Optimise Your Client's Tax Benefits: Capital Allowances in Manufacturing Explained
The manufacturing sector faces unique tax implications that require diligent management to optimise tax liabilities and compliance. Accountants playing a pivotal role in advising manufacturing clients must be well-versed in specific areas such as capital allowances, applicable tax incentives, and the criteria for qualifying expenditures.
The process of manufacture
South African Revenue Service (SARS) defines the "process of manufacture" refers to a series of steps or operations that transform raw materials into finished goods. This process is considered from both a legal and tax perspective, highlighting the criteria that determine whether activities qualify as manufacturing under tax laws. These guidelines are essential for accountants and tax practitioners to understand, as they impact the classification of expenses and the capital allowances that can be claimed by manufacturing entities. This understanding ensures that activities are correctly classified, maximizing tax efficiency and compliance with South African tax regulations.
Capital Allowances
Capital allowances are vital tools for manufacturers to reduce their tax liabilities by allowing the deduction of the cost of certain capital expenditures from their taxable profits. Here’s a summary of the main capital allowances available in terms of the Income Tax Act:
Allowances on Movable Assets (section 12C) include new and unused machinery and equipment used in the manufacturing process, excluding buildings, goodwill and assets leased from connected persons. To qualify, the assets must be used directly in producing goods. The deduction is 20% per annum on a diminishing balance, with an additional 20% in the first year, totaling 40%. Requires proof of use in manufacturing and ownership by the taxpayer.
Allowances on Immovable Assets (Section 13) covers construction and structural improvements for buildings. For these allowances, the expenditure must relate directly to the manufacturing site or facility. Covers expenses related to the construction or improvement of industrial buildings or structures used for specific industrial purposes by the taxpayer. It offers an annual deduction of 5% of the cost spread over 20 years. Documentation must clearly link the expenditures to manufacturing operations.
Intellectual Property and Research and Development (R&D) (Section 11D) provides a tax deduction for expenditures related to costs incurred in developing new products or patents incurred in scientific or technological R&D. It allows for a 150% deduction of qualifying expenses for activities must aim to achieve technological innovation or advancement. The deduction requires pre-approval from the Department of Science and Innovation, and taxpayers must keep detailed records on the R&D nature of the expenses demonstrating how the expenses relate to qualifying R&D projects.
Disposals and Recoupments: When assets that were used in manufacturing are disposed, the excess amount received is included in taxable income as a recoupment, effectively reversing part of the previous deductions.
Section 11(o) governs deductions related to the scrapping, loss, or destruction of assets. When an asset is scrapped, lost, or destroyed and the taxpayer receives compensation (e.g., insurance payouts) the taxpayer can claim a deduction for the remaining tax value of the asset, reducing taxable income by the amount that was not compensated.
Section 8(4)(a) addresses the tax implications of recouping amounts that were previously allowed as deductions for wear and tear or depreciation on assets. This occurs when an asset, for which depreciation was claimed, is sold for a value exceeding its tax-written down value (i.e., its book value for tax purposes).
Requirements for Claiming Allowances
To benefit from these allowances, manufacturers must comply with specific requirements:
Adequate records must be maintained to prove that the expenditure qualifies for the allowances claimed.
The assets or expenditures must be directly involved in the manufacturing process.
Claims for capital allowances must be made within the stipulated time frames as prescribed by tax laws.
Understanding and utilising these capital allowances can significantly impact a manufacturer's financial health by reducing tax liabilities and supporting reinvestment in the business. For accountants, providing informed guidance on these issues is crucial for aiding clients in maximising their tax benefits.
Learn more about the tax implication of a manufacturing business with CIBA’s July 2024 Tax Happy Hour CPD event!
CIBA’s Tax Happy Hour is a practical session explores the Income Tax Act's rules applicable to manufacturers, highlighting key opportunities and pitfalls. You'll gain insights into accelerated capital allowances, trading stock rules, government grants, and more. Available as a recorded live stream on your CIBA Academy profile, this course equips you to offer proactive, valuable advice to your manufacturing clients, helping them optimise tax benefits and navigate complex compliance issues effectively.
