Income
1367. Judgment throws useful light on aspects of section 8(4) (a)
January 2006 – Issue 77

Where a partner disposes of part or all of his interest in the partnership, does he thereby recoup, in terms of section 8(4)(a) of the Income Tax Act No. 58 of 1962 (the Act), his proportionate share of capital allowances in respect of partnership assets which had been claimed by him in his individual tax return? This was the central issue in the Supreme Court of Appeal decision in Chipkin (Natal) (Pty) Ltd v C:SARS (67 SATC 243).

In answering this question affirmatively, the SCA judgment throws useful light on the fundamental tax status of a partnership and on hitherto unsettled aspects of section 8(4)(a) where a partner disposes of his interest in a partnership.

It is trite that a partnership is not a taxable entity in its own right. The court expanded on this principle, saying (at paragraphs 4 and 11) –

"The definition of ‘person’ in s 1 does not include a partnership and a partnership is not a person at common law. … The [Income Tax] Act does not recognise a partnership. It recognises only income (gross income after allowing for tax-exempt income) that accrues to partners in common (in accounting terms, the income of the partnership) which it attributes to them proportionally, and it similarly attributes to the individual partners deductions and allowances that are granted by the Act, with a resultant ‘taxable income’ of the partners individually. A partnership cannot have a taxable income, simply because it is not a taxable entity."

The court held (at paragraph 9) that a distinction must be drawn between the acquisition of an asset by a partnership (and the cost of that asset to the partnership) and the acquisition by a partner of a share in the partnership. Similarly, said the court, a distinction must be drawn between the disposal by a partner of an interest in the partnership and the disposal, by the partners, of a partnership asset.

However, said the court (at paragraph 9), these distinctions do not prevent a partner from recouping (as envisaged in section 8(4) (a)) a pro rata proportion of a section 14bis allowance, calculated in terms of section 24H (5) (b), when that partner disposes of a share in the partnership, even though the partnership itself has not disposed of the capital asset in question. When a partner disposes of an interest in the partnership, he thereby disposes of a corresponding percentage of his undivided share in the partnership’s assets.

Partnership bought an aircraft and transported persons and goods for reward

In the present case, the taxpayer, who was one of eleven partners, had made a capital contribution to the partnership, in cash, which it had borrowed from a bank. This contribution entitled the taxpayer to a 30% share in the partnership and an undivided share in the partnership-owned aircraft.

The business of the partnership was to purchase an aircraft and transport persons and goods by air for reward. It duly acquired an aircraft which thus became an asset of the partnership, and a section 14bis allowance was claimable in respect of the purchase price.

The taxpayer’s share as a partner in the aircraft entitled him to a share of that section 14bis allowance, and he duly claimed a share of such allowances, year by year.

Some three years later, the taxpayer disposed of 99% of its 30% interest in the partnership. He did not receive any direct consideration in respect of the disposal; however the bank released him from liability on the loan account that he had taken out to finance his acquisition. By disposing of an interest in the partnership, he automatically disposed of an undivided share in the aircraft. The court held that the taxpayer thereby recouped, in terms of section 8(4) (a), the section 14bis allowances that he had been claiming.

Court rejected taxpayer’s argument

The court dismissed the taxpayer’s argument that there was no recoupment by him until the partnership had sold the aircraft, which occurred some years later. The basis of the taxpayer’s argument was that the section 14bis allowances had accrued to the partnership, and not to the partners individually, and that such allowances were thus recouped only when the partnership disposed of the aircraft.

The court implicitly conceded that this might have been true prior to the enactment of section 24H, but pointed out that sub-section (5) thereof –

"now makes it clear that a pro rata portion of a deduction or allowance shall be granted in the determination of an individual partner’s taxable income derived from the partnership – the entire deduction or allowance is not applied to the globular income of the partnership".

From this it followed, said the court (at paragraph 12) that it was possible for one partner to recoup an allowance granted to him even if the other partners recouped nothing.

"It is to the individual partner that a proportionate share of the allowance accrues when he becomes a partner, and it is the partner who recoups that allowance when he disposes of his interest."

This judgment illustrates the significant income tax consequences that can flow from the disposal by a partner of an interest in a partnership, where the partner has been claiming a proportionate share of capital allowances in respect of partnership assets. The principle laid down in this judgment must, logically, be applicable to all recoupable capital allowances.

It also needs to be borne in mind that the extinction or variation of a partner’s interest in a partnership can have capital gains tax consequences.

PricewaterhouseCoopers

Further comment:

The SCA made it clear that a partnership is not a taxable entity and therefore not a taxpayer itself. It further found that a recoupment occurs when a taxpayer recovers what he previously expended (for which he got a deduction), and that whether or not the asset is still in use, is irrelevant.

This case could have wide implications for both business and professional partnerships especially when new partners are admitted or retire. If for example, a partner in a professional practice retires or exits the partnership, he is deemed to have disposed of his interest in the partnership as well as in the underlying assets of the partnership. This means that he would have to account for recoupments on his pro rata share of tax allowances previously claimed on the partnership’s assets even if the underlying asset, on which the allowances were previously claimed, is not yet sold. It is hoped that SARS will bring out an Interpretation Note which provides clarity on the impact of this judgment.

MGI Bass Gordon

IT Act:S 1 , definition "person", S8(4) (a),S14bis, S24H (5) (b)

Editorial comment: This article deals with the Supreme Court of Appeal judgment. The lower court judgment was dealt with in item 1328 (September 2005).