The benefits that emanate from qualifying as an SBC are:

• An SBC which carries on a process of manufacture (or any other process which in the opinion of the Commissioner is of a similar nature), may write off expenditure incurred on or after 1 April 2001 in respect of the acquisition of plant and machinery (also referred to as investment expenditure) in full in the year in which the assets are brought into use for the first time by the taxpayer for the purposes of manufacture. The allowance is not reduced if the asset is used for less than 12 months during the tax year.

• The rate of tax for an SBC on its taxable income below a specified amount is considerably lower than the normal rate of tax for companies in general. Whereas a company pays tax at the rate of 30% on its taxable income, an SBC's tax is levied at a rate of 15% on the first R100 000 of taxable income for tax years commencing on or after 1 April 2000 and 15% on the first R150 000 of taxable income for tax years ending during the period of 12 months ending on or before 31 March 2003. (See par. 2(b) of Schedule 1 to the Taxation Laws Amendment Act, No. 30 of 2002.) Tax is levied at the normal company rate of 30% on the portion of the taxable income exceeding the aforementioned amounts of R100 000 or R150 000, as the case may be.

This note serves to provide guidance as to the application of the provisions of section 12E with reference to the requirements of a qualifying SBC. Any reference to a 'company' or 'shareholder' in this note includes a 'close corporation' and a 'member of a close corporation' respectively.

The requirements that have to be met in order to be classified as an SBC can be divided into the following three categories, all of which will be dealt with separately:

• Ownership requirement
• Turnover requirement
• Business activity requirement

Shareholders or members may not at any time during the year of assessment hold any shares or have any interest in the equity of any other company. (Excluded are shares in companies as contemplated in paragraph (a) of the definition of 'listed company' and any portfolio in a collective investment scheme contemplated in paragraph (e) of the definition of 'company' in section 1 of the Act.) Any shares or any interest in such other company, albeit for one day during the year of assessment will disqualify such taxpayer notwithstanding the fact that all the other requirements have been met. The reference to 'any other company' includes a close corporation, a dormant company and a co-operative.

The limitation on the gross income refers to the gross income received or accrued for a full period of 12 months , i.e. a full year of assessment. Where the SBC commenced trading during the year, the R1 million or R3 million, whichever is applicable for the specific year of assessment, should be reduced proportionately in order to determine whether the gross income received or accrued for the relevant period in question would have exceeded the limit of R1 million or R3 million, had the taxpayer been trading for the full year of assessment.

Example

An SBC with a financial year-end of 30 June commences trading activities on 1 December 2002. The gross income for the seven-month period from 1 December 2002 to 30 June 2003 amounts to R1, 9 million. As the SBC s financial year-end is on or after 1 April 2002, the turnover limitation of R3 million is applicable in this instance. This turnover must be reduced proportionately in order to determine what the company's turnover limit for the seven-month period should be.

R3 million x months actually traded/twelve months.
R3 million x 7mnths/12mnths = R1 750 000.

The gross income of the SBC may therefore not exceed an amount of R1 750 000 for the seven months in which it traded. The gross income for the period, however, amounts to R1,9 million and notwithstanding the fact that the SBC complies with all the other requirements of an SBC, the non-compliance with the turnover requirement disqualifies such SBC for the relevant year of assessment.

In calculating the gross income of a taxpayer, all income received or accrued, excluding capital gains, should be included. Capital gains made by a taxpayer are included in taxable income in terms of the provisions of section 26A of the Act, and such gains are therefore excluded in determining the gross income. Since gross income includes exempt income (such as South African dividends), exempt income should not be excluded from the R3 million requirement.

Not more than 20% of the taxpayer's gross income may consist of 'investment income' (as defined) and/or income from the rendering of a 'personal service' (as defined). The aggregate income from investment and personal services, should therefore not exceed 20% of the gross income. Where a taxpayer, for example, has no investment income, the personal service income may not exceed 20% of the gross income. Where the investment income, for example, constitutes 6% of the gross income, the personal service income may not exceed 14% of the gross income.

The investment income listed in section 12E refers mainly to amounts, which represent the return on investments. Any proceeds derived from investment or trading in financial instruments, marketable securities or immovable property is however, for the purposes of section 12E, also regarded as investment income.

