Technical FAQ – 24 April 2014

Author: SAIT Technical

1. Sec 10(1)(nB) exemption where the old and new property were rented

Q: With reference to section 10(1)(nB). Will the following expenditure paid by the employer on behalf of the employee being relocated qualify for the exemption?

1.     Deposit payable on the new rental contract in new location. 

2.     Penalty fee payable on the old rental contract. 

A: In order for such costs to qualify for the exemption, they would have to fall within the ambit of sec 10(1)(nB) of the Income Tax Act (No. 58 of 1962) (hereinafter referred to as ‘the Act’), which states the following: 

‘any benefit or advantage accruing to any employee (as defined in paragraph 1 of the Seventh Schedule) by reason of the fact that his employer (as defined in the said paragraph), has, in consequence of the transfer of the employee from one place of employment to another place of employment or the appointment of the employee as an employee of the employer or the termination of the employee’s employment, borne the expense—

(i) of transporting such employee, members of his household and the personal goods and possessions of himself and the members of his household from his previous place of residence to his new place of residence; or

(ii) of such costs as the Commissioner may allow which have been incurred by the employee in respect of the sale of his previous residence and in settling in permanent residential accommodation at his new place of residence ...’ 

(iii) of hiring residential accommodation in an hotel or elsewhere for the employee or members of his household during the period ending 183 days after his transfer took effect or after he took up his appointment, as the case may be, if such residential accommodation was occupied temporarily pending the obtaining of permanent residential accommodation.’ (own emphasis added).

The penalty fee payable on the old rental contract can only fall within the provisions of sec 10(1)(nB)(ii), as it was not incurred for purposes of subparagraph (i) (transportation of the employee, members of his/her household and their possessions) or subparagraph (iii) (hiring of residential accommodation before obtaining ‘permanent residential accommodation’). In sec 10(1)(nB)(ii), the legislature specifically referred to ‘... in respect of the sale of his previous residence ...’ If one ascribes an ordinary meaning to the word ‘sale’, it would imply that the residence should have been owned by the taxpayer and therefore not hired by him/her. This is even more evident when one considers the wording of the Guide for Employers in respect of Employees Tax (2015 Tax Year) which states the following:

‘The following items are exempt from tax if the employer reimburses the employee for the actual expenditure incurred: 

• Bond registration and legal fees paid in respect of a new residence that has been purchased;
• Transfer duty paid in respect of the new residence; 
• Cancellation fees paid of the cancellation of bond on the previous residence; and 
• Agent’s commission on sale of previous residence.’

From the guide’s wording (the four bullet points above) one can see that expenditure incurred by the employee to obtain ownership in respect of the new residence (bullet point 1 and 2 above) or to dispose of his/her ownership in the old residence (bullet point 3 and 4 above), would qualify for the exemption.

The deposit paid on the new rental contract may qualify for the exemption if it qualifies as an ‘expense’. Given the fact that the deposits are normally refundable, it is unclear whether the deposit would qualify as an expense. You would therefore have to consider the terms of the lease contract to determine if the deposit would qualify as an expense, in which case the deposit on the new residence may qualify for the sec 10(1)(nB)(ii) exemption.

Conclusion

As stated above, it would appear as if the penalty paid on the old rental contract would not fall within the provisions of sec 10(1)(nB)(ii). The deposit might qualify for the exemption in terms of sec 10(1)(nB)(ii), provided that it qualifies as an ‘expense’. The taxpayer would however still be allowed to claim the other relocation expenses provided for in sec 10(1)(nB) of the Act.

Should the employee intend to buy a residence in his new location, then you may make use of the provisions of sec 10(1)(nB)(iii), but this would only be available if the property is only temporarily being hired in anticipation of buying a permanent residence and may not be used for the first six months of hiring accommodation (where there is no intention to buy a residence ).

2. Income tax consequences for deposits taking the form of payments in advance

Q: My client receives deposits from customers in order to secure stock and/or the price of stock which are imported. The deposits have grown substantially over the last year and I am starting the worry about the time of supply and accrued/received rules. What is the definition of a deposit for tax purposes? Is there a generally accepted %? The result of these huge deposits is that my customer control account has a very high credit balance and for accounting purposes would have to be included in liabilities. There are no contracts drawn up and seldom any correspondence between supplier and customer. My client keeps the stock and insures the stock. A full deposit of the refund would be made if the customer decided not to take the stock. This hardly ever happens.

A: In giving guidance to this question, it is assumed that the company receiving the deposits is a ‘resident’ as defined in sec 1 of the Income Tax Act (No. 58 of 1962) (hereinafter referred to as ‘the Act’).

Income Tax Consequences

A deposit is not defined in sec 1 of the Act and one would therefore have to consider the word within its normal grammatical meaning i.e. by making use of a dictionary. It should be noted that ‘deposit’ can be used in more than one sense in that it can either be used ‘to give security’ or ‘in part payment’.

