August 2019

UKnow Editorial – Aug 2019

Two of the reasons why I am so proud of our firm is firstly our incredible team, and secondly our collective strive to achieve quality, deliver service excellence and focus on innovation. Our world, our profession and our business environment is constantly changing, and because of this we work hard to stay ahead of new developments and embrace challenges as new opportunities.

Against this background, we are very proud to be launching an exciting new chapter in our Unik journey soon, so watch our usual spaces for these announcements! We are looking forward to the enhanced service delivery and benefits that this will have for our clients.

As we focus on introducing more of our team members this year, please read about our amazing Daleen Louw who has been part of our team for over 35 years.

We also welcome Chrisanne Dicks, who recently joined our team.

If you want to respond to or comment on any of our news items or other relevant information, please contact us at news@unikone.co.za or 022 – 482 1169, or join the conversation on our social media platforms on Linkedin, Instagram and Facebook.

Warm regards until next month.

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Debt Relief Part II – Application Of Section 19 And Paragraph 12A

The previous article on debt relief focused on the legislation: the general application of the provisions and recent amendments.  To recap:  the provisions apply when a taxpayer obtains a “debt benefit” in consequence of a concession or compromise in respect of a debt.  Cancellation, waiver, redemption and debt to equity conversions all are actions that may give rise to a debt benefit.  See our previous article Debt Relief Part I

The tax treatment of the debt benefit depends on how the initial debt was applied.

Trading stock – Section 19(3), (4) and (5)

The tax treatment of a debt that was used to acquire trading stock will depend on whether the stock is still “held and not disposed of”.  A taxpayer is entitled to a deduction in terms of section 11(a) in respect of the cost of trading stock acquired.  So much of the stock that is still held at the end of the tax year is included in his taxable income as closing stock.  This amount is carried forward to the subsequent tax year as opening stock and taken into account as a deduction.  (Section 22(1) and (2))

If the trading stock is still held and not disposed of at the time the debt benefit arises, section 19(3) provides that the amount taken into account in terms of section 11(a) or 22(1) or (2) must be reduced by the amount of the debt benefit.  In certain circumstances, the amount of the debt reduction may exceed the amount taken into account for purposes of subsection (3).  This would for instance be the case where the taxpayer had opted to reduce the value of the trading stock as a result of a decrease in market value.  In terms of section 19(4) any excess amount of the debt benefit will, for purposes of section 8(4)(a), be deemed to be an amount that has been recovered or recouped and will be included in the taxpayer’s income.

In the instance where the taxpayer has already disposed of the trading stock when the debt is reduced, he would be deemed to have recovered or recouped any amount that had been allowed as a deduction in respect of the acquisition of the trading stock.

Goods and services – Section 19(5)

Subsection 19(5) applies to all other expenses, as well as stock no longer held (see above).  To the extent that the taxpayer had been granted an allowance or deduction in respect of the expense, the amount of the debt reduction will be deemed to be an amount that has been recovered or recouped for purposes of section 8(4)(a) and will be included in his income.

Allowance assets – Section 19(6) and Paragraph 12A(3)

Allowance assets are strange creatures, forever crossing the capital/revenue divide.  Accordingly, it is necessary to consider the implications for both CGT and income tax if the debt used to fund the acquisition of an allowance asset is reduced.

If the taxpayer still owns the asset when the debt is reduced, the starting point is paragraph 12A(3).  The aim of this provision is to reduce the base cost of the asset by the amount of the debt reduction.  Section 19(6) then kicks in and any excess amount of the debt reduction (to the extent that it exceeds the base cost of the asset) is applied to deductions or allowances granted in respect of the asset.  These amounts are deemed to have been recovered or recouped for purposes of section 8(4)(a) and are thus included in income.

The interaction between paragraph 12A, dealing with CGT, and section 19, catering for income tax, can be demonstrated in the following example:

In Year 1, Mr. A buys a machine for R1 000 000 on credit.  He is entitled to a wear-and-tear allowance of R200 000 p.a.  By year 2 his machine has an adjusted base cost of R600 000.  He runs into financial difficulties and the creditor waives R750 000 of the R1 million loan.  In Year 3 he decides to sell the machine for R800 000.  His liability for tax is calculated as follows:

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Now let’s do a time warp and switch the two events.  Mr. A sells the machine in Year 2, while the waiver giving rise to the R750 000 debt benefit occurs in Year 3.  Prior to the recent amendments, only the accumulated wear-and-tear allowance of R400 000 would have been deemed to be an amount recovered or recouped for purposes of section 8(4)(a).  Furthermore, since there is no longer an asset in respect of which paragraph 12A(3) can apply, the amount of the debt reduction can only be offset against his assessed capital loss.  If no such loss, one very happy taxpayer could have skipped into the sunset.

Well, the fiscus decided that it was not going to have any skipping, and as from the 1st of January 2019, this loophole has been closed.  Section 12A(4) now provides that where a debt benefit arises in respect of an asset that had been disposed of in a previous year of assessment, the “absolute difference” between the capital gain or loss in respect of that disposal and the amount that would have been determined had the debt benefit been taken into account in the year of the disposal, must be treated as a capital gain in the year in which the debt benefit arises.

