WHAT YOU NEED TO KNOW ABOUT THE TAXATION OF SALE AND LEASEBACK ARRANGEMENTS

WHAT YOU NEED TO KNOW ABOUT THE TAXATION OF SALE AND LEASEBACK ARRANGEMENTS

DISPOSING OF SHARES AT A NOMINAL VALUE FOR B-BBEE PURPOSES IS NOT A DONATION

A sale and leaseback arrangement is when a person sells an asset to a financier and enters into a lease agreement where the asset is hired back from the financier. The arrangement provides the seller with funding through the proceeds on the sale of the asset and the repayment of the financing takes the form of rent payable to the financier.

The South African Revenue Service (SARS) released Interpretation Note 135 on 22 October 2024 on sale and leaseback arrangements. In its Note SARS explains the perceived benefits of such an arrangement being the seller can deduct the full rental expenditure associated with the lease (both interest and capital portions), while the financier can claim an allowances on the asset, and so shield the gross income arising from the receipt of the rentals. Sometimes the financier will utilise the “tax benefit” received through the capital allowances to offer a lower interest rate which will be reflected in the rentals to the seller.

If one compares the sale and leaseback to a loan, only the interest portion (and not the capital) of the loan is deductible by the borrower and only the interest is taxable in the hands of the financier.

There are two provisions in the Income Tax Act, 1962 which deal with sale and leaseback arrangements, sections 23D and 23G. These provisions can change the tax treatment of a sale and leaseback arrangement that would otherwise have applied under other provisions of the Act.

Section 23D is an anti-avoidance measure that limits the allowances available to the financier leasing the asset back to the seller. It will apply when an asset, which has substantially increased in value due to currency depreciation or inflation, is sold at market value to the financier. In such circumstances a seller may claim a deduction for the lease rentals determined on the increased value of the asset.

Where the asset subject to the leaseback is a depreciable asset that was held by the seller within a period of two years before the start of the lease, the allowance that can be claimed by the financier is limited by section 23D to the cost of the asset less all deductions that were allowed by the seller on the asset. Added to this are any recoupments related to the asset in the hands of seller or capital gains on the disposal of the asset.

For example, Company A sells a machine that it purchased for R1 million to Company B for R2 million and thereafter enters into a lease with Company B for the machine. Before selling the machine, Company A had previously claimed a wear-and-tear or depreciation allowance of 20% i.e. R200,000. The portion that Company B can claim allowances on is therefore limited to R800,000 (R1 million – R200,000). If there were any recoupments related to the asset in the hands of Company A or capital gains on the disposal these amounts can be added to the R800,000.

Section 23G was enacted to prevent one entity from using the tax base of another to obtain a tax benefit. This can happen when a tax-exempt entity is introduced as the lessor or lessee. If the lessor is tax-exempt section 23G limits the deduction available to the lessee relating to lease payments due to the interest element of such payments. If the lessee is tax-exempt, the lessor will be taxed only on the interest element of the lease payments and will not be entitled to any depreciation allowances on the asset.

In summary, section 23D will limit the allowances that a lessor (i.e. financier) may claim under a sale and leaseback arrangement if the asset was held within a two-year period before the commencement of the lease. Section 23G on the other hand effectively treats a sale and leaseback arrangement like a loan agreement for tax purposes if a tax-exempt entity is a party to the lease.

 

Telephone: +27 31 570 5496,  Email: graeme.palmer@gb.co.za

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