The costs associated with black economic empowerment transactions are akin to obtaining a licence to operate; on this basis, these costs should form part of the income earning operations of the company.(1)
The Income Tax Act(2) contains various provisions relating to deductibility of specific expenditure, some of which have been identified as possibilities for the deduction of expenditure relating to indirect black economic empowerment measures, such as:
- Section 12H scholarship allowances;
- Section 12I additional investment and training allowances;
- Section 18A donations to public benefit organisations; and
- various capital allowance provisions.
If no specific deduction provision applies, the general deduction formula contained in Section 11(a), read together with Section 23(g), must be applied. It must therefore be determined whether any such empowerment expenditure was incurred in the production of income and that it is not of a capital nature.
It was confirmed in CIR v Pick ‘n Pay Wholesalers (Pty) Ltd(3) that expenditure incurred for general philanthropic purposes would most likely not be regarded as being incurred in the course of carrying on a trade and would therefore not be deductible under Section 11(a) read with Section 23(g). In Warner Lambert SA (Pty) Ltd v Commissioner for SARS,(4) the court dealt with the deductibility of social responsibility expenditure and found that the relevant expenditure incurred was deductible.
The company that had incurred the expenditure was a subsidiary of a US company and adhered to the Sullivan Code, which is very similar to the current empowerment principles in South Africa.
The South African Revenue Service (SARS) has issued two rulings dealing with the deductibility of similar expenditure. Binding Class Ruling 2 dealt with expenditure in respect of corporate social responsibility, indicating that such expenditure would be deductible (this expenditure related to bursary payments). Binding Private Ruling 113 (BPR 113) likewise indicated that expenditure associated with broad based black economic empowerment would be deductible.
Recently, Binding Class Ruling 2 has created some concern among taxpayers, given that its period of validity (August 28 2009 to August 27 2013) had expired and many taxpayers sought to rely on the ruling in deducting similar expenditure. In light of the above, it should be borne in mind that the application of Binding Class Ruling 2 was specifically limited to a class of taxpayers and could not be seen to be generally applicable to every taxpayer. SARS has no obligation to apply a class or private ruling to any other particular set of facts in the same way. Therefore, the taxpayer should always apply the provisions of the Income Tax Act – that is, either specific deduction provisions or the general deduction formula contained in Section 11(a), read with Section 23(g) – to their individual set of facts and not rely exclusively on rulings in determining the deductibility of empowerment or similar expenditure. This evaluation should have been completed both during the application of Binding Class Ruling 2 and after its expiry; as such, the expiry of the ruling is not a cause for great concern. SARS can only be bound by the provisions of general rulings and when it comes to empowerment expenditure, deductibility chickens should not be counted before they hatch.