Updated Interpretation Note 53 Clarifies Tax Allowances for Lessors

The South African Revenue Service (SARS) released an updated Interpretation Note 53 (IN 53), which provides guidance on how Section 23A limits allowances for lessors on affected assets. This update aims to offer clarity for accountants working with businesses involved in leasing assets.

Background

Section 23A of the Income Tax Act governs how certain capital allowances are treated for lessors who lease machinery, equipment, aircraft, or other specified assets. Historically, questions have arisen about how these allowances are calculated and applied, especially when rental income is insufficient to absorb the full value of allowances.

IN 53 addresses these challenges by limiting deductions to the net rental income derived from affected assets. Any unused allowances can be carried forward and used in future tax years, ensuring they are only set off against rental income from these assets.

Objectives and Scope

IN53 provides further guidance on the following:

1. Define "affected assets" and exclusions
   "Affected assets" are defined as machinery, plant, implements, utensils, aircraft, and ships that qualify for specified capital allowances, including sections 11(e), 12B, 12BA, 12C, 12DA, or 37B(2)(a) of the Income Tax Act. Importantly, the following are excluded:

   • Assets leased under an operating lease, provided they meet specific conditions.

   • Assets primarily used in non-letting trades during the year of assessment (e.g., more than 50% use in another trade).

2. Limit allowances
   Section 23A(2) restricts allowances to the net rental income earned from the affected assets. The net rental income is calculated after subtracting other deductible expenses related to generating rental income but before applying the allowances.

3. Carry-forward of disallowed allowances
   If allowances exceed the net rental income in a given year, the excess is carried forward to the next tax year. These allowances can only be deducted in future years if there is sufficient rental income.

4. Apportionment of mixed-use deductions
   When an asset is used both for letting and for another trade, the associated deductions must be appropriately apportioned between rental income and other income streams.

5. Tax treatment on disposal of affected assets
   IN 53 also provides detailed guidance on how to handle recoupments (amounts recovered from prior allowances) and taxable capital gains when an affected asset is sold. These are included as part of rental income and considered in the limitation.

6. Record-keeping requirements
   Taxpayers must maintain comprehensive records, including lease agreements, purchase details, and calculations for allowances and recoupments. These records must be retained for at least five years from the filing date of the tax return.

Examples and Scenarios

Practical examples are included illustrating the application of Section 23A, including:

• Limitation of allowances showing how allowable deductions are calculated when rental income is insufficient to absorb the full value of allowances.

• Operating lease exclusions highlighting cases where assets are leased to the public under operating leases and how these are excluded from the Section 23A limitations.

• Sale of an affected asset demonstrating the interplay of recoupments, taxable capital gains, and unclaimed allowances when an asset is sold.