An Interdisciplinary Study: Deferred Tax Implications of Lay-By Agreements for Financial Planning and Decision Making

Abstract

Due to tough economic conditions, more retailers are relying on lay-by agreements to maintain revenue. Lay-by agreements are thus part of their business models and are included in their forecasting and budgeting strategies. As part of financial planning, decisions need to be made based on financial information to achieve organisational goals. A recent South African income tax amendment regarding lay-by agreements resulted in three possible income tax interpretations. This study analysed and evaluated the implications of these amendments for South African deferred tax. The study utilised a doctrinal approach in an interpretive paradigm. The results show that the amendment in the South African Income Tax Act relating to lay-by agreements has an impact on deferred tax calculations, depending on the tax interpretation used. The resulting ambiguity and diversion in the practice of the deferred tax treatment may potentially lead to less useful financial information, contrary to the objectives of the International Accounting Standards Board for effective decision making. This study recommends that the National Treasury should clarify this ambiguity, through either legislative amendments or an interpretation note. This will create the necessary certainty for organisations to plan their finances.

1. Introduction

1.1. Context and Background

Lay-by arrangements refer to sales agreements that enable customers to acquire and make payments for goods over a specified duration, typically ranging from three to six months, without incurring any additional interest fees (National Treasury, 2023a). Lay-by arrangements can be considered a type of savings mechanism, as they enable a broader segment of the population to obtain goods without resorting to credit-based instalment sales arrangements, consequently mitigating the extent of indebtedness. As a result of the influence of the COVID-19 pandemic on household incomes and the prevailing economic conditions, a significant proportion of consumers have shifted to utilising lay-by services for the procurement of school uniforms and supplies (National Treasury, 2023a). However, recent amendments to the South African Income Tax Act No. 58 of 1962 (Income Tax Act) require suppliers to pay taxes in advance on lay-by sales, according to the view of the South African Revenue Service (SARS). The cost of the upfront cash outflow resulting from the change in the tax treatment of lay-by agreements may potentially be passed on to customers, which, in turn, could have a societal impact.

Prior to the recent amendment, upfront payments relating to lay-by agreements were not included in suppliers’ gross income for income tax purposes for two reasons. First, in Geldenhuys v CIR (1974) (3) SA 256 (C); 14 SATC 419, it was held that the words “received by … the taxpayer” in the definition of gross income means “received by the taxpayer on his own behalf for his own benefit”. Hence, the suppliers had not yet received the monies for their own benefit, and income was therefore not received in terms of the gross income definition. Second, in Mooi v SIR, 1972 (1) SA 674, 34 SATC 1, it was held that “accrued to” means unconditionally entitled to the amount. As the goods are still in the suppliers’ possession, the taxpayer is not unconditionally entitled to the outstanding lay-by amount and, hence, there is no accrual for gross income purposes.

Another section that may potentially have applied to lay-by agreements is section 24. In terms of section 24(1) of the Income Tax Act, the whole amount specified in a sales agreement is liable to be taxed immediately when a taxpayer sells trading stock under a suspensive sales condition. This condition pertains to situations where the transfer of ownership of movable or immovable property is scheduled to take place at a later stage, subsequent to the receipt of either a partial or a full payment of the total amount owed (Republic of South Africa, 1962). Lay-by agreements, which in nature are a suspensive sale, could therefore be interpreted to fall within the scope of section 24. However, according to the SARS (2018) Interpretation Note 48 Issue 3 (IN 48), section 24 only applies to lay-by agreements with a duration of 12 months or more.

The non-application of section 24 to lay-by agreements, per IN 48, was indirectly substantiated by the relief offered by section 24, as explained via the following reasoning: the full amount of a credit sales agreement is taxed upfront in terms of section 24(1). Section 24(2), then, offers relief to the taxpayer in the form of a debtors’ allowance. In principle, per IN 48, the relief offered is for the amounts still outstanding, with the allowance then calculated by applying the taxpayer’s gross profit percentage to the outstanding amount. However, the provided tax relief is exclusively applicable to contractual agreements that have a minimum duration of one year and involve a payment structure where a minimum of 25% of the total amount owed to the taxpayer is scheduled for payment in a subsequent year of assessment; in other words, lay-by agreements are not eligible for the relief under section 24 due to their usual duration of less than 12 months. These provisions and arguments made logical sense and provided certainty for taxpayers, as the interpretation was that only lay-by agreements with a duration of 12 months or more fell within the scope of section 24.

The scoping provision of section 24(1), was not amended. However, the insertion of a new relief provision in section 24 creates the impression that all lay-by agreements, irrespective of the period, are included in the scope of section 24(1), as the new relief provision in section 24(2A) reads as follows:

(2A) In the case of a lay-by agreement as contemplated in section 62 of the Consumer Protection Act, 2008 (Act No. 68 of 2008), the Commissioner may make an allowance in respect of all amounts which are deemed to have accrued under such agreement but which have not been received by the end of the taxpayer’s year of assessment.