The definition of ‘gross income’ in sec 1 of the Act, states the following:

‘in relation to any year or period of assessment, means—

(i) in the case of any resident, the total amount, in cash or otherwise, received by or accrued to or in favour of such resident ...’ 

Therefore, without determining whether a receipt is income or capital in nature, an amount would have to be ‘received by’ or ‘accrued to’ a person in order for it to be included in the person’s income. From SIR v Silverglen Investments (Pty) Ltd (1969 A) the inference can be drawn that a receipt must be included in gross income at the earlier of its receipt or accrual. One would therefore have to determine when a deposit is received by or accrued to the recipient in order to determine the timing of the inclusion in gross income. This determination is fact specific and would depend on various factors. In Geldenhuys v CIR (1947 CPD) it was held that the words ‘received by’ means received by the taxpayer on his own behalf and for his own benefit.  

It was held in the case of CIR v Genn & Co (Pty) Ltd 20 SATC 113 in the context of a loan (rather than a deposit) that ‘It certainly is not every obtaining of physical control over money or money’s worth that constitutes a receipt for the purposes of these provisions. If, for instance, money is obtained and banked by someone as agent or  trustee  for  another,  the  former  has  not  received  it  as  his  income.  At the same moment that the borrower is given possession he falls under an obligation to repay. What is borrowed does not become his, except in the sense, irrelevant for present purposes, that if what is borrowed is consumable there is in law a change of ownership in the actual things borrowed’. The fact that the amounts received are recorded as a liability for accounting purposes, would suggest that your client does not necessarily receive the amounts in the manner contemplated in the definition of gross income.

Cases that may be useful in your determination of when deposits (returnable deposits on containers) would have to be included in ‘gross income’ are Brooks Lemos Ltd v CIR 14 SATC 295, Pyott Ltd v CIR (1945 AD) and Greases SA Ltd v Commissioner for Inland Revenue 17 SATC 358. I’ll give provide you of a brief summary of Brooks Lemos Ltd v CIR 14 SATC 295, as both of the other two cases have similar facts. 

In this case, the taxpayer sold squashes in bottles only to licensed dealers and not to the public. One price was charged on the bottle and its contents, of which a portion of the price related to a deposit on the bottle. Should the bottle be returned, the taxpayer would have refunded the deposit to the client. The clients were however under no means obliged to return the bottles. When the taxpayer gave discounts to its clients, no discount was given on the portion of the price relating to the deposits. For accounting purposes, the portion of the price relating to the contents and use of the bottle were credited to sales, whilst the deposit part of the price was credited to a ‘bottle deposit account’. The court subsequently held that the deposits were received by the taxpayer for its own benefit and should therefore be included in its gross income.

Therefore, from the Brooks Lemos case (and the other two cases named above) it becomes evident, that irrespective of the accounting treatment of the deposits, if it is available to the taxpayer, to do with it as it/he/she pleases, then the deposits would be included in gross income and may consequently be subject to income tax. This is due to the fact that the deposits will be received by the taxpayer for own benefit (Geldenhuys case). Although it can be argued that in the above case law, the deposits were received as ‘security’ in order to ensure that an item is returned and not as an ‘in part payment’ as may be the case with your client, it nevertheless provide useful guidance with regard to the tax treatment of deposits.

These cases dealing with returnable containers may differ from your client's situation in the sense that the obligation to return the deposit was conditional and only arose when the container was returned. In the case of your client, the client is obliged to provide either the goods or repay the deposit. It may however be argued that similar principles should apply, as the terms of the arrangement between your client and its customers may also indicate a conditional obligation to return the amounts as this obligation only arises when the client decides not to take delivery of the goods. As a result it would in our view, similarly to the cases mentioned above, be difficult to argue that your client has not received the amounts as no unconditional obligation exists (these amounts could really be viewed as an early payment for the goods). (Should your client be required to repay the amount (i.e. when the obligation becomes unconditional at a later stage), it should be entitled to a deduction if this view is followed).

In our view, the only other alternative would be to argue that your client currently holds the amounts as trustee on behalf of its customers (as was suggested in the judgment of the Pyott case). In order for this to be the case, your client must not be the beneficial owner of the amounts. There are no hard and fixed rules as to when this would be the case. The facts and circumstances would have to be taken into account. This includes the terms of agreements or memorandums of incorporation as well as the creation of separate funds on behalf of the beneficial owner of the moneys by way of the agreements (refer to the case of C:SARS v Cape Consumers (Pty) Ltd 61 SATC 91). Whether the returns on the amount (interest) accrue to your client or its customers could be a further indication. It may also include keeping the money in a separate trust account (refer Greases case). As considered in the cases of Brookes Lemos and Greases, the mere fact that a separate general ledger account or records are kept of these amounts is not sufficient to evidence such a relationship. It is submitted that to a large extent, this would depend on the arrangement between your client and its customers and whether the customers intended to deposit the money with your client in such a way that it should be kept separate from your client’s own funds. The fact that there are no contracts in place between the taxpayer and its clients that sets out the terms of these deposits may however cause some concern. You would therefore have to consider whether enough evidence exists for such an argument to be followed. As your client would bear the burden of proving that it received these amounts as trustee, rather than for its own benefit (sec 102(1) of the TAA). It is recommended that your client should consider obtaining a legal opinion to this effect, if it wishes to follow this argument.

