Page 674 - SAIT Compendium 2016 Volume2

IN 78 Income Tax acT: InTeRPReTaTIon noTes IN 78 apply to transactions that have taken place, the reversal of the allowance claimed in the previous year of assessment may
take place in another taxpayer’s hands.*
7. Other
7.1 Analysis on a contract-by-contract basis
The analysis required under section 24C must generally be performed on an individual contract-by-contract basis and an allowance will only be permitted if the Commissioner is satis ed that the income received or accrued under a contract will be used to fully or partly nance the future expenditure which will be incurred as a result of performing under that same contract.†
Example 9 – Contract-by-contract basis
Facts:
In year 1 DEF concluded two contracts to build holiday homes. Contract A – DEF received a payment equal to 60% of the contract price of R1 000 000, total costs are estimated to be R700 000, building had not yet commenced and no costs had been incurred.
Contract B – DEF received a payment equal to 50% of the contract price of R700 000, total costs were originally estimated to be R600 000, however, DEF now estimates that the total expenditure will be R750 000 because subsequent to signing the contract there was a signi cant increase in the cost of raw materials and DEF discovered a costing error in its estimation methodology.
Result:
DEF must consider the two contracts separately when calculating the section 24C allowance. Contract A’s section 24C allowance = R700 000 / R1 000 000 × R600 000
= R420 000
Contract B’s section 24C allowance = (R750 000 / R700 000)* × R350 000
= R350 000
* = Limited to 1
Section 24C considers how much of the advance income will be used to wholly or partly nance the future expenditure that will be incurred in meeting the taxpayer’s performance obligations under that contract. Accordingly, the amount of the allowance can never exceed the amount of income and the cost percentage is therefore limited to 100%.
In some situations it may be very dif cult to analyse the future expenditure and link it to a particular contract. There is an obligation to perform under the particular contract and accordingly incur expenditure, however, there may be practical dif culties associated with being able to analyse the expenditure in suf cient detail to be able to link it to a particular contract. In these situations, if the contracts are similar and the taxpayer has the same obligations to perform under those contracts then, when calculating future expenditure, the contracts may be grouped together and the taxpayer may combine the advance income and expenditure. In contrast, in a contract to construct a building it is often practical, meaningful, realistic and necessary to analyse the contracts on an individual contract-by-contract basis and if, for example, a particular machine will be purchased and used on more than one contract, to allocate the cost of that machine to the various contracts based on the estimated hours of use, if appropriate. The machine in this example is one which is required for particular contracts and is not the replacement of an asset generally used in the business. This treatment appropriately takes account of the fact that building contracts are often not similar and have different obligations, revenue and cost pro les. It is critical that, even when contracts are grouped, each contract must contain unconditional obligations for the taxpayer to perform and the Commissioner must be satis ed that in performing those obligations the taxpayer will incur future expenditure. The principle being raised is that in determining the amount of future expenditure and the amount which the Commissioner will be satis ed will be funded by the advance income, it may be appropriate to perform the analysis at a higher level by taking a number of contracts into consideration. It is not possible to be prescriptive on the exact circumstances in which it will and will not be acceptable to take this approach – taxpayers will need to consider the particular facts and circumstances. Typically the appropriate circumstances arise when the business enters into multiple contracts on an almost daily basis that are similar in scope and nature with the same or similar performance obligations, revenue pro les and cost pro les. For example, it may be appropriate to group the following contracts together:
• Advance subscriptions for a particular magazine; or
• A transport business that sells bus tickets or air tickets in advance.
In these circumstances, it may be reasonable to use the taxpayer’s overall gross pro t percentage to calculate the section 24C allowance for contracts which have been grouped together. However, the particular contract must be considered because it may be appropriate and necessary to apply a more speci c gross pro t percentage, for example, the gross pro t percentage of a particular department. The gross pro t percentage calculation would also have to be reviewed to assess whether any costs or income must be excluded. For example, depreciation (represents past expenditure), nancing costs (often not included in gross pro t but the particular calculation needs to be considered), and items which have already been purchased and will be drawn from trading stock on hand at the end of the year of assessment, would need to be excluded. In addition, known or anticipated price increases and decreases should be taken into account.
* See sections 41 to 47 for details.
† ITC 1667 (1999) 61 SATC 439 (C); ITC 1697 (1999) 63 SATC 146 (N) and ITC 1527 (1991) 54 SATC 227 (T).
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