(National Treasury, 2023b, p. 20)

In explaining the reason for the above new relief provision in the explanatory memorandum, the National Treasury states that the upfront inclusion of lay-by proceeds without any allowable deduction creates an adverse tax result and hence the new relief was introduced (National Treasury, 2023a). The National Treasury made this statement even though it acknowledged in the same piece of writing that lay-by agreements typically span a period ranging from three to six months (National Treasury, 2023a). The only logical conclusion that a reader of the explanatory memorandum can come to is that lay-by agreements, irrespective of the period, fall within the scope of section 24(1); however, a relief will then be offered in terms of section 24(2A). The new insertion was implemented on 1 January 2023 and is applicable to assessment years that conclude on or after the said date.

The interpretation of the new section 24(2A) is, unfortunately, not as clear as it appears at first glance from reading the explanatory memorandum. According to Hassan and Van Heerden (2024), the introduction of the new relief provision can potentially result in the following three different income tax interpretations when examining the relationship between lay-by agreements and section 24 of the Income Tax Act:

• SARS’s view (Interpretation 1);
• Haupts’ view (Interpretation 2);
• Hassan and Van Heerden’s view (Interpretation 3).

According to SARS, section 24(1) encompasses all lay-by agreements, irrespective of their duration. The taxpayer is then also eligible for the section 24(2A) relief which, in terms of IN 48, is equal to the gross profit percentage multiplied by the outstanding debtors’ amount, hence referred to as a ‘debtors allowance’. According to Haupt and Haupt (2023, p. 173), the total amount in terms of the lay-by agreement is deemed gross income in terms of section 24, and, subsequently, the relief allowance is applied to the full deemed amount, resulting in a Rnil tax effect on taxable income for the taxpayer; that is, Haupt and Haupt does not apply the principle of the debtors’ allowance per IN 48 but, rather, allows for a 100% relief allowance for the full credit sales agreement amount. Applying the principles of Geldenhuys v CIR and Mooi v SIR, Hassan and Van Heerden (2024) argue that lay-by agreements should not be considered within the scope of section 24(1) due to the explicit provision in the Consumer Protection Act, No. 68 of 2008 (CPA), which affirms the consumer’s ownership of the amount received by the supplier. The aforementioned interpretation was further validated and affirmed in the case of ITC 24510, 2019, SATC. This interpretation is also endorsed by tax experts in the industry (see Louw, 2022; Nel, 2023), as well as by a recognised international tax authority; namely, the Australian Taxation Office (1995).

The impact of the three different interpretations on taxpayers’ taxable income can be presented by way of the following example:

Facts: Assume Company A enters into lay-by sales agreements amounting to ZAR 1,000,000 prior to the conclusion of the tax year, in which a 10% deposit is received. Further, assume that the taxpayer’s gross profit margin is 20% and no other cash flows are received during the year. Company A acquired the trading stock during the year of assessment in which they entered into the agreement.

Table 1. Effects on taxable income.

Income Tax Implication	Interpretation 1	Interpretation 2	Interpretation 3
Tax position at year-end in respect of lay-by agreements	ZAR	ZAR	ZAR
Deemed accrual of sales proceeds, per section 24(1) of the Income Tax Act	1,000,000	1,000,000	0
Section 24(2A) debtors’ allowance (based on gross profit %, therefore ZAR 900,000 × 20%)	(180,000)		0
Section 24(2A) debtors’ allowance (100% of the deemed accrual amount)		(1,000,000)
Purchases, deduction (ZAR 1,000,000 × 80% = ZAR 800,000)	(800,000)	(800,000)	(800,000)
Add: Closing stock, per section 22(1)	0 *	800,000	800,000
Effect on taxable income of Company A	20,000	0	0

* In practice, at year-end, the outstanding lay-by agreement stock is still on hand at the retailer. This raises the question: Should the lay-by agreement stock be included or excluded from closing stock values at year-end? Unfortunately, SARS is silent on how the closing stock of lay-by agreements should be treated at year-end. The impact of the closing stock issue can be explained in terms of the example. If SARS were to add the closing stock value to the taxpayer’s income (as the stock is physically still on hand at the retailer), the taxable income from the lay-by agreement would be ZAR 820,000. Surely, that is not SARS’s intention. SARS’s intention is to tax the taxpayer on the ‘cash basis’ principle, which can be explained in terms of the example: The ZAR 100,000 deposit received by the taxpayer, multiplied by the gross profit margin of 20%, results in a taxable income of ZAR 20,000. To end with a taxable income of ZAR 20,000, the only logical conclusion is that SARS will not require an add-back of closing stock under section 22(1) for lay-by stock.

illustrates the effects on the taxable income of Company A.

The divergent interpretations relating to lay-by agreements are highlighted through the example, which range from having an impact on the taxable income of a taxpayer to having no impact on the taxable income of a taxpayer. Consequently, the aforementioned circumstances gave rise to the research problem addressed in this study.

1.2. Research Problem and Justification for the Study

From an accounting perspective, it is important to understand and predict what the future tax consequences will be in relation to a specific transaction or line item in the statement of financial position to calculate the deferred tax implications (Mear et al., 2021). Hence, the overarching research question was formulated as follows: What is the implication for deferred tax given that there are three possible interpretations of the tax treatment of lay-by agreements?

