The ins and outs of buying a vehicle for business use, and the tax implication, seem to be questions of interest, judging from recent letters.
You have a business which buys a vehicle which costs R100 000 including VAT. We will assume the vehicle is a motor car, on which the business may not claim a refund of the VAT, owing to the tax laws.
As the vehicle is to be used for the business, for tax purposes, you will be able to claim wear and tear at 20 percent a year of R100 000 from the date that the vehicle is brought into use.
After six years the tax value of the vehicle is nil because wear and tear of R100 000 will have been claimed since the vehicle was bought.
At this point your business trades the vehicle in against the purchase of a new vehicle, which will cost the business R150 000, including VAT. You will pay for the new vehicle over a period of four years in terms of an instalment agreement. The trade-in value agreed with the garage is, say, R36 000.
The questions which arise are:
* Is the amount set off the price of the new vehicle, for purposes of the trade-in, treated as a recoupment of wear and tear previously claimed, namely as an amount to be brought into your taxable income? or
* Does the trade-in value simply reduce the cost of the new vehicle so that the amount of wear and tear that can be claimed in respect of the new vehicle is reduced by R36 000 x 20 percent a year, namely R9 000 a year?
The truth of the situation is that the first vehicle is being sold to the garage for R36 000. The fact that your business is simultaneously buying another vehicle from the garage does not alter this fact. In addition, the fact that the balance payable in terms of the instalment sale agreement is reduced by the amount of the trade-in, because the amount paid by the garage for the first vehicle is being treated as a "deposit" or advance payment for the new vehicle, does not alter the position.
Consequently, the correct treatment is for the R36 000 to be included in your taxable income as a recoupment in the year the trade-in occurs. In that same year the wear and tear on the new vehicle will be based on 20 percent of the full cost of R150 000 from the date it is brought into use - so the cost is not reduced by R36 000.
A further aspect to consider is the difference between the tax treatment of an asset bought using an instalment sale agreement and one acquired using a finance lease.
If you enter into an instalment sale agreement, the capital cost of the asset is claimed at a rate of 20 percent a year. Interest due on the outstanding balance on the instalment sale agreement will be payable as it is incurred. Because you will pay more interest at the beginning of the agreement, when the outstanding balance is larger, the total claim (wear and tear plus interest) against your taxable income will be larger in the earlier years than in the later years.
If you enter into a financial lease agreement, the claim against your taxable income will be the full lease payments made during each year, which will be equal over the course of the lease (assuming interest rates don't change).
Your tax deductions, if you use an instalment sale agreement, will be larger than if you had a lease agreement in the earlier years, but the deductions for a finance lease will be larger in the later years than an instalment sale agreement.
The fact that a finance agreement is used does not mean that you will not need to include an amount in your taxable income at the end of the lease, if you keep the asset, or it is sold and an amount paid to you or offset against a new asset. The market value or proceeds (as applicable) will be regarded as a recoupment in your taxable income of rentals previously deducted.
A word of warning, though - the decision to use instalment sale or lease should not be reached entirely on tax considerations. Cash flow and commercial issues are also relevant.