Deductibility of sponsorship expenditure

Over the last couple of decades we have seen changes to how businesses promote their brands, with a variety of methods deployed to get a brand’s name out to potential customers, along with more established brands vying to stay at the forefront of consumer’s minds, including by working with influencers. It’s timely, therefore, that Inland Revenue have issued refreshed guidance on the income tax treatment of providing sponsorship for consultation.

The new consultation item draws heavily on the previous guidance from the start of the century, giving a glimpse that while modes of sponsorship may have changed in the last two decades, the tax rules have remained fairly consistent. The key issue when it comes to sponsorship is whether the cost is a deductible business expense.

What is sponsorship?

While traditionally sponsorship might have been in the form of cash payments, over the years a variety of practices have evolved, including by donating trading stock in times of need and supplying product to influencers to try and promote.

Helpfully the draft statement provides a definition “supporting an organisation, event, person, or cause either monetarily or by providing products or services, where the taxpayer (the sponsor) intends that the sponsorship will promote or advertise their business.”

Is the expenditure deductible?

This is a bread and butter tax issue – is the expenditure incurred in deriving income or in the course of carrying on a business with the purpose of deriving income, and do any of the “limitations” apply, most notably the capital limitation or private limitation.

In most instances this will be a straightforward inquiry, with expenditure generally having some correlation to promoting the business to earn income, but in some cases this is less straight forward, with the draft statement including 17 examples to help illustrate boundary lines.

The draft statement makes some key points to be aware of:

• It’s necessary to ascertain the true character of the expenditure.
• The advantage or gain being sought is a subjective matter, and it isn’t a deal breaker if no additional income directly arises as a result of the expenditure.
• Whether a third party benefits is also not a deal breaker, but it may mean that some level of apportionment is required if that benefit is more than incidental.
• It has become increasingly common for larger businesses to “give back” to the community. This can have a philanthropic motivation but there is often also a business motivation. Having a philanthropic motivation won’t preclude deductibility (noting that it may also qualify for a deduction as a donation depending on the recipient).
• Things that support deductibility include: specific terms of a sponsorship agreement, a coherent marketing strategy, the relationship between the market and the taxpayer’s business, and the relationship between the expenditure and resulting income.

Limitations

In some cases a sponsor is entering into a long term arrangement. In these cases it’s important to look at how sponsorship expenditure should be deducted over a number of years. Again, this looks to standard tax (and accounting rules), to ensure that unexpired expenditure is added back and deducted in the following year.

The draft statement also considers the “private limitation” on the basis that it is possible, particularly in smaller businesses, where private benefits are obtained from the sponsorship and there might be a less clear correlation between the business and the thing being sponsored. A 1989 case is quoted about a radiator business that sponsors a go-karting team because the principal enjoyed go-karting; in that case the expenditure was held to be fully deductible with any private enjoyment of the owner being incidental to the purpose of advertising.

What about trading stock?

The rules around trading stock have always been slightly strained as section GC 1 of the Income Tax Act 2007 can apply if trading stock has been disposed of for an amount less than market value. So when trading stock is being provided as part of a sponsorship arrangement there can be some tension as to whether the benefits received are at least equal to the value of the trading stock. The draft statement provides helpful comments that section GC 1 generally won’t apply in non-associated person situations where trading stock is being provided on the expectation that it will be provided. The draft statement provides an example of cosmetic products being provided to a social media influencer (without a formal agreement) in anticipation that the products may be reviewed and featured. In this case the example concludes that a deduction is available and section GC 1 will not apply. While not specifically referenced, the influencer will need to be reading IS 21/08 content creators – tax issues.

Thoughts

Overall the draft statement provides a useful summary of the things to consider when determining whether a sponsorship cost is deductible. With this new guidance out, it’s timely reminder for businesses to consider what arrangements are already in place and to ensure the tax treatments are consistent with Inland Revenue’s expectations.

For more information, contact your usual Deloitte advisor.