Both in property investing and letting, investors need to understand some basics about taxes. These are not complex concepts, but they are concepts that help investors better understand, from a tax perspective, the working of accounting.

One of the more confusing issues, are allowances and depreciations. That is why it was our first article. This is the second article in this series.

When a company spends money on expenses, these expenses are deductible for tax purposes as business expenses. So, what happens when expenditure is of a capital nature and the amount spent cannot be expensed for tax purposes? Such amounts qualify for capital allowance deductions.

What is capital expenditure?

Capital expenditure is any spending done to acquire capital assets. Such assets are non-current assets and, are expected to be held and used, by the company, in the production of income, for more than 12 months. For example: the purchase of a building or a car.

Forms of capital allowances:

I will be dealing with the two most common capital allowances:

• Section 11(e) Wear and tear allowances
• Section 13 Building allowances.

Section 11(e):

This section deals with any implements, utensils, articles or machinery used by the taxpayer for the purposes of trade (i.e. any manufacturing items are excluded. Immovable property is also excluded as it is dealt with under section 13).

Such items in a property business include: lawnmower, computers that you run the business with cars as long as it is used for trade purposes (e.g. bakkie).

A very important thing to note is that the company must own the item and it must be paid off. A motor vehicle that is still being paid off under a finance agreement, where you accept the rights and obligations (such as maintenance), for example, will not qualify for this allowance.

How does the allowance work?

The allowance is a yearly deduction, from your income, of a certain portion of the value of the item.

What is the allowance value?

The value is not necessarily the cost to the taxpayer. It is the fair value of the item. So, if you paid R10 for a computer, the value used in the calculation would be the cash value of the computer, not the Ten Rand. (I say cash value because it excludes any finance costs and interest). It also excludes VAT The value includes any costs incurred to install or build the implement.  

How much do we write off every year?

The amount to be written off is specified in the act. Practice notes 19 and 39 state the assets and the amount of years they can be written off over. If we buy the item during our tax year, the allowance is apportioned for the part of the year remaining until the tax date. To see the practice notes go to:  www.acts.co.za Income Tax Act 58 of 1962 and search for these practice notes.

Example:

We buy a computer for 6,500; inclusive of V.A.T (assume this amount is the fair value).

First we take out V.A.T: 6500 X 100/114 = 5,701.75 (note, if you are not vat registered, use 6500 because you will not be able to claim the input V.A.T)

This will be the value we write off for tax purposes.

Practice note 19 States that, computers (Personal computers) can be written off over 3 years.

Hence, we will claim as a yearly deduction in income the amount of 5701.75/3 = 1900.58 (this is claimed every year for three years). The deduction is apportioned for a part of the year. If we bought this computer on 1 September and our tax year, ends on 31 December, we would claim:    

1900.58 x 4(months left)/12 = 633.53    in year one

                1900                        in year two   

                1900                        In year three

                1268.22 (the remainder)            in year four     

This is a very simple example, but it helps to demonstrate the effects of a capital allowance.

Section 13 building allowances

Section 13 deals with all types of buildings, including:

• Buildings used in the process of manufacture
• Residential buildings
• Commercial buildings

Manufacturing buildings are rather complex and I will deal with them should anyone request it.

I have already dealt with residential building allowances in a previous article called Section 13 Tax Allowances in respect of Residential Buildings

Commercial building allowance (section 13quin):

This section only applies to any commercial building which was contracted for on or after 1 April 2007 and the construction of which commenced on or after 1 April 2007.  Any residential building and building used in the process of manufacture are specifically excluded.

Requirements:

• The building or any improvements thereto, must be new and unused.
• The building or improvements must be used for producing income in the course of trade. (i.e. your company built an office building to run their business from or you are in the rental business and you built a new commercial building to rent out.)

What value do we place on the building?

The value of the building for tax purpose is the lower of:

• The cost actually incurred
• The fair value you would have incurred in a normal cash transaction.

How much can we deduct?

The deduction is 5% per year of the value of the building. Deduct every year as long as you still own the building and it is used in the production of income (for commercial purposes).   

Example:

    Company “A” builds a strip mall at a cost of 20 million. The fair value of the strip mall is 15 million.

Cost: lesser of:    Amount paid 20 million

            Fair value 15 million

Yearly allowance is: 15 million x 5% = 750,000

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