Section 12I

Participants:
Phil - Phil Richards
Greg - Greg Tarrant

Phil: Good day. My name is Phil Richards from PwC, and I am joined by my fellow PwC colleague Greg Tarrant. We’d like to spend the next 10 or 15 minutes talking to you about the Industrial Policy Project incentive which is set out in section 12I of the Income Tax Act. In the interest of time, we will limit ourselves to a high level discussion on the benefits the section affords and the requirements to qualify. If you require any further assistance please feel free to contact us.

Lets kick off by asking you, Greg, what the purpose of section 12I is.

Greg: Thanks, Phil. Section 12I is an incentive aimed at encouraging investment in strategic industrial projects by granting an additional investment allowance on industrial assets.

The incentive is called the Industrial Policy Project incentive (or IPP for short) and it is the successor programme to the Strategic Industrial Project incentive (or SIP for short) which is housed in section 12G of the Income Tax Act.

The Industrial Policy Project allowance is one of Governments means of achieving the goals of the National Industrial Policy Framework – one of which is the creation of more jobs. In fact, you may recall that President Jacob Zuma committed R20 billion to further employment in South Africa in his State of the Nation Address in February this year. When making this commitment he was referring specifically to section 12I.

Phil: Thanks Greg. You mention that section 12I provides an additional investment allowance…what additional allowances does it provide?

Greg: Well, typically, plant and machinery used in a process of manufacture (or a process similar to a process of manufacture) will qualify for an allowance under section 12C of the Income Tax Act. Where the plant is new and unused section 12C provides for an accelerated allowance over a four year period in the ratio: 40%; 20%; 20%; 20%.

Section 12I provides for a once-off additional capital expenditure allowance over and above the section 12C allowance. The quantum of the section 12I allowance depends on certain factors but is initially limited to either 35% (or 55% in the case of projects with preferred status) of the cost of the manufacturing assets.

In the case of greenfield projects, the maximum capital allowance is limited to R550 million (or R900 million in the case of a project with preferred status). In the case of brownfield projects the maximum capital allowance is limited to R350 million (or R550 million in the case of a project with preferred status).

The additional allowance may be claimed in full in the year in which the manufacturing assets are commissioned, i.e. total allowances for approved projects will be 135% (or 155% in the case of projects with preferred status) of the cost of the manufacturing assets with 75% or 95% being deductible in the year the plant is first brought into use. As with the section 12C allowance, there is no apportionment of the section 12I allowance for assets brought into use part-way through the year.

Phil: Wow, OK. So if you qualify you can get an additional 35% or 55% writeoff in the year you commission the assets – depending on the circumstances.

Greg: That’s right. But over and above additional writeoffs, section 12I also gives you additional deductions for training costs.

Training costs may be deducted under section 11(a) of the Income Tax Act. Where the training costs also satisfy the provisions of section 12H (learnership agreements) an additional deduction may be claimed.

Section 12I incentivises the provision of training even further by providing an additional training allowance for qualifying industrial projects. I.e. in certain circumstances a triple deduction of training costs can be achieved.

One more thing I would like to add - a further advantage of the additional investment allowance is that any assessed loss that arises to the extent of the allowance is increased on an annual basis for a period of 4 years from the date of approval of the project so as to preserve the value of the tax incentive.

Phil: OK, so section 12I gives you additional writeoffs on qualifying plant and machinery and additional training allowances – what then are the requirements to qualify…and what is the difference between a Greenfield and a Brownfield project?

Greg: Section 12I applies to greenfield manufacturing projects (that is, where a wholly new manufacturing facility is contemplated) and brownfield projects (that is, expansion projects). Different spend and qualification criteria apply depending on this project classification.

From a project spend criteria…in the case of a Greenfield project the the minimum spend on manufacturing assets is R200 million. In the case of a brownfield project the minimum spend is calculated as the lesser of R200 million or 25% of the expenditure incurred on existing assets with a floor of R30 million. This can be confusing – in the case of Brownfield projects just work with the minimum cost for qualifying asset as being R30 million.

