DISQUALIFICATION AS A QUALIFYING COMPANY UNDER SECTION 12R(4)(b)

Income Tax Act 58 OF 1962, Section 12R(4)(b)
Binding General Ruling (BGR) dated 22 February 2022

The Department of Trade and Industry has established various special economic zones (SEZ’s) within designated areas in South Africa.

SEZ’s are geographically designated areas of a country set aside for specifically targeted economic activities, supported through special arrangements and systems that are often different from those that apply in the rest of the country.

These SEZ’s are supported by means of government-provided infrastructure, business support services and streamlined approval processes. A number of targeted tax incentives are provided by Government to ensure SEZs’growth, revenue generation, creation of jobs, attraction of foreign direct investment and international competitiveness, which include income tax, value-added tax (VAT) and customs-related incentives.

This BGR provides guidance on the interpretation and application of the excluded activities under section 12R(4)(b) conducted by a qualifying company located within an SEZ. It does not address any aspect of the accelerated building allowance available under section 12S. This ruling sets out SARS’s view.

Although a company may be classified a “qualifying company” as defined in section 12R(1), it may be disqualified from participating in the income tax incentive if it conducts an activity listed in either section 12R(4)(a) or an activity listed in the SIC Code as gazetted by the Minister of Finance under section 12R(4)(b). In this regard the Minister of Finance issued a Government Gazette listing the activities from the SIC Code that constitute a disqualifying activity by a qualifying company.

The problem arises in that some of the activities listed in the Government Gazette may constitute ancilliary activities to the main business of the qualifying company. Because the qualifying company may conduct any of these activities, it could be disqualified from participating in the income tax incentive.

The disqualified activities under section 12R(4)(a) relate to certain specific manufacturing activities that are not targeted as part of the income tax incentive. Section 12R(4)(b) allows for the Minister to proclaim through the issuing of a gazette certain further non-manufacturing activities to constitute a disqualifying activity. The list of non-manufacturing activities in the gazette relate mainly to ancilliary activities that support the main trade of a qualifying company.

Both, subsections 12R(4)(a) and (b) refer to “a company that conducts any activity” and “is not a qualifying company”. Applying the same strict interpretation under both paragraphs, as is required following the judgement in Western Platinum Ltd v C:SARS, would result in a qualifying company being disqualified to participate in the income tax incentive as it is conducting a disqualified activity under section 12R(4)(b), which may only be an ancillary activity to the main trade of the qualifying company.

SARS lists some examples in the BGR to explain this dilemma.

Example 1: An excluded ancillary activity conducted by a qualifying company

Company M, a qualifying company, carries on the trade of manufacturing electronic appliances in a designated SEZ. Company M packages the final manufactured product for its safe and secure transport. Customers are invoiced for the final product and not separately for the cost of packaging.

Result: The activity of packaging is listed as an excluded activity in Government Gazette 39930.

The packaging activity is a necessary activity in support of the manufacturing trade of Company M and is not conducted as a separate income-earning activity. As the packaging activity is ancilliary to the income-earning activity, Company M will not be disqualified from participating in the income tax incentive by virtue of the application of section 12R(4)(b).

Example 2: Excluded activity conducted by a qualifying company as a separate income-earning activity

Company D, a qualifying company, carries on the trade of manufacturing motor vehicles in a designated SEZ. Company D owns and operates a fleet of customised vehicles to transport the vehicles it manufactures to the harbour which is several hundred kilometres away, for export. On the return trip Company D, on behalf of other motor vehicle manufacturers situated in the SEZ, transports vehicles imported by such other companies for a fee.

Result: The activity of land transport is listed as an excluded activity in Government Gazette 39930.

The activity by Company D of transporting the vehicles it manufactures to the harbour will be considered a necessary activity in support of its manufacturing activity and will not be disqualified from participating in the income tax incentive under section 12R. However, the activity of transporting vehicles imported by other vehicle manufacturers is not a necessary activity in support of its manufacturing activity and will be considered as one of the dual-trades of Company D. Company D will be disqualified as a qualifying company under section 12R, as it conducts an excluded activity as envisaged under section 12R(4)(b), and is therefore not entitled to the income tax incentive for that year of assessment.

In essence, a qualifying company will be disqualified from the income tax incentive under section 12R for that year of assessment if it conducts any activity listed in the Government Gazette. However, where that activity is an integral part of the manufactured product to protect or transport the final product, it is accepted that it is not disqualified, provided the secondary product is not sold separately.

Further information about Special Economic Zones is available here: https://fincor.co.za/sezs-or-special-economic-zones/

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