VAT implications

For VAT purposes, it is assumed that the taxpayer is a ‘vendor’ that supplies wholly taxable supplies. Sec 7(1)(a) of the Value-Added Tax Act (No. 89 of 1991) (hereinafter referred to as ‘the VAT Act’), is the charging section of VAT and states the following:

‘Subject to the exemptions, exceptions, deductions and adjustments provided for in this Act, there shall be levied and paid for the benefit of the National Revenue Fund a tax, to be known as the value-added tax—

(a) on the supply by any vendor of goods or services supplied by him on or after the commencement date in the course or furtherance of any enterprise carried on by him ...

calculated at the rate of 14 per cent on the value of the supply concerned or the importation, as the case may be.’ (own emphasis added).

Therefore, even before we look at the definition of ‘enterprise’ and thereafter the definition of ‘consideration’, there must first be a ‘supply’ (of goods or services) in order for a vendor to become liable for VAT. If there is no supply, then no output tax would have to be levied in terms of sec 7(1)(a). An ‘enterprise’ is defined in sec 1 of the VAT Act, the relevant part in your case reading as follow:

‘... in the case of any vendor, any enterprise or activity which is carried on continuously or regularly by any person in the Republic or partly in the Republic and in the course or furtherance of which goods or services are supplied to any other person for a consideration, whether or not for profit ...’ (own emphasis added).

In your client’s case, it has to be determined whether these deposits would constitute ‘consideration’ as set out in the definition of ‘enterprise’. This is due to the fact that should the deposits not qualify as ‘consideration’, it would be excluded from your client’s ‘enterprise’ and consequently would not be subject to VAT in terms of sec 7(1)(a) of the VAT Act. ‘Consideration’ is defined in sec 1 of the VAT Act as follow: 

‘... in relation to the supply of goods or services to any person, includes any payment made or to be made (including any deposit on any returnable container and tax), whether in money or otherwise, or any act or forbearance, whether or not voluntary, in respect of, in response to, or for the inducement of, the supply of any goods or services, whether by that person or by any other person ... Provided that a deposit (other than a deposit on a returnable container), whether refundable or not, given in respect of a supply of goods or services shall not be considered as payment made for the supply unless and until the supplier applies the deposit as consideration for the supply or such deposit is forfeited’.(own emphasis added).

Given the fact that your client refunds the deposits to its clients, should the sale be cancelled or if your client cannot deliver, you would have to determine when the deposits are applied as consideration (you would therefore not deal with ‘forfeited deposits’). As soon as the deposits are applied as consideration and a supply is made, output tax would have to be levied in terms sec 7(1)(a) of the VAT Act.

It is however submitted that it is not always easy to determine whether an amount would constitute a genuine deposit as such and one may therefore encounter grey areas in this determination. According to Juta’s Value-Added Tax (2010), it is ‘... stated in the current VAT 404 (Chapter 19) that a deposit which is lodged to secure a future supply of goods and held in trust until the time of supply is also excluded ...’ from the definition of ‘consideration’. We have however gone through the VAT 404 guide and in the current version no reference is made as to what constitutes a deposit, with Chapter 19 being deleted. 

Assuming that the deposits constitute deposits for purposes of the definition of ‘consideration’, no output tax would have to be levied on the deposits until the deposits are applied as ‘consideration’ for the supply i.e. when the deposits are made available to your client to do with it as it pleases and a supply relating to the deposit is made.

Conclusion

For income tax purposes, it would seem as if these ‘deposits’ are received by your client for its own benefit as it constitutes part payment for goods where no unconditional obligation exists to refund the deposits. Should this view be followed, a deduction will be available to your client when the amounts are refunded.

The other alternative your client has is to argue that it holds the amounts as trustee on behalf of the customers where it can be proved that your client is not the beneficial owner of the amounts (in accordance with the Pyott case). Sufficient evidence would however have to exist to proof this and it is advised that your client obtains a legal opinion if it wishes to follow this route.  

For VAT purposes, deposits are excluded from the definition of ‘consideration’ until it is, as in your client’s case, applied as such. Even though the deposits are applied as consideration, your client would not have any output tax liability until such time as the supply is made.