For the second time in less than a year, the Constitutional Court has been called upon to decide a dispute regarding section 24C of the Income Tax Act. Clicks Retailers (Pty) Ltd versus CSARS is the more recent of the two disputes, the earlier being Big G Restaurants (Pty) Ltd versus CSARS. The Clicks judgment clarified important principles of interpretation that were raised in the Big G dispute. It is important not only for the principles it established in the interpretation of section 24C but also for principles established pertaining to when the Constitutional Court has jurisdiction to decide tax cases.
The crisp issue of interpretation relating to section 24C that was decided in the Clicks case was whether Clicks was entitled to a section 24C allowance relating to its obligations in terms of its well-known Clubcard loyalty programme, against sales revenue it earned from its customers. It was the 2009 year of assessment that was the subject of the dispute.
The decision on the merits
By way of background, section 24C is essentially a provision that grants a tax deferral to a taxpayer. If a taxpayer receives income in terms of a contract in a given year and is obliged to incur expenditure in fulfilling its obligations under the same contract in a later year, subject to fulfilling the requirements of the section, the taxpayer is not exposed to full taxation on the amount received in the earlier year. It is most commonly, but by no means exclusively, encountered in the building and construction industry.
In 2009 the part of section 24C relevant to the dispute read as follows:
“If the income of any taxpayer in any year of assessment includes or consists of an amount received by or accrued to them in terms of any contract and the Commissioner is satisfied that such amount will be utilised in whole or in part to finance future expenditure which will be incurred by the taxpayer in the performance of their obligations under such contract, there shall be deducted in the determination of the taxpayer’s taxable income for such year such allowance as the Commissioner may determine…” (my emphasis).
As is apparent from the above wording, the contract that imposes the obligation to incur the future expenditure must be the same contract in terms of which the amount was received by or accrued to the taxpayer. It was this ‘sameness’ requirement that was precisely the point in dispute in both the Big G and Clicks cases.
In Big G the taxpayer was a Panarotti’s restaurant franchisee that claimed a section 24C allowance in respect of periodic refurbishments that the franchisor obliged it to undertake. Big G sought to deduct the section 24C allowance against the sales revenue that it derived from its customers. This was on the basis that the franchise agreement, which was the contract imposing the obligation to incur the future expenditure, was inextricably linked to the contracts whereby it sold meals to customers.
The Supreme Court of Appeal (‘SCA’) decided the matter in favour of SARS, expressly rejecting the notion the section 24C applies where two or more different contracts are inextricably linked. Instead, it held that section 24C required the taxpayer to incur the expenditure in the performance of its obligations in terms of the same contract as the contract under which it received income.
A few days after the SCA decision in Big G, the same court heard the Clicks case, which revolved around the Clicks Clubcard loyalty programme. A Clicks customer wishing to participate in the Clubcard loyalty programme would enrol in such programme, which enrolment gave rise to a contractual arrangement between Clicks and the customer in the form of a Clubcard contract. Although the contract in terms of which Clicks earned revenue from the customer was a contract of sale and not the Clubcard contract, Clicks argued that it was the sales contract that that gave rise to the obligation on Clicks to incur future expenditure, since the Clubcard contract itself did not give rise to an obligation upon Clicks to incur future expenditure. Clicks therefore argued that the conclusion of a sales contract brought into existence not only its right to income but also the obligation to incur future expenditure
However, the Supreme Court of Appeal rejected this argument, holding that the contract that created the right to income was the sales contract whereas the contract imposing the obligation to incur future expenditure was the Clubcard contract. Consequently, the SCA held that the requirements of section 24C was not met.
Shortly before the SCA decision in Clicks was handed down, the appeal by Big G to the Constitutional Court was heard. The Constitutional Court accepted that section 24C requires the contract in terms of which the income is received to be the same contract that imposes the obligation to finance future expenditure. However, the Constitutional Court held that two or more contracts may be so inextricably linked that they may satisfy the requirement of ‘sameness’.
The Constitutional Court held that the sameness requirement did not imply that there must, for example, in the case of a written contract, be one piece of paper stipulating for the earning of income and the imposition of future expenditure, and that two or more contracts may be so inextricably linked that they may satisfy this requirement. The Constitutional Court framed the question for decision as follows: “Whether the franchise agreements and the contracts of sale of food are so interlinked that the sale of food income may be held to be income that accrues in terms of each franchise contract; each franchise agreement, of course, being the contract that imposes the obligation to revamp in future and thus creates the future expenditure”.
