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and above the value of the cars traded in. The taxpayer
argued that had he used the old cars he would have had to
incur heavy and expensive repairs. These repairs, he
reasoned, would have been allowed as a deduction.
Instead, of doing repairs he bought better and newer motor
cars and saved the repair bill. The taxpayer was
unsuccessful. The court held at 280 that "(All) that can
be allowed is compensation for the loss of earning
capaciaty of the motor cars".
Diminished earning capacity is a question of fact. In
ITC 91 (3 SATC 235) the taxpayer was a hotelier. There
was considerable wastage each year of crockery, linen,
cutlery, etc. To meet this wastage, a large stock was
carried. Issues were made from the stock and were
written off as ‘’replacements" which was allowed. The
facts of the case satisfied the court that the "taxpayer
was carrying on a considerable business and was therefore
using up rather rapidly such things as linen, crockery,
cutlery, brooms, etc.
tTC 247 (6 SATC 379) a jockey was allowed the
replacement of saddlery, breeches and boots as a
deduction. "The wear and tear in the case of such
matters as saddlery, breeches and boots is not only large
but rapid". (At 380)
. 19 During the, year of assessment
The wear and tear of machinery, implements, utensils and
articles must occur during the y«*ir of assessment in
which the allowance is claimed. .Section 11(e)
specifically states - "diminished by reason of wear and
tear during the year of assessment".
-49 2-
1x1 I'TC 311 (S SATC 152) a taxpayer sold his business as a
going concern and claimed an amount as depreciation on
account of short provisions of depreciation in previous
years. Held at 154: "Now, confessedly, this is not
diminution during the year of assessment. This is an
adding to the accounts of diminution sustained in past
years", and "... the court has no jurisdiction to deal
with such losses in past years, and to bring that in as
diminution by reason of wear and tear during the year of
assessment".
If machinery, implements, utensils and articles are not
used by the taxpayer for the purposes of his trade during
the whole of the year of assessment, wear and tear would
onlv be allowed in respect of the period of use. This
pri. - £ pie was confirmed in ITC 295 * (7 SATC 350).
Referring to plant which stood idle during the year, the
court held at 351: "We are not clear as to the
proportion which that plant (idle plant) represents of
the whole of the machinery which is on Che premises, but
clearly no allowance could be made in respect of that."
A taxpayer is entitled to a wear and tear allowance up to
the date of sale of an asset (ITC 215 6 SATC 133).
20 Recoupment of wear and tear
Section 8(4)(a) of the Act provides that, subject to
certain exceptions, all deductions which are allowed in a
current or any previous year of assessment under the
provisions of section 11 to 20 of the Act, which have
been recovered or recouped, are to be included in the
taxpayer's income in the year of assessment during which
the recovery or recoupment takes place. The exceptions
which include the machinery and building investment
allowances do not extend to the wear and tear allowance.
Consequently, recoupments of wear and tear allowances
- 493 -
are, in terms of section 8(4)(a) read with paragraph (n)
of the definition of "gross income") included In gross
income of the taxpayer< Amounts which are required to ba
included in the taxpayer's income are in terms of
paragraph (n) of the definition of "gross income", deemed
to have been derived by the taxpayer from a source within
the Republic, notwithstanding that the amounts may have
been recouped outside the Republic.
21.21 How recoupments take place
Moorreesburg Produce Co Ltd v CIR (1945 CPD 289, 13
SATC 245) the taxpayer carried on the business of a
miller and produce and hardware merchants. Expensive
machinery were destroyed by fire and the ..:ayer
received an insurance payment which exceeded . tax
value. The court held at 252:- "But, the words-
'recovered' or ’recouped' are very wide. If after having
used a machine the taxpayer gets for it as much as he
paid for it, I should say that he has recovered or
recouped anything he may have written off as depreciation
during the period of use". The accountant member of the
court used a very interesting argument. He said that
suppose the insurers had simply replaced the machine
destroyed by other machinery exactly similar, of equal
age and equally worn, such replacement in that time of
scarcity and high prices would have cost them more than
the amount they have paid out. As this would have meant
more value to the company, could it then have been said
that the company had recovered or recouped the
depreciation deductions of previous years? The question
was not answered directly. The court further held at
252: "And to the extent to which he gets more than the
value shown by deducting from the original cost the
amounts he has written off, to that extent he recovers or
recoups those amounts". On the basis of the principle
established in that case, insurance moneys paid for the
destruction of a trade asset due to a cause other than
fire can likewise result in a recoupment of the wear and
tear allowances. The most common occurrence giving rise
to a recovery or recoupment of wear and tear allowances
is the sale or disposal of assets in respect of which
wear and tear allowances have been granted in terms of
section 11(e).
* ̂ Date on which recoupment takes place
While section 8(4)(a) provides for the inclusion in a
taxpayer's income, the recoupment of all wear and tear
allowances granted, the section does not state when a
recoupment shall be regarded as having taken place. Due
to the reasonable attitude of the Commissioner in this
matter, problems similar to those encountered as regards
the meaning of the word "accrued" seem to have been
avoided. The recovery or recoupment of an amount in
terms of section 3(4)(a) is regarded by the Commissioner
as having taken place on the date on which the taxpayer
first became entitled to demand payments of that amount.
For instance, if the purchaser of an asset is entitled,
in pursuance of an agreement, to pay the whole or portion
of the purchase price in a year subsequent to the year in
which the agreement was concluded, only so much of the
purchase price as is payable during the year of sale is
included in the seller's incoma for that year. The
balance will be included in the seller's income for the
year of assessment during which payment may be demanded
- 495 -
21.23 Amount of recoupment
The proceeds, whether in the form of an insurance claim
or a selling price of an asset are first approporiated to
the tax value of the asset, and thereafter to the
recoupment of wear and tear allowances previously
deducted in respect of the relevant asset. Any balance
remaining after thesr appropriations will normally be a
capital profit which will not attract taxation. Where
the proceeds are received in instalments the initial
payment will, in terms of departmental practice, be
firstly appropriated to the tax value of the asset
concerned, and may therefore contain a small element of
recoupment for the purposes of section 8(4)(a).
Example-------— R
Cost price of asset - 1979 750 000
Wear and tear allowances granted
~ 1979-1982 300 000
Tax value at beginning of 1983 450 000
The asset is then:
a) sold for R8Q0 000;
b) destroyed by fire resulting in an insurance claim of
R650 000;
c) sold on tetms with an initial payment of R500 000 and
the balance of
R300 000 paid as to R150 000 in 1984, and R150 000 in
1985.
■'V
- 496 -
Solution ( a )
R
(b)
R
(c)
R
1983 ~ Tax value 450 000
Proceeds 600 000
Surplus 350 000
Recoupment 300 000
Capital profit 50 000
1984 - Proceeds
Recoupment
Total possible recoupment
amounts to R300 000 of
which R50 000 was recouped
in 1983 therefore balance
remaining at beginning of
1984 - R25Q 000
1985 ~ Proceeds
Recoupment
Balance recoupable at
beginning of
1984 250 000
Less recouped 1984 150 000
Capital profit 1985
450 000 450 000
650 000 500 000
200 000
200 000
NIL
50 000
50 000
Mil
150 000
150 000
150 000
100 000
50 000
It is the practice of the Commissioner to allow a
taxpayer to use the market value of an asset acquired for
no value, for the purposes of calculating the wear and
tear allowance (see C21.4 supra)< A further practice of
the Commissioner is not to apportion any part of the
proceeds resulting from the loss, destruction or disposal
of such assets to the tax value of those assets. The
whole proceeds limited to the aggregate of wear and tear
allowances granted in current and past years of
assessments, are regarded as a recoupment. This practice
appears to be correct as the taxpayer has not incurred
any cost in relation to the acquisition of such assets.
