Page 669 - SAIT Compendium 2016 Volume2

IN 78 Income Tax acT: InTeRPReTaTIon noTes IN 78
The court considered whether warranty claims may be deducted under section 24C in ITC 1601.* The salient facts of the case were that the taxpayer concerned sold computers and measuring instruments. The taxpayer also provided the services of programming and setting up the hardware and instruments to the clients’ requirements. The contracts with the clients contained a warranty against defective workmanship and materials supplied. In addition, all manufactured goods contained a manufacturer’s warranty. A warranty claim arose on almost all contracts because of the technical nature of the work. The taxpayer’s claim for an allowance for future expenditure was disallowed by the Commissioner. The court held that in considering the facts before him, the Commissioner was entitled to come to the conclusion that he was not satis ed that future expenditure would be incurred. The court also held that on the facts of the particular case the Commissioner was entitled to come to the conclusion that he could not be satis ed that future expenditure will be incurred when a contingent liability is recoverable or partly recoverable under a guarantee.
In ITC 1739† the taxpayer manufactured certain components which were supplied to original equipment manufacturers that in turn manufactured and supplied vehicles to distributors and dealers. The vehicles were sold subject to a warranty. In the event of a warranty claim the taxpayer would supply the parts required and the distributor or dealer would perform the necessary repairs. The court held that the taxpayer was not entitled to claim an allowance for future parts that it may have to supply under the warranty obligation. The cost of the parts did not constitute future expenditure, it constituted losses incurred on supplying trading stock as replacement for the defective parts. The court explained the position as follows:‡
‘In terms of the section the Commissioner must be satis ed that the income or revenue will be used in whole or in part to nance future expenditure (as distinct from losses) which will be incurred by the taxpayer in the performance of his obligations under the contract before the allowance will be deducted. See ITC 1527 54 SATC 227 on 236.
Regard being had to the facts alluded to above in the present matter the appellant meets warranty claims made on it. In doing so it incurs losses in supplying parts from its trading stock in replacement of defective parts. For an allowance to be granted in terms of s 24C income must be received or accrued in the current year of assessment, which will be used to nance future expenditure.’
In the event of a warranty claim the facts of a particular case will determine whether the taxpayer –
• will use assets already purchased and on hand at the end of the year of assessment and will thus not incur future
expenditure; or
• would have to acquire the replacement asset and would thus incur future expenditure.
A section 24C allowance is not available in either situation because the event which potentially gives rise to the warranty claim (for example, the equipment malfunctioning because of a defect in labour or materials) is contingent and is not only dependent on the customer returning the item.§ The asset purchased by the taxpayer’s customer may or may not malfunction which means that there is insuf cient certainty that the related warranty expenditure will be incurred in the future.
4.2.6 Application of section 24C to maintenance contracts
It is not possible to formulate a general rule for the treatment of maintenance obligations under section 24C. The availability of a section 24C allowance will depend on whether the taxpayer’s obligations to perform are contingent on something other than just the client making the asset available for maintenance. In the result it must be established whether there is suf cient certainty to satisfy the Commissioner that expenditure will be incurred in the future. Each case must be determined on its own facts and circumstances.
For example, some contracts contain provisions for after-sales maintenance under which the maintenance will only be required if something breaks or malfunctions. In these circumstances the Commissioner will not be satis ed that the expenditure will be incurred in the future.
There are, however, circumstances in which the Commissioner will be satis ed that the expenditure will be incurred in the future, for example, in the case of a motor vehicle service plan under which certain maintenance must be performed at regular intervals (assuming the client makes its motor vehicle available for the service to take place). Such maintenance expenditure may qualify for a deduction under section 24C provided the other requirements of the section are met. The onus to satisfy the Commissioner that expenditure will be incurred in the future is on the taxpayer.
Example 3 – Maintenance contracts
Facts:
X runs a car service business from home. Business was slow and in an attempt to increase revenue X sold ‘Car health check and maintenance packages’. The price was payable upfront and the package was valid for a period of six months after purchase. At the end of the year of assessment X had sold 10 packages which had not yet been used and had not expired. Under the package, X will –
i) replace the oil;
ii) check and, if necessary, replace the brake pads, and
iii) wash the car.
X was able to reliably estimate the costs which will be incurred based on experience of the time the different tasks will take and the latest prices (which are not expected to change) for the labour and materials.
* (1995) 58 SATC 172 (C).
† (2002) 65 SATC 43 (G).
‡ At SATC 46.
§ In addition, there is no future expenditure if a taxpayer uses assets already purchased and on hand.
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