Taxation of the receipts of deposits – Part 2

Relevant Acts

Tax Administration Act 28 of 2011;
Income Tax Act 58 of 1962; and
Rental Housing Act 50 of 1999 (based on quoted examples in the SARS Guide)
Consumer Protection Act 68 of 2008 (based on quoted examples in the SARS Guide)

This is a follow-up article (2 of 2); please read part 1 before continuing with part 2.

SARS published Interpretation Note 177 in May 2021 providing guidance on the words “received by” in the definition of “gross income” in section 1(1) of the Income Tax Act and the treatment of the receipt of a deposit in the ordinary course of business.

Possible capital gains tax consequences attached to the receipt of a deposit does not form part of the scope of this Guidance Note.

In addition, the Note does not deal with amounts deposited by clients with banks and similar deposit-taking financial institutions.

This article deals with the following types of deposits:

Rental Deposits
Agreements of sale or service
Security deposits
Construction and building contracts
Impact of the Consumer Protection Act on deposits
Unclaimed deposits

Rental deposits

Under property lease agreements a lessor will usually require that the lessee pays a rental deposit (sometimes also referred to as a security deposit) on entering into a lease agreement.

The Rental Housing Act 50 of 1999 (the Rental Housing Act) applies to the leasing of a dwelling which includes a house, hostel room, hut, shack, flat, apartment, room, outbuilding, garage or similar structure, including any store-room, outbuilding, garage or demarcated parking space which is part of the leased property therefore the Rental Housing Act does not apply to the rental of commercial property.

Section 5(3) of the Rental Housing Act deems a lease to include certain terms and, among others, includes the following:

• The landlord may require the tenant to pay a deposit before moving into the property.
• The deposit must be invested by the lessor in an interest-bearing account with a financial institution.
• On expiration of the lease agreement, the lessor may apply the deposit and interest towards the payment of all amounts for which the lessee is liable under the lease agreement, such as reasonable costs of repairing damage caused to the property during the lease period and the cost of replacing lost keys. The balance of the deposit and interest must then be refunded to the lessee by the lessor not later than 14 days of restoration of the property to the lessor.
• Should no amount be due and owing to the lessor on expiration of the lease, the deposit with the accrued interest must be refunded to the lessee within seven days of expiration of the lease.

Since the above terms are deemed to be included in a lease, the parties to the lease agreement are bound by them whether they are explicitly included in the agreement or not.

The same income tax principles generally apply to rental deposits irrespective of whether the lease is governed by the Rental Housing Act. It is, however, necessary to evaluate the specific contract before a final conclusion is reached.

While the wording of the specific lease agreement is critical, a lessor generally receives the deposit in the position of a trustee and, since the rental deposit is not the lessor’s money, has an immediate obligation on receipt of the rental deposit to refund it to the lessee upon termination of the lease. Typically, the lease agreement provides that if the lessee does not meet all of the lessee’s obligations as set out in the agreement, for example, the lessee owes the lessor an amount for rental for prior months, the amount owing by the lessee may be set off against the rental deposit with the net amount being refunded to the lessee. Since the deposit is not the lessor’s money and the lessor is contractually liable to refund the rental deposit at the time it is received, the amount is not received by the lessor “on his own behalf for his own benefit” and thus is not included in the lessor’s gross income. If the lessee owes the lessor an amount under the lease, that amount will often represent gross income for the lessor (for example, a charge for repairs to be conducted by the lessor or outstanding rent).

The income tax treatment of a deposit that falls within the ambit of the Rental Housing Act is not necessarily altered by non-compliance with the deemed terms. For example, if a deposit is not invested with a financial institution in an interest-bearing account that does not automatically render the amount to be taxable provided the income tax requirements as considered above in this section of the Note are complied with.

A rental deposit is distinguishable from an up-front rental payment and a lease premium. The facts and circumstances of each case should be considered to determine whether the amount received constitutes a rental deposit, an up-front rental or a lease premium.

An up-front rental is for the use or occupation or right of use or occupation of the lessor’s property and therefore remains in the nature of rent which is included in the lessor’s gross income. A lease premium is usually an up-front amount paid for the use or occupation or right of use or occupation of a property and is not refundable. It represents an inclusion in gross income for the lessor.

Agreements of sale or service

For this type of issue, some Tax Court cases illustrate the current opinion.