"-T ■■ s i 'm 1 .J~ ■n^m f» *+
-497
21.24 Privileged classes of taxpayers
Subject to certain conditions, concessions are enjoyed by
certain privileged classes of taxpayers# A manufacturer
is one of these privileged classes of taxpayers. Should
wear and tear allowances be recouped as a result of
damage to or destruction of machinery or plant which was
used by the manufacturer directly in a process of
manufacturej or directly in any other process which in
the opinion of the Commissioner is of a similar nature,
Section 8(4)(e) provides that such recoupment shall not
be included in the manufacturer's income during the year
of recoupment, The manufacturer must, however, satisfy
the Commissioner that -
(a) "he has concluded or will within a period of one year
(or such longer period as the Commissioner in the
circumstances of the case may allow) from the date of
the event conclude a contract for the acquisition by
him of further new or unused machinery or plant
(hereinafter referred to as 1 further machinery or
plant1) to replace the aforesaid machinery or plant"
[Section 8(4)(e)(i)); and
(b) the further machinery or plant has been or will be
brought into use within a period of three years from
the date of the event and will be used by him
directly in a process of manufacture or any other
process which in the opinion of the Commissioner is
of a similar nature, for a period of not less than
five years or until the further machinery or plant is
scrapped or disposed of in the ordinary course of the
taxpayer's trade prior to the expiry of such period
of five year." [Section 8(4)(e)(ii)]
- 498 -
In other words if Che machinery or plant is scrapped in
the ordinary course of trade within five years the
Commissioner will remain satisfied. (The terras "new or
unused" machinery) "machinery or plant" and "process of
manfacture are not defined in the Act).
There is a proviso to section 8(4)(e) to the effect that
"ifj owing to arty occurrence or because of any
circumstances arising during any year of assessment the
Commissioner is n> longer satisfied in regard to the
matters ... (referred to above), the said amount shall be
included in the income of the taxpayer for the year of
assessment during which such occurrence takes place or
such circumstance arises".
The concessions are therefore only granted if the
Commiss ioner is satisfied about the matters specified
above, and can be enjoyed by taxpayers only as long as the
Cotrnniss loner continues to be so satisfied. These
discretionary powers of the Commissioner are not subject
to objection and appeal*
R
1979 Cost of new machine purchased for a process of
manufacture and to replace a machine destroyed
by fire 28 000
The untaxed recoupment of the destroyed
machine amounted to 4 000
1982: Allowances granted to date:
Initial allowance 6 000
Wear and tear 4 878
10 878
V
The machine is:
(a) Scrapped and sold for R.2 000
(b) Sold for R30 000
(c) Not sold or scrapped but becomes idle.
- 499 -
Solution (a)
R
<b)
R
(c)
R
1979 Original cost
Untaxed recoupment
1982 Allowances to date
Tax value
Scrapping allowance:
(a) Value received
R2 000:
(13 122 - 2 000)
Recoupment;
(b) Sold for
Surplus
28 000 28 000 28 000
(4 000) (4 000) (4 000)
(10 878) (10 878) (10 878)
13 122 13 122 13 122
Rll 122
30 000
16 878
Tax consequences of surplus:
Included in income:
untaxed recoupment 4 000
other allowances
granted in previous
years 10 878
Capital profit
Recoupment
The machine has not; been used
in a process of manufacture for at
least £ive years. Add to income
14 878
2 000
16 878
R4 000
1.25 Capital nature of recoupment
The Act does not distinguish revenue profits from capital
profits as regards recoupments of wear and tear* Tbs Act
also makes no provision for extraneous circumstances.
The taxpayer in ITC 559 (13 SATC 308) sold a motor car at
a profit of R210. The Commissioner included in his
income an amount of R148 being depreciation allowed in
the previous year. The taxpayer objected on the
following grounds; ,
, It was a capital profit and therefore the recoupment
system provided for in the Act did not apply.
. The profit was due to extraneous circumstances - the
type of car and the fact that the market boomed.
The court upheld the Commissioner's decision. It is
therefore irrelevant whether a recoupment is of a capital
nature.
•*-n I.'IC 681 (16 SATC 357) the taxpayer sold his business
to a company for R8 000 as follows;
. ' R
Debtors 3 276
Stock and work in progress 1 656
Plant and machinery 4 018
Furniture and fittings 400
9 350
Less: Sundry creditors I 350
8 000
The Commissioner determined an amount Co represent the
recovery or recoupment of amounts previously allowed as
wear and tear and included the amount in the taxpayers
taxable income. The taxpayer argued that ~
. in arriving at the purchase price, the goodwill of
the business was in effect taken into consideration
by the allocation of the said amounts in respect of
plant, machinery, furniture and fittings;
. that the amount as determined by the Commissioner was
of a capital nature; and
, chat in any event the recoupment related to previous
years and should have been added back in the
res e;jtive years* ,
The, covrfc agreed with the Commissioner -
. the agreement did not contemplate the question of
goodwill;
. ehe value, be it the replacement value, or the true
value or the market: value or the sale value o£ the
plant and machinery and furniture and fittings were
R4 018 and R4QQ respectively; (
. on the proper contruction of the section it was
immaterial whether the amount was an accrual of a
capital nature or not; and
. the section requires the inclusion of the full amount
recovered or recouped in the year in which the
recovery or recoupment took place.
In TTG 699 (17 SATC 99) the taxpayer purchased t hotel
business. The assets purchased included:
Furniture
Crockery, cutlery and utensils
Linens and soft furnishing
Carpets
Five years later the business was sold,
included;
Furniture
Crockery, cutlery and utensils
'Linen and soft furnishing
R
400
170
170
60
The assets sold
8 000
700
1 400
7
-502-
The Ccmmissloner added to the income of the taxpayer all
amounts allowed in previous years as wear and tear and
replacement costs of crockery, cutlery and utensils. The
court upheld the Commissioner's decision holding that it
is "immaterial that recoupment arose out of a capital
transaction".
21.26 "Lock stock and barrel11 transactions
A taxpayer arid his wife sold two hotels a.t a profit in
^TC 565 (13 3ATC 330). The hotels were sold "lock stock
and barrel" and the agreement of sale was silent as to
any portion of the price being attributable to goodwill.
The Commissioner included in the income of the taxpayer
an amount in respect of the recoupment of wear and tear
of assets other than fixed property. The court upheld
tfte Commissioner1 s decision..
The purchase price received by the seller of a business
even although expressed as a lump sum, it to be allocated
to the individual items smprising the business* This
tax principle was laid down by the Appellate Division in
. C1R v Niko 1940 AD 4l6j 11 SATC 124, and was applied by
the courts in disputes relating to the recoupment of wear
and tear allowances.
21.27 The incidence of inflation
Wear and tear allowances granted and calculated on the
historical cost of assets do not take into account the
depreciation in the value of money which commenced prior
to World War 2. Reserves for wear and tear which have
been set aside by taxpayers based on the historical cost
of assets, would therefore be inadequate to provide funds
required to replace those assets.
The Committee of Enquiry into the Income Tax* Act gave
£
serious consideration to this problem (Second and Final
Report, chapter 10 page 23). It was recommended that
subject to certain conditions in any case in which it is
established to the satisfaction oE the Commissioner that
the replacement cost of a fixed asset used by the
taxpayer in his trade and which is subject to wear and
tear allowances provided for in the Act, exceeds the cost
of such asset, the taxpayer should be entitled at his
option, to a replacement allowance in respect of such
asset. If implemented, these recommendations would have -
, enabled the taxpayer to preserve his capital intact
in the face of rising prices resulting from the drop
in Che purchasing power of money; and
. resulted in a fairer and more proper determination of
profits during financial periods of taxpayers.
The Income Tax Commission rejected the Committee's
recommenda cion for replacement allowances (First and
Final Report, page 33 paragraph 53) as "an unnecessarily
complicated set o£ provisions d e s i g n e d t0 take care of
what is at best a theoretical possibility".
