Depreciation vs Wear and Tear Allowances in South Africa

Depreciation vs wear and tear is the difference that catches out more South African owner-managers than any other item in the tax computation. You wrote the asset off over five years in the accounts, SARS allowed something else entirely, and now there is a deferred tax balance in the financial statements that nobody can explain.

The two numbers answer different questions. Depreciation answers how much of the asset your business consumed this year. The wear and tear allowance answers what the Income Tax Act permits you to deduct. They are calculated separately, they almost never agree, and the gap between them is not an error.

Two sets of numbers, one asset register

The practical consequence is that your fixed asset register needs two parallel columns for every asset: a book column carrying cost, accounting depreciation and carrying amount, and a tax column carrying the allowances claimed and the remaining tax base. Keeping them in separate spreadsheets is how reconciliations get lost between accountants.

It also assumes the register reflects what is physically on site. If assets have been scrapped, moved or replaced without the register being updated, both columns are wrong. Our guide to running a fixed asset verification sets out how to bring the register back to reality before year end.

How the accounting depreciation charge is set

Under IFRS and IFRS for SMEs, depreciation allocates the depreciable amount of an asset over its useful life to your business. Three judgements drive it, and all three are yours to make and defend:

• Useful life, being the period over which you expect to use the asset, not the period the manufacturer quotes and not the period SARS allows.
• Residual value, the amount you expect to recover on disposal. A meaningful residual reduces the annual charge.
• Method, usually straight line, but reducing balance or units of production where that better reflects the pattern of consumption.

These are estimates and must be reviewed at each reporting date. A change is a change in accounting estimate, applied forward, not a restatement of prior years. Componentisation matters too: a delivery vehicle and its refrigeration unit may have quite different lives.

What the Income Tax Act allows instead

The tax deduction is not depreciation at all. It is a capital allowance granted by a specific section of the Income Tax Act, and which section applies depends on the asset and the trade it is used in.

Two conditions are worth repeating because they are where claims fail: the asset must be used in the production of income in the trade, and the allowance is generally apportioned for the part of the year the asset was brought into use.

Where the two numbers separate

Put the two treatments side by side on a single asset and the pattern is easy to see. The total deduction over the asset's life is broadly the same. The timing is not, and timing is what creates the deferred tax.

How the difference lands in deferred tax

Deferred tax is simply the tax effect of the gap between an asset's accounting carrying amount and its tax base. When accelerated allowances have written the asset down faster for tax than for accounting, the carrying amount exceeds the tax base and you recognise a deferred tax liability.

1. 1Take the carrying amount of each asset class from the register at year end.
2. 2Take the tax base, being cost less the allowances claimed to date.
3. 3Calculate the temporary difference as carrying amount less tax base.
4. 4Apply the enacted corporate tax rate to that difference to get the deferred tax balance.
5. 5Move the balance from the prior year through profit or loss, and disclose the movement in the deferred tax note.

Getting it right in the tax computation

In the company tax return, accounting profit is the starting point. Depreciation is added back because it is not deductible, and the capital allowances are then claimed as a separate deduction. On disposal there is a further step: recoupment of allowances previously claimed is brought back into income, and any capital gain is dealt with under the Eighth Schedule.

Get the schedule wrong and the error repeats every year until someone rebuilds it. Our walkthrough of the ITR14 company tax return shows where the add-back and the allowance sit on the return itself, and if the asset base is a large part of your balance sheet you should also read our guide to independent review versus audit requirements before deciding what assurance you need over it.

How Synergy helps

We build and maintain dual-column asset registers, run the physical verification that keeps them honest, calculate the allowances by provision and prepare the deferred tax workings that support the financial statements. That work sits in our asset management service, and the resulting tax computation is handled by our tax services team so the register, the accounts and the return all tell the same story.