- October 9, 2020
- Posted by: vitalclick
- Category: Investments
The current economic conditions have significantly increased credit risk for many businesses already struggling to make ends meet. As important as securing ongoing business may be, it only contributes financially if payment is also received for goods or services rendered. Many business owners may therefore be considering implementing changes to their billing practices or payment terms in order to ensure payments are timeously received from all serviced customers. Those owners considering requesting advance payments or deposits from customers may need to take into account the tax and other consequences of doing so. Furthermore, landlords in the process of replacing tenants may be faced with refunding or applying deposits of vacating tenants as well as receiving deposits from new tenants taking occupation. In this article we will firstly be focussing on some of the key considerations of receiving advance payments or deposits; and secondly some of the implications of making such advance payments or deposits.
1) Accounting records:
For accounting and financial reporting purposes, advance payments and deposits received will generally be recognised as a liability thereby deferring its impact on profit or loss until the period to which the transaction relates.
2) Income tax:
The Income Tax Act includes such advance payments and deposits received within the definition of “gross income” if it has been “received by” the taxpayer. Courts have interpreted “received by” to mean received by the taxpayer on his own behalf for his own benefit. In most instances this means that advance payments or deposits received are included in gross income of the taxpayer, the exception being when deposits are received on behalf of a third party (for example by estate agents receiving deposits on behalf of landlords) or where there is a contractual obligation to refund the deposit at the end of the contract (for example a landlord to refund a tenant).
Section 24C of the Income Tax Act provides relief through an allowance in instances where such advance payments included in gross income are received in order to finance contracted future expenditure which will be incurred by the tax payer in the performance of his obligations under the contract (the value of the allowance to be determined by the value of the contracted future expenditure).
3) VAT:
The VAT Act requires VAT vendors to declare and pay the related output VAT on any advance payments and deposits (other than refunded deposits) at the earlier of the date of invoice or receipt of payment.
No VAT is due on refunded deposits (where there is a contracted obligation to refund the deposit at the end of the contract term). Output VAT on deposits is however payable by VAT vendors when the deposit is forfeited or applied as consideration for a supply (the timing is determined by when the deposit becomes forfeited or applied).
4) Other:
Landlords receiving deposits from residential tenants need to comply with the Rental Housing Act which requires deposits to be kept in a separate interest earning account with a financial institution at an interest rate that may not be less than the rate applicable to a savings account with that financial institution.
Making advance payments and deposits
1) Accounting records:
Financial reporting standards require advance payments (also referred to as prepayments or prepaid expenses) or deposits made to be classified as an asset on the balance sheet.
2) Income tax:
Section 23H of the Income Tax Act prohibits the deduction of prepaid expenses (that would otherwise have been deductible in terms of the Act) prior to the tax period to which the expense relates. Section 23H does however not apply to prepaid expenses in aggregate up to R100,000 or prepaid expenses of which the benefit will be received within 6 months of the end of the tax period (so these are available for deducted in the tax period in which the payment was made, provided that the expenses themselves are deductible in terms of the Act).
Refundable deposits (where there is a contracted obligation to refund the deposit at the end of the contract term) do not qualify for deduction when the deposit is paid and are not included in taxable income when the refund is received. The cost of any deposit applied as payment or forfeited should be considered for deduction in terms of the Act at the time when it is applied or forfeited (specific consideration should be given to it being in the production of income).
3) VAT:
Provided that the payment of the deposit (other than a refunded deposit) or prepaid expense is made to a VAT vendor, the input VAT can be claimed once a valid VAT invoice has been received stipulating the VAT amount included and full payment of the invoice has been made (assuming that it has been incurred in the production of taxable supplies).
No VAT can be claimed on a refundable deposit (where there is a contracted obligation to refund the deposit at the end of the contract term) made and no VAT is to be paid when the refund is received.
In conclusion
In a time where liquidity and credit risk are key to the success of most businesses, the use of advance payments and deposits may become more commonplace. Having a clearer understanding of the tax and other consequences of receiving or making upfront payments or deposits will aid both business owners and individuals alike in making more informed business decisions.