Professor JRP Morris expressed the following view in 1980
on behalf of The South African Institute of Chartered
Accountants:
"(The) inroads of inflation demands serious consideration
as the tremendous inflation of costs is placing heavy
demands on capital. These demands in turn are creating
pressures making it more difficult for smaller businesses
to start and to remain operative. The idea of any
general tax concessions to adjust for inflation is not
attractive as it appears to accept rather than fight
inflation and may well in the long term tend to fuel
inflation. In the area of capital equipment though the
impact of inflation is at its worst mainly because an
- 504 -
investment: made in year one is on the basis of present
tax law effectively deducted over the life of the asset
in rands of continually depreciating value. (An asset
t-v-isht in 1980 and paid for in 1980 rands will qualify
for the allowances in. 1980, 1981, 1982 etc., in rands and
thus the real value of the tax allowances will in a time
of inflation not come close to the total net cost of the
asset qualifying for allowance). There is a very simple
way to overcome this problem and that is to grant a 100%
allowance in the year of acquisition of irhe asset. In
this event the tax allowance is granted in the same rand
as is used to acquire the asset".
21.28 Departmental practice
The rate of wear and tear applied by the Commissioner
will depend on the type of article and the particular
facts and circumstances of each case. The rates at which
wear and tear allowances are granted by the Commissioner
in practice are reflected in Annexure F.
FART V
Losses made on Che disposal of fixed assets are normally
regarded under the South African Income Tax Act as losses
of a capital nature. The deduction of these losses in
determining the taxable income of a taxpayer is
prohibited by Section 11(a) or the Act. Where, however,
certain capital assets used for the purposes of trade,
have been scrapped by the taxpayer during the year of
assessment, relief is granted by section ll(o). Such
relief takes the form of a scrapping allowance. This
allowance is available to the taxpayer in respect of the
following assets used by the taxpayer for the purposes of
his trade -
, industrial building or improvements thereto;
. hotel buildings or improvements thereto;
. buildings or improvements to buildings used by
co-operative societies;
. shipbuilding structures or improvements thereto;
. residential units;
. machinery, implements, utensils or articles; and
, ships and aircraft.
- 506-
CHAPTER 22
SCRAPPING
22.1 Special features
The special features relating to the scrapping allowance
■ are as follows;
. No allowance is granted in respect of buildings or
shipbuilding structures and improvements to such
buildings or residential units which have been
scrapped within a period of ten years from date of
erection or purchase [Section ll(o)(i)],
. The allowance is not available to farmers [Section
ll(o)].
» The allowance is not available in respect of any
machinery implements, utensils or articles of which
the cost had been allowed as a deduction to a
taxpayer classified as a National Key Point under
Section 24D [Section i K o H v i ) ] .
. The cost of machinery* implements, utensils, or
articles is deemed to be its actual cost plus the
amount by which its value has been increased by
expenditure, other than expenditure deducted in terms
of section 11(a) which in terms of section 11(e)(v)
has ueen proved to the satisfaction of the
Commissioner to have been incurred by the taxpayer in
moving it from one location to another. From this
amount of cost must be deducted any untaxed
recoupment derived upon the damage or destruction of
an item, ,/hich the new item is intended to replace
[Section ll(o)(iii)]. It should be noted that the
- terra "machinery, implements, utensils or articles"
would include foundations and supporting structures.
-5 0 6 -
CHAPTER 22
SCRAPPING
22.1 Special features
The special features relating to the scrapping allowance
are as follows;
. No allowance is granted in respect of buildings or
shipbuilding structures and improvements to such
buildings or residential us,its which have been
scrapped within a period of ten years rrcir. date of
erection or purchase [Section ll(o)(i)J.
, The allowance is not available to fanners [Section
ll(o) ] •
, The allowance is not available in respect of any
machinery implements, utensils or articles of which
the cost had been allowed as a deduction to a
taxpayer classified as a National Key Point under
Section 24D [Section ll(o)Cvi)].
The cost of machinery, implements, utensils, or
articles is deemed to be its actual cost plus the
amount by which its value has been increased by
expenditure, other than expenditure deducted in terms
of section 11(a) which in terms of section 11(e)(v)
has been proved to the satisfaction of the
Commissioner to have been incurred by the taxpayer in
moving it from one location to another. From this
amount of cost must be deducted any untaxed
recoupment derived upon the damage or destruction of
an item which the new item is intended to replace
[Section ll(o)(iii)]. It should be noted that the
• term "machinery, implements, utensils or articles"
would include foundations and supporting structures.
- 507 -
The cost of ships ana aircraft must be reduced by
untaxed recoupments.
The amount of the allowance is equal to the balance
remaining after deducting from, the cost as mentioned
above, the sum of the following -
. initial machinery allowances previously made;
. wear and teat allowances previously granted; and
. the amount or value of any advantage accruing in
respect of the sale or other disposal of the
Example 1
R
1979 - Original cost of a machine used in a
process of manufacture
1982 - Allowances granted to date:
24 000
Initial allowance 6 000
Wear and tear 4 878
R10 878
the machine is scrapped and
a) retained
b) sold for R2 000
c) sold for R14 000
Solution
Original cost 24 000
Initial and wear and tear
allowances
Tax value - 1982
(a) , (b) (c)
R R R
24 000 24 000 24 000
(10 878) (10 878) (10 878)
13 122 13 122 13 122
Value received
Deficit/(Surplus)
NIL 2 000 14 000
13 122 11 122 (878)
Scrapping allowance 13 122 11 122 NIL
Recoupment of allowance 878
/ %
-508-
Example 2
1979 - Coat of new machine purchased for a process
of manufacture and to replace a machine which was
destroyed by fire
The untaxed recoupment on the destroyed
machine amounted to
1982 -* Allowances granted to date:
R
Initial allowance 6 000
Wear and tear 4 878
10 878
The machine is scrapped and:
(a) retained
(b) sold for R2 000 •
(c) sold for R26 000
28 000
4 000
Solution
Original cost
Untaxed recoupment
Initial and wear and tear
allowances
Tax value
(a) Ob) Cc)
R R R
28 000 28 000 28 000
(4 000) (4 000) (4 000)
(10 878) (10 878) (10 878)
13 122 12 122 13 122
Value received NIL 2 000 26 000
Deficit/(surplus)
Scrapping allowance
Recoupment: to be included in
income
13 122 11 122 (12 878)
13 122 11 122 NIL
- - 10 878
Urtder (c) above the machine was scrapped and sold for
R26 000. Section 5(4)(e) provides that the untaxed
recoupment of the destroyed machine (ie R4 000) will not
be included in income if the replacement machine is
"scrapped or disposed of in the ordinary course of the
taxpayer's trade”. If the machine in the above example
was not scrapped in the ordinary course of trade an
amount of R12 878 would be included in income.
The scrapping allowance under section ll(o) is
complementary co the wear and tear allowance under
section 11(e) (ITC 769, 19 SATC 214; ITC 905 24 SATC
87). There are however important differences in the
wording of the two sections. In each instance an
allowance is granted in respect of ''machinery,
implements, utensils and articles". Section 11(e)
prohibits the wear and tear allowance (which presumably
would otherwise be made) in respect of "buildings * or
other structures or works of a permanent nature",
formally a building would not be classified as
\vhinery, implements, utensil-?, and articles". The
proviso in section ll(«l would only be necessary where as
in the engineering industry, certain machinery may be
inseparable from the building which houses it. Under the
Australian Income Tax Act "buildings" form part of plant,
wholly or in part, when, and to the extent that the
structures are absolute essential to the support of the
working plant (see C21-.5 supra). Another instance of
where a permament structure may form part of plant would
be a concrete cooling tower. Therefore, although these
items may properly be regarded as an integral part of
plant and machines, the statutory wear and tear allowance
could not be claimed due to the "permanent nature"
characteristic. The restriction against an allowance of
wear and tear in respect of "buildings or other
structures or works of a permanent nature has no
- 509-
- 510 -
counterpart in section ll(o). It is therefore submitted
that there is a class of "machinery, implements, utensils
and articles", which, while it does not qualify for the
wear and tear allowance, does rank for the scrapping
allowance in terms of section tl(o).
It should further be noted that the scrapping allowance
under section il(o) is the "excess of the original cost
to such taxpayer ...» over the total amount arrived at by
adding all the allowances made in rcspect thereof ... to
any amount or the value of any advantage accruing to the
taxpayer .. ,11 Section 11(e) on the other hand, grants a
wear and tear allowance on the "value" of the item. The
effect of this difference in wording is that where an
article has for example been donated, the value on which
wear and tear has been calculated cannot be taken in
consideration when calculating the scrapping allowance
under section ll(o).
