How Ghana tax laws undermine capital creation and private sector growth: The case of maintenance expenses.

On January 1st, 2016 Act 896 of the Income Tax Act 2015 came into effect, superseding Act 592 of the Internal Revenue Act 2000.

Act 896 made significant changes to the rules for deducting repairs and maintenance expenses.

In this article, I will discuss the maintenance expense rules and their effect on investments by:

  • Comparing the rules in Income Tax Act 2015 (Act 896) to Internal Revenue Act 2000 (Act 592), the earlier law.
  • Comparing our rules with those of Nigeria and South Africa.
  • Assessing the effect on profits and investment.
  • Making recommendations.

What is the rule for deducting maintenance cost?

Section 9 of Act 896 sets out the fundamental rule for deducting expenses.

The rule is: an expense that is wholly, exclusively, and necessarily incurred in producing the income from investment or business shall be deducted in calculating taxable income. Expenses that are of a capital nature are not deductible.

Section 12 of Act 896 sets out the specific rules for repairs and maintenance. The section recognizes the rule in section 9 and adds the following restrictions:

  • Limits the deduction for maintenance cost of an asset to 5% of the written down value of the pool of assets. For capital allowance (tax depreciation) purposes, assets are grouped into defined pools. The balance after deducting capital allowance from the cost of the pool is the written down value (WDV).
  • Maintenance cost that is not allowed because it exceeds 5% of the written down value of the relevant pool must be capitalized and recovered through future capital allowances.

 

Comparison of maintenance rules in Income Tax Act 2015 (Act 896) to Internal Revenue Act 2000 (Act 592).

  Income Tax Act 2015 (Act 896) Internal Revenue Act 2000 (Act 592).
Fundamental rule Section 9 – expenses that are wholly, exclusively and necessarily incurred in the production of income from business or investment shall be deducted in ascertaining taxable income for the year. Section 13 – for ascertaining income from any business, employment or investment there shall be deducted:

a)       All outgoings and expenses wholly, exclusively, and necessarily incurred in the production of that income

Maintenance expense specific rules Section 12

a)       Deductions for maintenance to an asset shall not exceed five percent of the written down value of the pool at the end of the year.

b)      The excess expense that is not deducted because of the limitation in a) shall be added to the pool to which it relates.

Section 16 states that:

“For the purposes of ascertaining the income of a person for a basis period from any business or investment, there shall be deducted any outgoing or expense incurred during the period in respect of:

a)       The repair of any premises, plant, machinery, or fixtures, or

b)      The renewal, repair, or alteration of any implement, utensil, or article, to extend that the premises, plant, machinery, fixtures, implement, utensil or article is employed by that person in the production of the income”.

 

Under Internal Revenue Act 2000, Act 592, the only requirement for maintenance expense to be allowed is: the expense is “wholly, exclusively and necessarily” incurred for generating the income subject to tax. This has been the historical treatment of maintenance expenses.

 

Comparison of our rules to those of Nigeria and South Africa.

Ghana Nigeria South Africa
Section 9 of the Income Tax Act, 2015 – expenses that are wholly, exclusively, and necessarily incurred in the production of income from business or investment shall be deducted in ascertaining taxable income for the year.

Section 12

a)       Deductions for maintenance to an asset shall not exceed five percent of the written down value of the pool at the end of the year.

b)      The excess expense that is not deducted because of the limitation in a) shall be added to the pool to which it relates

Sect 24 of the Companies Income Tax Act (CITA), No. 28 of 1979 as amended to a date set out the rules for deduction allowed for income tax determination.

Extract of S 24 (e) of CITA.

For the purpose of ascertaining the profits or loss of any company of any period from any source chargeable with tax under this Act, there shall be deducted all expenses for that period by that company wholly, exclusively, necessarily and reasonably incurred in the production of those profits including, but without otherwise expanding or limiting the generality of the foregoing:

  • Any expenses incurred for repairs of premises, plant, machinery or fixtures employed in getting the profits, or for the renewals, repairs or alteration of any implement, utensils or articles so employed.

 

The deductibility for CIT purposes is based on the provisions of what we refer to as the General Deduction formula which is set out in Section 11(a) of the South African Income Tax Act No. 58 of 1962.

