Funny Tax Laws

Humour is not the first thing that comes to mind when you think of accountants and lawyers, but somehow, a joke has slipped into the South African Tax Code.

It concerns depreciating assets, but before you can depreciate… ahem… appreciate the joke, you need a little accounting background. In the world of accounting, assets depreciate in one of two ways:

  • Linearly: Called “the straight-line method”
  • Exponentially: Called “the declining-balance method” (or “diminishing-value method”)

Methods of asset depreciation

Although straight-line depreciation is the simplest method, it is (for most types of assets) not an accurate reflection of reality. The true value of most assets depreciates faster when they are new, so the taxpayer should be able to claim higher tax deductions earlier in an asset’s life (which, of course, helps cash-flow).

The “declining-balance” method is the logical solution to this inaccuracy, but it introduces another problem: assets never reach the end of their life, but just decay away ad-infinitum, burdening the accountant with inconsequential little bits and pieces of depreciation from ancient assets.

Most countries fix these two problems by allowing the taxpayer to choose between the two methods. For example, a US taxpayer has the following options for an asset with a nominal 5 year life:

  • The straight-line method at 20% pa
  • The declining-balance method at 40% pa

This choice gives rise to what is sometimes called accelerated depreciation, wherein the taxpayer begins with the declining-balance method and switches over to the straight-line method when the latter becomes more gainful, giving the accuracy of the declining-balance method, and the finite life of the straight-line method – the best of both worlds. (See the plot of accelerated depreciation in the US, below.)

Now, the South African Revenue Service clearly tried to emulate this widely-used system, but somehow ended up using the same rate (e.g. 20% for a 5-year asset) for both methods. Unfortunately this defeats the object. From the plot above, the declining-balance method at 20% pa clearly has a much longer life than 5 years. In fact, the method leaves the asset with 33% of its original value at what was supposed to be the end of its life. Soon enough, the taxpayer will realize that, for all his accounting efforts, he is only getting left behind, and switch over to the straight-line method. This gives us a very unique South African version of “accelerated” depreciation, which can more accurately be called decelerated depreciation.

What a joke

In effect:

  • Other countries’ tax codes say:  You can claim accelerated depreciation, but it requires more comprehensive accounting.
  • SARS says: You can do the thorough, comprehensive accounting, but then you will have to lend us additional money. So just forget about it and use the straight-line method.

References:

  1. United States Code: Section 26,168 (b)(1)
  2. SARS Binding General Ruling (Income Tax) No. 7: Example 2


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