The Court reached its decision that section 24C should not apply to Big G by on the basis of a comparison of the respective tax positions of a restauranteur unattached to a franchise, who would not enjoy a section 24C allowance for future refurbishments and the taxpayer, were it to be granted a section 24C allowance. The Court held that “it would be absurd in the extreme to allow Big G to enjoy the benefit of an allowance under section 24C whilst denying it to unattached restaurateurs who…are similarly placed”. It followed from the Constitutional Court’s judgment in Big G that a section 24C allowance may be claimed either if the traditional same-contract requirement is met or when the income and the obligation to finance future expenditure arise from two or more contracts that are so inextricably linked that they meet the requirement of ‘sameness’.
No doubt encouraged by the possibility that section 24C may apply even if the income and obligation are generated by different but interlinked contracts, Clicks proceeded to the Constitutional Court. Clicks sought to demonstrate that the factual and legal links between the Clubcard contract and the sale contract were such that the two contracts were ‘inextricably linked’. It argued that the contracts operated together, that the conclusion of the Clubcard contract did not itself generate any real obligations and that the obligation to award points was only triggered and given content when a qualifying purchase was made. The Constitutional Court found that the two contracts were inextricably linked to the extent that (a) obligations under the Clubcard contract were triggered by the sales contracts; (b) Clicks’ obligation to finance expenditure when Clubcard points were redeemed was determined with reference to the sales contracts; and (c) there was a significant factual overlap and nexus between the contracts.
Nevertheless, these links did not satisfy the requirement of ‘sameness’. In addressing the requirements of ‘sameness’, the Court held: “Whatever the outer limits of the concept of sameness in this context may be, at a minimum both the earning of income and the obligation to finance future expenditure must depend on the existence of both contracts. If either contract can be entered into and exist without the other, they can hardly achieve sameness.” The Court found that the obligation to incur future expenditure was sourced in the Clubcard contract and did not depend on the existence of a sale contract while the sale contract did not owe its existence to the Clubcard contract. It also found that there were many other respects in which the contracts functioned independently.
The Court stated: “These links do not render either contract dependent on the other for its existence, nor is their effect that income can only accrue to Clicks if both contracts are in place. The contract under which income accrues (the contract of sale) and the contract under which the obligation to finance future expenditure arises (the Clubcard contract) are simply too independent of each other to meet the requirement of contractual sameness.
Whilst they may operate together within the context of the loyalty programme and in that sense are inextricably linked or connected, this link is not sufficient to render the contracts the same for the purposes of section 24C. The contracts therefore fall short of the sameness that is required by section 24C”.
The Court therefore found that Clicks could not claim a section 24C allowance on either a same-contract basis or on a sameness basis and its appeal was dismissed with costs.
Jurisdiction of the Constitutional Court
The majority of the Constitutional Court in the Big G case found that it had jurisdiction to hear the matter in terms of section 167(3)(b)(ii) of the Constitution.
This provision requires the matter to raise an arguable point of law of general public importance. The majority held that the question of how interlinked the contracts were was a quintessential point of law. As to whether it was ‘arguable’, on the basis of the decision in Paulsen vs Slipknot Investments 777 (Pty) Ltd  ZACC 5, the Court held that “arguable entails some degree of merit in the argument. Although the argument need not, of necessity, be convincing at this stage, it must have a measure of plausibility” and that this requirement was met. As to whether the matter was of general public importance, because the principles would likely be of importance to other franchisees besides Big G and it would be of interest to the many Spur Group franchisees spread across the length and breadth of South Africa, the Court held that this general public importance requirement was also met. Accordingly, the Court entertained the Appeal.
The approach of the Constitutional Court in the Clicks case was largely the same as in the Big G case. The Court confirmed that the interpretation of contracts is a matter of law and not of fact. It stated that the legal question of contractual interpretation was not the same question that arose for decision in Big G and that neither was the question of statutory interpretation. In Clicks it was required to go further and ‘put meat on the bones’ of the sameness test as applied in Big G in the context of inextricably linked contracts. In relation to whether the matter was of general public importance, the Court noted that the decision would have implications for all other retailers who offered similar loyalty programmes, such as Pick ‘n Pay, DisChem, Ster Kinekor and Exclusive Books.
The decision in Clicks relating to section 24C has important ramifications, especially for operators of loyalty programmes. Based on the Constitutional Court judgment in Big G, the argument that the contracts in Clicks were inextricably linked and therefore that section 24C could apply seemed reasonable, but the Constitutional Court in Clicks added “some meat to the bones”. It is certainly clear from the Clicks judgment that an inextricable link between a contract whereby revenue is earned and a contract that imposes an obligation to incur future expenditure on its own is insufficient to meet the requirements of section 24C. Contractual ‘sameness’ is required In regard to when the Constitutional Court has jurisdiction to hear an income tax appeal, the decision also importantly confirmed the principles applied in the Big G case. In particular, the Court did not apply an overly narrow interpretation to the general public importance requirement in section 167(3)(b)(ii) of the Constitution.
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