Law change won’t hurt tax­payer

Busi­nesses can still claim in­ter­est against pre­pro­duc­tion costs de­spite scrap­ping of a sec­tion in the Draft Bill

Business Day - Business Law and Tax Review - - BUSINESS LAW & TAX REVIEW - DAVID WARNEKE

PRAC­TI­CALLY un­no­ticed amid a raft of dra­matic pro­posed changes con­tained in the Draft Tax­a­tion Laws Amend­ment Bill of 2011 (the draft bill) is the dele­tion of sec­tion 11(bA) from the In­come Tax Act.

In most years amend­ment bills have not con­tained any­thing like the sud­den sus­pen­sion of sec­tion 45 or the pro­posal to re­write our source rules — two of a num­ber of dra­matic pro­pos­als con­tained in the draft bill. It would seem that it is for this rea­son that a num­ber of other pro­pos­als, like the scrap­ping of sec­tion 11(bA), have not elicited any com­ment.

Sec­tion 11(bA) ap­plies in re­spect of in­ter­est or fi­nance charges (“in­ter­est”) re­lat­ing to a wide va­ri­ety of as­set types be­fore the date on which such as­sets are brought into use in a trade: there­fore the term pre­pro­duc­tion in­ter­est. The in­ter­est is ac­cu­mu­lated and de­ducted in a lump sum in the year of as­sess­ment in which the as­set is brought into use. It would seem from the word­ing of sec­tion 11(bA) that it ap­plies as a de­duc­tion pro­vi­sion of last re­sort: to any pre­pro­duc­tion in­ter­est “not other­wise al­low­able as a de­duc­tion un­der [the act]”.

The ques­tion is whether there is any­thing sin­is­ter in the pro­posed dele­tion of the pro­vi­sion. Is the in­ten­tion to deny tax­pay­ers a de­duc­tion for the in­ter­est in­curred un­der such cir­cum­stances?

Sec­tion 24J al­lows tax­pay­ers a de­duc­tion for in­ter­est in­curred in re­spect of an in­stru­ment, as de­fined in the pro­vi­sion. The def­i­ni­tion of in­stru­ment is wide and would in­clude loans and the type of fi­nanc­ing ar­range­ments typ­i­cally as­so­ci­ated with the ac­qui­si­tion of fixed as­sets. The other main re­quire­ments for de­ductibil­ity in terms of sec­tion 24J are that the in­ter­est must be de­ducted from in­come de­rived from the car­ry­ing on of a trade, and the in­ter­est must be in­curred in the pro­duc­tion of in­come. Sec­tion 24J is the main pro­vi­sion in terms of which in­ter­est or fi­nance charges are dealt with un­der the act. Sec­tion 24J does not con­tain a re­quire­ment that in or­der for in­ter­est to be de­ductible the in­ter­est must not be of a cap­i­tal na­ture. It has been ar­gued that pre­pro­duc­tion in­ter- est that is in­curred on a cap­i­tal as­set is cap­i­tal in na­ture as it is part of the cost of cre­at­ing a source of fu­ture in­come.

Where the tax­payer has com­menced trad­ing and in­curs pre­pro­duc­tion in­ter­est re­lat­ing to the ac­qui­si­tion or con­struc­tion of an as­set to be used in the trade, then it would seem as if sec­tion 24J would al­low a de­duc­tion to be claimed. The ob­jec­tion that such ex­pen­di­ture is part of the cost of cre­at­ing a source of in­come and is there­fore of a cap­i­tal na­ture is ren­dered ir­rel­e­vant by the word­ing of sec­tion 24J. More­over, in terms of the de­ci­sion in Sub-Nigel v CIR, for an ex­pense to be in­curred in the pro­duc­tion of in­come does not mean that in­come has to be pro­duced im­me­di­ately af­ter the ex­pense has been in­curred, or for that mat­ter that in­come has to be pro­duced at all. The test is sim­ply whether the ex­pense was in­curred for the pur­pose of pro­duc­ing in­come. If sec­tion 11(bA) is deleted, the only dif­fer­ence will there­fore be that the pre­pro­duc­tion in­ter­est will be de­ductible in the year(s) of as­sess­ment in which it is in­curred rather than in a lump sum in the year in which it is brought into use.

