Capital Allowances and Tax Implications

Ntebaleng Capital

Manoko

Allowances

UNIVERSITY OF LIMPOPO

Chapter 13

Learning Outcomes

  • Identify and distinguish between movable and immovable assets.
  • Identify the capital allowances applicable to each asset type.
  • Calculate and explain the tax consequences of leased assets.
  • Calculate and explain the capital allowances of intellectual property.

Income/Normal Tax – Framework

  1. Gross Income:
    • Less: Exempt income
    • Income
    • Less: Deductions and allowances
    • Less: Assessed loss
    • Add: Other amounts included in taxable income (e.g., recoupment)
    • Add: Taxable Capital Gain
    • Less: Deductions in terms of section 18A
  2. Taxable Income Calculation:
    • ext{Taxable Income} = ext{Gross Income} - ext{Exempt Income} - ext{Deductions} - ext{Assessed Loss} + ext{Other Income} + ext{Taxable Capital Gain} - ext{Deductions (s 18A)}
  3. Normal Tax:
    • At 27% of Taxable Income
    • Less: Tax rebates and tax credits
    • Final Amount:
      • Normal Tax Payable or Refundable.

Introduction

  • General deduction formula (Section 11(a)) does not allow for the deduction of capital expenditures.
  • Special deductions are available for certain expenditures that are either capital in nature or not incurred in the production of income, which can be deducted as capital allowances.
  • Capital Allowances: Involve writing off the cost of capital assets over a set period.
  • These concepts are covered in CTAA022 and will be re-lectured in CTAA031 as a revision.

Core Concepts - Machinery and Plant

  1. Definition of Machinery:

    • Not explicitly defined in the Income Tax Act.
    • Oxford Dictionary denotes machinery as:
      • Machines and their parts, collectively.
      • Mechanism or works of machines.
    • Related material covered in CTAA022 (not re-lectured in CTAA031).

  2. Definition of Plant:

    • Also not explicitly defined.
    • Oxford definition includes:
      • Fixtures, implements, machinery, and apparatus used in any industrial process.
    • Courts determined:
      • Plant includes devices used permanently by a business, exhibiting durability, not classified as trading stock, and is part of manufacturing processes.
    • Related material covered in CTAA022 (not re-lectured in CTAA031).

  3. Tangible Assets:

    • The term encompasses various assets including animals (not trading stock) that qualify under machinery, plant, implements, utensils, or articles.
    • "Article" refers to detachable, removable, easily stored, and remountable items.
    • Related material covered in CTAA022 (not re-lectured in CTAA031).

Core Concepts - Process of Manufacture

  1. Definition:

    • Not defined in the Act; subject to court interpretations.
    • Defined as an action or series of actions aimed at producing an object distinct from its materials (ITC1006).
    • No requirement for the actual composition of raw materials to change before it is considered a manufacturing process.
    • Importance is placed on the application of skill leading to a change in the raw material's character.
    • Individual activities should be assessed based on established facts.

  2. Similar Processes:

    • SARS outlines processes regarded as direct and similar to manufacturing.
    • Annexures to Practice Note 42:
      • Annexure A: Similar processes (e.g., dry-cleaning, construction).
      • Annexure B: Direct manufacturing processes (e.g., crushing stone, baking bread).
      • Annexure C: Excluded processes (e.g., dental surgery).
      • Note: The list is not exhaustive.

  3. Depreciable Assets:

    • Defined in the 8th Schedule as assets eligible for deductions or allowances based on cost or value, but excluding trading stock or debt.
    • Covered in CTAA022 (not re-lectured in CTAA031).

Capital Allowances Overview

  1. Movable Assets:
    • Section 12C, Section 11(e) impact on allowances.
  2. Immovable Assets:
    • Sections 13, 13 sex, and 13 quin outline relevant capital allowances.
  3. Leases:
    • Sections 11(f), 11(g) concerning lease-related allowances.
  4. Intellectual Property:
    • Sections 11(gB), 11(gC) detail allowances for IP.

Capital Allowances – Movable Assets (Section 12C)

  • Targeted for manufacturers, hotel keepers, and entities dealing with agricultural products (storage and packing).
  • Scope:
    • Machinery or plant (owned/acquired under suspensive sale) used for the first time by the taxpayer.
    • Equipment or implements in the manufacturing or similar processes.
    • Aircraft and ships under similar sale agreements: must be brought into use for trade.
    • Improvements on machinery or plant are also included (Section 12C).

