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Making a payment in return for you to have your video with your products and services played at an event, workshop or conference is undoubtedly in connection with production of income. A payment to a football club, or towards a school event, for no exchange of immediate goods or services from the recipient of sponsorship or third parties sounds somewhat a donation. However the fact that sponsorship does not result in an immediate supply of goods, services or benefit to the sponsor should not be the reason for disallowing it as an expense for income tax purposes. The motive for the sponsorship and its connectivity to the business of the taxpayer matters much more as fully explained below.
Expenditure is allowed for tax purposes if it has been incurred by the taxpayer in the production of income or for the purposes of the trade of the taxpayer. The case of Port Elizabeth Electric Tramway Co Ltd v Commissioner of Inland Revenue 8 SATC 13 (CPD) held that expenditure is for the production of income if its purpose is to produce income. In order for it to be viewed as such, the act to which it is attached should be performed in the production of income or performed bona fide for the purpose of carrying on trade which earns the income. The expenditure should be closely linked to such act that it can be regarded as part of the cost of performing it. It does not matter whether the expenditure in question is necessary for the performance of the act, attached to it by chance or bona fide incurred for the more efficient performance of business operations. The problem with sponsorship is that it is in the middle of the road between donation and advertisement. When viewed as a donation “in the production of income” motive becomes farfetched because of some element of philanthropy, hence disallowed for income tax purposes. The taxpayer must prove that the sponsorship was necessary in bringing brand eminence, awareness, publicity and advance its standing or market in the area in which the sponsorship activity has been undertaken to qualify for deduction. For example sponsorship of a football tournament or a football team can bring brand awareness and prominence to the audience and advance the business of a taxpayer.
In a nutshell, a close connection should exist between the sponsorship and the taxpayer’s business. It does not matter whether a third party is also to benefit out of the sponsorship. What matters is that the business is being promoted by incurring the sponsorship expenditure. Put differently, a nexus must exist between the sponsorship being incurred and the production of income in the year of assessment. As an example, a deduction may be allowed of the cost of reimbursing a sporting team for its purchased bus that displays the sponsor’s name or for sponsoring a sporting competition named after the sponsor. However, a deduction may not be allowed for a gift to a school attended by the donor’s child where the school is in another district away from where business activities are conducted or where the business proprietor sponsors a sporting activity which is part of his/her hobby. There must exist a relationship of the potential market to the taxpayer’s business and the relationship between expenditure and the ultimate income derived. For example, a sale of bulls at an agricultural show by a farmer sponsoring the event in return for being able to display the bulls shows a direct relationship between the sponsorship expenditure and the resultant income. A deduction may also be allowed for sponsoring a sporting team where the business name is displayed on players’ jerseys. Nevertheless, an up-front sponsorship payment covering more than a year advertising period may be subject to the rules on prepayments .These rules provide that expenditure is allowed in the year to which it relates.
Notwithstanding sponsorship expenditure being incurred in the production of income, capital nature sponsorship is disallowed. Capital nature sponsorship has its main object of creating an image or goodwill (e.g. promoting name of the company) or bringing an enduring benefit to the taxpayer. In the caseof Shell Rhodesia (Pvt) Limited v COT. J.273 (I.T.C. 1129, 31 S.A.T.C. 144); the taxpayer awarded bursaries to Rhodesian citizens and also paid certain sums to the Rhodesian College of Music to enable that college to assist its students. There was no obligation on any of the recipients of the bursaries to enter the taxpayer’s employment on completing his education. An attempt by the taxpayer to deduct the amounts as advertising expenditure, incurred wholly and exclusively for purpose of its trade was denied on the basis the expenditure was held to be of a capital nature because the object of the expenditure was not immediately and directly to increase taxpayer’s sales but to improve its public image and so to build up goodwill. The case of; Rothmans of Pall Mall (Rhod) Limited v COT. J. 336. (1973) was however distinguished. Over a period of four tax years, the taxpayer, a cigarette company, paid certain amounts in sponsoring the National Sports Foundation. It was common cause that the payments were made to secure an advantage over its competitors in the advertisement of its name and in marketing research. The Commissioner had contended that the expenditure was meant to create goodwill, but the court ruled that the taxpayer’s main object was not to create an image or goodwill but to provide an opportunity for advertisement and also to conduct market research. The advantage or benefit obtained was not long term or enduring. The expenditure was of a recurrent nature and was more closely related to the performance of the income producing operations than to the income producing machine and hence tax deductible.
The burden of proof that the sponsorship expenditure is deductible lies with the taxpayer. This can be strengthened by instituting proper internal control systems. For example when committing to a sponsorship agreement, it is important to spell out the benefits to be derived by the sponsor from the sponsorship. In turn the sponsorship agreement and supporting documents e.g. a letter of approach from the organisation, tax invoices for the sponsorship, written evidence of all contributions made, contract of terms and conditions for the sponsorship must be retained as evidence in support of the claim. The sponsorship agreement should be a specific requirement in the promotion of a taxpayer’s business. It should also reflect the extent and prominence of the business exposure. Making the sponsorship arrangement part of a coherent marketing strategy bolsters chances of the sponsorship expenditure being deducted.