According to Section 12E of the Act, two sets of accelerated capital allowance rates apply to the assets of an SBC. Subject to certain conditions, assets used directly in a process of manufacture or a process of a similar nature may qualify for a 100 per cent write-off in the year of assessment in which the asset is brought into use.
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Assets that do not fall into this category may qualify for a write-off over a period of three years at a rate of 50 per cent in the first year, thereafter, 30 per cent and 20 per cent in each of the following two years.
4.2.2.1 Immediate write-off of all plant or machinery used in the process of manufacture or a similar nature [Section 12E(1) of the Act]
A SBC can claim a capital allowance on all plant or machinery in the year that the assets are brought into use for the first time for the purpose of trade (other than mining or farming). The assets must be used by the entity directly in a process of manufacturing or a process of a similar nature in the year of assessment (Section 12E(1)). This capital allowance is equal to 100 per cent of the cost of any plant or machinery that meets the requirements of Section 12E(1). The SBC must be the owner of the asset. The total amount of the allowance available under Section 12E(1) may be limited to less than 100 per cent of the cost of the plant or machinery if funding was received from a small business funding entity or in the form of a government grant. Some terms referred to in Section 12E(1) are explained below.
a. Plant and Machinery
Plant
SARS (2018d: 22) states that the term “plant” is not defined in the Act, however, it has been considered in various court cases. In the case of Blue Circle Cement Ltd v CIR, 1984 (2) SA 764 (A), 46 SATC 21, several English cases were reviewed and it was agreed that applying a functional test and a durability test would be useful in arriving at a definition of “plant”. Using the durability test, the court held that “plant” connoted a “degree of durability and did not include articles that were quickly consumed or worn out in the course of a few operations”. The functional test considers how the particular asset is used and whether it is employed to carry on or promote the taxpayer’s business activities. SARS (2018d: 23) uses ITC 1468, (1989) 52 SATC 32 (C) to explain the meaning of “plant” using the functional test. In this
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case, the knives and shoe-lasts used in the manufacturing of shoes passed the functional test and were considered to constitute “plant”. This was because they were used by the taxpayer in the course of the business and enabled the machines in the factory to perform their manufacturing function.
Machinery
SARS (2018d: 23) explains that the term “machinery” is not defined in the Act; therefore the ordinary grammatical meaning is applied having regard to the context in which it is used. SARS uses the Collins Dictionary meaning where “machinery” is defined as “machines, machine parts, or machine systems collectively, particular machine system, or set of machines”.
b. Process of Manufacture or similar process
“Process of manufacture” is not defined in the Act; however, it has been used in a number of court cases. SARS (2018d: 24) points out that in SIR v Hersamer (Pty)
Ltd 1967(3) SA 177(A) and SIR v Safranmark (Pty) Ltd 1982(1) SA 113(A), the term “process of manufacture” comprises activities which constitute the production of a product. In this description, the term “process of manufacture” is different from the materials or components which are used in the production of the product.
c. Owned by and brought into use by the SBC
Section 12E(1)(a) requires that the plant or machinery should be brought into use for the first time by the taxpayer that owns the asset or acquired it as a purchaser under an instalment sale agreement. A lessee of plant and machinery, therefore, does not qualify for a deduction under Section 12E(1) because a lessee does not own the leased asset. The plant and machinery may be new or second-hand, provided it is being brought into use for the first time by the SBC seeking to claim the allowance.
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4.2.2.2 Tax incentive related to other assets of the Small Business Corporation - Section 12E(1A) of the Act
According to Section 12E(1A), a SBC has the incentive to elect to deduct either the wear and tear allowance (under Section 11(e)) or the accelerated amount calculated over a period of three years at a rate of 50, 30, and 20 per cent in the respective years. Tangible assets in respect of which a deduction is allowable under Section 11(e), such as machinery, plant, implements, utensil, article, aircraft, or ship (excluding plant or machinery used in a process of manufacturing or similar process) that was acquired on or after 1 April 2005, may all qualify. The taxpayer can choose the more beneficial rate between Sections 11(e) and 12E(1A) per asset - as illustrated further down.
The three years deduction of Section 12E(1A) does not allow apportionment in the case where the asset was used for part of the year of assessment; instead, the full amount is calculated and deducted. The allowance is calculated as follows:
50 per cent of the cost of the asset in the year of assessment during which it was first brought into use;
30 per cent in the second year of assessment; and
20 per cent in the third year of assessment.
SARS (2018d: 28) explains that Section 12E(1A) applies to assets “in respect of which a deduction is allowable under Section 11(e)”. Thus, a SBC will be entitled to a deduction under Section 12E(1A) only if the asset qualifies for a deduction under Section 11(e). A deduction is allowable under Section 11(e) if; any machinery, plant, implements, utensils, and articles owned by the taxpayer are used for the purpose of the taxpayer’s trade and have diminished in value. The reason for the fall in value should be because of wear-and-tear or depreciation during the year of assessment. However, the SBC should be aware that certain exclusions exist and in some instances, an allowance for some assets is prohibited under Section 11(e).
