10 June 2011

Contingent liabilities

After the judgment in the Ackermans case (2010) 73 SATC 1, and SARS' issuing binding Class Ruling 029 in respect of the deductibility of contingent liabilities when buying the assets and liabilities of another company in the same group of companies (Tax Alert dated 13 May 2011), in the draft Taxation Laws Amendment Bill 2011 there is a proposed new section 24CA.

In South Africa we are now moving to Australian based numbering with two capital letters after the number of the section! However the reason for this will become apparent.

The draft section provides that in the purchase of a business as a going concern, where the seller is relieved of any contingent liabilities as a result of the assumption of that contingent liability by the purchaser, and the consideration for the purchase of the business has been arrived at after taking into consideration the assumption of the contingent liability by the purchaser, then the fair market value of the contingent liability must be included in the income of the purchaser in the year of assessment in which the sale takes place.

Obviously the contingent liability must relate to the business being purchased. The purchaser will then be permitted the deduction of that contingent liability that is likely to be incurred in a future year of assessment in which it is included, if but for the contingency it would have been allowed as a deduction in that year of assessment. The amount allowed as a deduction is deemed to be a receipt or accrual in the following year of assessment.

This is similar to the "open transaction" methodology used in section 24M. The purchaser takes on this contingent liability/ies and the price he pays for the business reflects the value of the potential liability he assumes. Accordingly, there is an addition of the fair market value of that liability in his income. He can then claim a deduction to provide for the anticipated future expenditure of that or those amounts. This continues to be an addback in the following year, until the real liability becomes expenditure actually incurred. If the contingent liability never occurs, then the purchaser will have had an amount included in income. So readers will see the similarities with Section 24C as well.

The provision is to come into operation in respect of acquisitions on or after 1 January 2012.

Alastair Morphet, Director, Tax

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