Income accrues to a taxpayer only if he is “entitled” to it

Gavin Beckwith, a tax director at PricewaterhouseCoopers, says that the judgment of the Pretoria Tax Court in ITC 1824 70 SATC 27 which has just been published, brings welcome clarity to some previously uncertain aspects of income tax law, and holds important tax planning lessons.

In this case, the taxpayer had invoiced a client for two amounts in respect of fees for professional services rendered, the first for some R20 million and the second for some R12 million. The latter amount, but not the former, had been paid by the client. The taxpayer disclosed both amounts in his income tax return lodged with SARS as income that had “accrued”.

The client then disputed liability for both amounts, and the matter went to arbitration. Some two years later, the arbitrator ruled that the taxpayer had not been entitled to either amount. Both the taxpayer and the client agreed that the arbitrator’s ruling was correct.

In the meantime, SARS had assessed the taxpayer to income tax on these two amounts, and the time for lodging an objection to the assessment had expired.

SARS agreed to accept a late objection to the assessment relating to these two amounts.

The Tax Court ruled that it was for the court to determine whether, for purposes of the Income Tax Act, the amounts in question had, as a matter of law, “accrued” to the taxpayer, and held that there had been no accrual. The court ruled that the taxpayer had erred in including the two amounts as income that had “accrued”, and upheld the taxpayer’s objection to the assessment. The court said that the taxpayer was permitted to object to the assessment even though the error in the assessment had come about through the taxpayer's own action in reflecting the amounts as income that had accrued. The court said that the amounts in question could not be claimed as a bad debt because they had never been debts in the first place, and there was nothing to become “bad”.

Beckwith says that the tax planning lesson is that where the taxpayer invoices a client for goods sold or services rendered, and the client disputes liability for the invoiced amount, there is in law no “accrual” of income unless and until the dispute is resolved in the taxpayer’s favour. The taxpayer should, in the meantime, not include those amounts in its gross income when making up a tax return. It may be good practice, however, to disclose to SARS that certain amounts of income are in dispute, and have therefore not been included as an accrual.