Another significant difference between section 11(e) and
ll(o) i: that, whereas the Commissioner enjoys full
discretionary powers in respect of the amount of the wear
and tear allowance, his determination of the scrapping
allowance is subject to objection and appeal.
2 2‘2 ^.e.jnaanlng of l,sarapp^ng,, ,
"Scrapping" is not defined in the Act, it was left to the
courts to decide its meaning. Rowlatt J (In Sou th
Metropolitan Gas Company v Dodd, 13 TC 211) in dealing
with the question of obsolescence said: "It is quite
clearly a question of degree, and a question of fact when
machinery becomes obsolete". A view frequently expressed
in American decisions regarding obsolescence is that "to
warrant a deduction, it requires that the operative
causes of the present and growing uselessness arise from
- 511 -
external forces which make it desirable or imperative
that the property be replaced, and it is not enough that
the taxpayer has decided to abandon facilities or
discontinue their use" (Real Estate Land Company v United
States 309 US 13, 160 ALR,at page 1248).
Xn ITC 657 (15 SATC 495, at 498) the court agreeing with
the view of Rowlatt J above, held as regards scrapping:
''Again the question is one of degree, depending on the
nature and extent of the business operations which have
been curtailed". In the same case, the president of the
special court, D 0 K Bayers stated further at 496;
"Ordinarily an article is scrapped when it is consigned
to the scrap heap", and scrapping means "withdrawn
because they (assets) have served their purpose and are
now useless or worthless". According to the obiter
dictum in ITC 852 (22 SATC 187) it is not a requisite of
the scrapping allowance that the article in question is
ready for the scrap heap as long as it is no longer fit
for use in the taxpayer's business.
It is therefore not essential to the granting of the
scrapping allowance that the asset "scrapped" should be
sold or disposed of; it is sufficient that the taxpayer
ceases to use the asset in his trade. Once an asset is
scrapped and then sold or otherwise disposed of, the
proceeds or value of any ocher benefit muse .be applied to
reduce the allowance. Where an asset is scrapped and
retained by the taxpayer, the quesion arises whether a
value should be placed on the scrapped asset. Section
ll(o) is silent on this question and our courts have not
to date been required to decide this question. In
practice the Commissioner does not place a value on a
scrapped article which has been retained by the taxpayer.
Physical deterioration - during the course, of carrying on
a trade
Section ll(o) must he read in conjunction with section
11(a)*' The latter paragraph speaks of diminution in the
value of any machinery* implements, utensils and
articles, "by reason of wear and tear during the year of
assessment". This wear and tear clearly refers to
physical deterioration or depreciation, and where it is
not shown that such items has undergone such wear and
tear it does not appear that the taxpayer can claim a
scrapping allowance. In the first reported case (ITC
200, 5 SATC 389) on the subject a taxpayer closed down a
branch of his business and sold the furniture used at the
branch at a loss* He claimed this loss as a scrapping
allowance. On the facts the court found nothing to show
that the furniture had become useless. The sale was
regarded as a disposal of a capical assee, and the loss
was not deductible,. It was a loss due to the closure of
the branch, and not due to the furniture scrapped in the
course of trade,
ITC 311 (8 SATC 152) the taxpayer sold his business as
a going concern. He contended that most of the plant
sold was obsolete and that the purchaser had to scrap
some of those assets. The court held that a person
sustaining a loss on the sale of his business cannot
claim that such, a loss is due to depreciation or
obsolescence«
Another example is that of a solicitor in ITC 460 (11
SATC 186) who claimed a scrapping allowance in respect of
law books which have been replaced by new ones. The
court found that he did not scrap the books as they were
Still on his shelf. It ia submitted that this does not
presupppose that the taxpayer must actually divest
himself of Che asset but that rather such asset should
not be capable of being put to any further use by the
taxpayer, i.e. the law books would have to be withdrawn
from the library.
In ITC 657 (15 SATC 495) the taxpayer operated a cafe and
a restaurant in adjoining premises. Due to slow business
he closed down the restraurant, sold the furniture and
fittings a.nd incurred a loss of R1 748. This he claimed
as a scrapp.-ag allowance. The court held:
. Scrapping can only be applied to machinery which has
been worn out or has suffered physical
deterioration. Where this has not taken plaeej no
advantage can be taken of scrapping.
. The loss attendant on the scrapping (is there was)
was incurred owing to a cessation of a “substantial
portion of the business. The sale was nothing more
* than a disposal of capital assets and the loss was of
a capital nature.
The decision in ITC 657 (supra) was approved in ITC 754
(18 SATC 424), In the latter case the taxpayer sold
equipment in respect of which wear and tear had been
allowed in previous years, and thereupon ceased to carry
on trade. He contended that although he closed his
general dealers business, he was continuing in business
as a building contractor and was therefore entitled to
the scrapping allowance in that "... for the purposes of
his trade..." applies to the circumstances. The court
again concluded that the loss was du*-,' to cessation of
business. On the facts of the esse it vas shown that the
general dealers business which was discontinued was in
itself a substantial portion of the appellant's
act ivities.
The decision in ITG 769 U 9 SATG 214) differs from those
•̂n TTC 657 and ITG 754 (supra). In the former case a
subsidiary part of the business was sold whereas in the
latter cases a substantial portion of the businesses were
sold. The facts of ITG 769 (supra) were briefly as
follows”: The taxpayer- carried on the business of a ferry
contractor and in conjunction with chat business also
conducted a tearoom business. While continuing the
ferrying business which was his main business, he
discontinued the tearoom business which was carried on in
a boat. The boat was broken up and sold as scrap
timber. The Commissioner refused to allow a scrapping
allowance, holding that the deduction is only available
if the taxpayer Still carried on business in relation to
which the article was scrapped. The court held that this
point falls away as the tea business was carried on in
conjunction with the appellant's main business. The
Commissioner's decision was overruled.
Another example of a taxpayer carrying on two busin<sses
was ITC 7$5 1 (20 SATC 107). In this case the taxpayer
carried on business in two hotels, as hotelier. The
business in one of the hotels was ceased due to the
cancellation of the right of occupation, Whan this
happened the company found that a small portion of the
furnitui'e and equipment could be used in its other
hotel. The greater portion was useless for its purpose,
and was sold at an auction, or taken by the director at
prices fetched at the auction. What was left was junk,
not fit for further use and ready for the rubbish heap,
The company abandoned it and told members of staff to
take it if they so wished. The Commissioner refused to
grant a scrapping allowance based on the decisions in ITG
200 (supra) ITC 657 and ITG 754 (supra). The court did
not agree and allowed the company a deduction. The court
found that the scrapping was in the ordinary course of
the company's business and that the company did not at
any material time cease to carry on its business.
The court, confirming the decision in ITC 754 (supra),
refused to allow a scrapping allowance in ITC 852 (22
SATC 187). In this case a general dealer disposed of his
cash registers at a loss as a result of closing down his
business.
-*-n IXC 955 (24 SATC 631) the taxpayer claimed a scrapping
allowance in respect of the loss he'made in disposing of
his fittings as a result of closure of his drapery
business. The taxpayer contended that ."scrapped" means
nothing more nor less than, that the taxpayer had ceased
to use the articles for the purpose of his trade. The
court in placing a more restricted meaning to the word,
held-that the scrapping must be made irt the course of the
taxpayer's trade. The allowance was refused* It was
further held that the articles in respect of which the
claim was made should have become "worn out or physically
deteriorated".
ITC 900 (23 SATC 501) the taxpayer sought to deduct a
scrapping allowace in respect of a loss made on the sale
of industrial land, with buildings thereon. The
contention was that the building was useless and that the
purchaser was only interested in the land. The taxpayer
was unsuccessful as he could not show that no amount was
paid in respect of the buildings. It is submitted that
the decision may have gone the other way, if an amount in
respect of the building was stipulated in the agreement
of sale.
