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Income Tax Act, 1962 (Act 58 of 1962)

Department of Finance

Practice Note No. 13

Allowance Granted in terms of Section 24 of the Income Tax Act (No. 58 of 1962, as amended)

 

 

Date: 19 March 1991

 

1) Apropos paragraph 6 of Practice Note No. 12, issued on 27 February 1991, details of the manner in which transactions entered into prior to 1 March 1991 will be treated for the purposes of determining the phasing-out of the finance element of the hire purchase debtors allowance for income tax purposes are set out in this Practice Note.

 

2) The effect of the change in practice will be that—
a) where goods were sold under a qualifying suspensive sale agreement formally and finally signed by every party thereto prior to 1 March 1991; and
b) the contract provided that ownership will only pass to the purchaser after payment of the whole or portion of the purchase price

it will impact on the income tax position of an affected taxpayer. In order to provide some measure of relief, while not extending this benefit to the full term of many transactions which have been structured to obtain substantial tax benefits, the following phasing-out provisions will be applied to the various types of transactions.

 

3) inancing transactions

The affected agreements will be classified into two categories, namely A and B.

3.1 Category A

Qualifying individual agreements of sale in terms ofwhich the original loan capital does nor exceed R 500 000

a) Determination of amount to be phased out

The difference between the calculation using the previous practice and the new practice at 28 February 1991 or, at the option of the taxpayer, the said difference at the end of the immediately preceding year of assessment, must be determined.

In both instances the amount subject to phasing-out must be limited to the taxable income for the year in which the option was exercised after the add back of the previous year's section 24 allowance and the deduction of the unearned finance charge element for that year.

b) Period of phasing-out

The amount determined in (a) above should be phased-out over a period of forty eight months, commencing on 1 March 1991 on a straight line basis. Thus, for example, where the period from 1 March to the end of the year of assessment is 7 months, the amount to be subject to tax in that year would be

 

 

An example is contained in Annexure A.

 

3.2 Category B
a) Only qualifying individual agreements of sale in terms of which the original loan capital exceeds R500 000 fall within this category.
b) This category must be sub-divided into two further sub-categories, based on the terms of each contract.
3.2.1 Category B1

Contracts, the full term of which, at 28 February 1991, is five years or less

The allowance will continue to be determined on the basis of the previous practice for a further four years provided that—

a) no extension to the original period of the contract will be recognised for the purpose of determining the allowance; and
b) the gross profit percentage which will be recognised for the purpose of determining this allowance each year may not exceed the percentage determined at 28 February 1991. For the purpose of determining this percentage the interest rate prevailing on each individual contract at 28 February 1991 must be used to project the interest for the remainder of the contract period.

Where a contract has not reached finality by 1 March 1995, the difference between the allowance determined on this basis and allowance determined in accordance with Practice Note  No. dated 27 February 1991 will immediately be taxed in full.

3.2.2 Category B2

Contracts, the full term of which, at 28 February 1991, is longer than five years

The allowance will continue to be determined on the basis of d previous practice for a further period of four years but subject the following limitations

* the actual gross profit percentage, not exceeding a maximum of 50%, must be used; and
* the above-mentioned percentage will be applied to the lesser of the actual outstanding receivables or three times the original loan capital.
a) Determination of amount to be phased out

The difference between the allowance granted on the of the previous practice and the above basis must be determined on 30 June 1991.

b) Period of phasing-out

The amount determined in (a) above will be phased out eve; a period of 44 months or the remaining duration of the contract, whichever is the lesser, commencing on 1 July, 1991 on a straight line basis.

Where a contract has not reached finality by I March 1995, the full difference between the allowance determined on this basis and the allowance determined in accordance with Practice Note No. 12 dated 27 February 1991 will immediately be taxed in full.

 

3.3 General
a) The allowance will not be permitted to exceed the gross profit percentage applied to relevant outstanding receivables.
b) Where, as a result of changes in the rate of interest or other factors which occur on or after 1 July 1991, any increase or decrease in the allowance must be set off against or added to the remaining balance subject to phase-out. This amount must be phased out over the remaining balance of the applicable phase-out period as determined at year end.

An example is contained in Annexure B.

