The timing of income tax in relation to retailer gift cards was recently addressed by the Cape Town Tax Court in A Company v The Commissioner for the South African Revenue Service.(1)
Judge Binns-Ward neatly set the scene in the judgment's opening paragraph:
The taxpayer carries on business as a high street retailer of clothing, comestibles and general merchandise. As part of the facilities offered to its customers, it 'sells' gift cards. These can be redeemed for goods at any of the taxpayer's stores. The question in this appeal… is whether the revenue from the 'sale' of the taxpayer's gift cards during [the tax year] constituted part of its 'gross income' for the purposes of the Income Tax Act [No 58 of 1962 (ITA)] as soon as it was received by the taxpayer (as contended by the Commissioner), or would become such only when the card was redeemed, or having not been redeemed, expired (as contended by the taxpayer).
Under Section 1 of the Income Tax Act, gross income must include all of the amounts "received by or accrued to or in favour of" the taxpayer. In this case, it was clear that the taxpayer had not accrued the amounts in question, as such, the question was whether the taxpayer had received the amounts.
Until the 2013 tax year, the taxpayer declared all of the revenue it generated through gift card sales as having been received by it; accordingly, it included these sales in its gross income for the year in which the cards were issued and paid for.
However, the introduction of the Consumer Protection Act (68/2008), which contains provisions that deal specifically with prepaid gift cards, complicated this process. Put simply, Sections 63 and 65 of the Consumer Protection Act provide as follows:
(2) A prepaid certificate, card, credit, voucher or similar device contemplated in subsection (1) does not expire until the earlier of—
(a) the date on which its full value has been redeemed in exchange for goods or services or future access to services; or
(b) three years after the date on which it was issued, or at the end of a longer or extended period agreed by the supplier at any time.
(3) Any consideration paid by a consumer to a supplier in exchange for a prepaid certificate, card, credit, voucher or similar device contemplated in subsection (1) is the property of the bearer of that certificate, card, credit, voucher or similar device to the extent that the supplier has not redeemed it in exchange for goods or services, or future access to services.
(2) When a supplier has possession of any prepayment, deposit, membership fee, or other money, or any other property belonging to or ordinarily under the control of a consumer, the supplier—
(a) must not treat that property as being the property of the supplier;
(b) 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; and
(c) is liable to the owner of the property for any loss resulting from a failure to comply with paragraph (a) or (b).
(3) A person who assumes control of a supplier's property as administrator, executor or liquidator of an estate—
(a) has a duty to the consumer—
(i) to diligently investigate the circumstances of the supplier's business to ascertain the existence of any money or other property belonging to the consumer and in the possession of the supplier; and
(ii) to ensure that any such money or property is dealt with for the consumer's benefit in accordance with this section [...].
After the Consumer Protection Act came into force, the taxpayer changed the way that it dealt with the gift card sales. It began to transfer the revenue generated from gift card sales to a separate bank account that had been opened only to hold the proceeds of its gift card transactions until the cards had been redeemed or expired. This course of action is relatively common among retailers in other jurisdictions where gift cards are used.
Once the taxpayer began transferring its gift card revenue to this account, it stopped including it in its gross income on the basis that the amounts had not been 'received' within the meaning of the Income Tax Act. In this regard, the court stated as follows (at Paragraph 17):
The taxpayer's argument that the receipts in respect of the 'sale' of unredeemed gift cards did not constitute part of its gross income was advanced on two levels. The first was that, as a matter of principle, and irrespective of the incidence of the [Consumer Protection Act], the fact that the monies received by it in respect of the 'sale' of gift cards are held in a separate bank account, and are not applied in the conduct of the taxpayer's business, until the cards are redeemed or expire, and that they are discretely accounted for in its financial records as an unredeemed gift card liability, renders it inconsistent with it being 'income' within the ordinary meaning of the word until such time as it is appropriated. This argument is premised on the contention that the facts demonstrate that the money is not received for the taxpayer's own benefit, but rather to be held for the benefit of another (ie the bearer of the gift card). The taxpayer… obtains the benefit of the money taken in only when it discharges its obligation or the card expires. The second level of the taxpayer's argument was premised on what it contends is the legal effect of the characterisation of its receipts in respect of unredeemed gift cards in ss 63 and 65 of the [Consumer Protection Act], coupled with its treatment in practice of those receipts consistently with the statute.
The court rejected the first level of the taxpayer's argument. It found that the argument was based on the notion that the moneys had been received and, pending the redemption or expiry of the cards, somehow held in trust for the cardholders' benefit. The court held that the mere segregation of the receipts for unredeemed gift cards in a separate bank account (identified for that purpose) did not mean that the taxpayer had not held the money for itself and for its own benefit.
While the taxpayer might have seen itself as a trustee, there was no evidence that it had legally bound itself to hold the receipts in a fiduciary capacity. It did not matter where the taxpayer kept the moneys or how it accounted for this in its books, as it could have spent or saved it as it wished and for its own benefit.
Accordingly, the court found that the taxpayer had been correct to have included its receipts for unredeemed gift cards as part of its gross income before the Consumer Protection Act came into force. However, this changed once the act was introduced. According to the court, the question which then arose was whether the taxpayer's method of dealing with its gift card receipts in apparent compliance with the Consumer Protection Act entailed that it receive the proceeds for itself or the gift card bearers. The court held that the act required it to take and hold the receipts for the card bearers and to refrain from applying them as if they were its own property. The court found that the taxpayer had done just that. The act prohibited the taxpayer from receiving the moneys held for gift cards for itself until the cards had been redeemed. Accordingly, the gift card receipts had been received by the taxpayer, not for itself, but to be held for the card bearer.
Based on its findings, the court held that the taxpayer had been correct in excluding the gift card receipts in its gross income and that the relevant assessments should be set aside.
The counsel for the commissioner raised an interesting argument – namely, that the Consumer Protection Act was introduced to protect consumers' rights, and not to change the incidence of tax. In that regard, the court held as follows:
[I]f the manner in which the [Consumer Protection Act] 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. 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 [Consumer Protection Act] does not express any such intention. And any such effect would be at odds with the scheme of the [Income Tax Act]. A conflict between the two sets of legislation arises only if it is construed in the manner contended for by the Commissioner. It does not arise on the approach contended for by the taxpayer's counsel.
The court accordingly dismissed that argument. Essentially, it found that the commissioner cannot apply fiscal laws in a vacuum; instead, they must determine the incidence of tax in the real world, and in light of all of the relevant facts and circumstances, including common law or legislation, that requires taxpayers to act in a certain manner.
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