1.3. Research Objective

The objective of this study was to discuss the deferred tax consequence due to the three possible tax interpretations and to evaluate the implications thereof for the financial reporting of entities affected by lay-by agreements. This objective was achieved by first examining the revenue accounting implications of lay-by agreements and then, in answer to the research question, determining the deferred tax implications based on the three different tax interpretations of section 24 and lay-by agreements. The revenue accounting implications are primarily informed by the International Financial Reporting Standards (IFRS) Accounting Standards principles of IFRS 15 Revenue from Contracts with Customers (IFRS 15). The deferred tax implications are primarily informed by the principles of IAS 12 Income Taxes (IAS 12) supported by other fundamental principles in the IFRS Accounting Standards. The study’s objective prompted the formulation of the following sub-research questions to effectively address the primary research questions:

• Sub-research question 1: What are the revenue recognition implications of lay-by agreements? and
• Sub-research question 2: What are the deferred tax implications following from the three tax interpretations?

1.4. Contribution of This Research

This research makes a valuable contribution to the field of taxation and accounting by conducting an in-depth analysis of the revenue recognition implications of lay-by agreements and the resulting deferred tax implications, based on the application of the three tax interpretations. This study is original, as the researchers could not find any other published study on the deferred tax implications of lay-by agreements. The study recommends that the National Treasury enact legislative amendments in order to establish tax certainty on the treatment of lay-by agreements, as there are currently three different interpretations, which have an impact on the deferred tax implications. The subsequent section provides a description of the research methodology employed in this study.

2. Materials and Methods

Ontologically, this research falls into the category of social research, as reality is a construct of the human mind, created by cultural and social practices and a shared belief system (Stack, 2019). According to McKerchar (2010), research may reflect “either positivism or non-positivitism” (p. 15), with its methodological approaches comprising either non-doctrinal or doctrinal research. Chynoweth (2008) refers to doctrinal research as research in the interpretive paradigm. The selection of the interpretive paradigm (i.e., non-positivism) was deemed suitable for this research endeavour due to the necessity of interpreting and applying various accounting standards, such as the IFRS Accounting Standards, as well as other written materials. Scholars in the field of accounting concur that a disparity exists between accounting research and accounting practice (Inanga & Schneider, 2005; Parker & Guthrie, 2014; Singleton-Green, 2009; Tucker & Lowe, 2014; Wilkinson & Durden, 2015). There is a need for collaboration among accounting policy, practice, and research in order to address this disparity (Evans et al., 2011). Hence, it is critical that accounting researchers consider the practical implementation of accounting principles, rules, and concepts (Coetsee, 2019). In addition, this study adopted the same view that the IFRS standards have not been tested as a theory through a traditional scientific research approach that supports the use of doctrinal research (Inanga & Schneider, 2005; Van Wyk & Coetsee, 2020).

Conducting doctrinal research entails the utilisation of secondary sources and commentary to ascertain the existing knowledge and gaps pertaining to the research subject. This process involves incorporating a literature review (Hutchinson & Duncan, 2012). Therefore, the research methodology employed in this study was a doctrinal approach, applying an authoritative interpretation of the literature in line with the view of Van Hoecke (2011). This approach involves a systematic analysis of the Accounting Standards and principles that pertain to a specific issue, that is, lay-by agreements—in this instance, the principles associated with revenue recognition in terms of IFRS 15 and the resulting deferred tax implications in IAS 12. This study utilised many data sources to conduct the literature review. Information and documents were gathered through online searches utilising search engines such as Google Scholar and Scopus Search. The websites of the following entities were also examined: professional accountancy firms, governmental bodies, including SARS and the National Treasury, and international organisations, such as the Australian Tax Office and the IFRS Foundation. The search phrases employed encompassed, but were not restricted to, the keywords in this study. The study established the validity and reliability of its findings by constructing a robust argumentative framework. This study did not collect primary data, which is recognised as a study limitation.

3. Literature Review

3.1. Accounting Implications for Revenue Recognition in Terms of IFRS 15

Revenue is considered a key performance indicator for companies and, therefore, needs to be accounted for accurately (Van Wyk & Coetsee, 2020). Revenue is also important from an income tax perspective, as tax liabilities are calculated from accounting information (Napier & Sadler, 2020). IFRS 15 was issued by the International Accounting Standards Board (IASB) in 2014 and implemented for reporting periods starting on or after 1 January 2018. The objective of IFRS 15 (IASB, 2022c: A890) is to “establish the principles that an entity shall apply to report useful information to users of financial statements about the nature, amount, timing and uncertainty of revenue and cash flows arising from a contract with a customer”.

From the objective above, IFRS 15 seeks to provide useful information to users of financial statements, including tax authorities. Information needs to be useful from a measurement point of view, which refers to the amount that should be recognised (including any uncertainties) as well as the timing of the revenue, which refers to when the revenue should be recognised. To achieve this objective, the IASB has brought in the core principle to recognise revenue in a manner that depicts the transfer of the good or service to customers and that also reflects the consideration to which the company will be entitled (IASB, 2022c). The core principle is reflected in the five-step revenue recognition model of IFRS 15, which is presented in Figure 1.

The five steps of the revenue recognition model of IFRS 15 are briefly discussed below before they are applied against lay-by agreements in Section 4 of this article.