In a case dating back to 1950; 17 SATC 224(C), the taxpayer received advance payments for funerals to be rendered at a later date. The court held that the advance payments constituted gross income, since they represented ordinary revenue income of the taxpayer’s business and the taxpayer had at all material times dealt with the advance payments as his own money. The money went into the taxpayer’s ordinary business account, it was not put into a trust fund or any special account and was used by him in the ordinary course of his business to either fund the running of the business or possibly to make investments for his own benefit.

In another case from 1984 (3) SA 210(ZS), 46 SATC 57C v COT, the taxpayer, a company carrying on business as a fuel-selling and service station, experienced a change in industry business practice which required it to pay cash for its bulk fuel deliveries. To help fund this cash-payment requirement, the taxpayer gave its regular customers the option of paying cash for their purchases or to continue paying monthly for their purchases but only after paying a deposit equal to a 12th of their annual expenditure on fuel. The taxpayer intended the deposits to be in the nature of a loan. These amounts were deposited into the sole bank account of the taxpayer and were used by the taxpayer for the payment of fuel, the purchase of spare parts and other expenses. The deposits were recorded as credits in each customer’s name until the customer closed his monthly credit account facility, in which event the deposit became due for repayment immediately and the customer was entitled to demand repayment.

The credits did not reflect on the customers’ monthly statements and were not applied against monthly purchases made by customers. Upon request from customers the taxpayer provided documentary acknowledgement of the indebtedness to the customers’ auditors. The taxpayer contended that the deposits were loans for consumption in its hands and this was their overall intention. It was held that the receipt of the deposits did not constitute ordinary revenue income but was “working capital” just as it would have been had a bank supplied the taxpayer with a loan. The fact that no interest was payable by the taxpayer and that there was no fixed date for repayment was irrelevant in this instance. The deposits were therefore not required to be included in gross income. While the court found that in this case the “deposit” was factually a loan, it is submitted that the substance of the transaction must always be taken into account and often in arrangements of this nature it is likely that the deposit will be an advance payment which is for the benefit of suppliers and must be included in gross income.

In case number (1950) 17 SATC 206 (N), the taxpayer, a company, which carried on the business of technical consultants and advisers in connection with the erection, construction, maintenance and operation of machinery and plant of all kinds, received an amount comprising payment for services rendered during the year of assessment as well as services to be rendered over a period of ten years. The taxpayer included only a portion of the amount received in gross income in the particular year of assessment. The Commissioner raised an assessment including the full amount received. The court held that the decision of the Commissioner was correct and, that since the amount received was not of a capital nature, it was received by the taxpayer in that year of assessment and should be included in taxable income for that same year.

A contract of sale or service delivery may have suspensive or resolutive conditions. The conditions attached to the agreement and the various clauses of the agreement will determine whether and when a deposit, if applicable, must be included in gross income.

Deposits are common in the sale and purchase of immovable property. Although the particular contract must be considered, generally, when a purchaser pays a deposit in respect of the purchase of immovable property, it is paid into an estate agent or attorney’s trust account and held in trust for the purchaser until such time as it is applied in partly settling the purchase price of the immovable property. Until it is applied in settling the purchase price, the money is the purchaser’s property and any interest earned on it is generally included in the purchaser’s gross income.

Security deposits

Many taxpayers let equipment or goods as part of their business and require a deposit to be paid on acceptance of a quote to secure the booking as well as to cover any charges levied in the future for damage to the items or failure to return the assets.

It depends on the particular contract but as in the case of rental deposits (above), security deposits are usually held in trust and are refundable by the taxpayer at the end of the contract, but may be set off against any amounts owing by the customer for damage to the item or failure to return the items timeously. In these circumstances, on receipt the money is not the taxpayer’s and there is an unconditional obligation on the taxpayer providing the goods or equipment to refund the deposit. Therefore, the deposit is not received by the taxpayer “on his own behalf for his own benefit” and accordingly should not be included in the taxpayer’s gross income on receipt. Any amounts the customer is charged for damages or failure to return the items timeously will generally be gross income for the taxpayer.

Accommodation establishments often charge a deposit to secure a booking. The deposit is then deducted from the balance of the accommodation fees payable and, subject to the establishment’s cancellation policy, may be refunded in whole or in part upon cancellation of the booking. It depends on the particular contract, but as in the case of returnable containers (also explained above), deposits or advance payments of this nature are usually received by the taxpayer “on his own behalf for his own benefit” and should be fully included in gross income on receipt. The establishment may become obliged at a later date to refund the deposit or part of it if the guest cancels the booking.

