Our question relates to the calculation of tax for exempt institutions (clubs, PBO's, Body Corporates). Previously we understood the taxable income was calculated and the basic exemption was then deducted from the net taxable income.
Important:
This answer is based on tax law for the tax year ending 28 February 2020.
Answer:
We accept that the entity was approved by SARS as a public benefit organisation (section 30), or as a recreational club (section 30A).
Your request relates to a complex issue and we will only provide guidance (and will not comment on your calculation or interpretation).
We are aware that the SARS guide (Tax Guide for Recreational Clubs (Issue 3)) states the following:
“General (indirect) expenditure
Expenditure incurred which does not specifically relate to a particular source of income but which can be attributed to various sources of gross receipts and accruals, must be apportioned on a pro rata basis. Examples include accounting fees, audit fees, bank charges or overhead expenses.
Basis on which general expenditure may be apportioned
The expenditure will be apportioned based on the gross receipts and accruals. on page 21 of the guide.”
The “Tax Exemption Guide for Public Benefit Organisations in South Africa” (Issue 5) doesn’t refer to the issue at all.
It must be remembered that a guide is not an “official publication” as defined in section 1 of the Tax Administration Act 28 of 2011 and accordingly does not create a practice generally prevailing under section 5 of that Act.
Interpretation Note 64 (Issue 3) deals with bodies corporate, amongst others, and does create a practice generally prevailing. The practice in this regard is then given in the following paragraph:
“The use of a fixed percentage of the general expenditure for the purpose of allocating it to a particular source of income is not acceptable. General expenditure must be allocated to the various sources of income on a logical, fair and reasonable basis. For example, depending on the facts, it may be acceptable to allocate the general expenses pro rata by applying the ratio that a particular source of receipts and accruals bears to the total receipts and accruals derived by the entity.”
The principles relating to apportionment
It is the taxpayer who must apportion the ‘dual purpose’ expenses.
In order for any taxpayer to make a deduction it is necessary that the taxpayer must be able to meet the burden of proof that a trade was being carried on, and that the amount of the expense was incurred in the production of the income.
In terms of section 23(f) no deduction is possible in respect “any expenses incurred in respect of any amounts received or accrued which do not constitute income as defined in section one”. The amounts that qualify for exemption under section 10(1)(c0)(i) – (iii) and under section 10(1)(e)(i) would not constitute ‘income’, but so would the exemptions provided for in section 10(1)(c0)(iv) and under section 10(1)(e)(ii).
Section 23(g) also is relevant and prohibits the deduction of “any moneys, claimed as a deduction from income derived from trade, to the extent to which such moneys were not laid out or expended for the purposes of trade”.
The Income Tax Act does not prescribe how apportionment must be done. The issue of the apportionment of expenses was considered recently by the Supreme Court of Appeal – CSARS v Mobile Telephone Networks Holdings (Pty) Ltd. Judge Ponnan commented as follows:
“Where - as here - expenditure is laid out for a dual or mixed purpose the courts in South Africa and in other countries, have, in principle, approved of an apportionment of such expenditure…”
“Over time, the courts have applied various formulae to achieve a fair apportionment.”
“Apportionment is essentially a question of fact depending upon the particular circumstances of each case (Local Investment Co v Commissioner of Taxes (SR) 22 SATC 4). As Beadle J put it in Local Investment Co (at II):
“It does not seem possible to me to lay down any general rules as to how the apportionment should be made, other than saying that the apportionment must be fair and reasonable, having regard to all the circumstances of the case. For example, in one case an apportionment based on the proportion which the different types of income bear to the total income might be proper, as was done in the Rand Selections Corporation’s case, supra. In another case, however, such an apportionment might be grossly unfair;”
Relevant to the issue of whether the section 10(1)(c0)(iv) and section 10(1)(e)(ii) amount must be deducted before an apportionment, on the basis of receipts, must be done, the following decision by Judge Corbett in CIR v Standard Bank of SA is relevant. The Judge said that “…there is no valid basis for treating portion of the interest paid by the Bank to depositors as not falling within the general deduction formula of s 11 (a) or as being excluded from deduction by s 23 (f).” The principle that follows from this is that expenditure that were incurred in respect of receipts that will later, once the 5% rule for instance is applied, qualify for exemption, can be seen as expenditure not incurred to produce the exempt part.