23 January 2011
Posted by: Author: Wounter Scholtz
Are they tax-deductible?
Are Share-Based payments made by companies for goods or services deductible? Does this represent "expenditure actually incurred” for income tax purposes? Traditionally, SARS allowed companies a deduction equal to the nominal value of the shares issued to pay for assets or services.
However, in recent years SARS has changed its stance and begun to deny such claims on the basis that the issue of such shares does not constitute "expenditure actually incurred” for income tax purposes. The question we therefore need to ask is whether or not a company that makes a share-based payment is allowed to claim a deduction for such payment for income tax purposes.
One of the requirements of Section 11(a) of the Income Tax Act is that the taxpayer must have "actually incurred” expenditure. If this requirement is not met, it is clear that the expenditure will not be deductible.
There are tax case law principles to determine whether an expense has been "actually incurred”. If the outcomes of relevant case law regarding "actually incurred” are followed, share-based payments for services are deductible if the taxpayer incurs an unconditional legal liability in regard to the expenditure.
The following two reported South African tax cases address the issue of share-based payments: ITC 1783 (2004) 66 SATC 373, andITC1801 (2006) 68 SATC 57.In ITC 1783 the Income Tax Court concluded that "when a company is obliged to allot shares in return for services rendered to it, there is no laying out or expending of any moneys or assets which, it is submitted, is an essential requisite of the words ‘expenditure actually incurred’ in Section 11(a)”.
On the contrary, it was concluded in ITC 1801 that "the expression ‘expenditure actually incurred’ means...that the taxpayer should have incurred a nun conditional legal obligation in respect of the amount concerned. It is not required that the obligation should also be discharged”, and that "where the obligation has been incurred, the expenditure becomes deductible…”.
In other words, if a taxpayer incurred a liability to pay an amount, that amount would have been ‘actually incurred’, notwithstanding that the obligation to pay was subsequently settled by an issue of shares. However, as the above cases were Income Tax Court cases, they were not binding on the High Court.
The insertion of Section 24B into the Act provided some clarification in regard to share based payments for assets. The law, however, was still unclear regarding shared-based payments for services until the recent High Court decision in C: SARS v Labat Africa Ltd [72 SATC 75], where more light was shed on the matter.
The Labat case concerned a taxpayer who purchased a business, inclusive of the purchase of a trademark, from the seller. The purchase price was a global amount, but a portion of the purchase price could be apportioned to the acquisition cost of the trademark. The taxpayer issued shares in settlement of the liability to pay for the mark. The taxpayer claimed an allowance in terms of Section 11(gA) on the basis that it had incurred expenditure in acquiring the trademark. The Commissioner disallowed the allowance, relying on ITC 1783. However, the tax court, and then the High Court on appeal, held that the decision in ITC 1783 was incorrect, and permitted the allowance claimed in terms of Section 11(gA) of the Act.
The Labat case affirmed the principle that once a taxpayer incurs a liability to pay, expenditure will have been "incurred”, and that it does not matter that the obligation to pay is subsequently settled by an issue of shares.However, while the Labat case revolved around the acquisition of an asset, and the meaning attributed to "actually incurred” in the context of Section 11(gA), the reasoning adopted by the High Court should be equally applicable to the settlement, by way of an issue of shares, of "expenditure incurred” in respect of services rendered, and claimable under the general deduction formula in Section 11(a).
This article first appeared in Mazars’ in-house tax publication, "Let’s Talk Tax”.
Source: By Wounter Scholtz (Taxbreaks)