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VENTURES: How To Go Bankrupt


Recent Western Cape Business News

When a business closes down there are many expenses that need to be covered, such as retrenchment payouts, legal expenses, lease installments, rentals and interest that continue after closure. If these expenses are not tax deductible, they become very costly indeed.

David Warneke, a Tax Partner at Cameron and Prentice Chartered Accountants, discusses the parameters of expenses that qualify for tax deductions.

For expenses to be allowed as deductions, they must pass each of three main tests:

The expenses must be incurred for the purpose of producing income, they must be laid out for purposes of trade, and they must not be of a capital nature.”

In this context the stumbling blocks are most often the first two requirements. In particular, there is a potential problem where an expense is incurred in order to facilitate the closure of the business or division, or after it has closed. “

Unfortunately, says Warneke, “we do not have clear, authoritative precedent on this issue. According to Silke on South African Income Tax, the general principle in operation is that an expense incurred under an obligation assumed during the course of the existence of the business will continue to be deductible despite the closing of that business.”

With regard to retrenchment payouts and continuing rental or lease obligations to the end of the current lease term, in principle, these should be deductible as obligations assumed while the trade had been carried on.” 

However, Warneke warns that once a business has ceased operation, expenditure incurred subsequently cannot be ‘in the production of income’. This would apply, for instance, to legal fees incurred subsequent to closure and removal expenses.

There is also a potential problem with the deductibility of interest from the date of closure. The Income Tax Act deems interest to be incurred relative to accrual periods, which basically are the periods between the payment of debt installments. Therefore, if a loan is taken out in connection with the trade prior to closure, the interest relating to the installment periods after closure may not be tax deductible, as this interest is deemed to be incurred after closure.”

The third requirement above may also debar certain types of expenses since they would constitute expenses of a capital nature. This is the case with expenses relating to the ‘capital structure’ of the business and would include consulting and legal fees relating to the decision whether or not to close the business, or how the closure should be structured.

The same general principles should apply whether the issue is the closure of the entire business or a division or branch of the business.

In summary, it is likely that certain expenses, particularly those incurred under an obligation that arose after the closure and those that are capital in nature, will correctly be disallowed as deductions by the SARS,” says Warneke.

Making the decision to close a business or division is often harrowing and stressful with worries over future earnings and security at the fore.  The last thing anyone needs is added and unnecessary costs that further deplete finances.  By understanding which expenses are tax deductible and which are not brings more certainty as to the true cost of closure,” concludes Warneke.

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