1132. Inept creditors - is the lucky debtor taxable?
October, 2003
In ITC 1634 (60 SATC 235), the taxpayer, a shipping, clearing and forwarding agent, was held to be taxable on amounts owing for services rendered to it, but which had never been invoiced by the creditor. The Transvaal special court found that there had been a recoupment of expenditure incurred, despite the fact that the creditor had not even raised invoices. The court found that section 8(4)(a) of the Income Tax Act, which provides that expenditure previously incurred must be included in the income of the taxpayer when it is recouped, applied to the amounts not invoiced. In so doing, it rejected the contention of the taxpayer that no amounts had accrued as required by the income tax definition of gross income and that the credits were merely accounting entries.
The Supreme Court of Appeal recently had the opportunity to settle the argument once and for all in Omnia Fertilizer Ltd v C:SARS (65 SATC 159). In tax years preceding 1991 the taxpayer had purchased raw materials and raised the costs as expenditure incurred in the production of income even where creditors had not issued invoices. In each case the appropriate expenditure account would be debited and a holding account called "received but not invoiced" would be credited. When an invoice arrived, the amount would be transferred from the holding account to that of the creditor. When certain of the creditors for these purchases failed to submit invoices, the taxpayer would reverse the debits from the holding account to the income account over two years. In this manner, during the years 1991 to 1994 the taxpayer annually wrote back to income amounts of between R1 million and R2.2 million.
When C:SARS included these amounts in gross income, the taxpayer objected on the grounds that its mere accounting treatment of them did not render them "receipts, accruals, recoveries or recoupments" within the meaning of the Act. The taxpayer contended that ITC 1634 had been incorrectly decided and that so long as the indebtedness still existed in law, there could be no recoupment. The debts in question had not yet prescribed. In his judgment Howie P stated that section 8(4)(a) had to do with the recoupments of amounts, not the extinction of liabilities. He continued:
"Where unpaid expenditure has been allowed as deduction from taxable income there is not just an expenditure entry in the taxpayer’s books of account reflecting the relevant debt. There is, in addition, an assertion by the taxpayer, accepted and acted upon by the Commissioner, recognising the likelihood, if not the inevitability, that the debt will be paid. That is the basis for regarding the unpaid debts as actual expenditure. If the taxpayer later, in effect erases the debt from its books and treats the amount concerned as available for another purpose, the questions which arise are:
a) whether the debt has for some reason ceased to exist and, if not, b) whether the amount unpaid, but expended in the eyes of the tax law, has nevertheless, for all practical purposes, reverted to the taxpayer’s ‘pocket’".The taxpayer argued that (a) was the essential question, whereas the court found (b) to be the crucial enquiry, and that the decision in ITC 1634 had been correct. Even if the relevant entries themselves did not effect recoupments of the expenditure, the facts compelled the conclusion that the taxpayer, in writing back the debts, had admitted that they had in effect been recouped.
It is difficult to find fault with this judgment. Although it is always dangerous to apply logic to tax matters, logic nevertheless demands that a taxpayer cannot expect to be able to claim a deduction and then, when it never materialises, not to suffer the results of what, in effect, was not necessarily a valid deduction in the first place.
Finally, it surely goes without saying that where a debt prescribes, if the expenditure to which it relates was taken into account in arriving at taxable income, there can be no question but that there has been a recoupment. The taxpayer’s argument in this case, and a vain one it turned out to be, was that the debt legally still existed.
Deneys Reitz
IT Act:S 8(4)(a)
Editorial comment: This type of recoupment is now covered by a new section 8(4)(m).