Step 1: Identify the contract with the customer

The first step is crucial in the accounting treatment of revenue from lay-by agreements, as it establishes the enforceable rights and obligations in the contract that have an impact on the revenue recognition (timing) and measurement (amount) (IASB, 2022c). The contract needs to meet certain criteria in terms of IFRS 15 that support the enforceable rights and obligations in order to be considered valid. In terms of IFRS 15, the contract can be written or verbally agreed upon and should be based on customary business practices that establish enforceable rights and obligations;

Step 2: Identify the performance obligations in the contract

According to Napier and Sadler (2020), this step encourages companies to provide distinct performance obligations when contracts are negotiated. A performance obligation in terms of IFRS 15 is identified as “a good or service that is distinct or a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer” (IASB, 2022c, para. 22). Ernst & Young (2015) provides a two-step process to determine whether a good or service is distinct. First, a ‘benefit assessment’ must be made that focuses on the ability of goods and services to generate economic benefits. Thereafter, the ‘separately identifiable’ assessment is conducted to assess whether goods and services are distinct at the contract level. The IASB (2022c, para. 28) identifies the two separate assessments as follows: (1) A customer should be able to benefit from the good or service either on its own or together with other readily available resources and (2) the good or service needs to be separately identifiable from other promises in the contract, in the context of the contract. The outcome of this step is important, as it triggers the recognition of these distinct goods and services in Step 5 of the revenue recognition model (Van Wyk & Coetsee, 2020);

Step 3: Determine the transaction price

IFRS 15 refers to the transaction price as the amount the entity expects to be entitled to in exchange for the promised goods and services that will be transferred to the customer (IASB, 2022c). The transaction price consists of fixed and variable amounts. According to Van Wyk and Coetsee (2020), the transaction price is usually stipulated in the contract but can also be implied as part of the customary business practices of the entity, which also aligns with the principles contained in IFRS 15 (IASB, 2022c);

Step 4: Allocate the transaction price to the performance obligations in the contract

The objective of the allocation of the transaction price to the performance obligations is to determine the amount that the entity expects to be entitled to for each distinct good and service (performance obligation) identified (IASB, 2022c). According to Van Wyk and Coetsee (2020), the allocation principle is crucial for contracts with multiple performance obligations, which may be satisfied at different stages. The principle applied for the allocation is that the transaction price should be allocated based on the “standalone selling prices” of each identified performance obligation (IASB, 2022a, para. 74), which also aligns with the objective of the allocation;

Step 5: Recognise revenue when the performance obligations are satisfied

The recognition of revenue (timing) from lay-by agreements was a key aspect of resolving the research problem in this study. IFRS 15 requires goods or services to be recognised when the performance obligation is satisfied through the transfer of the goods or services, which can be at a point in time or over time (IASB, 2022c). However, the satisfaction of the performance obligation is underpinned by the principle of control, specifically when the transfer of control to the customer takes place. The IASB (2022c, para. 33) defines “control” in IFRS 15 as follows:

“Control of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. Control includes the ability to prevent other entities from directing the use of, and obtaining the benefits from, an asset.”

3.2. Deferred Tax Implications in Terms of IAS 12

Investors and analysts consider deferred tax as a complex accounting phenomenon (EFRAG, 2011; Graham et al., 2012; PwC, 2007). According to Saptono and Khozen (2021), it is essential for companies to deliberate taxation implications due to new revenue recognition developments such as IFRS 15. Graham et al. (2012) reported that financial accounting and tax researchers are focusing on the accounting for income taxes, with evidence that it is a very active area of research. Most of the studies found were empirical, primarily testing the incremental information content of the tax accounts and their role in earnings management.

A principal issue in IAS 12 is how to account for the current and future tax consequences of the future recovery/settlement of the carrying amount of assets/liabilities that are recognised in an entity’s statement of financial position (IASB, 2022b). This objective is also supported by a study by Mear et al. (2021), which focused on the ability of deferred tax to predict future tax expenses. This was also confirmed by another systematic study analysing the literature since the 1990s (Görlitz & Dobler, 2021), in which the authors highlight that there is substantial evidence for the value relevance of various deferred tax items. Purnamasari (2019) found that deferred tax affects a company’s earnings management. Given the significance of deferred tax, the correct and consistent accounting thereof, free of error, ensures that the objectives thereof are achieved.

The researchers’ interpretation of deferred tax is that it is a valuation adjustment made to assets and liabilities to ensure that users understand the correct and relevant inflow or outflow of economic benefits an entity is going to receive or pay. The carrying amounts of assets and liabilities in financial statements are presented on a pre-tax basis; therefore, these carrying amounts reflect the inflow or outflow of economic benefits on a pre-tax basis. However, the relevance of deferred tax lies in the entity presenting to users the future tax effects on the realisation of these assets or the settlement of the liabilities. The future tax effects are calculated by determining the tax consequences of the asset or liability as if it were realised or paid at the reporting date based on actual tax rules enacted or substantially enacted at the reporting date.

To achieve the above, IAS 12 presents the balance sheet method of calculating deferred tax. Under this method, an entity lists all the assets and liabilities (the items) and compares each item’s carrying amount to its tax base. The differences between the carrying amount and the tax base are called “temporary differences”. Deferred tax liabilities or assets are recognised for these temporary differences. The balance sheet method can be illustrated in the four steps presented in Figure 2. Each of the steps is explained in more detail below, after which the principles are applied to lay-by agreements in Section 4.