- 515 -
found Chat the scrapping was in the ordinary course of
the company's business and chat che company did not at
any material time cease to carry on its business.
The court, confirming the decision in ITC 754 (supra) ,
refused to allow a scrapping allowance in ITC 852 (22
SATC 187). In chis case a general dealer disposed of his
cash registers at a loss as a result of closing down his
business,
I1C 955 (24 SATC 631) the taxpayer claimed a scrapping
allowance in respect of the loss he ’made in. disposing of
his fittings as a result of closure of his drapery
business. The taxpayer contended that "scrapped" means
nothing more nor less than that the taxpayer had ceased
Co use the articles for Che purpose of his trade. The
court in placing a more restricted meaning to the word,
held-that the scrapping must be made in the course of the
taxpayer's trade. The allowance was re fused„ It was
further held that the articles in respect of which the
claim was made should have become "worn out or physically
deteriorated",
*n ITC 900 (23 SATC 501) the taxpayer soughC to deduct a
scrapping allowace in respect of a loss made on the sale
of industrial land with buildings thereon. The
contention was that the building was useless and that the
purchaser was only interested in. the land. The taxpayer
was unsuccessful as he could not show Chat no amount was
paid in respect of the buildings. It is submitted that
the decision may have gone the other way, if an amount in
respect of the building was stipulated in the agreement
of sale.
- 516 -
It is submitted that any loss on the disposal of assets
due to the cessation of business or a substantial part of
the business would not ordinarily be regarded as
"scrapping". Under those circumstances the assets would
have ceased to Serve their purpose due to cessation of
■ trade and not due to physical deterioration. Such losses
would, however, under certain circumstances qualify as
"scrapping". It appears that if a taxpayer has not
ceased his main or a substantial part of his business
activities, any such losses sustained in subsidiary
activities would be allowed as a "scrapping" deduction
from the income of the taxpayer's main business.
22.4 Decision to scrap and cessation of use
"Now for 'scrapping there -must be a decision to scrap
accompanied or followed by cesser of user. When both
these factors exist there has been a scrapping and
subsequent disposal or perhaps valuation will determine
the amount that may be allowed". This principle was laid
down in ITC 631 (15 SATC 100. at 101). In ITC 657 (C22.3
supra) there was no decision to scrap, it was a decision
to dispose of certain articles, not because they were
useless or unsuitable, but because the business which
they served was being run at a loss. The principle laid
down in ITC 631 (supra) was confirmed in ITC 955 (C22.3
supra) . In ITC I03',l (26 SATC 63) a Zimbabwean farmer
sold his machinery and equipment at a loss and claimed a
scrapping allowance. Confirming the decision in ITC 631
nsupra) the court held that the taxpayer sold his
machinery because he sold his farm and not because the
machinery was of no further use to him.
-*-n ITC 1159 (33 SATC 190) the taxpayer was engaged in the
fishing industry and was the owner of a certain motor
vessel. He entered into an agreement with a company
whereby the company chartered the vessel for research
purposes, with an option to purchase. The company
exercised its option and the taxpayer made a loss of R3
609 which he claimed as a scrapping allowance. Refusing
to allow the claim, the court held that the taxpayer was
never in a position either to make a decision to scrap or
to cease using the vessel, and therefore could not have
scrapped the vessel.
A Zimbabwean taxpayer in ITC 1245 (38 SATC 13) owned two
industrial stands with buildings thereon. Anticipating
an expanding demand for its product, and also because of
the situation of the land and the age of the buildings
thereon, the taxpayer decided in 1957 to move its
undertaking to another industrial area. During 1972 the
taxpayer sold the land and buildings at a loss and
claimed a scrapping allowance. The court applied the
facts of the case to the principle laid down in ITC 631
(supra) and refused the claim. The court held that the
two requirements envisaged, viz that of the decision to
scrap and cesser of user necessitated a factual
determination. Although cesser of user must occur during
the year of assessment, a decision to scrap need not
occur during the currency of that year. In this case a
decision was made to remove the operation from one site
to another, The motivation for that decision was not
related to the obsolescence of the buildings but rather
to their location and sizie.
fFK-JT
-518
2 2.5 Owner of as»et;
A taxpayer, to qualify for the scrapping allowance, must
be the owner of the asset scrapped. In ITC 205 (6 SATC
42) the taxpayer entered into a contract with a
manufacturer of a machine whereby he paid 50% of the cost
price. The machine, w c* to be used in an experimental
process and ownership vested in the manufacturer until
proved successful. If not successful the parties agreed
to share any eventual loss. The machine proved
unsuccessful and the taxpayer claimed the loss as a
scrapping allowance. The court held that the allowance
is not available to non-owners of machinery.
22.6 For the purposes of trade
The asset scrapped must be used by the taxpayer for the
purposes of his trade. In ITC 322 (8 SATC 243) a
commercial traveller claimed a scrapping allowance equal
to the difference between the tax and trade-in value of
his motor vehicle. The court reduced his claim by 25%
being the estimated use for private purposes.
An anomalous situation arises on the scrapping of an
asset used partly for private purposes and partly for
businssg purposes. From the wording of section ll(o) it
would appear that the full scrapping allowance with
reference to the original cost must be granted since no
provision is made for the apportionment of the allowance
between private purposes and trade purposes., The section
requires that the asset must be "used by the taxpayer for
the purposes of his trade". The words "wholly or
exclusively" are absent.
V .< •
-519 -
Example,}
R
Original cost of asset
Wear and tear - year 1
■ - year 2
year 3
The asset is used 50% for private
purposes and 50% for business pruposes.
Scrapping allowance strictly in terms of
section 11(o):
R
20 000
4 000
3 920
3 136
Solution
Original cost
Wear and tear for business purposes ■
(50% x 11 056)
Scrapping allowance
Scrapping allowance in terms of
departmental practice:
Original cost
Wear and tear -* private and business
Scrapping allowance for business - 50%
The Commissioner's practice, which has
long been established, has not yet been
seriously challenged.
4 472
20 000
5 f.V8
14 ft? 2
20 000
ii o h
R9 944
22.7 During the year of assessment
The scrapping allowance is restricted to items which have
been scrapped during the year o£ assessment. In ITC 358
(9 SATC 179) the taxpayer who was a manufacturer decided
in 1933 to cease certain manufacturing operations and to
dispose of machinery used for that purpose. Sales took
place over a period of two years and were finally
concluded in 1935 during which year a scrapping allowance
was claimed. Disallowing the claim the court held that
the time of the scrapping must be some period during the
year of assessment, In ITC 631 (C22.4 supra) the
taxpayer claimed a scrapping allowance in respect of a
current and a previous year, The claim in respect of the
previous year was disallowed. It appears from the
judgement in ITC 1245 (C22.4 supra) that the cesser of
user must occur during the year of assessmenc whereas the
decision to scrap may be made in a prior year.
1
-521-
PART VI
The cost of improvements to leasehold property, being of
a capital nature, would not, but for section 11(g), be
deduct ibis by a taxpayer in the determination of his
taxable income. Section 11(g) is therefore one of the
few instances where the legislature has departed from the
tax principle that expenditure of a capital nature is not
deductible from income*
-522-
CHAPTER 23
LEASEHOLD IMPROVEMENTS
Margo J held (in ITC 1188, 35 SATC 150) that there are
four requirements which must be satisfied before a
taxpayer qualifies for an allowance under section 11(g)J
viz -
. there must be an agreement whereby the right of use
or occupation of land or building is granted to the
taxpayer by any ocher person;
. there must be an obligation incurred by the taxpayer
under that agreement to effect improvements on the
land or to the buildings*
, the land or building must be used or occupied for the
production of income or income must be derived
therefrom; and
, the expenditure sought to be allowed must be incurred
by the taxpayer in pursuance of the aforesaid
obligation to effect improvements on the land or to
the buildings.
