Page 668 - SAIT Compendium 2016 Volume2

IN 78 Income Tax acT: InTeRPReTaTIon noTes IN 78
Example 2 – Acquisition of an asset
Facts:
In the rst year of assessment (year 1) a taxpayer, BB (Pty) Ltd, entered into a two-year contract with the local municipality for the construction of a road. The Contract price was R1 000 000. The municipality paid BB (Pty) Ltd R500 000 in year 1, R300 000 in the second year of assessment (year 2) and R200 000 in the third year of assessment (year 3). BB(Pty) Ltd did not incur any expenditure in year 1. On the rst day of year 2 BB (Pty) Ltd purchased a truck, which was only used in the construction of this road, for R150 000. SARS allowed the truck to be written off under section 11(e) over a period of three years.
Result:
Year 1
Gross income
Less: Cost of the truck to be purchased [section 24C(2)]
Year 2
Gross income
Section 24C allowance allowed in year 1
Section 24C allowance*
Less: Wear-and-tear allowance [33,3% × R150 000, section 11(e)]
Year 3
Gross income
Section 24C allowance*
Less: Wear-and-tear allowance [33,3% × R150 000, section 11(e)]
R
500 000 (150 000)
300 000 150 000 Nil
(50 000)
200 000 Nil
(50 000)
*A section 24C allowance was not allowed in year 2 or year 3 as the truck was purchased at the beginning of year 2 and its cost is therefore actual expenditure and not future expenditure at the end of those years of assessment.
4.2.4 Application of section 24C to ceded contracts
In certain situations a taxpayer may cede a contract under which the taxpayer has received advance income and has previously claimed an allowance under section 24C. An example of this situation arises when the contract is sold as part of the sale of an enterprise as a going concern. Under these circumstances [that is, the cessionary (transferee or purchaser) has taken over the cedent’s (transferor’s or seller’s) obligation for future delivery under the contract]:*
• The cedent is no longer responsible for any performance under the contract and will not incur any future expenditure. Accordingly, the cedent will have to include the prior year’s section 24C allowance for that contract in income† and will not be able to claim another section 24C allowance. The cedent will therefore be taxed on the advance income received.
• The cessionary will be entitled to a section 24C allowance for any advance income the cessionary receives, provided the detailed requirements of section 24C are met. The cessionary will not qualify for a section 24C allowance in relation to any advance income which the cedent received.
The above is applicable if the cession is effective. If the cession is not yet effective at the end of the year of assessment,‡ although the seller is still responsible for performance under the contract, the likelihood of the sale becoming effective and the obligation to perform passing to the purchaser must be taken into account in estimating the quantum of future expenditure that the taxpayer will incur. The amount of future expenditure will be nil in the seller’s hands at the end of the year of assessment if all the conditions have been met and it is merely a matter of time passing until the agreement is effective on the rst day of the new year of assessment.
4.2.5 Application of section 24C to warranty claims
Contracts under which advance income is received may contain a warranty against defective workmanship or materials supplied. The term ‘warranty’ as it relates to the law of contract is de ned in the Collins English Dictionary§ as –
‘[a]n expression or implied term in a contract collateral to the main purpose, such as an undertaking that goods contracted to be sold shall meet speci ed requirements as to quality, etc’.
In the event that the workmanship or material supplied is defective and the asset, for example, malfunctions, the taxpayer will be required to correct the de ciency and in so doing will often incur expenditure. A warranty may be included as part of a contract, for example, the sale of an electrical appliance which has a 12-month warranty. Alternatively, a warranty may be the subject of a separate contract which gives rise to its own income; for example, the sale of an electrical appliance may include a 12-month warranty but customers may also have the option of purchasing an extended warranty which increases the warranty to 24 months. The principles discussed in 4.2.1(b) are applicable to both of these types of warranties.
* Assuming the provisions of the corporate rules in sections 41 to 47 are not applicable.
† Section 24C(3).
‡ For example, the sale of a going concern if the transfer will or may only take place in the subsequent year of
assessment.
§ HarperCollinsPublishers.
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