Deducting future expenditure, don’t make a meal of it

A taxpayer may deduct an allowance for future expenditure provided that the requirements in section 24C of the Income Tax Act, 1962 are met. In a recent judgment, B v Commissioner for South African Revenue Service (SARS), the Western Cape Tax Court had to decide whether a taxpayer who operated a restaurant chain under a franchise agreement, was entitled to deduct the future expenditure of refurbishing and upgrading its restaurants.

Graeme Palmer

Section 24C applies where a taxpayer, in a year of assessment, has income that is received or accrued to it in terms of a contract, which amount will be utilised in whole or in part to finance future expenditure. The future expenditure should be incurred by the taxpayer under the contract from which he receives the income. In such circumstances, the taxpayer can deduct such future expenditure as an allowance. The allowance deducted is deemed to be income in the following year of assessment.

The franchise agreement required the taxpayer to refurbish the restaurants at reasonable intervals as determined by the franchisor. SARS submitted that, for section 24C to apply, only one contract must exist from which income is earned or received, and from which an obligation is created to incur future expenditure. In the present case, there were two separate legally independent contracts. First, there was the franchise agreement which created the taxpayer’s right to establish and operate the restaurants. Second, there was the contract for the day-to-day sales of meals by the taxpayer to its customers to which the franchisor was not a party. SARS argued that section 24C did not apply, as no income was received by the taxpayer under the franchise agreement and no future expenditure incurred in terms of the sales transactions to customers.

The court held that the taxpayer was obliged to sell meals to its customers and a failure to do so was a material breach of the franchise agreement.  In other words, no sales meant no franchise agreement at the franchisor’s sole election. The franchise agreement intruded into every aspect of the taxpayer generating income and was inextricably linked to the sales of meals to customers.  The court was thus persuaded that the income was earned for purposes of section 24C under the same contract as the taxpayer’s future expenditure was incurred. Therefore, the taxpayer’s appeal succeeded.

This article has been written by Graeme Palmer, a Director in the Commercial Department of Garlicke & Bousfield Inc

NOTE: This information should not be regarded as legal advice and is merely provided for information purposes on various aspects of tax law.

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