Section 24C allowance and the possible inclusion of closing stock in terms of section 22(2A) & 22(3A) of the Income Tax Act No. 58

In this regard, the income received in terms of any contract is required to be utilised in whole or in part to finance future expenditure in a subsequent year of assessment and in the performance of the taxpayer’s obligations under such contract.

Section 24C of the Act was specifically enacted to apply to construction, building, engineering and other similar trades but has found broader application and has been applied to any industry provided that the requirements of the section are complied with.

In order to qualify for an allowance under section 24C, the following requirements must be met:

• There must be a receipt of funds by the taxpayer;
• The receipt must be in terms of a contract;
• That contract must place an obligation on the taxpayer to incur expenditure; and
• Such expenditure will be incurred in a subsequent year of assessment.

In a recent court case, Big G Restaurants (Pty) Ltd v Commissioner for the South African Revenue Services [2020] ZACC 16, the Commissioner disallowed the section 24C allowance on the basis that the income received from the franchise agreement between Big G Restaurants (Pty) Ltd and the Spur Group and the obligation to incurred future expenditure were not under “such contract”, questioning the “sameness” of the contacts. This will apply when the income received in advance and the obligation to incur future expenses do not form part of the same contract.  In this instance, should there be more than one contract it should be inextricably linked to meet the “sameness” test in order to qualify for an 24C allowance. Therefore, should the income received in advance and the obligation to incurred future expenditure not pass the “sameness” test, a risk exists that a section 24C allowance might not be allowed under “such contract”.

The section 24C allowance is calculated with reference to the following formula:

Total cost / Total revenue x Income Received in Advance.

The calculation of the section 24C allowance is often problematic for construction companies. The calculation of income received in advance is often affected by the accounting policies in place with regards to revenue recognition. The income received in advance for accounting purposes should be adjusted to arrive at an amount which represents “income received by or accrued” to a taxpayer for the year of assessment for tax purposes.  In this regard in order to determine the income received in advance the revenue certified to date, debtor’s retentions, underclaims and Work-in-Progress should be accounted for by calculating the income received in advance for the purpose of the section 24C allowance.

The amount so derived is multiplied by the cost percentage. The income received in advance for purposes of the section 24C allowance must be limited to the actual cost incurred to date for tax purposes. The actually costs incurred for accounting purposes should be adjusted to reflect expenses “actually incurred for the purposes of trade” during the year of assessment for tax purposes.  The actual cost to date for tax purposes is calculated by the inclusion of actual cost to date, creditor’s retentions, under claims and Work-In-Progress excluding provisions. The difference between the income received in advance for purpose of section 24C allowance less the actual cost incurred for tax purposes will represent the section 24C allowance that can be claimed.

Furthermore, in terms of section 22(2A) of the Act where any person carries on any construction, building, engineering or other trade in the course of which improvements are effected by him to fixed property owned by any other person, any such improvements effected by him and any materials delivered by him to such fixed property which are no longer owned by him shall, until the contract under which such improvements are effected has been completed, be deemed for the purposes of this section to be trading stock held and not disposed of by him.

The application of section 22(2A) of the Act requires a taxpayer to include in its taxable income closing stock. The cost price of the trading stock includes the sum of all costs to the taxpayer of material used by the taxpayer, further cost incurred in accordance with International Financial Reporting Standards (IFRS) or any other cost incurred by the taxpayer in accordance with IFRS incurred in connection with the relevant contract; less a deduction of so much of:

a) Any income received by or accrued to the taxpayer in respect of the relevant contract;

b) Any portion of an amount payable to the taxpayer under the relevant contact (but not exceeding 15% of the total amount payable to him under such contract) the payment of which has been withheld as a retention; and

c) Any of the said cost included under this subsection as exceed the portion of the contract price which relates to the improvement actually affected by him.

In this regard, should a section 24C allowance be claimed on the basis that the income received in advance is more than the actual cost incurred for tax purposes it will not result in a closing stock adjustment. However, should the actual cost be more than the income received in advance and after adjusting for b) to c) above, the amount so derived will be an amount to be included as closing stock in the calculation of taxable income.

Conclusion

The calculation of the section 24C allowance and of closing stock in terms of section 22(2A) & 22(3A) of the Act remains a challenge for all companies in the construction industry. It is therefore important to ensure that the methodology applied in the calculation of the section 24C allowance and closing stock, if challenged by the South African Revenue Services, will be justifiable.

By Elmien Theron

25/04/2022