Step 1: Determine the carrying amounts of the assets and liabilities

In this step, the carrying amounts of the respective assets and liabilities presented in the statement of financial position are determined in accordance with individual IFRS Accounting Standards. The relevant assets and liabilities for lay-by agreements would be contract assets and contract liabilities determined in accordance with IFRS 15 and the inventory determined in accordance with IAS 2. It is possible for a line item to have a zero carrying amount. Some items may have a tax base but are not recognised as assets and liabilities in the statement of financial position (IASB, 2022b, para. 9);

Step 2: Determine the tax base of the assets and liabilities

The IASB (2022b, para. 5, 7–8) defines the tax base, the tax bases of the assets and liabilities as follows:

“The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes.

The tax base of an asset is the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an entity when it recovers the carrying amount of the asset. If those economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount.

The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods. In the case of revenue which is received in advance, the tax base of the resulting liability is its carrying amount, less any amount of the revenue that will not be taxable in future periods.”

The IASB further indicates that where the tax base of an asset or liability is not immediately apparent, it is helpful to consider the fundamental principle upon which this Accounting Standard is based. This fundamental principle is that an entity shall, with certain limited exceptions, recognise a deferred tax liability (asset) whenever recovery or settlement of the carrying amount of an asset or liability would make future tax payments larger/smaller than they would be if such recovery or settlement were to have no tax consequences (IASB, 2022b, para. 10). This confirms the future tax nature of deferred tax;

Step 3: Determine the temporary difference

The temporary difference is the difference between the carrying amount and the tax base. Temporary differences can be taxable or deductible and are defined by the IASB (2022b, para. 5) as follows:

“… taxable temporary differences, which are temporary differences that will result in taxable amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled; or

deductible temporary differences, which are temporary differences that will result in amounts that are deductible in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled.”;

Step 4: Choose the appropriate tax rate and measure the deferred tax

Deferred tax is recognised for temporary differences, with certain exceptions. As the carrying amount of an asset reflects the economic benefits that will flow to the entity in future periods, when the carrying amount of the asset exceeds the tax base, the amount of taxable economic benefits will exceed the amount that will be allowed as a deduction for tax purposes. This difference is a taxable temporary difference, and the obligation to pay the resulting income taxes in future periods is a deferred tax liability (IASB, 2022b, para. 16).

Similarly, the carrying amount of a liability will be settled in future periods through an outflow from the entity of resources embodying economic benefits. These amounts may be deductible when determining taxable profit in future periods. This is represented by the temporary difference that exists between the carrying amount of the liability and its tax base. Accordingly, a deferred tax asset arises in respect of the income taxes that will be recoverable in future periods when that part of the liability is allowed as a deduction in determining taxable profit (IASB, 2022b, para. 25).

4. Results

4.1. The Revenue Recognition Implications of Lay-By Agreements

To address Sub-research question 1, the accounting treatment of lay-by sales is discussed and evaluated using the five steps of the revenue recognition model of IFRS 15.

4.1.1. Identify the Contract with the Customer

The IASB (2022c) regards enforceability as a matter of law, which can be regarded as contract law in South Africa, but also considers other necessary laws and regulations. More specifically, the retailer is bound by the Consumer Protection Act (CPA) and the enforceable obligations as part of the requirements of the Act. Section 62 of the CPA (Republic of South Africa, 2008) states the following:

Lay-bys 62. (1) If a supplier agrees to sell particular goods to a consumer, to accept payment for those goods in periodic instalments, and to hold those goods until the consumer has paid the full price for the goods—

(a)

each amount paid by the consumer to the supplier remains the property of the consumer, and is subject to section 65, until the goods have been delivered to the consumer; and

(b)

the particular goods remain at the risk of the supplier until the goods have been delivered to the consumer. [emphasis added]

In simple terms, the retailer has the obligation to transfer the identified goods as per the lay-by agreement and also to adhere to the requirements regarding returns, cancellations, and safekeeping of the identified goods as per the lay-by agreement. The retailer also has the right to receive the total consideration they are entitled to as part of the agreement. This right should be regarded in the context of other terms and conditions on the sale of goods, such as cancellations and return policies for damaged goods. There are different permutations of lay-by agreements based on the analysis of various lay-by agreements on listed retailers’ websites; however, it is clear that these agreements need to adhere to the requirements of the CPA.

4.1.2. Identify the Performance Obligations in the Contract

In the context of a lay-by agreement, the goods identified as per the agreement need to be regarded as distinct. Goods identified in the lay-by agreement will meet the requirements of being distinct, as the customer can benefit from their use; additionally, no other elements in the contract can modify the goods, nor are the goods dependent on any other services as part of the lay-by agreement.

4.1.3. Determine the Transaction Price

The transaction price in a lay-by agreement is easily determined, as it would be the fixed amount listed on the goods sold by the retailer and directly observable in a store and on an online platform. There are no financing components, as the CPA requires that no interest is charged by the retailer while the customer is paying off the cost of the goods acquired from the retailer. The timeframe is usually reasonably short, normally between a two-month and a six-month period, which also makes any financing immaterial in the context of the contract.