'Personal service' means any service in the field of accounting, actuarial science, architecture, auctioneering, auditing, broadcasting, broking, commercial arts, consulting, draftsmanship, education, engineering, entertainment, health, information technology, journalism, law, management, performing arts, real estate, research, secretarial services, sport, surveying, translation, valuation or veterinary science, which is performed personally by any person who holds an interest in the company or close corporation.

Section 12E was enacted for the specific purpose of encouraging new ventures and employment creation, i.e. active small businesses. The provisions relating to SBCs are therefore not intended to benefit any professional person such as, for example, an architect or a lawyer who renders his/her service by means of a company or close corporation. For this reason, the income attributable to the performance of any 'personal service' by any person who holds an interest in the SBC, combined with any investment income, may not exceed 20% of the SBC's gross income.

The Act does not prescribe any method of record keeping, but a shareholder and/or a connected person to such shareholder who is of the opinion that that portion of the SBC's gross income which is attributable to the personal service rendered by such shareholder and/or connected person, does not exceed the 20% limitation, is required to substantiate this fact, either by means of a charge out system per hour/per job or any other method used by such taxpayer.

In view of the fact that the full cost of an asset is deducted when brought into use for the first time, such asset will not qualify for a scrapping allowance in terms of section 11(o) of the Act.

Any amount recovered or recouped in respect of a asset which is disposed of, is however subject to the recoupment provisions in terms of section 8(4)(a) of the Act.

In the case of a damaged or destroyed asset, any amount recovered or recouped can be deferred in terms of the provisions of section 8(4)(e) of the Act and such amount can be set off against the cost of an asset acquired as a replacement for the damaged or destroyed asset. The section 12E deduction is therefore, in such instance, determined on the adjusted cost, i.e. the actual cost less the amount recovered or recouped which was not included in income in terms of section 8(4)(e) for the current or any previous year of assessment.

Example

A small business corporation with a 28/29 February financial year-end, acquires a machine costing R320 000 on 1 August 2001 and immediately brings the machine into use for manufacturing purposes. The machine is however damaged in a fire on 31 May 2002 and an amount of R200 000 is paid out in terms of a contract of insurance.

Notes: The taxpayer has indicated that -

• a replacement machine will be acquired within a period of one year subsequent to the event in which the original machine was damaged; and
• the replacement machine will be brought into use within a period of three years from the date on which the original machine was damaged.

Calculate the following:

1. The 12E allowance for 28 February 2002.
2. The amount recovered or recouped for 28 February 2003.
3. The allowance for 29 February 2004 assuming that a replacement machine was acquired for R450 000 on 31 May 2003 and immediately brought into use.

Insurance proceeds of R200 000 under ordinary circumstances subject to section 8(4)(a) recoupment provisions. The recoupment is however deferred as the taxpayer complies with the requirements of section 8(4)(e).

Amount recouped for year ended 28 February 2003 is therefore R Nil

The recoupment will, however, not be deferred until such time as a new machine is acquired should any circumstances arise indicating that the taxpayer did not comply with the provisions relating to the application of such deferral in terms of section 8(4)(e). The recoupment will be included in the income of the taxpayer for the year of assessment during which such circumstances arise.

The cost of the asset to the taxpayer, for the purposes of section 12E(2) is deemed to be the lesser of -

• the actual cost to the taxpayer; or
• the direct acquisition cost that a person would have incurred if the asset had been acquired under an arm s length cash transaction on the date on which the transaction was in fact concluded; or
• the actual cost less the deferred recoupment in terms of section 8(4)(e).

The above cost excludes interest and finance charges, but includes the direct cost of installation or erection of the asset. The allowance will not be available where the taxpayer acquired an asset for no consideration, for example, by means of a donation or as a dividend in specie.

The examples in the following table indicate which rates are applicable where a company has any one of the reflected financial year-ends. The examples are based on the assumption that all the companies do meet the relevant requirements relating to ownership, turnover and business activities.

The gross income limitation of R3 million came into operation on 1 April 2002 and applies for any year of assessment ending on or after 1 April 2002. The increase of taxable income to R150 000 (refer to paragraph 1 above) applies in respect of years of assessment ending during the period of twelve (12) months ending 31 March 2003.

An SBC which has complied with all the requirements of an SBC in one year does not necessarily indicate compliance in respect of any subsequent year of assessment. The facts of each case will therefore have to be considered for every year of assessment in order to determine whether the SBC complies with all the requirements for the specific year under review.