Some people are easy to find gifts for, but if the person is picky or you don’t know them all that well, a gift card or voucher is a good alternative. 

Such offerings can however pose tax challenges for retailers, especially if they aren’t accounted for properly. One retailer in particular faced an additional assessed income (taxable income) amount of R13 million after the owner changed the way he accounted for the income from gift cards on his tax return.

The retailer objected to the additional assessment and, after his objection was disallowed, took his case to the tax court, says PwC tax director William Eastwood in the firm’s April tax update.

The retailer always kept the amounts received for the gift cards in a separate bank account, representing the amount that was redeemed and the unredeemed value.

Previously, it was practice to declare the amounts received for the issue of gift cards as gross income, and to then claim an allowance for future expenditure once the cards were redeemed.

Sars’s ‘cash sale’ stance

The South African Revenue Service (Sars) argued that the issuing of a gift card represented a sale, and that the consideration should be treated as revenue from a cash sale.

The Consumer Protection Act (CPA), which came into effect in March 2011, introduced new provisions around gift cards. In terms of the CPA any amount paid to a supplier for a prepaid certificate, card, credit voucher or “similar device” is the property of the bearer of the device “to the extent that the supplier has not redeemed it in exchange for goods or services”.

In his 2013 return the retailer only included the income from redeemed or expired cards, which led to an audit and the additional assessment.

An article written by DLA Piper’s Andrew Lewis and Benjamin Mbana (director and senior associate respectively) notes that the tax court accepted the change in the way the retailer accounted for the income accrued to him due to the changes in the CPA.

The court held that the “pertinent provisions of the CPA create a legal construct” that results in the taxpayer (the retailer) initially taking the gift card receipts not for [himself], but for the card bearer.

Issuers must keep the funds available

In its judgment, the court stated that the taxpayer (the retailer) is placed under a fiduciary duty to the bearer of the card to ensure that the funds are kept available until the prepayment is redeemed.

“The CPA required [the retailer] to take and hold the receipts for the card bearers, and to refrain from applying them as if they were [his] own property, and [the retailer’s] method of dealing with the receipts was directed to doing just that,” the tax court found.

Sars argued that the object of the CPA is the protection of consumers, and not the deferral of tax liabilities.

However, the tax court found that if the manner in which the CPA protects consumers entails the deferral of “beneficial receipt of revenue” by suppliers as a matter of fact, then the knock-on effect on the determination of the suppliers’ taxable income is only to be expected.

Tax on income not yet received not the intention

“Were it otherwise, the necessary implication would be that suppliers fall to be taxed on income they have not yet received, and which has not yet accrued to them. The CPA does not express any such intention,” the tax court found.

Eastwood noted that the CPA is explicit that the consideration given for a gift card is the property of the bearer and remains the property of the bearer until the supplier redeems the card in exchange for goods or services, or the card expires.

He says the CPA has created an effect that may not have been contemplated when it was enacted. However, the provisions of the Income Tax Act must be applied to the facts. “Here, the facts clearly are that, in law, the supplier is not the owner of the consideration given in exchange for a gift card.”

Lewis, who is part of the South African Institute of Tax Professional’s business tax committee, said that although it is only a timing issue (when the tax will be paid), the judgment will be of great interest to retailers who have not been treating the accruals (receipts) from the sale of gift cards on this basis.

“It is also a reminder to taxpayers in general that tax legislation must not be applied in isolation, but regard must also be had to the legislative framework within which taxpayers conduct their business.”