Muses of a retired tax accountant MUSING ON SOME THORNY QUESTIONS ON THE TOTAL ASSET METHOD (8 of 13)

8.2 The “direct” in direct identification and tracking

“Direct” means without intervening factors or intermediaries; with no one or nothing in between.?

“So, in your example above, if the specific loan proceeds first went into another bank account before paying out to the vendor of the assets, the direct test is not met?”

“On the face of it, yes.”

“Stop throwing qualifications at me! Cut to the chase, please!”

“When a bank disburses a loan, it pays the loan amount into your bank account and is available for your use. On the face of it, the loan proceeds come to you first before they go to the asset vendor. Your bank account becomes the ‘something or someone in between’”.

“So, in this instance, the direct test is not met?”

“Right, if the tax regulator applies the eTaxGuide as the law and gives the strictest meaning to ‘direct’.”

“Don’t you think the eTaxGuide should explain the conditions when this direct test is and is not met?”

“Yes.”

8.3 Some thoughts on asset funding out of bank overdraft

“What is this about?”

“This one is about direct identification and tracking of fundings made out of overdraft accounts or bank facilities with features of a bank overdraft.”

“Really? Spit it out!”

Interest is paid or payable on a borrowing. No interest is payable when the borrowing is repaid or extinguished.

“Kindergarten stuff. I understand. Go on.” Voice urged impatiently.

Assume we have three overdraft withdrawals on three separate dates, say Borrowings-1, -2 and -3. The bank charged interest on each drawdown.?Borrowing-1 was taken out to pay for a non-income-producing asset.

After Borrowing-1 was repaid, no matter what interest the bank charged, none would be for Borrowing-1. Contractually, the lender cannot charge interest on this drawdown after it was repaid. That also meant whatever the lender charged for interest after the repayment of Borrowing-1 could only be for Borrowings-2 and -3.?

The core of this thinking? No interest can be incurred on a borrowing that has been repaid.

?“What’s so important about this, err, ‘discovery’?’”

Not a discovery. Just a factual reality.

“The interest expense for the Section 14(1)(a) deduction claim is what is actually charged by the lender. The taxpayer’s job is to identify the borrowing, track its use, and calculate the interest charged from the initial drawdown to the repayment of the borrowing.”

“The reality is the interest the lender charges for the actual use of the funds in an overdraft account. The assumed use to fund all the company assets at balance sheet date is not the reality.”

“So, one way of looking at it is this. The underlying assumption (and its two extensions) in the eTaxGuide overrides Section 14(1)(a).”

“Wait. Start with what you mean by the reality.”

“Remember my earlier muses on the first and second extensions of the underlying assumption?”

“The eTaxGuide says any interest on borrowings other than the interest on specific loans to fund asset acquisition is a common interest expense. As a common interest expense, it is assumed to have been paid on borrowings to fund the total asset of a company.”

“Yes. Yes. Yes. Get to the point!”

A drawdown from an overdraft to fund an asset purchase is always identifiable. The bank charges interest on this from the date of the drawdown. Subsequent payments into the overdraft account progressively reduce this borrowing from the bank until it is fully repaid. By then, the bank charges no interest on this drawdown.

The eTaxGuide sweeps aside the reality that the tranche taken from the overdraft to pay for, say, a non-income-producing asset has been repaid. It assumes the interest expense paid on subsequent sums taken from the overdraft is paid on borrowings to fund this asset purchase. Thus, interest on borrowings having nothing to do with the asset funding is apportioned to the non-income-producing asset for disallowance. This would not have happened under Section 14(1)(a).

Effectively, the eTaxGuide (or, more accurately, the administrative discretion) has the force to override what Section 14(1)(a) allows.

“You think they will buy this?” Voice asked with a wink.

“No idea. What I think is irrelevant…..”

“It is what the court thinks that counts!” Voice again finished the sentence for me.

Then Voice fell into deep thought.

“Wonder what the court thinks when it looks at all these assumptions embedded in the TAM.”

I wanted to hear no more of his random thoughts. I banished him with a hard kick on his butt.

(Continue in the next instalment.)?

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