If the deposit or a portion of it is refunded, a deduction of the refunded amount may be claimed by the establishment under section 11(a) in the year of assessment in which it is refunded, subject to the requirements of that section being met.

Construction and building contracts

In the construction and building industry it is common practice for advance payments to be required before the commencement of the work which will be executed. These payments, which may sometimes be referred to as a deposit, are generally available to the contractor to use to purchase building material or equipment and accordingly are received for own benefit and must be included in gross income.

Impact of the Consumer Protection Act (CPA) on deposits

In a 2019 Tax Court case, (2019) 81 SATC 267 (C), the taxpayer was a retailer that “sold” gift cards to its customers that could be redeemed at any of its stores. Although colloquially referred to as a “sale”, the court found that the “sale” was actually a prepayment and the physical gift card merely vouched for the existence of a personal right against the taxpayer for redemption of the prepayment. In line with the principles considered in this Note, the Court found that prior to considering the impact of the Consumer Protection Act 68 of 2008 (the CPA), there was no applicable trust relationship and the amounts would have been received by the taxpayer for purposes of gross income. This view was not altered by the fact that after performing the relevant reconciliations the taxpayer transferred and retained moneys for unredeemed gift card receipts in a separate bank account. However, the Court found that the taxpayer was a supplier as defined in the CPA and that the “sale” was regulated by section 63 and section 65 of that Act. Section 63 provides that the consideration received is the property of the bearer of the gift card to
the extent it has not been redeemed in exchange for goods or services.

Section 65 provides that the supplier must not treat the consideration as the supplier’s own and “in the handling, safeguarding and utilisation of that property, must exercise the degree of care, diligence and skill that can reasonably be expected of a person responsible for managing any property belonging to another person”. The Court held that the CPA and the taxpayer’s adherence to its requirements resulted in some form of statutory trust in which the card holder is given a proprietary interest and the taxpayer has a fiduciary duty to the bearer. Otherwise stated, after applying and complying with the CPA, the taxpayer did not receive the money from the “sale” of gift cards on its own behalf for its own benefit and it should not be included in gross income.

The specific facts and circumstances of each case, the relevant provisions of the CPA and the taxpayer’s compliance with the requirements of the CPA must be considered in determining whether an amount should be included in gross income. If the taxpayer did not comply with the provisions of the CPA, the general principles considered in the Taxation of the receipts of deposits Guidance Note from SARS may prevail.

Unclaimed deposits

The treatment of an unclaimed deposit depends on its prior treatment for income tax purposes. For example, if a rental deposit, which was not included in the lessor’s gross income under the principles considered in the Guidance Note at the time it was received or prior to prescription is for some reason never claimed by a previous lessee, then after the relevant prescription period when the deposit becomes the lessor’s money, it must be included in the lessor’s gross income.

Refer to sections 10, 11 and 12 of the Prescription Act 68 of 1969 regarding the periods of prescription and the date on which debts prescribe. The prescription period generally commences from the date on which the debt becomes due, however, there are a few exceptions to this rule.

For example, a taxpayer’s intention towards a deposit that was not initially received by the taxpayer for own benefit and on own behalf (and accordingly was not initially included in gross income) may change in the future to keeping the deposit for own benefit notwithstanding that it is legally owing to the lessee and requiring inclusion in gross income at that point in time.

In contrast, if a customer pays a deposit for the supply of goods in the future and underthe principles considered in the Guidacne Note the deposit was received by the supplier for own benefit and included in gross income when received, then if the goods are not supplied and the customer does not claim the deposit, it will not be included in gross income again. If the supplier refunds the deposit, it may constitute a deductible expense for the supplier.

Conclusion derived from the SARS Guidance Note

The Guidance Note deals only with general principles. The facts and circumstances of each case, including the conditions attached to the deposit and the intention of the taxpayer, must be considered.

Deposits received by a taxpayer must be included in the taxpayer’s gross income if received by the taxpayer “on his own behalf for his own benefit”. For a deposit to be excluded from gross income on the basis that it has not been received by the taxpayer, the amount must be held in trust and generally be held in a separate bank account.

The use of a separate bank account, however, does not override the true nature of the transaction and intention of the taxpayer. Thus, even if the taxpayer keeps the deposits in a separate bank account but there is no intention of refunding them, they must be included in gross income in the year of assessment in which they are received.

If applicable, the consequences of the CPA and any obligations it places on a taxpayer must be considered in determining whether a deposit must be included in a taxpayer’s gross income.

Author Crag Tonkin

Leave a Reply

Your email address will not be published. Required fields are marked *