Also, in addition to the project spend requirements, there are other pre-requisites for a project to qualify for approval. They are energy efficiencies and skills development. These are the over-arching requirements of the industrial policy programme and the Regulations detail specific targets which must be met before a project can claim to have met these requirements.

Phil: Regulations – what regulations?

Greg: Yes, whilst the provisions of section 12I were promulgated more than a year ago (2008, in fact), the application and project adjudication criteria are governed by Regulations, without which, potentially qualifying projects have been unable to apply. The Regulations were gazetted in July 2010.

Phil: So what do these regulations provide?

Greg: Well, we’ve spoken about greenfield and brownfield projects and the minimum spend requirements. We’ve also mentioned the overarching requirements of the incentive, namely energy efficiencies and skills development.

There are other requirements as well. Section 12I stipulates these requirements and the Regulations clarify their application.

Phil: Can you give some examples of these additional requirements and the basis for their application?

Greg: Sure. The Regulations adopt a balance scorecard approach to the requirements listed in the Act. In order to meet approval a project must achieve a minimum of 5 points (8 in order to achieve preferred status) out of a maximum of ten, against a scorecard that covers:

• Innovation;
• Energy efficiency;
• General business linkages;
• Procurement of goods and services from SMME’s;
• Direct job creation; and
• Skills development.

Phil: That sounds like quite a difficult list to fulfil.

Greg: It is, and any company looking to qualify must first seek approval from the Department of Trade and Industry and ultimately the Minister of Trade and Industry.

Phil: Ok, so pre-approval is necessary.

Greg: Yes, mandatory. And very importantly, approval must precede the date on which the assets are contracted for.

Phil: You mentioned that an over-arching requirement was energy efficiency. This also appears on the list of scorecard requirements.

Greg: Ja. Clearly any industrial projects must be energy efficient in order not to place too much demand on our already overburdened energy supply. In order to qualify projects must demonstrate how they are going to be energy efficient.

Phil: Are there any industrial projects which won’t qualify or any circumstances where approval won’t be granted?

Greg: Yes. Very importantly, any project which falls outside of Major Division 3 of the Standard Industrial Classification Code will not be considered for approval. In addition, the following manufacturing projects are specifically excluded: the manufacture of alcoholic beverages, tobacco products, arms and ammunition; and bio-fuels which impact negatively on food security.

Also, any project which receives a concurrent benefit / incentive may be denied approval. Concurrent benefits include any benefit received in terms of the Automotive Production and Development Programme (excluding automotive component manufacturers), the Small Medium Manufacturing Development Programme, the Productivity Asset Allowance, the Small Medium Enterprise Development Programme; or any other programme of any national sphere of Government which provides grants, subsidies etc (unless immaterial).

Phil: Ok, our time is almost up. Greg can you give a 1 minute summary?

Greg: Sure Phil.

Section 12I provides qualifying industrial projects with a supercharged writeoff of assets as well as a potential triple deduction on training allowances. There are certain project spend as well as other minimum requirements which must be adhered to – the requirements for which are set out in the Act and the Regulations. Pre-approval is required.

Phil: Thanks Greg. To end off, we would like to inform you that PwC is able to assist you with seeking approval for the Industrial Policy Project Incentive. Is this not so, Greg.

Greg: Yes, Phil. We review proposed projects to determine whether they could qualify for the section 12I allowances and to point out potential risks to successfully applying for approval;

We advise on how to structure and/or implement projects in order to increase probability of successfully applying and maximise scorecard points;

We conduct section 12I applications on behalf of clients and project manage the application process;

We do cost analyses, budget projections, feasibility and viability studies, as well as financial and cash flow implications of expected tax savings.

Phil: Thank you Greg for your valuable insights and good bye to our listeners.

Greg: Thank you, Phil, goodbye.