Income Tax: The deduction of security expenditure

In today’s increasingly security-conscious world, businesses and individuals alike are faced with the need to invest in safety measures. Whether it's hiring security personnel, installing alarm and video surveillance systems, access control systems, perimeter fencing, outdoor lighting, or other security-related measures, these costs can add up quickly. In addition to incurring these security expenses, many taxpayers also make contributions to organisations that focus on preventing and combating crime. The good news is that, under certain conditions, these security-related expenses may be eligible for deductions when calculating income tax.

In this article, we will explore the basics of security expenditure, the rules surrounding deductions, and how businesses or individuals can benefit from tax relief by claiming security costs as allowable expenses.

Security expenditure usually falls within one or more of the following categories:

·      Expenditure of a domestic or private nature

·      Donations

·      Business-related expenditure

Expenditure of a domestic or private nature

The requirements for a deduction under the general deduction formula are, amongst others, that the expenditure must be incurred for purposes of carrying on a trade and in the production of income.

Section 23(b) of the Income Tax Act also prohibits the deduction of domestic or private expenditure, including, amongst others, expenses in connection with any premises not occupied for trade or any dwelling-house or domestic premises.

The expense of securing an individual’s private residence does not qualify as a deduction under the general deduction formula since it is not incurred in the carrying on of a trade and in the production of income. Such an expense is further prohibited under section 23(b). A taxpayer who uses part of a private residence for purposes of trade, for example, a home office, must make an appropriate apportionment of the security expenditure incurred.

For capital gains tax purposes, security expenditure of a capital nature may qualify as part of the base cost of immovable property held for domestic or private purposes, such as a primary residence or holiday home. Examples of such improvement or enhancement expenditure include the cost of installing an electric fence or the price of a burglar alarm system, which is integrated into the fabric of a building.

Donations

Generally, donations are not deductible for income tax purposes because they will either be of a private or domestic nature or not be incurred for purposes of carrying on a trade.

The word “donation” is defined for purposes of the donations tax and means “any gratuitous disposal of property, including any gratuitous waiver or renunciation of a right”.

A donation is therefore a gratuitous disposal by the donor out of liberality or generosity, under which the donee is enriched and the donor impoverished. It is a voluntary gift freely given to the donee. There must be no quid pro quo, no reciprocal obligations and no personal benefit for the donor. If the donee gives any consideration in exchange, it is not a donation.

Section 18A(1) does however provide for the deduction in the determination of the taxable income of any taxpayer so much of the sum of any bona fide donations by that taxpayer in cash or of property made in kind, which was actually paid or transferred during the year of assessment to certain entities or organizations carrying on in South Africa any Public Benefit Activity in Part II of the Ninth Schedule.

The protection of the general public's safety is listed as a Public Benefit Activity in Part II of the Ninth Schedule for purposes of section 18A.

Thus, a deduction will be available for a deduction of any bona fide donation under section 18A(1), provided it is supported by a section 18A receipt issued by the relevant organisation or an employees’ tax certificate as defined in the Fourth Schedule issued by the organisation under section 18A to an employer on which the amount of bona fide donations contemplated is given.

It is essential that a donation to a qualifying entity be distinguished from a contribution made as a member of an organisation that protects the safety of the general public, such as a neighbourhood watch.

Business-related expenditure

For an expense or loss to be deductible under the general deduction formula, it must be actually incurred, in the production of income, and not of a capital nature.

Conversely, section 23(g) denies the deduction of any moneys against income derived from trade to the extent such moneys were not laid out or expended for trade.

Recurring costs which do not create an enduring benefit are likely to be of a revenue nature and will be deductible under the general deduction formula. Examples include the monthly service fees for a satellite tracking system for motor vehicles, monthly payments to an armed-response company, salary costs of security personnel and the cost of food and veterinary bills for a guard dog.

Capital expenditure is not deductible under the general deduction formula. Characteristically, it is incurred “once and for all” and creates an enduring benefit. Examples of capital expenditure include the cost of installing an alarm system, an electric fence and acquiring a guard dog.

While capital expenditure is not deductible under the general deduction formula, it may qualify for a deduction, albeit over a period, elsewhere under the Act, for example, under section 11(e) (wear-and-tear or depreciation allowance) or section 24D (security expenditure).

Persons carrying on farming operations are entitled to claim the cost of fencing. Still, the deduction is limited to taxable income derived from farming operations, with any excess being carried forward to the succeeding year of assessment.

Section 12U allows a taxpayer to claim a deduction on an amount actually incurred during the year of assessment on, amongst others, the erection of any fence used by such person for their trade of generating electricity, which exceeds five megawatts from specified sources of renewable energy. In addition to a deduction of the amount incurred on erecting the fences, the expenditure actually incurred on the foundation or supporting structure designed for such fence and on improvements to the fences, and the foundation or supporting structure for the fences, is also deductible.

Contributions to anti-crime initiatives

Contributions to crime-prevention initiatives may take the form of non-deductible payments; donations deductible under section 18A; or advertising or sponsorship expenditure deductible under the general deduction formula.

Sponsorship generally involves the support or promotion of an activity, such as a sporting event, in return for advertising of the sponsor’s products or services. In terms of security expenditure, a company that, for example, provides an armed response service or installs security gates may offer to secure a certain premises in return for extensive advertising of the company’s logo at the premises or at a high-profile event. The sponsorship may also take the form of the provision of products related to the advancement of crime-initiative projects.

From an income tax perspective, the question has been raised whether contributions to anti-crime initiatives are deductible. The contributions may take the form of cash, goods and products, or services rendered free of charge. For the contributions to qualify as a deduction under the general deduction formula, they must be incurred in the production of income in the carrying on of a trade, such as advertising a contributor’s business.

Cash contributions will be limited to the extent that the taxpayer can prove they produced commercial value for the business through exposure of its name or products.

A taxpayer who can prove that the contribution of trading stock produced commercial value for the business through exposure of the taxpayer’s name or services will be allowed a deemed deduction. Such a deemed deduction could apply, for example, to the contribution of a car by a motor vehicle manufacturer as part of an anti-crime campaign.

Expenditure incurred in providing security to employees

Employers sometimes incur security expenses related to their employees, such as the cost of an armed-response service at an employee’s home, the provision of bodyguards for employees, the supply of a guard to protect an employee’s home or family while the employee is away on business or on leave, or the installation of a security system at an employee’s home.

From the employer’s perspective, these expenses are simply an expense of employment or a form of insurance and should qualify for a deduction.

However, security expenses incurred by an employer in relation to employees may give rise to a taxable benefit in the hands of the employees under the Seventh Schedule, with associated employees’ tax implications.

Conclusion

In considering whether the security expenditure incurred by a taxpayer qualifies for a deduction, regard must be had to whether the expenditure is of a domestic or private nature; whether a donation meets the requirements under section 18A(1);  whether the business-related expenditure meets the requirements of the general deduction formula read with section 23(g) that it be actually incurred, in the production of income and not be of a capital nature.

Security expenses incurred by an employer in relation to employees may give rise to a taxable benefit in the hands of the employees under the Seventh Schedule, with associated employees’ tax implications.