Accrual revisited

‘Businesspeople unlucky enough to have plenty of tardy debtors might pay tax on money they don’t have.’
Issue date: 3 April 2009

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The South African income tax calculation begins with the calculation of gross income. Gross income is defined in Section 1 of the Income Tax Act as: “any amount in cash or otherwise that is received by or accrued to a South African resident.” No-one disputes that cash income received is taxable in the hands of the recipient. It’s the concept of accrual which has given rise to problems over the years. The concept is a little tricky. When an amount of money has “accrued”, it means it’s been earned by the recipient but not yet paid to them. In other words, it’s money that’s definitely owed.

To be clear, gross income, in terms of the Income Tax Act, includes all amounts received in cash (or actually received), plus all amounts that are earned but haven’t been received. Businesspeople unlucky enough to have plenty of tardy debtors might pay tax on money they don’t have. They can either claim a bad debt or try to argue that an accrual has not actually taken place.

The tax treatment of bad debts can be the subject of another column. Very briefly, when the debt becomes bad, the amount is written back and the taxpayer would be entitled to a refund for tax paid on it. The issue of the accrual of income in ascertaining gross income was the subject of a couple of Appeal Court cases. Notable ones include the Commissioner for Inland Revenue v People’s Stores (Walvis Bay) (Pty) Ltd 1990(2) SA 353 (A) and the earlier Lategan case, heard in 1926 as CIR v Lategan 1926 CPD 203.

Accrual stands up in court
The definition of the word “accrue” or “accrual” was central to both cases, and became clearer with the hearing of the “People’s Stores” case. Here, the judges held that income didn’t need to be an amount of money, but might be every form of property earned by the taxpayer, whether corporeal or incorporeal, which had a money value. This included debts and rights of action.

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It followed that only one thing is needed for an accrual to have taken place – the taxpayer has to have become entitled to an amount of money. This applies even if that money can’t be claimed immediately. The Lategan case held that every form of property which had a money value, including debts and rights of accrual, formed part of the taxpayer’s income. This was applied in 1999, in the case of Cactus Investments (Pty) Ltd v CIR, 1999 (1) SA 315 (SCA). Here a taxpayer tried to trade his taxable income that had accrued for tax-free dividend income. Because he became entitled to the taxable income, the interest from loans advanced, when the money was transferred to the lender, and nothing more was required of him to complete his side of the lending agreement, the interest accrued and he couldn’t divest himself of it.

Avoiding accrual
It’s clear accrual must be looked at carefully in any enquiry into the taxation of an entity. Should a taxpayer not want accrual to take place, they should ensure the amount in question doesn’t become due until, say, a certain event or condition is fulfilled. In legal terms, inserting a suspensive clause into a contract would halt accrual until fulfilment of the condition.     |fw