DEDUCTIONS

2073. Wear and tear allowance

June 2012 - Issue 153

There are several provisions in the Income Tax Act No. 58 of 1962 (the Act) that allow a deduction from taxable income for the benefit of taxpayers investing in assets to be used in carrying on a trade. The sections that are most commonly applied include section 11(e) (wear and tear allowance), section 11D (allowance in respect of assets used for purposes of research and development) and section 12C (assets used by manufacturers or hotelkeepers, aircraft and ships and in respect of assets used for storage and packing of agricultural products). There are other sections available to be applied but are in most instances specific to a taxpayers' trade or very specific in terms of the nature of the asset.

Section 11D and section 12C specifically deem the cost of the asset for purposes of determining the relevant allowance to be the lesser of actual cost or market value.

Section 11(e) on the other hand refers to the term 'value' for purposes of determining the relevant allowance. Furthermore sub-paragraph (vii) of section 11(e) states that where the value of an asset for purposes of section 11(e) is to be determined having regard to cost, such cost shall be deemed to be the cost which a person would, if he had acquired such asset under a cash transaction concluded at arm's length, have incurred in respect of the direct cost of the acquisition of such asset, including the direct cost of the installation or erection thereof.

The term 'value' is not defined in the Act and the purpose of the inclusion of sub-paragraph (vii) in section 11(e) is not clear. In particular, there is no provision in section 11(e) which requires the value of an asset to be determined having regard to its actual cost! Consequently it has been the subject of much debate whether the term 'value' in the context of section 11(e) can be interpreted to refer to the market value of the asset, where the market value exceeds the actual cost incurred.

To illustrate this point let's assume that Taxpayer A acquires furniture to be used in the carrying on of trade from an unconnected person for a cash cost of R10,000. Based on several different adverts for the exact same furniture from other suppliers, the actual market value of the furniture is in the region of R20,000. The question arises whether the section 11(e) wear and tear allowance must be calculated on the R10,000 (actual cost) or the R20,000 (market value).

SARS provided guidance on the issue in Interpretation Note 47 (Issue No.2) (IN47) and confirmed therein that the taxpayer's cost of acquisition of an asset (that is, the cash cost excluding finance charges) is to be used when determining the section 11(e) allowance.

Normally an Interpretation Note is simply an explanation of SARS' view and does not create legal binding precedent. This appears to be the case with the remainder of IN 47 which doesn't address the two points mentioned above.

But IN 47 states that it is a Binding General Ruling (BGR) made under section 76P, in relation to section 11(e) in so far as the determination of the 'value' of an asset for purposes of section11(e), and the determination of the amount which will qualify as an allowance, is concerned. A BGR is binding on SARS in terms of section 76H(3) and (6) read with section 76P of the Act.

Further, on 11 April 2011 SARS issued Binding General Ruling: No 7 (BGR7) dealing with section 11(e). BGR7 states that SARS' policy has always been, unless otherwise prescribed, to regard the value of an asset for purposes of determining the section 11(e) allowance as the taxpayer's cost of acquisition (that is, the cash cost excluding finance charges). SARS substantiates this policy with the findings in ITC 1546 [1992] 54 SATC 477 where a landlord acquired second-hand furniture and fittings at a bargain price from the liquidator of its tenant. The landlord attempted to claim the wear and tear allowance on a revalued amount, based on sub-paragraph (vii) of the proviso to section 11(e). This argument was rejected by the court, which held that the allowance was properly claimable only on the cost of the articles.

SARS explains that the only exception to this policy is where the asset is acquired by way of a donation, inheritance or as a distribution in specie, in which case the allowance is based on the market value of the asset, subject to the Commissioner's discretion. Alternatively, where the asset is acquired from a connected person the provisions of section 23J need to be applied.

BGR 7 reiterates what is already confirmed in IN 47 and seems to be SARS' attempt to rule out any uncertainty and that 'value' for purposes of determining the section 11(e) allowance is the actual cash cost incurred, excluding finance charges (unless the asset in question is acquired by way of a donation, inheritance, as a distribution in specie or from a connected person).

However a BGR is not binding on the taxpayer. Neither is ITC 1546 binding on the taxpayer as it is merely a tax court case. BGR 7 and IN 47 do not clarify the reason for the deeming provision of sub-paragraph (vii) in section 11(e). Therefore although BGR 7 and IN 47 suggest that a taxpayer will have to go to court to use 'value' in the context of a section 11(e) allowance, if a taxpayer has enough at stake, there may be merit in pursing the matter. Hence the uncertainty referred to may not quite be ruled out!

Ernst & Young
IT Act: S11(e), S11D, 12C
BGR 7
IN 47