4.1.4. Allocate the Transaction Price to the Performance Obligations in the Contract

In the context of a lay-by agreement, there will be no need to allocate the transaction price, as there is usually only a single performance obligation in the contract that needs to be recognised in the final step of the revenue recognition model.

4.1.5. Recognise Revenue When the Performance Obligations Are Satisfied

The first consideration is whether the customer has the ability to direct the use of the goods. The IASB (2022a) considers this to be the case when the customer has the present right to direct use of the goods in the lay-by agreement. Lay-by agreements usually specify that a customer only has the right to collect the goods once the full payment has been received during the lay-by period stipulated in the contract, which indicates that the customer only has a present right to use the goods once the full payment has been received by the retailer. Furthermore, the agreements also state what happens when a customer fails to pay the full amount during the lay-by period. In these cases, the reserved goods are returned to the stock list of the retail store where the lay-by was initiated. In the second consideration, the IASB (2022a) refers to the customer’s right to deploy the asset or restrict someone else from deploying the asset. This would be the point at which the customer has obtained the right to use the goods. The final consideration is that the customer obtains substantially all the remaining benefits from the asset. The benefits that the customer would obtain from control over the goods would be to use the goods according to the customer’s needs.

If one considers control from the perspective of the retailer, it is imperative to take into account the enforceable requirements of the CPA. The CPA is clear in section 62(1) that the “supplier”, who is the retailer, will hold onto the goods until full payment has been received. Notwithstanding the above, the CPA makes further obligations to the retailer that (1) the cash paid by the customer in meeting the contractual requirements remains the ‘property’ of the customer until the goods have been delivered to the customer and (2) the supplier will take the risk for any damages or theft of the goods while in possession of the goods during the lay-by period. Both these aspects indicate that retailers have the ability to direct the goods in the lay-by period because they are in their possession and, thus, the retailers are still exposed to the risks and rewards of ownership of the goods. In addition, the cash deposited in the retailer’s bank account is legally still the possession of the customer, and, therefore, the retailer does not have the ability to directly use the cash deposited.

Therefore, the arguments above indicate that IFRS 15 determines that revenue from lay-by sales will only be recognised when the full payment has been made by the customer and the customer has taken physical possession of the goods purchased through the lay-by agreement. Therefore, any cash received by the entity before the recognition of revenue will be recognised as a contract liability until the point in time when revenue is recognised.

Similarly, the goods will only be recognised as cost of sales when the customer has taken physical possession thereof and will remain in the inventory, irrespective of any upfront cash received from the customer.

4.2. The Resulting Deferred Tax Implications

In response to Sub-research question 2, the deferred tax implications of lay-by arrangements are discussed and evaluated based on the accounting treatment from Sub-research question 1 and the three possible tax interpretations. The example of the facts in Section 1.1 of this article was used for this purpose. The results of this study, namely the different deferred tax implications, are illustrated in

Table 2. Deferred tax implications based on the three interpretations: balance sheet method.

	Interpretation 1	Interpretation 2	Interpretation 3
Deferred Tax Implications Using the Balance Sheet Method	ZAR	ZAR	ZAR
Deferred tax implications for contract liability (Section 4.2.1)
Carrying amount of the contract liability	ZAR 100,000 1	ZAR 100,000 1	ZAR 100,000 1
Tax base	0 2	0 2	ZAR 100,000 3
Deductible temporary difference	ZAR 100,000	ZAR 100,000	0
Deferred tax asset @ 27%	ZAR 27,000	ZAR 27,000	0
Deferred tax implications for unearned revenue (Section 4.2.2)
Carrying amount of unrecognised revenue	0	0	0
Tax base	ZAR 900,000 4	ZAR 900,000 4	0
Deductible temporary difference	ZAR 900,000	ZAR 900,000	0
Deferred tax asset @ 27%	ZAR 243,000	ZAR 243,000	0
Deferred tax implications for section 24 allowance (Section 4.2.3)
Carrying amount of the section 24 allowance	0	0	0
Tax base	ZAR 180,000	ZAR 1,000,000	0
Taxable temporary difference	ZAR 180,000 5	ZAR 1,000,000 5	0
Deferred tax liability @ 27%	(ZAR 48,600)	(ZAR 270,000)	0
Deferred tax implications for inventory (Section 4.2.4)
Carrying amount of inventory	ZAR 800,000 6	ZAR 800,000 6	ZAR 800,000 6
Tax base	0 7	ZAR 800,000 8	ZAR 800,000 8
Taxable temporary difference	(ZAR 800,000)	0	0
Deferred tax liability @ 27%	(ZAR 216,000)	0	0
Total deferred tax asset recognised	ZAR 5400	0	0

