[Question] Member's Loan - substance over legal form finance lease

[NTH]

There is a client who entered into an installment sale agreement with a motor vehicle financier.
The client has a history of always purchasing a company vehicle in the name of the company in the past.
However during one particular year the company was not in time for the trade in of its old vehicle for a new one and this caused the member to purchase it on an installment sale agreement but on the member's
own name.

The company then undertook to pay for the installments, and enjoyed the use and the operation of the vehicle.
The company pays for the fines, petrol, insurance and all costs relating to the maintenance and running of this vehicle.
The only assertion outstanding is that the vehicle is not in the name of the company. But the ISA is between the vehicle financier and the member himself.

Theoretically and legally, this vehicle cannot be recognized in the AFS of the company as its rights and ownership of the vehicle does not rest in the company's name.
However, the installments paid every month, as well as all costs mentioned above (petrol, fines etc) relating to this vehicle now forms part of the member's personal loan from the company.
Causing the member to owe the company literally the entire cost of the vehicle (all installments) as well as the other costs.

The vehicle was eventually traded in, for another one but this time in the name of the company.
Thus, the vehicle in question is now disposed of.

However, the loan owing by the member to the company (an asset) will never be repaid by the member because he argues that the vehicle was used for business purposes.
Because this loan is not recoverable, it clearly should be impaired.
However the impairment of this loan will look very odd in the AFS as well as the tax consequences.

My question is: can I argue the principle of "substance over legal form IAS 17)?
Meaning, I will recognize that vehicle (in the year it was relevant) as the company's vehicle between the company and the financier.
And it's corresponding ISA debt. (dr asset; cr isa debt)
And upon trading in , do the necessary gain/loss etc?
This in turn eliminating the member's loan account.

Or can one let the member create a lease agreement between him and the company, whereby he charges the company rental costs for the use of the asset, which eventually totals to all the installments raised
as the member's loan amount? I know that the member will have to declare this as income in his personal tax.
However I find this solution dodgy as the vehicle is not paid by the member so he has no right to claim rent from the company who is initially paying the vehicle's costs?

Is there another solution to the write off of this loan, in a manner whereby I can recognize that vehicle or some form of expense as technically that loan will never be recoverable as the
company enjoyed the benefits and not the member?

I feel that the first option seems the most accurate in presentation and fairness of the AFS.

Thank you.

[Andromeda]

NTH, I would personally use the second choice. I have to do this regularly and regard it as a hire transaction, not even a rental.

I understand your preference for the first option, but the company can never be the owner of the vehicle and you would have to look at impairing the whole thing. But if at the outset you intend impairing it, then you shouldn't be capitalising it in the first place. Your accounting policies probably state that pp&e is stated at initial cost ect etc. In this case you would be hard pushed to justify a cost.

[sterne.law@gmail.com]

There is another option

When you traded the vehicle, who got the benefit of that trade in?
I am guessing the company benefited by having a lower amount to pay.

[NTH]

Thank you for the responses. I'm glad that I am not the only one having to deal with this issue.

The trade in amount was net off against the debt still owing for the vehicle.
The vehicle was traded in within 2 years over a 6 year ISA.
And the company had to pay an additional amount to settle the debt too.

So the new vehicles purchased by the company had no trade in allowances as deposits to lower their principal debt.

If I were to raise it as a hire/rental cost, it would in substance be inaccurate.
The company is paying for the vehicle, not the member.
The member incurs no cost whatsoever for this vehicle.
The economic benefits flows to the entity and not to the member from this vehicle.
"indirect" control is thus vested in the entity and not member through substance.
It will seem dodgy for the company to deduct this as a valid rental expense when it is merely capital in nature to reduce a capital loan account?

Am I correct. Or are there other options for this dilemma?

[Dave A]

Who has been driving/having use of the vehicle?
Has the vehicle been used 100% for business use only?
Has there been any private use of the vehicle by the owner?

[NTH]

Who has been driving/having use of the vehicle?
Has the vehicle been used 100% for business use only?
Has there been any private use of the vehicle by the owner?

It is a luxury vehicle, an SUV.
The member uses it for business (to from work, clients, business trips etc) and personal (taking it home and over weekends).
The company always purchased these SUV's in its name and the member always used it as mentioned above.
So the nature of the use of this vehicle in question remained the same to how it would have been used if owned by the company.

I know that this gives rise to fringe benefits and tax in the hands of the member.
As well as an additional employee benefit expense (personal use portion) in the records of the company.

