Should SOEs get a tax break for fruitless and wasteful expenditure?
Fruitless and wasteful expenditure at state-owned entities can run into billions each year, resulting in a large and possibly unjustified deduction, writes Tertius Troost
In the recently published draft Taxation Laws Amendment Bill, the Treasury has made it clear that it will be joining efforts to ensure proper governance of public entities as it proposes that no income tax deduction will be allowed for fruitless and wasteful expenditure.
Fruitless and wasteful expenditure is defined in the Public Finance Management Act (PFMA) as expenditure that was made in vain and would have been avoided had reasonable care been exercised. Examples include interest and penalties on overdue accounts‚ litigation and claims, cancellation fees for accommodation and ineffective implementation of hardware.
Section 11(a) of the Income Tax Act, colloquially referred to as the general deduction formula, makes provision for the deduction of expenditure actually incurred in the production of income, provided that such expenditure is not of a capital nature. Conversely, Section 23 of the Income Tax Act disallows certain expenditure, even when it meets all the requirements of Section 11(a).
As fruitless and wasteful expenditure is currently not explicitly included in Section 23, if companies are able to show that the expenditure was incurred in the production of income and not of a capital nature, even if this these expenses were not necessary, it could still be allowed as a deduction.
Numerous reports by the Auditor-General Thembekile Kimi Makwetu show that fruitless and wasteful expenditure at state-owned entities (SOEs) can run into billions of rand each year, resulting in what the public might feel is quite a large, unjustified deduction for certain SOEs.
As the government, together with Public Enterprises Minister Pravin Gordhan, continues to ensure the proper governance of SOEs, it is proposed in the draft bill that fruitless and wasteful expenditure (as defined in the PFMA) be disallowed as a deduction for income tax. The Treasury hopes this will encourage further accountability for these institutions.
In addition, to ensure tax neutrality, it is further proposed that any amount of fruitless and wasteful expenditure that was not allowed as a deduction and was recovered by the public entity be deemed exempt from income tax during the year of assessment in which it is received or accrued.
As most SOEs are currently in assessed loss positions, the public will have to wait and see whether the proposed amendment will generate additional revenue for the fiscus. As things stand, it will probably only reduce the balance of assessed losses of these entities. Furthermore, when these entities are in a profitable position and able to distribute dividends, the question must be asked what affect this amendment will have.
On the assumption that the entity is wholly owned by the state, the corporate income tax, dividends withholding tax, along with the actual after tax dividend, will all eventually be included somewhere in state coffers that is, either through SARS, or a government department).
This proposed amendment indicates the Treasury’s commitment to support government in its fight to clean up SOEs, however, it seems to be more of a public relations tactic than additional revenue collection.
• Troost is a senior tax consultant at Mazars.