To: Breaking News From: LLB Tax Law Student Date: 26 May 2024 Re: Deductibility of expenditures under the Income Tax Act 1993
Introduction
This legal opinion addresses the deductibility of two specific expenditures incurred by Breaking News, a local private television station. The expenditures in question are (a) a contribution of M345,000 towards the rebuilding of a house for a private citizen, and (b) legal costs of M150,000 incurred in an unsuccessful defence against a breach of industry regulations.
The central issue is whether these expenditures meet the criteria for deduction set out in section 33(1) of the Income Tax Act 1993 of Lesotho (ITA 1993). Specifically, this opinion will analyse whether each expenditure can be considered as having been incurred "in the production of income". This analysis will be based on the provisions of the ITA 1993 and the interpretation of similar statutory language by the courts, particularly in Southern Africa, whose jurisprudence is often considered persuasive in Lesotho.
The General Deduction Formula in Lesotho
The primary provision governing the deduction of business expenses in Lesotho is section 33(1) of the ITA 1993. This section provides the general rule for deductibility, stating:
"For the purpose of ascertaining the taxable income of any person, there shall be deducted from the income of such person all expenditure and losses, not being expenditure or losses of a capital nature, wholly, exclusively and necessarily incurred by such person in the production of his income."
For an expense to be deductible under this section, it must satisfy several cumulative requirements:
- It must be an expenditure or loss.
- It must not be of a capital nature.
- It must be incurred "wholly, exclusively and necessarily".
- It must be incurred "in the production of income".
This opinion will focus on the final requirement, "in the production of income," as it is the most contentious element in relation to the two expenditures made by Breaking News.
The phrase "in the production of income" has been the subject of extensive judicial interpretation. A key test was established in the influential South African case of Port Elizabeth Electric Tramway Co Ltd v CIR (1936), which is likely to be persuasive in Lesotho. The court held that for an expenditure to be incurred in the production of income, it must be a necessary concomitant of the business operations. The court asked whether the expenditure is attached to the performance of the income-earning operations, as opposed to being attached to the income after it is produced. There must be a sufficiently close link between the expenditure and the act of producing income.
(a) Contribution Towards House Rehabilitation (M345,000)
The Legal Issue
The first issue concerns the M345,000 contributed by Breaking News to rebuild the house of an old lady following its destruction in a flash storm. The question is whether this payment has a sufficient connection to the station's income-producing activities to be considered as incurred "in the production of income".
Analysis
The argument in favour of deductibility would be that this expenditure is a form of public relations or marketing. As a local television station, Breaking News relies on its reputation and connection with the community to attract viewers, which in turn attracts advertisers and generates revenue. By making this very public and generous contribution, the station could be seen as enhancing its brand image and generating significant goodwill. This goodwill can translate into increased viewership and, consequently, income. In this sense, the expenditure is not pure charity but a strategic business decision aimed at promoting the company.
This line of reasoning was accepted in the South African case of CIR v Pick 'n Pay Wholesalers (Pty) Ltd (1987), where a supermarket's donations to local schools were held to be deductible. The court found that the donations were part of a deliberate marketing strategy to attract customers with children and were therefore sufficiently connected to the company's income-earning activities.
However, the revenue authorities are likely to argue against the deduction. The primary counter-argument is that the expenditure is too remote from the station's core business of broadcasting. The direct purpose of the payment was to help the old lady, which is an act of benevolence or social responsibility. While this may create goodwill, this is an indirect and unquantifiable benefit. The courts require a closer and more direct link between the expenditure and the income-production process.
In Joffe & Co (Pty) Ltd v CIR (1946), another key persuasive authority, the court noted that the purpose of the expenditure is important. If the purpose was not to produce income but was, for example, to satisfy a moral obligation or act out of generosity, then the expense is not deductible. In the present case, without clear evidence that the contribution was part of a structured marketing or public relations campaign with measurable business objectives, it is likely to be viewed as an act of detached generosity. The connection to income production seems incidental rather than purposeful.