Section 11(a) reads as follows: “For the purposes of determining the taxable income derived by any person from the carrying on any trade, there shall be allowed as deductions from the income of such person so derived – (a) expenditure and losses actually incurred in the production of income, provided such expenditure and losses are not of a capital nature”

So, the base principles that need to be considered to achieve a deduction are:

  1. The expense must have been incurred or accrued.
  2. It must have been incurred in the production of the taxpayer’s taxable income.
  3. And must not be of a capital nature.

 

Similarities

All three jurisdictions:

  • Recognize the difference between revenue and capital expenditure. Revenue expenditure is expenditure to keep the productive capacity of the asset. Capital expenditure extends or enhances the productive capacity of the asset.
  • Allow revenue expenditure to be deducted from income in the year of expenditure, while capital expenditure is not.
  • Require that the maintenance expense has been incurred in the production of income.

Differences

In South Africa, the expenditure must be incurred in producing the income. In Ghana and Nigeria, you must meet other requirements before you can deduct the expenditure. The other requirements are:

  • Ghana – the expense must be wholly, exclusively and necessarily incurred.
  • Nigeria – the expense must be wholly, exclusively, necessarily, and reasonably incurred.

Ghana is the only country that puts a monetary limit on the amount that can be deducted after all the other conditions have been met.

The problem with the Ghana Law

 The treatment of maintenance expenses was comparable to the treatment in Nigeria and South Africa until the passage of Act 896. The limit on maintenance expenses is problematic for the following reasons:

  • The law requires that the excess expenditure that is not allowed be capitalized as part of the relevant pool. This treatment defies the globally accepted principle that revenue expenses are charged to income in the year of expenditure. It also breaks the principle in the law that only expenses of a capital nature should be capitalized.
  • What is the basis for the 5% limit? Is it based on data from all industries? Until data is provided to prove the choice of 5% as a limit, I will assume that this is an arbitrary number.
  • Why written down value? Written down value is a historical cost. In an economy plagued by inflation and currency depreciation, current costs tend to be higher than historical costs.
  • It costs more to maintain an old machine than a new one. Unfortunately, the written down value of the pool also reduces with time. The 5% of written down value of the pool severely limits the amount that can be deducted in the tax year. This may negatively affect capital-intensive industries such as manufacturing, construction, and mining.
  • Who is best placed to decide maintenance strategy? Is it the government or the entrepreneurs and business managers? My view is business managers should decide the maintenance strategy and not government.

The limit on maintenance expense deduction boosts taxes. The government seems eager to tax, without regard to fairness or effect on goals such as attracting investment and growing stronger businesses that leads to job creation.

Impact on businesses and investment

The effect of the law:

  • Discourages maintenance to preserve production capacity, capital-intensive businesses such as manufacturing, construction, and mining must maintain capital assets regularly. This restriction discourages maintenance, hurts production capacity and discourages investment. Ghana does not have enough capital-intensive businesses. It needs to attract, not repel such businesses.
  • Higher taxes – limiting deduction for maintenance, leads to a tax higher than it should be if maintenance expenses are fully deducted. The higher tax reduces returns to shareholders and the cash available for reinvestment. This is a disincentive to investment.

International investors may also consider tax laws in their decision-making process. Our maintenance expense rules are not competitive with that of Nigeria and South. We are at a competitive disadvantage in the effort to attract capital-intensive industries e.g. manufacturing.

My Recommendations

  1. Remove this restriction

This restriction is unfair. It also deters investment in capital-intensive businesses.

  1. Pursue equity in taxation

There must be equity in taxation. Changing tax laws to reduce deductions for maintenance expenses is unfair and unwise. Investors consider tax laws when making investment decisions. Governments have the power to make tax laws, but it is investors who decide whether to invest or not.

  1. Prioritize international competitiveness

Nations compete to attract capital-intensive businesses. Compared to Nigeria and South Africa, Ghana is not attractive. Maintenance cost is significant for such businesses.

In Summary

The government must remove the limit on deductible maintenance cost. It is arbitrary. It breaks the basic rule that expenses that are “wholly, exclusively and necessarily” incurred can be deducted in full to calculate income tax. It deters investment in capital-intensive businesses, which are the sort of businesses we need to solve unemployment.

Written by Collins Boateng

Collins Boateng is a partner in SCG Chartered Accountants.