As the economic implications of the coronavirus pandemic become evident, Government has committed to helping the most impacted sectors of our economy. But how is COVID-19 Government relief treated for tax purposes? Once again, we must look at the capital vs revenue debate.
Generally, receipts or accruals of a capital nature are excluded from a person’s gross income. Accordingly, receipts or accruals of Government grants will only form part of a person’s gross income if they are of a revenue nature.
SARS have issued guidance in this regard in Interpretation Note 59 on 10 December 2010 (IN59), which gives us an indication of which receipts or accruals of government grants will be, whether a capital or revenue nature. Paragraph 3.2.3 states the following:
A government grant will be of a revenue nature in the hands of a person carrying on trading operations if it is a trading receipt. A grant is a trading receipt if its receipt is a normal incident of a person’s trading operations. The nature of the grant received and the relationship which exists between the grant received and the recipient’s activities needs to be examined.
A government grant will be a trading receipt when it is paid in order to assist in meeting a person’s trading obligations or in order to assist in carrying on trading operations. A grant of this nature results in trading receipts being supplemented and accordingly is itself a trading receipt.
By contrast, any amount received or accrued for the purpose of:
• establishing an income-earning structure, or
• compensation for the surrender of such a structure, is of a capital nature.
In case law, there are various cases stating that in determining whether a receipt or accrual is capital or revenue in nature one must look at whether the receipt arose from the realisation of a capital asset or whether it was received in pursuance of a profit-making scheme. The courts have also stated that commercial and good sense must always be the overarching factors on which such a determination must be made.
In a more recent case (2017) of Volkswagen South Africa (Pty) Ltd v Commissioner for South African Revenue Service 80 SATC 179, these principles have been applied and reliance has been placed on the contents of IN59.
The issue in this case was whether the accrual of rebates – calculated with reference to capital expenditure, and to which Volkswagen became entitled under a government scheme to support the local motor industry – should be regarded as accruals of a revenue or capital nature.
In this regard as an incentive for the automotive manufacturers to embark on expensive capital projects the productive asset allowance (PAA) was introduced to those manufacturers that had invested in dedicated productive assets for the assembly of light vehicles and manufacture of automotive components.
For a PAA certificate to be issued, any claim for such benefits had to be audited by external financial auditors using prescribed audit standards to verify the investments in productive assets. The value of the PAA certificate would be 20% of the capital investment so audited and verified.
These PAA certificates could then be used by the manufacturer to offset the duty which it became liable to pay on importing fully made up vehicles for sale in South Africa. As a result of their participation in the PAA scheme and the rationalisation of the motor vehicles they were producing, the manufacturers were reimbursed an amount of 20% of the capital expenditure incurred in the rationalisation process by, effectively, paying less import duty than would have been the case had they not participated in the scheme.
The court considered the case on the following two questions:
- What was the real and basic cause of the accrual, ie in respect of what activity was the grant made)?
- Whether the abovementioned cause was more closely associated with the equipment of the taxpayer’s income-producing machinery (which would make it capital in nature) or with its income-earning operations (which would make it revenue in nature)?
SARS contended that the PAA certificates could only be redeemed by the payment of customs duties and therefore only accrued once the motors had been imported. As such, they were so closely connected to the income producing activities of the Taxpayer that they were revenue in nature.
However it was found that the PAA certificates were in no way received as part of a scheme of profit making but that the PAA certificates were issued to compensate manufacturers for at least a portion of the capital expenditure incurred in pursuance of the rationalisation of motor vehicle models and that this clearly distinguished them as capital in nature.
From the above it is evident that although there are no hard and fast rules set to determine whether a government grant is capital or revenue in nature, of most importance is that the purpose of the grant must be established.
However, it should be noted that even if the grant is of a revenue nature, there may be relief from tax.
Section 12P of the Income Tax Act provides exemption through:
- Eleventh schedule listing, or
- Identification by the minister in the Government Gazette
Taxpayers that receive government grants that are either listed in the Eleventh Schedule to the Income Tax Act or identified by the Minister of Finance by notice in the Government Gazette, will be exempt for income tax purposes. However, no tax deductions will be allowed against such exempt grants as double-dipping rules will apply.
Alternatively, the provisions of section 10(1)(y) of the Income Tax Act may apply that currently exempts various programmes, more specifically with respect to the provision of relief in the case of natural disasters. However, these are approved by the Minister under the national budget process.
The jury is therefore out on whether or not the Minister will exempt COVID-19 grants through the Gazette outside the budget process.
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