¹ ZAR 100,000 received by the entity before the recognition of revenue will be recognised as a contract liability until the point in time when revenue is recognised. ² The tax base will be determined as the carrying amount of the contract liability (ZAR 100,000), less any amount of revenue that will not be taxed in the future (ZAR 100,000), resulting in a tax base of zero for both interpretations 1 and 2. ³ The tax base will be determined as the carrying amount of the contract liability (ZAR 100,000), less any amount of revenue that will not be taxed in the future (ZAR 0), resulting in a tax base of ZAR 100,000, as the revenue will only be taxed in the future based on the interpretation. ⁴ The unrecognised revenue of ZAR 900,000 will be the value of the tax base, because that will be the amount that will reduce the tax liability in the future. ⁵ The section 24 allowance of ZAR 180,000 (interpretation 1) or ZAR 1,000,000 (interpretation 2) is allowed in the current year, but is added back for tax purposes in the next year. Therefore, the section 24 allowances will result in taxable temporary differences and deferred tax liabilities of ZAR 48,600 (interpretation 1) and ZAR 270,000 (interpretation 2). ⁶ In terms of IFRS, the inventory is not considered sold, and, therefore, a carrying amount of closing inventory of ZAR 800,000 exists at year-end for all three interpretations. ⁷ For interpretation 1, the cost of the stock of ZAR 800,000 will be deducted in the current year for income tax purposes; therefore, the tax base will be zero, as no deductions will be allowed in the future. ⁸ For interpretations 2 and 3, the tax base will be ZAR 800,000 to reflect the future deductions.

and are presented based on four considerations: contract liability, unearned revenue, section 24 allowance, and inventory.

4.2.1. Deferred Tax Implications for Contract Liability

Section 4.1 determines that any cash received, in this example ZAR 100,000, by the entity before the recognition of revenue will be recognised as a contract liability until the point in time when revenue will be recognised. The contract liability will apply the tax base of “income received in advance” in terms of IAS 12, as it is the same item with a different designation. Therefore, for interpretations 1 and 2, the tax base will be determined as carrying the amount of the contract liability (ZAR 100,000), less any amount of revenue that will not be taxed in the future (ZAR 100,000), resulting in a tax base of zero (IASB, 2022b, para. 8). However, interpretation 3 will result in a tax base of ZAR 100,000, as the revenue will only be taxed in the future based on the interpretation. Interpretations 1 and 2 will result in a deferred tax asset (ZAR 27,000), as Company A is already taxed on the cash received in the lay-by arrangement and will not be taxed again when revenue is recognised in profit or loss in the next financial year when control has been transferred. However, interpretation 3 will not result in any deferred tax implications, as it is interpreted that there should not be any taxation on the amounts received, and, therefore, no temporary difference exists.

4.2.2. Deferred Tax Implications for Unearned Revenue

Interpretations 1 and 2 also create finer complexities and permutations that need to be considered for deferred tax. These complexities relate to the unearned revenue that is included in gross income in the current year. Interpretation 3 avoids the complexities of resulting deferred tax on unearned revenue because the tax and accounting treatments are the same.

Because there is no asset or liability recognised in accounting for the unearned revenue of ZAR 900,000, paragraph 9 of IAS 12 is used to solve the problem (IASB, 2022b). The principle applied is to analyse the future tax effect by considering the effect in the current year and the economic benefits that may arise from a tax perspective in the future. The unrecognised revenue of ZAR 900,000 will be the value of the tax base, because that will be the amount that will reduce the tax liability in the future. This will result in a deductible temporary difference because the company is taxed on the unrecognised revenue of ZAR 900,000 regardless of the fact that IFRS 15 does not allow any revenue recognition until control has been transferred to the customer. At the point in time, when revenue is recognised for accounting purposes, SARS will not tax the company again, even though revenue has been recognised in the financial statements. This is considered a tax saving in future. The result of the above for interpretations 1 and 2 is to recognise a deferred tax asset of ZAR 243,000 in the current year.

4.2.3. Deferred Tax Implications for Section 24 Allowance

The section 24 allowance of ZAR 180,000 (interpretation 1) and ZAR 1,000,000 (interpretation 2) granted in the current year will also cause complexities in the deferred tax calculation. Similar to Section 4.2.2, there is no carrying amount from an accounting perspective and, therefore, paragraph 9 of IAS 12 applies. The section 24 allowances of ZAR 180,000 (interpretation 1) and ZAR 1,000,000 (interpretation 2) are allowed in the current year, but are added back for tax purposes in the next year; therefore, the section 24 allowances will result in taxable temporary differences and deferred tax liabilities of ZAR 48 600 (interpretation 1) and ZAR 270,000 (interpretation 2). Once again, interpretation 3 does not have any complex deferred tax considerations, as the tax and accounting treatments are the same.

4.2.4. Deferred Tax Implications for Inventory

The interpretations of the tax treatment of the inventory sold on lay-by but kept on the premises of the retailer also result in different deferred tax consequences. In terms of IFRS, the inventory is not considered sold, and, therefore, a carrying amount of closing inventory of ZAR 800,000 exists at year-end for all three interpretations. The inventory will apply the tax base of an asset, which is the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an entity when it recovers the carrying amount of the asset (IASB, 2022b, para. 7). For interpretation 1, the cost of the stock of ZAR 800,000 will be deducted in the current year for income tax purposes. Therefore, the tax base will be zero, as no deductions will be allowed in the future. This will trigger a deferred tax liability of ZAR 216,000. In contrast, applying interpretations 2 and 3 will not result in any deferred tax consequences because of the inclusion of closing stock in taxable income in terms of section 22(1). This means that the tax base will be ZAR 800,000 to reflect the deductions in future, resulting in no temporary difference created and, therefore, no deferred tax liability or asset.

