Reserve set aside to meet loyalty card obligations found to be not deductible
On 3 December 2019 the Supreme Court of Appeal delivered its judgment in the matter of CSARS v Clicks Retailers (Pty) Ltd Case No 58/2019 (not yet reported in SA Tax Cases). In doing so it reversed the decision of the tax court and disallowed the taxpayer’s claim for an allowance under section 24C of the Income Tax Act (Act) in respect of its customer loyalty programme..
The taxpayer operates a loyalty programme known as Clicks ClubCard. Membership is voluntary and in no way limits the freedom of customers to shop wherever they choose. When a customer presents a membership card when making a purchase, one loyalty point is earned and recorded in the records of Clicks for every R10 spent. At quarterly intervals, a customer who has accumulated at least 100 points is awarded a voucher for R10 for each 100 points. Vouchers may not be exchanged for cash, but may be redeemed against the cost of subsequent purchases.
During the 2009 year of assessment, the taxpayer claimed an allowance of about R44 million to be deducted from its gross income, calculated on the basis of the cost of sales to the taxpayer in honouring vouchers that the taxpayer expected customers to redeem in the following tax year. SARS disallowed the claim and rejected the taxpayer’s objection to the disallowance.
The taxpayer succeeded on appeal to the tax court, for the following reasons:
(a) it was artificial and factually incorrect to regard the taxpayer’s expenditure as arising from a different contract from the first purchase and sale contract that had occasioned the customer’s acquisition of the points;
(b) the first purchase and sale agreement triggered the both the earning of income by Clicks and an obligation on the taxpayer to incur future expenditure;
(c) the obligation to incur future expenditure was therefore incurred under the same contract from which the income was earned and the requirements of section 24C were met.
Section 24C provided in 2009 that for the allowance for future expenditure to apply:
1. SARS must be satisfied that an amount of expenditure “will be incurred” after the end of the year;
2. in a manner that the amount will be deductible in a subsequent year of assessment; or in respect of the acquisition of an asset in respect of which any deduction will be admissible under the Act;
3. the income of a taxpayer in any year of assessment includes or consists of “an amount received by or accrued to him in terms of any contract”, and SARS is satisfied that all or part of the amount will be used to finance future expenditure which the taxpayer will incur “in the performance of his obligations under such contract”.
4. The allowance must be added back to income in the following year of assessment.
The most recent decision on section 24C was CSARS v Big G Restaurants (Pty) Ltd [2018] 81 SATC 185 SCA, in which the court held that the income and the expenditure must arise from the same contract. It does not avail the taxpayer if two contracts are “inextricably linked”. The operative concept is “contract”, not “scheme” or “transaction”.
SARS contended that there were at least three contracts: the ClubCard contract, which was issued free of charge and gave rise to no income in the taxpayer’s hands; the first contract of purchase and sale, when the customer bought merchandise from the taxpayer and triggered the award of points under the ClubCard contract; and the second contract of purchase and sale, when the customer bought merchandise and was entitled to redeem the voucher. The points awarded arose from the ClubCard contract. So the probable future expenditure arose from the points awarded under the ClubCard contract.
The taxpayer contended that the only issue for determination was whether or not the first contract of purchase imposed an obligation on the taxpayer, as the tax court had found. There was, according to the taxpayer a “direct and immediate connection” between each qualifying contract of sale and the obligation on the taxpayer to issue rewards to the customer. The ClubCard contract itself did not create or impose on the taxpayer any exigible obligation to grant any rewards on the taxpayer. The conclusion of a qualifying purchase not only brought into existence an exigible obligation on the taxpayer to issue rewards, but also determined the content of that obligation, with reference to the value of the qualifying purchase. It followed that the “same contract” requirement was met.
The court stated that the ClubCard contract establishes the right of the customer to receive points and then vouchers redeemable against subsequent purchases. This was how the taxpayer described the position in its reply to the SARS enquiry. When it came to the objection, however, the taxpayer shifted its ground. It continued to say that the expenditure was incurred in performing its obligations under the loyalty programme, but started to equivocate regarding the relationship between this and the contracts that generated the rewards. It stated that “there is no separate contract of purchase and sale relating to the goods purchased – the customer’s presentation of the ClubCard when paying at the till-point being inextricably interwoven with and an integral part of each purchase and sale of goods transaction entered into by the ClubCard customer”.
The phrase “inextricably linked” was the kiss of death for the taxpayer. The court referred to the decision in Big G, where the SCA had rejected this concept in relation to section 24C. The income from the first sale contract would be used to finance the acquisition of stock for future sales, thus enabling the taxpayer to meet its obligations under the second sale. The contract that created the right to income was the first sale. The contract that obliged the taxpayer to honour the vouchers was not the first sale, nor the second sale, but the ClubCard contract, a different contract from either of the sale contracts.
The taxpayer’s argument had as its object the reduction of the contractual relationship with a customer to a single qualifying contract of sale, which is both income-earning and obligation-imposing, because the taxpayer is obliged to award points to the customer. This argument ignored the reality of the arrangement, in which three contracts are operative under the loyalty plan. Consequently, the taxpayer did not have access to the section 24C allowance.
After the unanimous decision of the court, delivered by Dlodlo JA, Wallis JA, the author of the definitive judgment on interpretation in Natal Joint Municipal Pension Fund v Endumeni Municipality [2012] ZASCA 13, dealt with the decision in Big G, to show, according to the learned judge, why the outcome of Big G’s current appeal to the Constitutional Court would not affect the present judgment. In section 24C there is a clear link between “a contract” and “such contract”. It was this link that had been fatal to the taxpayers in both cases. In doing so he, not surprisingly, applied the principles he had summarised in Natal Joint Municipal Pension Fund, by considering the reason for the introduction of section 24C in 1980. This was to provide relief to taxpayers who in the ordinary course of their operations would be required to make provision for replacement of machinery and equipment in order to keep their operations up to date. The learned judge referred to situations where construction companies receive upfront payments from clients to enable them to obtain the necessary equipment and materials to commence a contract.
In the case of businesses such as Big G, sensible management would in any event dictate that the external appearance in internal décor be regularly refurbished, regardless of whether or not the undertaking was operating under a franchise agreement. To allow a provision for such future expenditure would be to permit the deduction of expenses before they had been incurred, which would offer taxpayers a means of manipulating the timing of tax payments. The SCA had found in Big G that the sale of meals and the expenditure incurred on refurbishment arose from two different contracts. And this was the same argument that applied in the present matter. When a customer buys goods from the taxpayer and leaves the shop, that is the end of the transaction. It is only later, when the customer returns to the shop and makes another purchase, that the loyalty points awarded in terms of the ClubCard contract, and based on the value of the first transaction, come into operation. And the taxpayer’s obligation under the second transaction arises only from the need to acquire the goods necessary to conclude the second sale contract. If one views the matter from the perspective that the loyalty programme is merely an undertaking to offer the customer a discount on the next purchase, that hardly qualifies as expenditure contemplated under section 24C.
It seems that Big G and now the present matter have confirmed a strict interpretation of section 24C, where different contracts cannot be bundled together and treated as one.