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Audit Fees Are Automatically Deductible—Right?

27 December 2010   (0 Comments)
Posted by: Author: Steven Jones
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Audit Fees Are Automatically Deductible—Right?

Not necessarily – it depends on a number of factors, including what’s being audited

You don’t need to be a tax expert to have a list of "automatically-deductible” items in the back of your mind, and for many people, audit fees will appear on most such lists.So imagine the shock experienced by this particular taxpayer when they found out that SARS had in fact disallowed the bulk of their claim for audit fees.

In this particular case (number 12 401) heard by the Gauteng South Tax Court earlier this year, the taxpayer concerned had claimed,over a period of four tax years(2001 – 2004), audit fees totalling R1 674 932, as well as consulting fees amounting to R878 142. SARS had disallowed 95% of the audit fees and 100% of the consulting fees.

Reasons for disallowing the audit fees

The taxpayer concerned received its revenue from dividends and interest.For tax purposes, virtually all revenue received falls under the definition of "gross income” as contained in the Income Tax Act. However, the determination of taxable income is based on gross income, less exempt income, less deductions.

Since dividends are exempt from tax, such revenue falls under "gross income” for tax purposes but, by virtue of the exemption of dividends, not under "income”. As a result, the argument advanced by SARS in disallowing the audit fees was that, in terms of Section 23(f), deductions are prohibited in respect of "any expenses incurred in respect of any amounts received or accrued which do not constitute income as defined in Section 1”.

Arguing firstly on the basis of the facts of Port Elizabeth Tramway Co Ltd v CIR, 1936 CPD generating operations. While the court conceded in favour of the taxpayer on the issue of the expense being part of the taxpayer’s trade, it was on the second point that the pendulum swung in SARS’ favour. While a number of cases were cited, it was held in Nchanga Consolidated Copper Mines Ltd v Commissioner of Taxes, 1962 (1) SA 381 (FC)that, as a starting point to determine whether the nature of a particular expense is capital or revenue in nature, it would be "proper first to try to determine whether, according to the true nature of the expenditure, it was made as part of the cost of performing the income earning operations or as part of the cost of the income earning machine or structure”.

According to evidence submitted to the court by the taxpayer, "[the Hyperion] system was introduced … in 2004 tax year in order to effectively capture,record and index certain aspects related to its financial affairs, and which system assists it in the conduct of its business, and which system aids also in the consolidation of its financial results and the reporting of its results to other companies within the XYZ Group”.

Based on this evidence, the court held that the taxpayer obtained an enduring benefit from the implementation of the Hyperion system, and that the cost of installing and configuring such system was part of the taxpayer’s "income earning structure” and could not be seen as "part of the cost of performing the income earning operations”. The court thus upheld SARS’ decision to disallow the consulting fees on the basis that such fees represent an expense of a capital nature.

Source: By Steven Jones (Tax breaks)


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