Allowances for Movable Assets

  • Implications:
    • Owned new and unused machinery or plant: 40%, 20%, 20%, 20% allowances respectively for the years.
    • Second-hand machinery: 20% allowances across five years.
    • Let out machinery for manufacturing: 20% allowance yearly regardless of condition.
    • Aircraft and ships (new/second-hand) also receive a 20% allowance annually.

Costs Considerations

  • Claims are made on the lesser of actual cost or market value, adding direct costs of installation.
  • Excludes: interest, finance charges.
  • Moving costs can also be deducted, especially if assets are already fully written off.

Example Calculation for ABC Limited:

  • Assets Acquired:
    • Machine A (second-hand) at R1,500,000.
    • Machine B (new) at R3,000,000 with an additional installation cost of R50,000.
    • Moving costs incurred for both machines in the following periods.
  • Allowances Breakdown:
    • For year ending June 2024:
    • Machine A: 1,500,000 imes 20 ext{%}
    • Machine B: (Cost + Installation) (3,000,000 + 50,000) imes 40 ext{%}
  • Further calculations to be continued in subsequent years based on similar deductions.

Capital Allowances - Wear and Tear (Section 11(e))

  1. Scope:

    • Covers machinery, plant, implements, utensils, and articles owned or acquired by taxpayers.
    • Must be used within the taxpayer's trade.
    • Subject to depreciation from wear and tear.

  2. Implications:

    • Small assets (cost < R7,000): full write-off in the year of use.
    • Larger assets: based on specific write-off periods per Binding General Ruling 7.
    • Value defined as: market value + installation costs, exclusive of re-valuation and finance costs.

Capital Allowances – Immovable Assets

Manufacturing Building (Section 13)

  1. Scope:
    • Building or improvements made by the taxpayer or acquired from another entitled to section 13 allowance.
    • Must be used mainly for trade and manufacturing.
  2. Implications:
    • Annual allowance of 5% on buildings erected from 1 October 1999 onwards based on actual costs (excluding land preparation and financing).
    • The allowance is not apportioned.

Residential Building (Section 13 sex)

  1. Scope:
    • New and unused residential units specifically for the taxpayer’s trade.
    • Requires ownership of greater than five residential units in South Africa.
  2. Implications:
    • Low-cost residential units (R300,000 and below): annual allowance of 10%.
    • Other units: 5% annual allowance based on the lesser of actual or market value.
    • Unallocated expenses for partial acquisitions.

Commercial Building (Section 13 quin)

  1. Scope:
    • New, unused buildings used wholly for taxpayer’s trade.
  2. Implications:
    • Consistent 5% annual allowance based on costs, including acquisition and improvements, not apportioned.

Capital Allowances – Leases

Lease Premiums (Section 11(f))

  1. Scope:
    • Lease premium provides rights to the use of assets in income production.
    • Includes various asset types like land, buildings, machinery, and intellectual properties.
  2. Implications:
    • Allowance deducted over the lease period, limited to 25 years, and is apportioned.

Normal Tax Calculation Example (ABC Limited)

  • Annual Rent and Lease Premium Calculation provided for FY 2025, 2026.

Leasehold Improvements (Section 11(g))

  1. Scope:
    • Expenditure on improvements enforced through lease agreements must be used in income production.
  2. Implications:
    • Allowance deducted over remaining lease periods but capped at 25 years.
    • Unclaimed allowances can be addressed upon termination, with excess expenditures evaluated for Section 13 allowances.
Example Calculation for ABC Limited's Leasehold Improvements
  • Costs: Total cost incurred for constructing factory premises for income generation, calculated based on the stipulated agreement.
  • Calculations to break down allowances as stipulated.

Capital Allowances – Intellectual Property

  1. Registration and Renewal (Section 11(gB)):

    • Scope includes expenditures for patents, designs, trademarks vital for income generation.
    • Implication: Full deduction of incurred expenditures.

  2. Acquisition (Section 11(gC)):

    • Expenditures to acquire inventions, designs, or copyrights pertinent to trade.
    • Implications:
      • Design assets allow for a 10% annual allowance, and other assets a 5% annual allowance.
      • Full deduction if expenditure is ≤ R5,000 in the year the asset is brought into use.

Conclusion

  • Key Capital Allowances Summary:
    • Movable Assets: Sections 12B, 12BA, 12C, and 11(e).
    • Immovable Assets: Sections 13, 13 sex, 13 quin.
    • Lease allowances: Sections 11(f), 11(g).
    • Intellectual Property: Sections 11(gB), 11(gC).

End of Document

  • Thank you for reviewing the material from the University of Limpopo.