Page 670 - SAIT Compendium 2016 Volume2

IN 78 Income Tax acT: InTeRPReTaTIon noTes IN 78
Result:
In order to perform under the contract and to provide the service as agreed, X’s employees must replace the oil, check the brake pads and wash the car. X will incur expenditure for the oil, shampoo and water which will be used and accordingly these amounts will constitute future expenditure. Although X will have to check the brake pads, X does not know whether the brake pads will need to be replaced as that will depend on the condition of the particular car’s brake pads. Accordingly, despite the fact that X has included the cost of replacement brake pads into the budget and that experience and statistical data indicate that X will need to replace the brake pads on some cars, there is insuf cient certainty to satisfy the Commissioner that X will incur future expenditure in relation to the possible replacement cost of brake pads.
5. Determination of the amount of the section 24C allowance
The amount of the section 24C allowance is –
• the amount of future expenditure which in the Commissioner’s opinion relates to the amount of advance income; and • which does not exceed the amount of such income received or accrued in the particular year of assessment.
5.1 The amount of future expenditure which in the Commissioner’s opinion relates to the amount of advance income
The principles as discussed in 4.2 are relevant in determining what amounts constitute future expenditure. A section 24C allowance is not available for the portion of advance income which effectively represents the taxpayer’s pro t or which was used* to fund expenditure that has already been incurred in respect of the contract. The reason being that the Commissioner cannot be satis ed that the advance income will be used to fund future expenditure if it funds pro t or expenses already incurred. Stated differently, taxpayers need to determine and be able to substantiate how much of the future expenditure relates to the advance income which was received or accrued under the relevant contract. For example, assume a taxpayer receives 50% of the contract price in year one and does not incur any expenditure. Although all the costs the taxpayer will incur in the future in performing under the contract are future expenditure, all the costs do not constitute future expenditure which relates to the amount of the advance income. The advance income represents an element of pro t and an element of future expenditure. SARS agrees with the suggestion in Silke† that it is the intention of the recipient and not the payer which is relevant in this regard.
The amount of future expenditure which relates to the advance income will depend on the facts and circumstances of the particular case. The Act does not prescribe the methods which must be used to make this determination. An allocation based on the gross cost percentage will, however, be appropriate in a number of cases. If the ‘gross cost’ method is appropriate, taxpayers will need to –
• estimate the total amount of expenditure which will be incurred in order to meet the obligations under the contract,
remembering that certainty that the expenditure will be incurred in the subsequent year of assessment is a critical factor;
• determine the total amount of income which will be received by or accrued to the taxpayer under the contract;‡
• determine the total amount of income received by or accrued under the contract to date;§
• determine what amount of that future expenditure relates to the amount of income received or accrued to date by
applying the formula listed below; and
limit the amount of the section 24C allowance calculated in terms of the formula above to the amount of income received or accrued under the contract in the particular year of assessment (see 4.1 for income, see 5.2 for more detail on the calculation of the limit).
The gross cost method may not be appropriate in all cases, for example, if the advance income relates solely to a particular stage of a project or to speci c items of expenditure, as agreed between the taxpayer and the client.
Taxpayers must base their determinations of the amount of future expenditure on fair and reasonable estimates which take into account the latest available information. The level of detail required to support the determination will depend on the speci c facts and circumstances. However, as a general guideline, the estimates and calculations must contain suf cient detail to demonstrate that –
• the expenditure included in the calculation results from the future performance of obligations under the contract;
• the expenditure only includes permissible expenditure (for example, excludes wear-and-tear allowances and items
taken from assets previously acquired); and
• the items taken into account can be reviewed and audited.
The section 24C allowance is subject to the discretion of the Commissioner and taxpayers must be prepared to substantiate a claim with supporting evidence.
* Or “will use” if the taxpayer has incurred an unconditional liability but must still settle that liability. † South African Income Tax 2010 in paragraph 8.60.
‡ This does not include the reversal of prior year’s section 24C allowances.
§ This does not include the reversal of prior year’s section 24C allowances.
¶ Excluding the reversal of prior year’s section 24C allowances. ** Section 24C(2).
Section 24C allowance = [(Total costs / Total revenue)* × Income received or accrued to date§] – Actual expenses incurred to date relating to that income
* Limited to 1 (a section 24C allowance is granted on an amount received by or accrued to a taxpayer that will be used to nance future expenditure, accordingly the maximum possible allowance before deducting actual expenses incurred to date or applying the limitation in the point below, is the amount of the income received or accrued to date.¶ This means Total costs / Total revenue is limited to 1).
662 saIT comPendIum oF Tax LegIsLaTIon VoLume 2