Payment does not guarantee an income tax deduction

Section 23H ensures that deductions are aligned with the period in which the underlying benefit is received, thereby preventing the premature acceleration of tax deductions. However, the practical application of section 23H is significantly influenced by its proviso’s, particularly the 6-month rule (proviso (aa)) and the R100,000 de minimis threshold (proviso (bb)), which often determine whether the limitation applies at all.  

When section 23H applies 

Section 23H applies where: 

The expenditure qualifies for deduction under provisions such as section 11(a); and  

The expenses relate to goods, services, or benefits that will not be fully consumed within the same year of assessment. 

In such cases, the deduction must generally be spread over the period during which the benefit is enjoyed, rather than being claimed in full in the year of assessment in which it is incurred. 

The importance of the proviso’s 

The provisos to section 23H are not mere technical in nature. They are critical exceptions that can override the apportionment requirement entirely. 

Importantly, the provisos must be considered in a specific order. The proviso’s (aa), (cc) and (dd) should be applied first before the R100,000 threshold in proviso (bb) is considered. 

The 6-month rule 

In terms of proviso (aa), the provisions of section 23H does not apply where all goods, services or benefits are supplied or enjoyed within 6 months after the end of the year of assessment in which the expenditure was incurred. 

The rule should be applied on a transaction-by-transaction basis, and it allows a full immediate deduction, even if the benefit extends into the following year of assessment. The 6-month rule recognises that short-term prepayments are part of normal business practice and should not be subject to strict timing adjustments. 

Example 

In January, a taxpayer with a February year-end pays for services to be rendered in January – April. 

As the full benefit is consumed within six months after the year-end, the full deduction is allowed in the year in which the expenditure is incurred. 

The R100 000 threshold 

In terms of proviso (bb), the provisions of section 23H do not apply where the total prepaid expenditure that would otherwise be subject to limitation does not exceed R100 000. 

This test should be applied to the aggregate of all prepaid expenditure, and not on a transaction-per-transaction basis. It applies only to the balance of prepaid expenditure excluding amounts that qualify for deduction under the other proviso’s. If the threshold is exceeded, the entire amount becomes subject to section 23H, not merely the excess. 

Other relevant proviso’s 

While the 6-month rule and the R100 000 threshold are the most frequently applied, two additional provisos are worth noting: 

Proviso (cc): Excludes expenditure governed by interest rate agreements (s24K) and option contracts (s24L) 

Proviso (dd): Applies to payments that are legally required by legislation and who are unconditional in nature for example prepaid municipality rates may qualify. 

Step-by-step application 

Step 1: Identify all prepaid expenses. 

Step 2: Exclude prepaid expenses covered by the 6-month rule, which represent statutory payments, and derivative-related expenditure. 

Step 3: Determine the total of the remaining prepaid amounts. 

Step 4: Compare the balance with the R100,000 threshold. 

Conclusion 

Section 23H is a cornerstone provision governing prepaid expenditure, but its practical impact is largely determined by its proviso’s. Proper sequencing of the proviso’s is essential for correct application.