Income Tax Implications for Debtor: Reduction Or Cancellation Of Debt Relating To An Allowance Asset
12 August 2013
Posted by: Author: Doria Cucciolillo
Author: Doria Cucciolillo
Section 19 of the Income Tax Act 58 of 1962
("the Act”) regulates the tax implications that may arise for the debtor in the
event that an amount owed to a creditor is reduced or written-off. This section
is relevant for years of assessment that commence on or after 1 January 2013 and
provides for the inclusion of a deemed recoupment in the debtor’s taxable
income. The purpose of this recoupment is to reverse income tax deductions that
resulted from the application of the borrowed funds.
Three different scenarios
are addressed under section 19, which includes the acquisition of allowance
assets. Allowance assets are capital assets, used or applied for business
purposes, which qualify for specific deductions (known as capital allowances) in
terms of the Act. Capital allowances are
granted on these assets to provide a deduction for wear-and-tear that occurs
This article investigates
the implications of section 19 in the event that a waiver of debt, that was
used to acquire one or more allowance assets, takes place.
The scope of section 19
In order to
avoid double taxation, the provisions of section 19 will not apply in the
the reduction of debt constitutes a donation (as defined in section 55(1)) or a
deemed donation in terms of section 58. In this instance the donor may be
liable for donations tax at a rate of 20%.
- Where debt is owed to a deceased estate of which
the debtor is an heir or legatee. If the deceased estate reduces the debt and
the reduction forms part of the estate’s property, such amount may be subject
to Estate Duty.
- Where debt owed by an employee, is discharged or
reduced by an employer and a taxable fringe benefit arises. The cash
equivalent, calculated in terms of Seventh Schedule to the Act, will be
included in the employee’s taxable income.
Capital gains tax implications
provisions of paragraph 12A of the Eight Schedule to the Act need to be
considered. After it has been determined that the debt relates to the
acquisition of an allowance asset, it must be determined as to whether, or not,
the allowance asset is still in the debtor’s possession on the date of debt
In the instance
where the asset is still owned by the debtor, the base cost of the asset will
be reduced with the amount of debt reduction. This will result in a higher
capital gain with future disposal of the asset. Since the base cost of an asset
can only be reduced to a minimum of nil, the amount of debt reduction that
exceeds the base cost of such asset will be taxed under section 19.
In contrast to
the above, an amount of debt reduction will be subject to section 19 in full if
it relates to an asset that is no longer in the taxpayer’s possession.
The implications of section 19
The reduction of
debt that was incurred to fund the acquisition, improvement or creation of an allowance
asset will trigger a deemed recoupment in terms of section 19(6). The
recoupment is granted under section 8(4)(a), the general recoupment provision
and is therefore included in "gross income”.
In addition, section
19(6) determines that the recoupment included in the taxable income of the
debtor during the year of assessment in which the debt reduction took place, is
limited to the sum of all capital allowances claimed on the asset less any decline in the base cost of the
asset as a result of the debt reduction.
regulates the situation where capital allowances are claimed on an asset that
relates to a debt reduction transaction. Future allowances and deductions
claimed by the debtor in respect of this asset may not exceed the following: The
total expenditure incurred to acquire the asset less the amount of debt reduction less total deductions previously claimed by the debtor in respect
of the relevant asset.
On 1 March 2012,
Company X borrowed R1 800 000 of which an amount of R60 000 was
used to purchase a non-depreciable asset. The remaining funds were used to
purchase a new machine at a total cost of R1 740 000 that was
immediately brought into use in a process of manufacturing. During the 2013
year of assessment the capital allowance claimed on the machine amounted to
R696 000. During the 2014 year of assessment the creditors discharged the
R1 800 000 of debt due to Company X’s inability to pay.
Effect of the
above on Company X’s 2014 year of assessment (VAT implications ignored for
purposes of this example):
amount of R1 740 000 (the reduction in debt of R1 800 000 limited to the amount used to fund the
acquisition of the asset) must be applied to reduce the base cost of the asset
(paragraph 12A). The base cost of the asset on the date of debt reduction
amounted to R1 044 000 (initial cost of R1 740 000 less capital allowances of
Once the base
cost of the asset has been reduced to nil, the excess of R696 000 (R1740
000 – R1044 000) will be taxed as a recoupment in terms of section 19. It is
evident that the recoupment in term of section 19 is limited to the total
capital allowances previously claimed on the asset.
capital allowances can be claimed on this asset due to the provisions of
section 19(7). In terms of this section, future allowances may not exceed the
following: The total expenditure incurred to acquire the asset
(R1 740 000) less the amount
of debt reduction (R1 740 000) less
total deductions previously claimed on the asset (R696 000). Since the
latter result into a negative amount, no capital allowances are available for
Capital Gains Tax implications with any subsequent disposal must be considered.
If it is assumed that the proceeds with disposal amounts to
R1 440 000, the disposal will result into a net capital gain of
R744 000, calculated as follows: proceeds of R744 000 (Selling price
of R1 200 000 less former
recoupment of R696 000) less base
cost of R0.