Conclusion on Expenditure (a)
On balance, it is unlikely that the M345,000 contribution would be considered deductible under section 33(1). While a commercial benefit in the form of goodwill may arise, the link between the payment and the station's income-producing operations is arguably too tenuous. The expenditure appears to be more in the nature of a philanthropic donation than a business expense "wholly, exclusively and necessarily" incurred to produce income. Breaking News would need to provide strong evidence of a direct marketing purpose to succeed with this claim, which seems difficult on the facts provided.
(b) Legal Costs for Breach of Regulatory Rules (M150,000)
The Legal Issue
The second issue is whether the M150,000 in legal costs, incurred in unsuccessfully defending the station against an alleged breach of regulatory rules, is deductible. The station lost the case to the Lesotho Communications Authority.
Analysis
As a general principle, legal expenses incurred in the course of trade are often deductible. They are typically considered a necessary part of business operations, incurred to protect the company's assets or its ability to earn income. The expenditure of defending a legal case that threatens the business's operations would, on the face of it, seem to be closely connected to the production of income. The purpose of incurring the legal fees was to protect the business and allow it to continue its income-earning activities, for instance by avoiding a suspension of its broadcast license or a crippling fine.
The fact that the defence was unsuccessful does not, in itself, prevent the legal costs from being deductible. The test is not whether the expenditure actually produced income, but whether it was incurred for the purpose of producing income as part of the business's operations (Port Elizabeth Electric Tramway). Defending the business's right to trade is an inherent part of carrying on that trade.
A more significant complication arises from the nature of the legal action: it was a defence against a breach of regulatory rules. This raises a public policy question. Fines and penalties imposed for breaking the law are generally not deductible. The reasoning is that such penalties are not incurred in the production of income; rather, they are a punishment for failing to conduct the business in a lawful manner. Allowing a deduction would, in effect, reduce the punitive impact of the penalty, which would be contrary to public policy.
However, there is a distinction to be drawn between the penalty itself and the legal costs incurred in defending the action. The legal costs were not a punishment for the breach; they were an expense incurred to protect the business from the consequences of the allegation. The expenditure was aimed at preserving the income-earning capacity of the business. Therefore, it can be argued that these costs are a legitimate business expense and are sufficiently closely connected to the production of income. The expenditure was an unavoidable risk of carrying on a regulated business.
Conclusion on Expenditure (b)
The legal costs of M150,000 are likely to be deductible under section 33(1). Despite the case being lost and relating to a regulatory breach, the expenditure was incurred for the purpose of defending the company's income-earning operations. The costs are a direct result of carrying on the business in a regulated industry and can be seen as a necessary concomitant of the station's trade. This position distinguishes the legal costs from any non-deductible fine that may have been imposed as a result of the judgment.
Overall Conclusion
In summary, my opinion on the two expenditures is as follows:
- Contribution of M345,000: This expenditure is unlikely to be deductible. It is difficult to establish a sufficiently close connection between this payment and the station's income-producing activities. It is more likely to be classified as a non-deductible act of benevolence.
- Legal Costs of M150,000: This expenditure is likely to be deductible. The costs were incurred to defend the business's ability to trade and are therefore considered an expense incurred in the production of income, regardless of the outcome of the case.
This opinion is based on the general principles of tax law in Lesotho and persuasive authority from the region. The final determination would rest with the Lesotho Revenue Authority and, ultimately, the courts.
References
Legislation
Lesotho, (1993) Income Tax Act 1993 (Act No. 9 of 1993).
Case Law (South Africa – Persuasive Authority)
Commissioner for Inland Revenue v D & N Promotions (Pty) Ltd (1995) 57 SATC 178.
Commissioner for Inland Revenue v H L Hall & Sons Ltd (1954) 19 SATC 172.
Commissioner for Inland Revenue v Pick 'n Pay Wholesalers (Pty) Ltd (1987) 49 SATC 132.
Joffe & Co (Pty) Ltd v Commissioner for Inland Revenue (1946) 13 SATC 354.
Port Elizabeth Electric Tramway Co Ltd v Commissioner for Inland Revenue (1936) 8 SATC 13.