A taxpayer may deduct the cost of improvements to
leasehold property under section 11(g) on the following
conditions ~
. the expenditure must be actually incurred by the
taxpayer;
, there must be an obligation on, the lessee to effect
the improvements;
. the improvements are restricted to those effected to
la,nd or to buildings;
. the expenditure must be incurred under an agreement
of lease; and
« the land and buildings must be used by or occupied byt
the taxpayer for the production of income or income
must be derived fchereftjm.
5?3-
Limitations
Certain limitations are set to the allowance under
section. 11(g):
Limitation 1 ~ amount
the aggregate of the 'allowance shall not exceed the
amount stipulated in the agreement as the value of the
improvements or, if no amount is so stipulated, an amount
representing in the opinion of the Commissioner the fair
and reasonable value of the improvements (Section
11(g) (i)],
Limitation 2 ~ period
The total amount of the allowance is written off ovtft* the
period of the lease. The period of the lease which is
reckoned from the date on which the improvements are
completed is, however, restricted to a maximum of twenty
five years [Section 11(g)(ii)|.
Limitation 3 - use
If the taxpayer is entitled to use or occupation of the
property for an indefinite period, he shall be deemed to
be entitled to such use or occupation for such period as
in the opinion of the Commissioner represents the
probable duration of such use or occupation [Sll(g)(iii) ].
Limitation 4 - aggregate
The aggregate of the allowance under section 11(g) in
respect of buildings or improvements referred to in
section 13(1) (manufacturers), section 13(4)
(hotelkeepers) o t section 27(2)(b) (co-operative
I
societies) shall not exceed the following;
cost of improvements
less: untaxed recoupments in terms of section
13(3) and section 2 7 (4 )
less: 2% annual allowances in terms of section
13(1), section 13(4) and section
, 27(2)(b) ( manufacturers, hotelkeepers •
and co-operative societies respectively).
This limitation is contained in proviso (iv) to'
section 11(g). The proviso was inserted by the
amending. Income Tax Act of 1962. The purpose of the
proviso is clear. In the absence of the proviso a
taxpayer would be allowed more than the cost of the
improvements. The proviso therefore limits the total
deduction to the actual cost of the improvements.
Example (manufacturer, hotelkeeper or co-operative)
Amount stipulated in lease agreement R20 000
Actual cost of improvements to lessee 30 000
Period of: lease 10 years
- 524 -
Solution
Amount stipulated in lease
Annual allowance under 11(g)
(20 000 i 10)
Actual cost to lessee
Less: Amount taken into
account in cal
culating the allow
ance under section
*l(g)
Annual 2% building allowance
2% x 10 000
Total annual allowance
Annual
Allowance
R R
20 000
30 000
20 000
10 000
2 000
200
2 200
Claimable:
For 10 years - 10 x 2 000
For 50 years - 50 x 200
Actual cose of improvements 30 000
20 000
10 000
Limitation 5 “ cost
Proviso (v) to section 11(g) was inserted in 1982 and is
effective as from the commencement of years of assessment
ended or ending on or after I April 1982. Where any
expenditure has been incurred on any improvements to la u
or buildings, and such expenditure or portion thereof has
or will qualify for deduction under any other provision
of the Act, the allowance under section ll(g) is
limited. The allowance, shall not exceed the amount or
value stipulated in the lease agreement or if no amount
is stipulated, an amount which in the Commissioner's
opinion is the fair and reasonable value of the
improvements.. The purposes of this proviso is -clear, it
is to prevent a taxpayer from enjoying a deduction of
improvements in excess of actual cost to the taxpayer.
In order to ensure that taxpayers may still qualify for
the investment allowance on certain improvements, which
result in aggregate allowances in excess of the cost to
taxpayers, certain types of improvements are excluded -
. buildings mainly or wholly used for the purposes of
carrying on therein any process o£ manufacture, or
any other process which in the opinion of the
Commissioner is of a similar nature;
. buildings mainly or wholly used for the purpose of
carrying on therein the trade of hotelkeeper;
. buildings wholly or mainly used by a co-operative as
a storage building; and
. residential units as defined in section 13 ter. This
latter section, however, ensures that the total
duction in respect of residential units under the
provisions of the Act does not exceed actual cost
Uection 13 ter (9)].
Prior to this amendment it was for instance, possible for
a taxpayer to claim both section 11(g) allowances and
ll(-t) allowances in respect of costs incurred on leased
land in order to provide housing for employees.
Limitation 6 - tax exempt entities
To qualify for an allowance in respect of leasehold
improvements, a lessee must be obliged to effect
improvements. It is not always easy for the lessee to
arrange a lease agreement in such a way that he is
burdened with such an obligation because this means that
the landlord is taxed on any improvements [paragraph (h)
of the definition of "gross income"]. Section 11(g) was
amended in 1983 to the effect that it shall not apply "in
relation to any such expenditure incurred under an
agreement concluded on or after 1 July 1983, if the value
of such improvements or the amount to be expended on such
improvements3 as contemplated in paragraph (h) of the
definition of 'gross income' in section 1, does not for
the purposes of this Act constitute income of the person
to whom the right to have such improvements effected has
accrued".
The reason for the 1983 amendment appears to be that
companies with large tax bases have utilised those tax
bases to their financial « vantage and to the loss by the
Fiscua. They exploited those tax bases by means of
participation in leveraged lease schemes under which tax
exempt entities would be interposed as lessors. In doing
so those companies ensured that the lessee qualified for
a deduction while the lessor escaped tax.
* .y« 7
-527
23.2 Leverage Leasing
A situation, which is causing some concern by the Fiscus,
has developed in the financial sector. There is a growi' ,
realisation by companies with large tax bases that the.
tax bases can be utilised to their financial advantage.
These _ tax bases are exploited by means of participation
in leveraged leases.
Leverage leasing is a form of leasing where the lessor
provides only a percentage (20% to' 40%) of the capital
needed to finance improvements to land. The balance of
the required capital is borrowed from investor
* participants against the security of the rentals due from
the lessee. In large schemes there may be several
investor participants, In view of the fact that the
lessor only invests 20% to 40% of the required capital
while receiving all the tax benefits flowing from section
11(g), its return is "geared up" or "levered".
Example
A local authority is the owner of land and wishes to
erect a civic centre, the cost of which is estimated to
be RIO million. The leveraged lease structure would be
as follows:
a) A partnership is formed for the purposes of acting as
lessor of the civic centre,
b) The partnership enters into a written lease in
respect of the land owned by the local authority.
The partnership will be obligated under the terms of
the lease to erect improvements to the specifications
of the local authority.
c) The funds required to finance the improvements are
obtained fvom:I
the partnership ** 20% - 40%; and
investor participants - 60% ~ 80%.
d) On completion of the civic centre, the partnership
will lease the improvements back to the local
authority under an improvement lease.
Diagram of the leveraged lease structure
' „ Local authority
» ' ■ ■ ■ Lessor under
, land leasei_.... ..
Lessee under
improvement lease
: ' ^
£
f
i
Lessee under
land lease
Lessor under
improvement lease
Partnership
Partners investor
participantsi
Results of the scheme
The partnership -
. as lessors under the improvement lease receives
taxable rental income;
* as lessees under the land lease pays rental for
the land which is deductible;
• as lessees under the land lease with an
obligation to improve is entitled to section
11(g) allowances; and
-529
. pays fees to the partners which is deductible.
Each partner participates proportionally in t:;..- above.
. The annual allowance under section 11(g) is
calculated on RIO million divided by the period of
the land lease.
. By making use of a construction company, the
partnersip will in effect be allowed to deduct
pre-commissioning expenses. Pre-production interest
will be allowed proportionately to each member of the
partnership in terms of section ll(bA). That section
provides for the deduction of interest incurred by a
taxpayer on a loan to finance the erection or
construction of buildings or improvements to
buildings,.
. Although the lessor partnership under the improvement
lease is taxed on all rental receipts from, the
lessee, these receipts are applied almost in their
entirety to pay*
. interest on loans from investor participants;
' and
. rental in terms of the land lease, under which
it is the lessee.
The lessor under the land lease in the above leveraged
scheme is the local authority the revenues of which are
exempt from tax in terms of section 10(1)(b) of the Act.
