Capital Allowances can only be claimed on the cost of buildings and not on the cost of land.
A distinction between repairs and improvement must still be made in the case of non-depreciable assets such as land. This is because there is no capital allowance pool for such assets. The cost of repairs to non-depreciable assets are deductible under section 41(1)(b) of the Income Tax Act, which the cost of improvements to such assets are added to the cost base under section 58(5) and recognized as a reduction of gain upon disposal.
Buildings, whether used for business purposes (for example, a factory building, shop, or warehouse) or for producing business rental income, are treated as depreciable assets and are eligible for the capital allowance deduction. However, since land is a non-depreciable asset, where a price is paid for land and a building that price must be apportioned and only the part paid for the building qualifies for the allowance (see section 39(11).
Under the system, eligible assets are classified unto five groups:-
1 plant, machinery and equipment, including cars, trucks and other vehicles
2 all other tangible depreciable assets except building, and intangible depreciable assets, including goodwill.
3 industrial, manufacturing and agricultural buildings.
4 other commercial buildings such as office buildings or retail buildings.
5 other buildings, such as residential real estate.
In a year in which a capital expenditure is incurred and a depreciable asset is put to use, it is necessary to establish to which of these five groups the asset belongs. This determines the rate at which the asset is depreciated. Assets belonging to Group 1 are depreciated at a 40 percent rate, assets in Group 2 & 3 are depreciated at a rate of 10 and 15 percent, assets in Group 4 at 10 percent, and assets in Group 5 at 5 percent.
It would be to the taxpayer’s advantage to try to classify all expenditure under Group 1 so as to qualify for the 40% deduction. It is the tax auditors function to examine purchases of capital items to confirm that the correct classification has been made.
The taxpayer may wish to claim capital allowances in respect of all of his capital expenditure but this is not permitted by the law and the tax auditor must also check that all the expenditure does qualify under one of the Groups.
For example, in Group 3, expenditure on buildings used to house industrial, manufacturing or agricultural activities would qualify for the 15% rate. The tax auditor should check first that the company carried on an industrial, manufacturing or agricultural business and that the building was used to house one of these activities.. Secondly the tax auditor should check that the expenditure was in respect of a building. Expenditure on construction of roads, storerooms, car parks, outbuildings etc may not qualify because they do not “house” the qualifying activity.
Part 2 Pooling
All assets belonging to a particular group are placed into a single “pool” and are depreciated, in a single calculation each year, at a uniform rate.
In May 2000, T takes over a road transport business that his uncle had operated successfully for a number of years. T’s purchase price, for the entire business as a going concern, is agreed at Le 60,000,000, made up as follows:-
|Asset||Group 1||Group 2||
Buildings (garage and Accompanying office) Land (cost = Le 10,000,000)
|Tools, office furniture etc||Le 10,000,000|
|Balance||Le 30,000,000||Le 5,000,000||Le 15,000,000|
The cost of the land does not qualify for Capital Allowances because land is not a depreciable asset.
Adjustment to the Pool
The balance of a pool is calculated by taking its balance at the end of the previous year, adding the cost of new assets placed in the pool during the year and subtracting the consideration received for assets taken out of the pool (see section 39 (5) of the Income Tax Act ). To this new balance at the end of the year of assessment, the appropriate percentage rate is applied to calculate the allowable capital allowance deduction.
When a depreciable asset is required for the purpose of earning income, and is put to use in the business (or other income-producing activity), it is added to the pool (section 39 of The Income Tax Act(7). If it is bought in one year but not put to use that year, it cannot be added until it is put to use.
In most cases it will be the actual cost of the asset that is added to the pool (section 39(7) of The Income Tax Act). Where the asset is acquired in a non-arm’s length transaction, the cost is deemed to be the market value of the asset (section 58(3)of The Income Tax Act).
Example : (a continuation from example 1)
During the 2000/01, T purchases:
- a new truck, for Le 20,000,000
- an office computer, for Le 1,000,000
- some new tools for servicing the vehicles Le 200,000
All of these assets belong to Group 1, and total of Le 21,200,000 is added to that pool, bringing the balance to Le 51,200,000 as at the end of the year.
Consequently, for the year of assessment, T is entitled to the following capital allowance deductions:
|Description||Group 1||Group 2||Group 3|
|Acquisition||Le 30,000,000||Le 5,000,000||Le 15,000,000|
|Balance as 31st March 2001||Le 51,200,000||Le 5,000,000||Le 15,000,000|
|Allowance at 40%- 10%-10%||Le 20,480,000||Le 500,000||Le 1,500,000|
|Opening Balance 1st April 2001||30,720,000||4,500,000||Le 13,500,000|
Part 3 Apportionment of Cost
In two instances, the new law requires the cost of an asset to be apportionment. As already mentioned, land is not a depreciable asset and, where a single price is paid for land and a building, the price must be apportioned as is reasonable to arrive at a separate value for the building. The tax auditor, acting on behalf of the Commissioner General, can apportion the price where no agreement can be reached with the taxpayer.
The second case occurs where an asset is acquired for a dual purpose. For example, a taxpayer buys a car that is used partly for business and partly for personal use. In that case, the cost must be allocated in proportion to the percentage of business use to total use (section 39(12) of the Income Tax Act). That is to say, if the car is used 60 percent for business purpose and 40 percent for private use, only 60 percent of the cost of the car is added to the pool.
The same principle is used if a commercial building contains parts that are not used to produce income – such as residential accommodation occupied by the owner. Capital allowances are only due on the qualifying part of the property.