Table 3. Deferred tax implications based on the three interpretations: income statement method.

	Interpretation 1	Interpretation 2	Interpretation 3
Deferred Tax Implications Using the Income Statement Method	ZAR	ZAR	ZAR
Accounting profit	0	0	0
Add: Deemed accrual of sales proceeds, as per section 24(1)	1,000,000	1,000,000	0
Deduct: Section 24 allowance (ZAR 900,000 × 20%)	(180,000)		0
Deduct: Section 24 allowance (100% of deemed accrual)		(1,000,000)	0
Deduct: Purchases, deduction (ZAR 1,000,000 × 80% = R800,000)	(800,000)	(800,000)	(800,000)
Add: Closing stock (section 22(1))	0	800,000	800,000
Total deductible temporary differences	20,000
Deferred tax asset @ 27%	ZAR 5400	0	0

provides proof that the deferred tax implications are the same and reconciles them using the alternative income statement method.

5. Discussion

The analysis of the doctrines of IFRS 15 and CPA indicated that revenue is expected to be recognised when full payment has been received from the customer and the customer has taken possession of the goods in the lay-by agreement. This is the point when control over the goods is transferred to the customer, which depicts the revenue performance of the company based on IFRS 15; similar findings have been underlined by Van Wyk and Coetsee (2020). It is also the point at which section 62(1) of the CPA relieves the company of the obligation to repay the cash deposited by the customer. The results also highlight the importance of revenue recognition (Napier & Sadler, 2020) from a tax perspective, as this triggers the deferred tax consequences, which are discussed further below.

From the analysis, it can be deduced that the different tax interpretations will lead to different future tax consequences and, therefore, different deferred tax balances. The deferred tax expense can thus affect a company’s earnings management, as per Purnamasari (2019). Depending on which interpretation is taken, it could result in a diversion from practice that could influence the decisions of users of the financial statements and the predictability of future tax expense and cash flows, which, according to Mear et al. (2021), is not aligned with the objectives of IAS 12. This creates a practical implication for companies and regulators, such as the Johannesburg Stock Exchange (JSE), to have consistency in the deferred tax treatment of lay-by sales. The result of the different tax interpretations could impact liquidity management and the need to balance the amount owed for tax purposes against cash received from lay-by sales. Furthermore, it could necessitate companies to engage in detailed tax planning to manage tax compliance and liquidity.

It must be noted that this particular example does not result in a material difference between the different views; however, the aim of the example is to illustrate the effect using simple facts. That being said, lay-by agreements are becoming more material in the operations of retailers in South Africa, which could lead to material diversion in financial statements depending on which interpretation is followed. The lay-by contribution to the revenues of Pepkor Holdings Limited (Pepkor) was 8% in 2024 (Pepkor Holdings Limited, 2024), confirming the impact on the retail industry. The researchers submit that liquidity and verification by auditors, as well as tax planning and business decisions, will be impacted, contingent on the interpretation, resulting in varying deferred tax balances.

6. Conclusions

This study analysed the different interpretations of the tax implications of lay-by sales together with the consequential accounting treatment; specifically, the deferred tax implications in terms of IAS 12. Lay-by sales transactions have been introduced by retailers to respond to the financial difficulties faced by many consumers in South Africa by reducing customers’ exposure to debt. Furthermore, more retailers are relying on lay-by agreements to maintain revenue performance, as evidenced by Pepkor reporting that 8% of their total revenue came from lay-by agreements. Therefore, the tax and accounting treatments of lay-by sales are important to ensure fair outcomes for the customers and the companies involved in lay-by transactions.

This study followed a doctrinal approach by applying an interpretative paradigm. The validity and reliability of the findings were supported by constructing a robust argumentative approach.

The study found that the recognition of lay-by sales revenue is deferred until control is transferred in terms of IFRS 15. Interpreting the CPA legislation together with the principle of control in IFRS 15, revenue from lay-by sales will only be recognised when the full payment has been made by the customer and the customer has taken physical possession of the goods purchased through the lay-by agreement. However, the tax implications based on the three interpretations potentially trigger different deferred tax implications depending on the interpretation used, and could result in diversion in practice, which has practical implications for companies from a liquidity and tax planning perspective. The different interpretations and resulting deferred tax treatments could influence the decisions of users of the financial statements and the predictability of future tax expenses and cash flows. The different interpretations highlight the need for further guidance or amendments to tax legislation to ensure fair and consistent treatment from a tax perspective. In order to reduce the uncertainties and diversion, it is recommended that the National Treasury amend legislation or provide relevant interpretation notes to provide certainty.

A key limitation of the study is that it is interpretive in nature and does not provide empirical results. However, as lay-by sales become more material in financial statements, future research can evaluate tax and accounting treatments using data available in such statements. Future research can also investigate the impact on retail companies by conducting surveys or interviews to obtain rich information on the impacts on liquidity and other business decision-making based on the different interpretations highlighted in this study. Finally, future research can also be conducted to investigate how auditors treat lay-by stock at year-end stock counts.