 

4) The following information must be submitted for each individual contract falling in Category B1-
4.1 Name of client;
4.2 Date contract was formally and finally signed by all parties to the contract;
4.3 Contract number;
4.4 Original loan capital, excluding any finance charges;
4.5 Original maximum duration of the contract;
4.6 Variable or fixed interest rate;
4.7 Prevailing interest rate at 28 February 1991;
4.8 Earned finance charges to the expiry of the present financial year;
4.9 Projected finance charges to the expiry of the agreement;
4.10 Gross profit percentage based on earned and unearned finance charges on the contract;
4.11 Total outstanding relevant receivables at year end.

The following information must be submitted in respect of contracts falling in Category B2 in addition to that required in Category B1-

4.12 Maximum amount of the allowance which may be claimed at 50% (or the lesser allowance, if applicable);
4.13 Amount to be phased out.

Where this information is not made available in respect of each individual contract, the phase-in provisions of Category A will be applied.

 

5) General
5.1 The minimum allowance granted will in all instances be the unearned finance charges calculated in accordance with Practice Note No. 12 dated 27 February 1991.
5.2 The right is reserved to limit the allowance on any particular transaction. This limitation will not be invoked in normal business transactions of a taxpayer but will be implemented where a taxpayer has entered into a transaction which is not related to his normal business activities or where a scheme is entered into to make use of the gross profit element of the allowance.

 

6) Other transactions

In view of the change in practice in the recognition of finance charges, taxpayers who also qualify for the hire purchase debtors allowance on the gross profit element as a result of their normal trade, will enjoy a considerable tax benefit. In order to remedy this position it has been necessary to amend the determination of the gross profit element of the allowance.

With effect from the first year of assessment ended or ending on or after 1 March 1991, the gross profit element of the allowance will be determined on a new basis which excludes finance charges from the determination of the gross profit percentage and the qualifying outstanding debtors.

6.1 Determination of gross profit percentage

The formula which will be applied is as follows-

 

Gross profit (excluding finance charges)


100

Sales (excluding finance charges)

X

1

 

The percentage determined above will be applied to qualifying outstanding debtors, excluding finance charges.

6.2 Phase-out

As a result of the change in practice, certain taxpayers may be detrimentally affected. In order to provide some measure of relief the following phase-out provisions will be applied—

a) Determination of amount to be phased out

The difference between the calculation using the previous practice and the new practice at 28 February 1991 or, at the option of the taxpayer, the said difference at the end of the immediately preceding year of assessment, must be determined.

In both instances the amount subject to phasing-out must be limited to the taxable income for the year in which the option was exercised after the add back of the previous year's section 24 allowance and the deduction of the unearned finance charge element for that year.

b) Period of phasing-out

The amount determined in (a) above should be phased-out over period of forty eight months, commencing on 1 March 1991 on straight line basis. Thus, for example, where the period from 1 to the end of the year of assessment is 7 months, the amount to subject to tax in that year would be

 

7


phase-out amount

48

X

1

 

An example is contained in Annexure C.

 

Annexure A

Category A

Qualifying individual agreements of sale in terms ofwhich the original loan capital does not exceed R 500 000.

 

Data

Change-over date

Year end


28/2/91

30/6/91


R

R

Net profit before tax

 

   3 996

Debtors - excluding finance charges

193 916

223 004

Unearned finance charges

 45 540

 52 371


239 456

275 375

 

Gross profit percentage (previous practice)

30%

Section 24 allowance 30/6/90 (previous practice)

R 48 202

Unearned finance charges on 3016/90

R 39 601

 

Assumptions

1) The option in respect of the difference between the calculation using the previous practice and the new practice at 28 February 1991 is exercised.
2) No further adjustments to the net profit before tax have to be made in order to determine taxable income.

 

Determination of maximum phase-out amount


R

Section 24 allowance (previous practice)


30% x 239 456

71 837

Less: Section 24 allowance (new practice)

45 540

Maximum phase-out amount

26 297

 

This amount will be limited to taxable income after add back of previous year's allowance and deduction of allowance on new basis.

