On 26 March 2025, the South African Revenue Service ("SARS") issued Interpretation Note 137, providing guidance on the tax implications of Section 8(4)(k)(iv) of the Income Tax Act, which deals with the scenario where a depreciable asset (that was not previously held as trading stock) is converted into trading stock. This is effective for assets commencing to be held as trading stock on or after January 15, 2020.
This article aims to provide you with a concise overview of the key aspects of this interpretation note and its potential impact on your business. This is a crucial area for businesses, and we want to ensure you are aware of the key aspects of this interpretation note.
Background
Generally, when a company has claimed deductions or allowances on an asset (like wear-and-tear or depreciation) and then disposes of that asset for more than its tax value, the difference is "recouped" and taxed as income. However, the rules are more nuanced when a depreciable asset is not sold, but instead, its purpose changes, and it becomes trading stock.
Prior to the amendment of Section 8(4)(k), the Income Tax Act did not specifically address the situation where a depreciable asset, on which deductions or allowances had been claimed, was subsequently reclassified as trading stock. This created a potential loophole where previously claimed allowances were not recouped for normal tax purposes when the asset's usage changed.
Key Provisions of Section 8(4)(k)(iv) and Interpretation Note 137
Deemed Disposal: The core of the interpretation note revolves around section 8(4)(k)(iv) of the Income Tax Act. This section addresses the situation where a depreciable asset (not originally held as trading stock) commences to be held as trading stock. In this case, SARS will consider that the asset has been disposed of at market value. This means that, for tax purposes, the asset is treated as if it were sold at its market value on the date of the change in usage.
Recoupment of Allowances: This deemed disposal triggers a recoupment of any deductions or allowances previously claimed on the asset under specific sections of the Income Tax Act. This recoupment is included in the taxpayer's gross income for the year of assessment in which the change occurs.
Capital Gains Tax (CGT) Implications: In addition to the income tax implications of the recoupment, the deemed disposal also has CGT implications. A capital gain or loss is calculated based on the difference between the market value at the time of the deemed disposal and the asset's base cost (original cost less any capital allowances claimed).
Trading Stock Valuation: The market value of the asset at the date it becomes trading stock is used as its cost for trading stock purposes. This value is then used to determine the opening stock value in the year of assessment following the change in usage. The interpretation note emphasizes that determining when an asset "commences" to be held as trading stock is a factual question. SARS will consider factors such as:
- The nature of the asset
- The nature of the taxpayer's business
- Internal policies and procedures of the taxpayer's business
- Evidence of a change in intention
Market Value Determination: The market value of the asset at the date it becomes trading stock is critical for determining both the recoupment amount and the CGT implications. The interpretation note emphasises that "market value" is the price obtainable between a willing buyer and a willing seller in an open market, acting at arm's length. The taxpayer bears the burden of proving the market value.
Interaction with Section 8(4)(a): The interpretation note clarifies the interaction between section 8(4)(k)(iv) and section 8(4)(a), which is the general recoupment provision. Section 8(4)(k)(iv) deems the asset to be sold at market value but does not regulate the recoupment or its amount. The latter is regulated under section 8(4)(a).
Exclusions: The interpretation note also highlights specific exclusions where the recoupment rules *do not* apply. The most relevant exclusion is for assets contemplated in paragraph (jA) of the definition of "gross income." These are assets manufactured, produced, constructed, or assembled by a person, similar to other assets they manufacture for sale. These assets are treated as trading stock from creation, preventing the application of Section 8(4)(k)(iv).
Practical Implications
Record Keeping: Accurate records of the original cost, capital allowances claimed, and the market value of depreciable assets are crucial.
Timing: The timing of the change in usage can significantly impact the tax implications.
Professional Valuation: Obtaining a professional valuation of the asset at the time it becomes trading stock is highly recommended to support the market value determination.
Examples
The Interpretation Note includes examples illustrating the application of these principles. These examples demonstrate how to calculate the recoupment and CGT implications in different scenarios.
Example 1: Illustrates the tax treatment where an asset becomes trading stock before 15 January 2020. In this case, the allowances are not recouped under section 8(4)(k)(iv) but are factored into the capital gain calculation.
Example 2: Demonstrates the tax treatment where an asset becomes trading stock on or after 15 January 2020. Here, the allowances are recouped under section 8(4)(k)(iv), and this recoupment reduces the proceeds for CGT purposes, preventing double taxation.
Example 3: Deals with assets excluded from recoupment under paragraph (jA) of the definition of "gross income" (i.e., manufactured goods).
Impact and Recommendations
Interpretation Note 137 provides welcome clarity on a complex area of tax law. It is essential for businesses to carefully consider the implications of this interpretation when reclassifying depreciable assets as trading stock.
We recommend that you:
- Review your current asset holdings and identify any depreciable assets that may be considered for reclassification as trading stock.
- Maintain accurate records of the original cost, deductions claimed, and market value of such assets.
- Seek professional advice to determine the specific tax implications of any proposed reclassification.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