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Annexure A of Binding General Ruling No. 7 of income tax presents a schedule of proposed write-off periods of different assets acceptable to SARS (SARS 2012: 13 – 19). The shortest write-off period is one year and it is acceptable for the writing-off of main frames of self-developed computer software, gymnasium spinning equipment, and wire line rods. The longest write-off period is 25 years in relation to absorption type chillers, artefacts, valuable paintings, and portable safes.
In order to claim the allowance, the asset must be owned by the taxpayer or it must have been acquired in terms of an instalment credit agreement as defined in the VAT Act. The depreciable cost of the asset is the lesser of the actual cost to the taxpayer or the arm’s length cash price at the time of acquisition. Any foundation structure to which the asset is mounted or affixed forms part of the asset and qualifies for the allowance. The value of the asset is increased by the amount of any expenditure incurred by a taxpayer during any year in moving the asset from one location to another.
To demonstrate the calculation of the allowance according to Section 12E(1A), the following illustration is provided. Assume Company A, a SBC according to Section 12E, had a taxable income of R120 000 (before allowances) in year 1 and is expected to grow by R20 000 per annum for the next four consecutive years. Company A acquired a vehicle under an instalment credit agreement at a total cost of R150 000.
The first illustration reflects the results for the SBC if the company’s accountant has elected to deduct the Section 12E (1A) allowance in claiming Company A’s vehicle. Using the 2018 - 2019 tax table presented above in table 4.1, over the next 5 years, the Section 12E(1A) allowance would impact company A’s tax liability as indicated in table 4.3 below.
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Table 4.3: Calculation of normal tax payable if Section 12E (1A) allowance is applied Year 1 (R) Year 2 (R) Year 3 (R) Year 4 (R) Year 5 (R)
Taxable income (before allowances) 120 000 140 000 160 000 180 000 200 000
Less: Section 12E(1A) allowance (75 000) (45 000) (30 000) - -
Taxable Income 45 000 95 000 130 000 180 000 200 000
Normal tax payable by the SBC
(Tax rates: 1/04/2018 – 31/03/2019) 0 1 180 3 630 7 130 8 530
Source: Author
In the illustration above, the SBC would deduct an allowance of R75 000 (50 per cent of the total cost of the vehicle costing R150 000) in year one, R45 000 (30 per cent) in year two, and R30 000 (representing the remaining 20 per cent) in year three. The allowance has a more significant impact on taxable income in year one, as only R45 000 (R120 000 – R75 000) would remain as taxable income after the allowance is deducted. Therefore, the SBC would not pay any normal tax in year 1 (the taxable income would be below the tax threshold of R78 150 for SBCs). The allowance would be claimed over three years, resulting in no deduction in year four and year five.
Using the same facts and information as in table 4.3, the next illustration reflects the results for the SBC if the company elects to claim the Section 11(e) allowance instead of Section 12E(1A). The vehicle would be claimed over a period of 5 years at 20 per cent in each of the five years. Table 4.4 below shows how company A’s tax liability would be impacted.
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Table 4.4: Calculation of normal tax payable if the Section 11(e) allowance is applied
Year 1 (R) Year 2 (R) Year 3 (R) Year 4 (R) Year 5 (R)
Taxable Income (before
allowances) 120 000 140 000 160 000 180 000 200 000
Less: Section 11(e) allowance (30 000) (30 000) (30 000) (30 000) (30 000)
Taxable income 90 000 110 000 130 000 150 000 170 000
Normal tax payable by the SBC
(Tax rates: 1/04/2018 – 31/03/2019) 830 2230 3 630 5 030 6 430
Source: Author
In the above Section 11(e) illustration, the SBC would deduct an allowance of R30 000 (20 per cent of the cost of the vehicle) for a period of 5 years. As seen above, in year 1, the SBC would pay R830 as normal tax, whereas in the case of the company claiming an allowance of 50 per cent of the vehicle under Section 12E(1A), the SBC would not pay any normal tax in year one. In year two, the SBC would pay R2 230 in normal tax if it elects to claim the Section 11(e) allowance as compared to paying R1 180 in normal tax if it were to claim the Section 12E(1A) allowance.
In comparing the total tax that would be payable over 5 years in both cases, a SBC that elects to claim the Section 11(e) allowance under the above circumstances as per table 4.4, would pay R18 150 as a total tax liability. On the other hand, a SBC that elects to claim the Section 12E(1A) allowance, would pay a total tax liability of R20 470. Therefore, in the long run, the SBC that claims a Section 12E(1A) allowance, would pay more tax than one which claims the Section 11(e) allowance. It is clear that the Section 12E (1A) allowance is preferable in the short run, as less tax would be paid by the SBC in the first year. This is because the allowance significantly reduces the taxable income the first year. This can enable the SBC to
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retain more cash flow to utilise in growing its business operations, especially when setting up or expanding the capital infrastructure.
4.2.3 Possible pitfalls, gaps, and concerns with tax incentives for Small Business