled out by the incurring of the said expenses).
The legislation is supported by an Interpretation Note issued by the South African Revenue Service (“SARS”) on 29 July 2014, Interpretation Note 78 (“IN”).
Although originally aimed at the construction industry, section 24C may find application in a number of instances, and many South African companies have made use of this allowance. One has applied it to the income derived applying its loyalty programme (allowing customers to redeem their points for free or reduced purchases later). Another has applied it to the income earned from restaurant patrons and the expenses for restaurant upkeep required by their franchise agreement. Other possible applications could include products that are sold subject to a warranty agreement.
These two companies have found themselves at odds with SARS over the applicability of the section to their business operations, and have fought through the court system right to our highest courts. The issue in dispute in both cases revolved around the requirement that the income claimed as an allowance should arise from the contract that obliged the future expenditure.
The Constitutional Court has found that it is a requirement of section 24C that the contract in terms of which the income that is to finance future expenditure is received or accrued, must be the same contract under which the expenditure is incurred. Therefore, there is a requirement of “sameness”. However, the sameness requirement does not connote that there must, for example, in the case of a written contract, be one piece of paper stipulating for the earning of income and the imposition of future expenditure. The Court held that two or more contracts may be so inextricably linked that they may satisfy this requirement.
Time will tell which of these applications will hold water. For now, caution should be exercised in cases where the future expenditure is required from a contract that is different to, or not inextricably linked to, the contract in terms of which the relevant income is received or accrued.
Liesl Kruger
Liesl has a BComm, BComm (Hons), LLB and LLM and was admitted as an advocate in 2000. She specialises in tax work, having performed such work at Deloitte and KPMG, and as a director at Cliffe Dekker Hofmeyr and ENS. She joined Caveat in 2019.