So because of the nature being the same as it was if owned by the company, it is why I thought that I could use the principal of IAS 17 sub/legal form.

If not, then what other way is there for me to write down this loan that the member does not want to repay or cannot repay as he is clearly stating that the loan was due to his company
not meeting a deadline to buy the vehicle? And because of that he just took it on his name, with the company literally being the indirect lessee?
It is quite a dilemma for me.

[Dave A]

I trust a log book recording business vs private travel is available.

You present two scenarios.

1. The member is acting as an agent of the company. All expenses are dealt with in the company's hands and the member incurs a fringe benefit tax liability.
2. The member rents the vehicle to the company. The rent is treated as income to the member, who in turn will be able to claim allowable expenses in the generation of that rental income.

The third scenario that comes to mind is a variant on scenario 2 - the company pays a per-kilometer travel claim i.r.o. the business use portion. Similar tax treatment to scenario 2 applies.

As long as there's no evidence of tax avoidance, ordinarily SARS's interest is simply that the tax liability is appropriately reported and paid over.

Personally I'm kinda curious if you follow those through all the way, which one works out to be the most tax efficient overall.

[Andromeda]

NTH, is the purchase agreement an Instalment Sale or a Finance Lease Agreement?

You actually have two issues with this, financial reporting in the AFS, and then the tax issues of the company and of the director. That being the case, the exact nature of the purchase agreement is important.

[Moriarty]

My question is: can I argue the principle of "substance over legal form IAS 17)?
Meaning, I will recognize that vehicle (in the year it was relevant) as the company's vehicle between the company and the financier.
And it's corresponding ISA debt. (dr asset; cr isa debt)
And upon trading in , do the necessary gain/loss etc?
This in turn eliminating the member's loan account.

Given the history of company vehicle purchases and subsequent trade in of the vehicle in question plus the law of agency:

"Agency

What is an Agent?

An agent is one who performs a service for a principal, a service that the principal may find impracticable, inconvenient, or difficult to do for himself, and which he proposes to do through another. In legal terms, the agent’s activities are most commonly concerned with the formation, variation, or termination of contractual obligations. An agent has the ability or power to do certain acts which will alter his own or another’s legal position.[1]

An agent is empowered to enter into, vary or terminate a specified contractual obligation, or a specific contract as a whole, contracts or contractual obligations of a specified class, or contracts or contractual obligations generally. The obligation, obligations, or contracts usually being those of the principal and not the agent.[2]

Actual Authority

The actual authority of an agent is where parties expressly or impliedly agree that one shall have power to act for and on behalf of the other. Such authority is usually given before action is taken. It may also be given with retrospective effect with ratification by the principal.[3]" http://www.straussdaly.co.za/2016/10...dacom-blunder/

I would agree that substance over form applies and that the fairest presentation in the AFS would be treating the vehicle as an asset in the hands of the company with the appropriate related party disclosures in the notes. Or am I missing something?

[NTH]

Thank you all for the assistance and recommendations on this matter, I really appreciate it.

After careful consideration and looking back at the documentation, I think that the substance / form is a rather tough argument to prove when it comes to tax/legal compliance and moral practice.
It's clear that the member wants this loan to be written off to get the balance sheet healthy and to make his benefits from the company appear less.
Also, it is difficult to argue the substance when the nature of the vehicle is both personal and business. (Easier if it were a machine or delivery vehicle)

From a legal matter, I think the rental idea is the best. Unfortunately with that comes the tax implications on his personal side which one cannot do much about but what Dave A mentioned.
That said, I'll recommend the rental idea to him, and in the end it is his choice to follow through with all of that admin. But for now it stays as a loan in the AFS.

However I don't think that I will follow through with capitalizing the vehicle as clearly the nature of it being both personal / business is already a problem, as well as the fact that
the trade in of the vehicle never granted an allowance deposit for the new one, which means the company never even benefited out of this trade in at all either.
Also, it wasn't the company's decision to trade in the vehicle in such a short period of time, it was his, so indirectly he is controlling matters.
All signs that it was for personal benefit.

If the rental isn't what he wants, then unfortunately paying back the loan is the only option and in future he will need to consider increasing his salaries to account for
all his future expenses that the company pays on behalf of him. (In turn increasing his personal tax liability).

Sad story but I guess a lesson learnt is seeking advice from one's accountant or tax practitioner first before purchasing items which could have these implications on the AFS.