Prior to the amendments, the tax consequences for Mr. A would have been as follows:

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Had the debt benefit occurred in the same year, the capital gain would have been calculated as follows:

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The absolute difference between this gain and the loss incurred by Mr. A in Year 2 is R600 000.  This amount must be taken into account as a capital gain.  However, in terms of paragraph 8 the gain must be set off against the capital loss of R200 000 carried forward from Year 2.  He therefore has a net capital gain of R400 000.

Non-allowance assets – Paragraph 12A(3) and (4)

It is much simpler to account for the reduction of a debt used to fund the acquisition of a non-allowance asset (an asset in respect of which no deduction or allowance is granted in terms of the Act).  If the asset is still held by the taxpayer at the time of the reduction, paragraph 12A(3) provides that the base cost of the asset must be reduced by the amount of the reduction.  As mentioned above, the base cost can only be reduced to zero and the provision cannot create a negative base cost.  Any excess must, in terms of subparagraph (4), be applied to reduce the taxpayer’s assessed capital loss.  If he has no assessed capital loss, that is the end of the road and the debt reduction has no further tax implications.

If the taxpayer no longer holds the asset, subparagraph (4) applies in the manner explained above, except that there would be no recoupment of allowances.

In conclusion

The underlying message to taxpayers is that there is no such thing as a free lunch.  When a taxpayer incurs an expense, whether to purchase stock or pay rent or buy a machine or fixed property, certain tax consequences arise.  He may be granted an outright deduction or an allowance, and at the very least he will end up with a base cost that he can deduct from proceeds should he sell his asset.  When the debt is reduced or compromised, the taxpayer is left with only the tax benefit.  The debt benefit provisions aim to rectify this situation by effectively reversing or neutralising the tax benefits originally obtained by the taxpayer.  In practice, the application of the provisions may prove problematic because it is not always possible to specify how borrowed funds were applied.  Many businesses are funded by both borrowings and earnings and do not necessarily keep track of which funds are used to finance which expense.  Going forward, it might be a good idea to keep accurate records of how borrowed funds were applied.

Annalize Duvenage

Specialist Tax Consultant

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Planning on selling property?

Have you heard the saying “location, location, location” when it comes to property?  My parents own a beach house and years ago one of their friends came to visit and spent the night. The next morning, the man stood on the stoep with his coffee, looking out over the ocean.  He turned to my mother and said: “It’s a crummy house, but what a location!”

When a client informs us just before the end of the financial year that they are planning on selling a property, they often tell us not to worry about the tax consequences for the current tax year, as the property will not be transferred before year-end. That is exactly when we start to worry….

The first question we ask is on what date the contract (deed of sale) was signed and if there are any special or suspensive conditions. This would for instance be the case if an offer is subject to the buyer’s financing being approved. The reason for this question is that the Income Tax Act states that you need to pay the tax when income is received or accrued, whichever happens first.

The proceeds from the sale of fixed property, and therefore the related capital gain, accrues on the date that the contract is signed, unless there is a suspensive condition.  In that case, accrual takes place on the date that the condition is met, for instance the date on which the buyer’s application for a bond is approved.  For tax purposes, this is the effective date. Full stop, end of discussion.

The requirement that transfer of ownership must be registered at the Deeds Office is not a suspensive condition.  For tax purposes, this is merely regarded as a formality.

If the terms of a contract are met, let’s say 30 January, and the transfer is only completed on 2 March (so you will only receive the payment for the property on or after the 2 March), the transaction is considered to have taken place on 30 January for the calculation of tax.  You will therefore need to take the capital gain into account for your IRP6 provisional tax payment at the end of February. This can have a significant cash flow impact.

So, when you purchase a property the location may be the most important factor, but when it comes to selling, it is all about the right timing for tax!

Petro van Deventer

Senior Manager

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Welcome to our team!

We would like to welcome Chrisanne Dicks to our Unik family!

She recently joined our team as Personal Assistant to our Director, and will also be attending to HR, Trust and Estate administration.

We hope you have a wonderful journey with us!

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Meet our Team – Daleen Louw

Being referred to as “part of the furniture” in our firm is a badge of honour. This honour is very much deserved by Daleen Louw, who has been with the firm that today is Unik Professional Services for over 35 years.

Daleen started out as a typist back in the day of typewriters and then the revolutionary fax machine. She progressed to the typing of our very important financial statements, which later modernised by her using more sophisticated software to produce our various documents. Today she also oversees a team of administrative staff, is our managerial assistant, assists in our Debtors Department and handles many other ad hoc tasks thrown her way.

Daleen is very special to me, as she has known me since I was a child growing up and popping into the office often, then when I did vacation work and later during my training contract. She has supported me and our business throughout the years in all our changes, new ideas and various ventures.

Daleen, you are truly a pillar of strength and a right-hand! We appreciate you.

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