 

Determination of taxable income for the 1991 tax year

 


Yearend 30/6/91


R

Net profit before tax

 3 996

Add:

Unearned finance charges - current year

52 371



56 367

Less:

Unearned finance charges - previous year

39 601



16 766

Add:

Section 24 allowance - previous year

48 202



64 968

Less:

Section 24 allowance (new practice)-

 


unearned finance charges

52 371

Taxable income before phase-out allowance

12 597

Less:

Phase-out allowance*

11 547

Taxable income

  1050

 

*Determination actual phase-out allowance

 

Amount subject to phase-out = 26 297 but limited to

12 597

Phase-out allowance



12 597


44





1

X

48

=


11 547

 

Annexure B

Category B2

 


Change-over date

 

Year end

 

Year end

Data

30/6/90

31/12/91

31/12/92


R 000

R 000

R 000

Net profit per accounts

-

 34 560

 41 472

Total outstanding receivables

619 174

619 174

619 174

Unearned finance charges

-

411 818

370 346

Section 24 allowance (previous practice)

519 174

 

 

Unearned finance charges (previous year)

446 378

 

 

Gross profit percentage

 

 

 

Total receivables

619 174

 

 

Cost

100 000

 

 

Gross profit

519 174

 

 

Gross profit %

83,85

 

 

 

Assumption

1) No restructuring of the contract has taken place.
2) A single payment for the full capital and accumulated interest is payable on the expiry of the contract.

 

Calculation of taxable income for the 1991 the year

 


Yearend 31/12/91


R 000

Net profit per accounts

 34 560

Add: Unearned finance charges - current year

411 818


446 378

Less: Unearned finance charges - previous year

446 378


         0

Add: Section 24 allowance - previous year

519 174


519 174

Less: Section 24 allowance

468 832

300 000* x 50%

150 000

Phase-out allowance

 


369 174


38


 


1

X

44


318 832

Taxable income

 50 342

 

Determination of actual phase-out amount at 30/6/1991

 

Section 24 allowance


(previous practice)

519 174

Less: 3 times cost* x 50%


= 300 000 x 50%

150 000

Phase-out amount

369 174

*Vide paragraph 3.2.2

 

Calculation of taxable income for the 1992 tax year

 


Year end 31/12/92


R 000

Net profit per accounts

 41 472

Add: Unearned finance charges

 

- current year

370 346


411 818

Less: Unearned finance charges

 

- previous year

411 818

Add: Section 24 allowance

468 832

- previous year

150 000

- phase-out allowance

318 832

Taxable income before section 24 allowance

468 832

Less: Section 24 allowance

 370 346 *

Taxable income

98 486

 

*Note:

Section 24 allowance

150 000

50% x 300 000

 

Phase-out allowance

218 148


369 174


26


 


1

X

44


368 148

 

As this amount does not exceed the unearned finance charges, the unearned finance charges will be the minimum allowance granted.

 

Annexure C

Other transactions

 


Change-over date

Year end

Data

28/2/1991

30/6/91


R

R

Turnover, including finance charges

 

293 953

Cost of sales

 

125 055

Gross profit

 

168 898

Deductible expenses

 

40 000

Net profit

 

128 898


 

 

Balance Sheet

 

 

Debtors

266 334

306 285

Unearned finance charges

132 733

152 643


399 067

458 928

Gross profit percentage

 

 

(previous practice)

72%

 

Gross profit percentage

 

 

(new practice)

35%

 

Section 24 allowance

 

 

- 30/6/90 (previous practice)

160 611

 

Unearned finance charges

 

 

on 30/6/90

111 872

 

 

Assumption

The option in respect of the difference between the calculation using the previous practice and the new practice at 28 February 1991 is exercised.

 

Determination of taxable income for the 1991 tax year

 


Yearend 30/6/91


R

Net profit per accounts

128 898

Add: Unearned finance charges

152 643

- current year

281 541

Less: Unearned finance charges - previous year

 

(caused by cumulative effect)

111 872


169 669

Add: Section 24 allowance-previous year

160 611

Taxable income before section 24 allowance

330 280

Less: Section 24 allowance

316 104

- Unearned finance charges

152 643

- Gross profit element

 


35


306 285


 


100

X

1


107 198

Phase-out

 


* 61 378


44


 


1

X

48


56 263

Taxable income

14 176

 

Determination of maximum phase-out amount

Section 24 allowance - (previous practice)


72% x 399 067

287 328


225 950

Unearned finance charges

132 733

Gross profit element


35% x 266 334

93 217

*Phase-out amount

61 378