The above scheme and other schemes which, for example,
interposed pension funds as lessors were the targets of
the 1983 amendments.
23.3 Lease agreement
If there is no lease agreement there can be no obligation
to effect improvements by the lessee. In the first
reported case (ITC 12, 1 SATC 117) a taxpayer occupied
premises on a monthly tenancy basis. On the undertaking
. X , ■, ...
by the lessor not to increase the rental for a period of
two years, he voluntarily carried out alterations to the
premises. On the facts of the case the court found that
there was no lease in existence and disallowed his claim
for a deduction.
2-3.4 Period of lease
The cost of improvements on land or to buildings must be
written off over a maximum period of twenty five years.
ITC 519 (12 SATC 271) a taxpayer entered into a long
lease ie ninety-nine years. Improvements were effected
in terms of an obligation under the lease agreement. The
Commissioner contended that since the leases were all
leases in longum tempus, they conferred upon the lessee
real righcs in the property. In consequence, he argued,
the improvements did not pass to the lessor. The fact
that the leases were all leases in longum tempus, were
held by the court to b<?. immaterial.
23.5 The amount of the allowance
: - 530“
The amount of the allowance is limited to the amount
stipulated in the agree, lent. In ITC 456 (11 SATC 171)
the taxpayer was a sporting club, rioftducting a race
course on leased premises. Improvements t:o the value of
R2Q 000 had to be effected in terms of the 14388* The
actual amount spent by the lessee was R.4 6 600. IK was
held that the amount in excess of R2G 000 Was spettfc
voluntarily and not under compulsion in terms of the
lease. The excess did not qualify as . a deduction# In
another case (ITC 785, 19 SATC 419) improvements to
create extra lavatory facilities on leased premises were
also held to be of a voluntary nature. The lessor in
that case was required by the municipality to create the
extra facilities. At the request of the lessor* the
lessee contributed 50% Cowards Che cosC and claimed a
deduction, which was disallowed.
If no amount is stipulated in the agreement the quantum
of the obligation should be determined as the equivalent
of the fair and reasonable value. The same would apply
where a minimum amount is stipulated. In terms of the
lease in the Ridgeway Hotel case (C23.8 infra) the lessee
was obliged to effect improvements to "a value not less
that R80 000". As to the meaning of the words "not less
than", Clayden CJ said at 621; "That is the normal way
in which an obligation to make improvements of
some value is expressed. What is'stipulated1 is not what
a person may choose to do, but what he is obliged to do,
and where there is an obligation to build the only
practical way of expressing the obligations in terms of
money is to state a minimum expenditure. If such an
obligation were stated at an exact sum^ as for example
' to erect buildings to the value of £l 000,' it would be
read as meaning El 000 at least, and satisfied if
buildings of a greater value were erected". In
Professional Suites case (C23.8 infra) the words "not
less than" were also used. The court took the value of
the improvements to be the actual cost because the actual
expenditure exceeded the minimum amount (-stipulated. In
ITC 1036 (26 SATC 84)the lease stipulated that the lessee
should erect buildings to the value of at least £250
000. A further condition was that such buildings were to
be used primarily as a modern parking station to provide
accommodation therein for the simultaneous parking of not
less than one thousand motor vehicles. The lessee spent
£330 000, The court found that the obligation was not
restricted to £250 000 in that the lessee was obliged to
meet the lessor's requirements even if the cost was in
excess. As the president of the court, James J> put it
at 86: "If he (the lessee) can show that the parking
station, as stipulated for, could not be built for £250
000 then, in our view, he will be entitled to an
allowance representing the fair and reasonable cost of
sun, a station, because the lease obliged him to erect
it".
A. Zimbabwean taxpayer in ITC 898 (23 SATC 491) entered
into a lease containing an obligation:
"Within a period of twenty four months from the date of
commencement of the term hereby created to erect a good
and substantial building to the approval of the local
authority and the value of not less than £5 000 ..." The
taxpayer completed the building at a cost of £15 000 and
thereafter applied to the lessor for a variation of the
terms of the lease agreement altering the figure of
£5 000 to £15 000. A claim was made by the taxpayer of a
deduction of the leasehold improvements based on the cost
of £15 000. The claim was refused and the court allowed
him a deduction based on £8 450. It m s held: "The
appellant's obligation is to erect the minimum building
that the Council would approve provided it is of a value
of £5 000. More than that it is not obliged to do, and
if it does more than that it is not doing it in pursuance
of its obligation so far as the excess is concerned".
The issue which the court had to decide was what the
minimum building would have been which the Council would
have allowed to be erected on the stand. Taking into
consideration the size of the stand and the building
costs at the time, the figure of E8 450 was arrived at.
The variation agreement was not taken into consideration
by the court in arriving at its decision.
- 532 -
Obligation
No allowance can be claimed if there is no express
obligation in terms of the agreement to effect
improvements. The landlord must have the right in terms
of the lease to insist on the making of improvements. In
A v GOT. [1954(1) SA 38(SR), 19 SATC 29] a farmer leased a
farm and in terms of the lease was required to carry on
mixed farming "in a proper and husbandmanlike manner".
One branch of farming selected by him was that of tobacco
growing. For this he needed curing sheds and claimed the
cost of these sheds over the period of the lease. The
cost was held non-deductible as it was not incurred in
pursuance of an obligation but by the voluntary action of
the lessee in selecting as one of his farming operations,
tobacco growing. The tenant must be under a liability to
perform, Qu>snet J expressed the following at 31; "The
agreement must confer a jus in personam ad faciendum upon
the landlord, and the tennant must be under a liability
to perform. In such a case performance does not occur as
a result of the exercise of a right to make a free
choice, it follows upon a duty which the tenant is bound
co fulfil and which, if not fulfilled, would found a
claim for specific performance or for damages" (Confirmed
by Erasmus J in ITC 964, 24 SATC 709).
A term of a lease whereby the lessee "shall at own
expense make structural alterations as may be required by
the local authority" was not regarded as an obligation iu
ITC 940 (24 SATC 380), The taxpayer claimed there was an
obligation because if he did not make the necessary
alterations he would not be able to trade, The court
held that the term in the lease only freed the landlord
from any costs in meeting with the requirements of the
local authority.
«JF W m
-534
In ITC 964 (supra) a taxpayer carried on business in a
portion o£ a building leased by him under a written
agreement. During the currency of the agreement he
entered into a verbal agreement with the lessor for
additional space and the erection of display windows. On
the facts of the case it was held that the verbal
agreement merely permitted and did not oblige him to
erect the display windows.
A taxpayer lessee (In ITC 6C5, 16 SATC 372), in order to
recoup itself in respect of ..ortion of the high rental,
obtained permission from the lessor to make improvements
and to sublet these. He unsuccessfully claimed a
deduction in respect of the improvements over the period
of the lease, 33 the court found nothing in the lease
agreement binding him to make the improvements.
23.7 Implied obligation
Must there be an express obligation, or would an implied
obligation suffice in order for a lessee to claim an
allowance under section 11(g)?
This question was decided in Rex Tearoom Cinema, v CIR
(1946 TPD 338, 14 SATC 76). The taxpayer in this case
leased premises t'nr the restricted purposes of a
cafe-cinema. The premises were unsuitable and the lease
provided that the lessee might alter at own risk in
, accordance with drawn plant'* The Commissioner disallowed
the claim by the lessee on the grounds that there was no
express obligation. The court held that as the lessee
was not entitled * j use. vhe premises for any other
purpose, he was obliged to render it fit for business.
The taxpayer might have elected not to alter the premises
in which event the lessor might have ,'me.d for breach of
contract. .
In another case, (IVC 1034, 26 SATC 78) although premises
ware also unsuitable for use the taxpayer, relying on the
decision in the Rex Tearoom Cinema case (supra), was
unsuccessful in his claim for a deduction. The taxpayer
leased vacant land. The lease provided that the lessee
"may" erect premises in accordance with approved plans.
On. the facts of the case the court held that although the
taxpayer would have found it difficult if not impractical
to use the premises if it did not erect buildings, there
was no obligation to do so.