Where the tax­payer has yet to com­mence trad­ing and in­curs pre­pro­duc­tion in­ter­est re­lat­ing to the ac­qui­si­tion or con­struc­tion of an as­set to be used in the trade, the ques­tion arises as to whether the po­si­tion is dif­fer­ent. In this case it would seem from the word­ing of sec­tion 24J that a de­duc­tion of such in­ter­est may not be claimed. This is be­cause of the re­quire­ment that the in­ter­est must be de­ducted from in­come de­rived from the car­ry­ing on of a trade. There­fore, if trad­ing has not com­menced, at least by the end of the year of as­sess­ment, it would seem as if the pre­pro­duc­tion in­ter­est re­lat­ing to that year may not be claimed in terms of sec­tion 24J. How­ever, in these cir­cum­stances the tax­payer may look to sec­tion 11A, which al­lows a de­duc­tion of pre­trade ex­penses gen­er­ally, not only pre­pro­duc­tion in­ter­est.

The main re­quire­ment for de­ductibil­ity in terms of sec­tion 11A is that the ex­pen­di­ture for which a de­duc­tion is sought must be ex­pen­di­ture that would have qual­i­fied for de­duc­tion un­der var­i­ous pos­si­ble pro­vi­sions of the act had the ex­pen­di­ture or losses been in­curred af­ter trade had com­menced. The list of such pos­si­ble pro­vi­sions is wide and in­cludes sec­tion 24J. It would there­fore seem that in these cir­cum­stances sec­tion 11(bA) is also not nec­es­sary as a de­duc­tion of pre­pro­duc­tion in­ter­est may be claimed in terms of sec­tion 11A. The word­ing of sec­tion 11A im­plies that pre­trade ex­penses will be ac­cu­mu­lated and de­ducted in a lump sum in the year in which trade com­mences. To this ex­tent the treat­ment of pre­trade in­ter­est in terms of sec­tion 11A mir­rors the treat­ment of pre­pro­duc­tion in­ter­est cur­rently con­tained in sec­tion 11(bA). Fur­ther, if the trade in re­spect of which the in­ter­est was in­curred never com­mences, the treat­ment un­der both pro­vi­sions is the same in that the in­ter­est is never de­ductible. In cir­cum­stances where trade has com­menced but the as­set has still not been brought into use, pre­pro­duc­tion in­ter­est in­curred af­ter the com­mence­ment of trade would be de­ducted as in­curred un­der sec­tion 24J.

The ques­tion of ex­actly when trad­ing com­mences is an in­ter­est­ing one. In CSARS v Con­tour En­gi­neer­ing (Pty) Ltd 61, in cir­cum­stances where the tax­payer had no premises, no equip­ment, no stock and no staff, it was held not to be trad­ing. In the US case of Rich­mond Tele­vi­sion Corp V Com­mis­sioner 345 F.2d 901 (4th Cir.1965), it was held that even though a tax­payer has made a firm de­ci­sion to en­ter into busi­ness and over a con­sid­er­able pe­riod of time spent money in prepa­ra­tion for en­ter­ing that busi­ness, the tax­payer still has not en­gaged in car­ry­ing on any trade or busi­ness un­til such time as the busi­ness has be­gun to func­tion as a go­ing con­cern and per­formed those ac­tiv­i­ties for which it was or­gan­ised. How­ever, var­i­ous de­ci­sions of the US courts have in­di­cated that it is not al­ways nec­es­sary for a com­pany to have opened its doors for busi­ness be­fore it can be said to be car­ry­ing on busi­ness.

In the UK case of J&R O’Kane & Co v The CIR 12 TC 303 (HL) it was held that the act of keep­ing open a shop was es­sen­tial to the car­ry­ing on of the busi­ness of a seller. SARS has in­di­cated in its In­ter­pre­ta­tion Note No 33 that it will as­sess each case on its mer­its in de­cid­ing whether to re­gard a com­pany as hav­ing com­menced the car­ry­ing on of a trade. It states that much will de­pend on the na­ture of the com­pany’s ac­tiv­i­ties.

It can there­fore be con­cluded that the pro­posed dele­tion of sec­tion 11(bA) from the act will not be detri­men­tal to tax­pay­ers, ei­ther in cir­cum­stances where trad­ing has al­ready com­menced or where it has not yet com­menced.

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