Possible tax treatments of the transfer of accounting provisions during he sale of a business and subsequent tax considerations

The potential buyer of a business evaluates the attractiveness of the transaction byconsidering the financial status of the business being sold. In determining thefinancial status of a business it is more important to determine the nature of the assetsand liabilities recorded on the balance sheet rather than the mere existence thereof.Included in the liabilities are accounting provisions recorded in terms of the GenerallyAccepted Accounting Practice (GAAP) to reflect a fair representation of the financialstatus. Although these provisions are made for accounting purposes, they cannotnecessarily be deducted under the terms of the Income Tax Act, no 58 of 1962. Thetax deductibility of accounting provisions has long been a potential contention when abusiness is sold.The Income Tax Act has specific sections that must be applied in determining thedeductibility of accounting provisions, for example, section 11(a), which is the generaldeduction formula; section 23(g), which prohibits expenses not laid out for thepurposes of trade; and section 23(e), which does not allow a deduction when areserve fund is created (for example a leave pay provision).In conducting this study, seven types of accounting provision generally recorded bybusinesses were identified: the bonus provision, leave pay provision, warrantyprovision, settlement discount and incentive-rebate provision, post employmentprovision, retrenchment cost provision and other provisions. These provisions arediscussed in view of their possible income tax deductibility, and relevant case studieswere identified to confirm the possible deductibility of these accounting provisions.In this study, the transfer of accounting provisions during the sale of a business isconsidered for the purposes of both the buyer and seller. The tax implications for thebuyer and seller are then evaluated, as well as the subsequent treatment of the accounting provisions for the purposes of the buyer. Because the wording of thepurchase contract is extremely important when a business is acquired, three examplesof the wording of a purchase contract are discussed as well as the income taximplications thereof.The extent of the advice given by a tax practitioner will depend on the allegiance of thepractitioner (either for the buyer or seller) and will determine how the contract will beconcluded. In conclusion a tax practitioner would want to assist his client to obtain themost effective tax position for the transaction and therefore each purchase contractmust be reviewed on its own set of facts.