The obligation to improve leasehold property and the
lease agreement itself need nor. necessarily be stipulated
in one agreement. This situation is illustrated in CIR v
Carltonville Motors (Pty) Ltd (1964(3) SA 581 AD, 26 SATC
195]. In this case a General Motors franchise holder
agreed to lease a vacant stand from Caltex Oil Company.
Originally Caltex as the landowner proposed to erect a
garage on the site but, as this did not meet General
Motors' requirements it was agreed that Caltex would
advance the sum of R20 000 Co the lessee who would make
its own building arrangement, The contractual
arrangements were contained in two separate agreements;
% lease of property which was silent as o the
improvements and an acknowledgement of debt in respect of
Che R20 000 which was stated to be. an advance for the
purposes of erecting a garage. The lessee was successful
in his claim for an allowance in respect of the
improvements. The court held that the splitting of the
transactor, into two parts was a matter of form only;
and the two parts were in substance composite and
complementary. Beyers JA said at 202: "Neither party
could claim to exercise its rights under the one covenant
without at the same time performing its obligations under
tha oth< i' covenant".
Another case where the obligations was not stipulated in
the actual agreement was that of ITC 1186 (35 SATC 129).
The taxpayer in this case was concerned with the bulk
shipping of exports of maize and wheat products. There
were three different agreements to the transactions, all
of which were silent as to the obligation of the lessee
to improve the property. However, prior to the
agreement,? an obligation was mentioned in
corresportk. >.ce: "In the event of cargo tonnages reaching
a certain level, it will be incumbent upon your firm to
provide additional storage facilities and certain
alterations to the siding are necessary to meet the
Administrator's requirements and your company must be
prepared to arrange accordingly at your cost". On the
facts of the, case the court held that it was clear from
the correspondence that the expenditure was obligatory.
It was further held that the imposition of the obligation
in a document other than the agreement of lease did not
constitute two agreements; the instruments were in
substance complementary and contained between them the
essential and complete transaction between the parties.
Variations to lease agreements
The general rule is that if the obligation to improve is
not contained irt the original lease, then the lessee can
claim no deduction, and the lessor will not be liable for
tax in respect thereof. This rule was upheld in
Professional Suites Ltd v COT [(High Court of Northern
Rhodesia) (December I960), 24 SATC 573]. A variation
deed increased the lessee's obligation. The court held
that Che Variation deed could not be taken into
consideration as it was executed after the completion of
the building* It is submitted that the decision appears
correct as a taxpayer cannot change his tax position by
way of an agreement having retrospective affect. The
general rule was not, however, followed in a later case
COT v Ridgeway Hotel Ltd [(Federal Supreme Court)
(November 1961), 24 STAC 616]. In that case the lessee's
obligations 't as ' increased in a variation deed entered
into before the improvement were completed. In his book
"Tax Strategy" E.3. Broombarg says (At page 93) : "The
textbook writers reconcile, these two decisions (which
incidentally, did not refer to nne another) on a simple
factual basis, namely, that in the 'Professional Suites'
case the building was already completed when the deed of
variation was agreed upon; whereas in the 'Ridgeway
Hotel' case the building was still in the course of
construction when the amount was increased, and the
amendment therefore came in time.. It is submitted,
however, that the principles underlying these two
decisions are irreconcilable; and that a basic premise
underlying the 'Ridgeway Hotel' decision is that a
taxpayer can alter his tax position by entering into a
contract having retrospective effect. It is however
doubtful whether such a principle could be said to have
been received in our tax law, and accordingly the
'Ridgeway Hotel' decision may not be followed in the
future".
Proportionment
The allowance is proportionately reduced according to the
period of use of the property during the tax year. In
ITC 971 (24 SATC 791) the lessee, in terms of the lease,
was obliged to make improvements of R9 600. During the
first year the taxpayer was allowed a proportionate
deduction in respect of eight months of that tax year for
which he had use of the premises. In the second year,
due to differences between the parties, he vacated the
premises and sought to deduct the balance of the cost of
the improvements. The court held -
. the allowance is spread over the period prescribed in
the agreement and was not affected by the abandonment
of occupation; and
. the lessee was nut entitled to re-assessment of past
years by ceason of any subsequent variation of the
lease.
According to the authors of "Silke on South African
Income Tax (Tenth Edition at page 399) the allowance is
not proportionately reduced in che final year if the
property is not productive of income fcr the whole of
that year, because of termination of the lessee's
occupation for any reason whatever.
The tax treatment of che lessor
The lessor is taxed on leasehold improvements under
paragraph (h) of the definition .of "gross income":
"---in the case of any person to whom, in terms of any
agreement relating to the grant to any other person of
the right of use or occupacion of land or buildings or by
virtue of the cession of any rights under any such
agreement, there has accrued in any such year or period
the right to have improvements effected on the land or to
the buildings by ar.y other person -
(i) the amount stipulated in the agreement as the
value of the improvements or as the amount to be
expended on the improvements; or
(ii) if no amount is so stipulated, an amount
representing in the opinion of the Commissioner
the fair and reasonable value of the
improvements".
The introduction of the above paragraph is the direct
result of CIR v Butcher Bros (Pty) Ltd (1945 AD 301, 13
SATC 21). The facts were briefly as follows: The
-538
. the allowance is spread over the period prescribed in
the agreement and was not affected by the abandonment
of occupation; and
. the lessee was not entitled to re-assessment of past
years by reason of any subsequent variation of the
lease.
According to the authors of "Silke on South African
Income Tax (Tenth Edition at page 399) the allowance is
not proportionately reduced in the final year , if the
property is not productive of income for the Whole of
that year4 because of termination of the lessee's
occupation, for any reason whatever.
23.10 The tax treatment of the lessor
The lessor is taxed on leasehold improvements under
paragraph (h) of the definition .of "gross income":
”---in the case of any person to whom, in terms of any
agreement relating to the grant to any other person of
the right of use or occupation of land or buildings or hy
virtue of the cession of any rights under any such
agreement, there has accrued in any such year or period
the right to have improvements effected on the land or to
the buildings by any other person -
(i) the amount stipulated in the agreement as the
value o£ the improvements or as the amount to be
expended on the improvements; or
(ii) if no amount is so stipulated, an amount
representing in the opinion of the Commissioner
the fair and reasonable value of the
improvements".
The introduction of the above paragraph is the direct
result of CIR v Butcher Bros (Pty) Ltd (1945 AD 301, 13
SATC 21). The facts were briefly as follows: The
-539-
taxpayer lessor leased a property to African Theatres Ltd
for a period of 50 years with an option to renew the
lease for a further period of 49 years. The lessee was
in terras of the lease obliged to erect a building to a
value of not less than R110 000., The Appellate Division
held that the benefit: of the improvements was taxable in
the hands of the lessor. On the facts of the case it was
found that an "amount" which would have been subject to
tax could not be determined. The value of the
improvements was not ascertainable due to the period of
the lease> ie, 99 years. The lessor in this case escaped
tax on the improvements.
The effect of paragraph (h) is that the value of
improvements effected under a lea^e agreement are taxable
in the hands of the lessor in the year during which the.
right to have the improvements effected accrues to him.
The cost of such improvements may, on the other hand, be
deducted by the lessee only in equal annual amounts 'over
the whole period of the lease, which is subject to a
maximum of 25 years,
The general rule is that the lessor will be taxable on
the value of the improvements only if the lessee can
deduct the costs incurred by him. All the foregoing
cases which dealt primarily with deductions by lessees
would therefore apply equally to lessors. One case not
discussed above is that of ITC 767 (19 SATC 206) which
dealt specifically with a lessor. In this case the lease
provided that "The lessee —~ undertakes to effect suchf
repairs, renovations and alterations as may be required
for the beneficial occupation by the lessee provided that
all structural alterations shall be done in accordance
with a previously prepared plan submitted to and approved
by the lessor". The word "in accordance with an approved
plan", swayed the court to hold that the lessor had the
Author Coetzee H AName of thesis Capital allowances in terms of South African Tax law 1984
PUBLISHER:University of the Witwatersrand, Johannesburg
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