Winning Idols Is A Taxing Affair
12 November 2012
Posted by: Author: Sophia Brink
Winning Idols Is A Taxing Affair
On 2 October 2012, South Africa’s eighth Idols winner was announced,winning prizes worth R1 000 000 (including R500 000 in cash, a car and a recording deal with Universal Music SA). Almost three million South Africans voted and Kaya Mthethwa was crowned the winner of the singing competition.
The question arises whether this prize received by Mthethwa may be subject to normal income tax. The ‘gross income’ definition in the Income Tax Act No. 58 of 1962 (the Act) includes a general inclusion definition as well as specific inclusions (as set out in paragraph (a) - (n)).
The basis for the levying of normal income tax lies in the definition of ‘gross income’ in section 1 of the Act. The definition reads as follows:"Gross income, in relation to any year or period of assessment, means –
• in the case of any resident, the total amount,in cash or otherwise, received by or accrued to or in favour of such resident … during such year or period of assessment, excluding receipts or accruals of a capital nature...”
Normal income tax can be levied only if all the requirements of the definition are met. The prizes received by Mthethwa will meet the first three requirements, i.e. total amount, in cash or otherwise, received by or accrued to. Uncertainty exists about whether or not the prize received is of a capital nature.
The general rule is that any prize or winnings are capital in nature and therefore excluded from a taxpayer’s gross income. The example most commonly used is proceeds from gambling activities. When gambling activities are undertaken as a means of entertainment or hobby, the proceeds are capital in nature and not taxable. If gambling activities are systematically undertaken, to the extent that they become a business or scheme of profit-making, all the proceeds are income in nature. Amounts derived by a professional gambler or a racehorse owner are therefore subject to normal income tax where betting is a regular practice.
Similarities Between A Gambler And An Idols Contestant
Although entering the Idols competition differs in so many ways from gambling, there seems to be some similarities from a tax perspective.When a person is not a professional gambler,gambling activities will be undertaken as a means of entertainment or as a hobby,compared to a professional gambler who would probably have certain strategies, be very serious about each bet and have a lot of experience. If an amateur singer enters a karaoke competition for fun, the winnings will be of a capital nature and therefore not taxable. Although Idols is a competition for amateur singers, we can argue that by the time the contestants reach the finals they can be regarded as professionals. Not only do most South Africans know them, but they already have a recorded single, appeared in a television advertisement and have a music video. They are celebrities and have done shows all over the country. Mthethwa may have started out as an amateur but over the past seven months (the duration of the competition), he has certainly become a professional (possibly even more professional than most of the would-be popstars these days). Even if he did not walk away with the title, he would probably still have had a very successful singing career, as is evident from previous seasons’ runners-up (Lloyd Cele,Mark Haze and Andriette Norman).
If a singer should win a music award or if an employee should receive an award for outstanding service, that award (even if it is a lump sum) will be income in nature and therefore taxable. If Mthethwa can be regarded as a professional singer at the time of winning the competition, the winnings will be of an income nature and taxable.
What Does The Term Capital Mean?
Unfortunately the Act contains no definition of the term ‘capital’. From the many conflicting court rulings on the subject,it is obvious that a single infallible test to distinguish between capital and income does not exist. In CIR v Visser it was determined that income is what capital produces, or is something in the nature of interest or fruit as opposed to principal or tree. Whether an amount is capital in nature is a question of fact and several factors must be taken into account in order to determine its nature. The following points should be considered.
The most important test used by the courts in deciding whether a receipt is income or capital in nature is the intention of the taxpayer. The most obvious reason an Idols contestant will enter the competition is to establish a singing career. The cash and recording deal will realise any amateur singer’s dreams.
Frequency of a transaction
The frequency of a transaction may provide a useful guide in distinguishing between income and capital. An isolated or once-off transaction usually indicates a capital nature. An Idols contestant can only win the competition once and therefore it will be a once-off event. A once-off transaction can, however, be of an income nature if a scheme of profit-making is present.
Scheme of profit-making
An example of a scheme of profit-making applicable for this scenario could be a Miss South Africa winner with a long history of entering beauty pageants. If she entered every imaginable beauty pageant since she was five-years old it may indicate a scheme of profit-making and in considering if the Miss SA winnings are taxable, the Commissioner will consider this fact and probably reach the conclusion that the winnings are income in nature and therefore taxable.
Onus Of Proof
Whether or not the winnings are of a capital nature is clearly a grey area and each case must be evaluated on its own merits. In terms of section 82 of the Act, the burden of proof that an amount is of a capital nature rests upon the taxpayer. In order for Mthethwa to escape the tax net in terms of the general gross income definition, he must indicate that a scheme of profit-making was not present and that he cannot be regarded as a professional singer at the time he was awarded the Idols title.
Paragraph (C) Of The Definition Of Gross Income
Although receipts and accruals of a capital nature are in principal expressly excluded from the general gross income definition,they may still be included in gross income in terms of the special inclusions to gross income. Paragraph (c) of the definition of gross income includes in a person’s gross income any amount received or accrued in respect of services rendered or to be rendered including a voluntary award. Even though Mthethwa is not an employee of the Idols competition, he still rendered a service and received an amount based on these services rendered. He entertained the South African public for months and based on his service she received an income. In CIR v Crown Mines Ltd, it was determined that the words "in respect of” means that the income would not have been received had the services not been rendered.There must be a causal relationship between the amount received and the services rendered. Even though an element of chance is present because the results are in the hands of the South African public, in the end he still received the amount based on his performances (services rendered).
If a scheme of profit-making is present and the Idols winner can be regarded as a professional singer the winnings will be taxable in terms of the general gross income definition.A causal relationship exists between the prize received and the services rendered and therefore the amount will fall within the scope of paragraph (c) of the gross income definition. Although the amount may be taxable under the general gross income definition and paragraph (c), the amount cannot be included under both provisions as there is a necessary implication against double taxation.
Other Idols Tax Implication
Shortly after the announcement of Idols winner Elvis Blue, he revealed that he and fellow contestant Lloyd Cele had entered a pact that whoever was named the winner would share the R500 000 cash prize with the runner-up.For tax purposes, Blue won R500 000 and donated R250 000 to Cele. The lump sum received by way of a gift or a donation would have been capital in nature in the hands of Cele and therefore not taxable. Blue would have been liable for donations tax at a rate of 20% after deducting the exemption of R100 000 for donations by a natural person (Section 56(2)(b) of the Act).
Most Idols contestants are between ages 16 and 25 and would therefore in all probability not have paid any taxes before. It is therefore important that prospective contestants are aware of the tax implications associated with the winnings (although this is probably the furthest thing from their minds when entering the competition).
Source: By Sophia Brink (TaxTalk)