General Deductions

Chapter 6

Part 1
TAA117V
Learning Outcomes:

Demonstrate an in-depth knowledge of the general deduction formula and the application
thereof through relevant case law principles by identifying an amount as a deduction in
practical scenario.

Identify and explain whether an amount should be disallowed as a tax deduction.

 Income/Normal Tax – Framework

Gross Income XXXX

Less: Exempt income (XXX)
Income XXX
Less: Deductions and allowances (XX)
Less: Assessed loss (XX)
Add: Other amounts included in taxable income (E.g., recoupment) XX
Add: Taxable Capital Gain XX
Less: Deductions in terms of s 11F (To be covered in second semester) (XX)
Less: Deductions in terms of s 18A (XX)
Taxable Income XXXX
Normal Tax @ 27%/ or tax per table XXX
Less: Tax rebates and tax credits (XX)
Normal Tax Payable or (Refundable) XXXX
Introduction

After establishing income, the next step is to

determine DEDUCTIONS for income tax
purposes.

Certain “RULES” that need to be met before

an expense can be deductible for tax
purposes.

Expenses can be deducted in terms of:

• general deduction formula (s11(a) read with s23),
• special deduction (s11(c) to s 11(w)), or
• Other deductions (s 18A and ss 22 to 24)
General Deductions

General
Deduction
Formula

Positive test Negative test

Section 11(a) Sections 23

General Deduction Formula.

 Elements of General Deduction Formula ( s 11(a) and 23(g)):

 Expenditure and Losses
 Actually incurred
 During the year of Assessment
 In the production of income
 Not of a capital in nature.
 To the extent that it is laid out or expended for the purposes
of trade (s 23(g)).
What is the responsibility of the
taxpayer ?

 In terms of section 102 of the Tax Administration Act,

 It is the responsibility of the taxpayer to prove that an
amount or item is deductible.
General Deduction Formula –

expenditure and losses

Not defined in the Income Tax Act

Court Case laws are used to interpret its meaning

Three court cases:

• Labat Africa Ltd
• Joffe and Co
• Port Elizabeth Electric Tramway
Expenditure and Losses –

Labat Africa Ltd

Facts:
• Purchased an intangible asset (a trademark)
• Pay for the trademark by issuing its own equity shares
to the owner of the trademark.

Issue:
• Is Labat entitled to claim allowances on the
trademark?
Expenditure and Losses –

Labat Africa Ltd

Judgement:
• Labat is not entitled to allowances in respect of the trademark
• As it does not incur expenditure when it issues its own shares as a
consideration to another person.
• This is based on the view that the company’s net assets do not diminish
when it issues its own shares.

Principle:
• The ordinary meaning of expenditure refers to the action of spending
funds; disbursement or consumption; and hence the money spent.
• This also include the disbursement of other assets with a monetary
value.
• Expenditure requires a diminution (even if only temporary) or, at the very
least, movement of assets of the person who expends.
Expenditure and Losses –

Joffe & Co
Facts:
• The company carried on a concrete engineering business.
• A concrete hood, which the company, was supervising,
collapsed; killing a workman.
• The hood killed a workman because the company was negligent.
• The company paid workman’s widow a compensation.

Issue:
• Is the compensation to the widow and legal costs deductible?
Expenditure and Losses –

Joffe &Co
Judgement:
• The word loss has several meaning ; that in the
context of a provision almost identical to s 11(a)
• Its meaning was somewhat obscured, and that it was
not clear whether it meant anything different from
expenditure .

Principle:
• The word loss has the same meaning as the word
expenditure.
Expenditure and Losses –

PE Electric Tramway

Facts:
• A driver employed by the taxpayer died as a result of
injuries sustained from an accident.
• The taxpayer paid damages to the driver’s widow and legal
costs resisting the claim.

Issue:
• Is the compensation to the widow and legal costs
deductible?
Expenditure and Losses –

PE Electric Tramway
Judgement:
• The word loss means losses of floating capital employed in
the trade which produces the income.

Principle:
• The word loss means losses of floating capital employed
in the trade which produces the income.
Expenditure and Losses –

Watermayer CJ
 In relation to trading operations the word loss is sometimes used to
signify a deprivation suffered by the loser, usually an involuntary
deprivation, whereas expenditure usually means a voluntarily
payment of money.
General Deduction Formula –

Actually Incurred
Not defined in the Income Tax Act

Court Case laws are used to interpret its meaning

Three court cases:

• Nasionale Pers Bpk
• Edgars Stores
• Golden Dumps (Pty) Ltd
Actually Incurred –

Nasionale Pers Bpk

Facts:
• Taxpayer claimed a provision for bonuses as a deduction.
• The amount was only payable at a future date.
• The provision was raised for the liability as a result of the
employees working for a full year and becoming entitled to
their bonus.
Issue:
• Is the provision expense actually incurred during the year of
assessment?
Actually Incurred –

Nasionale Per Bpk

Judgement:
• Bonus was payable in a future date (another year of
assessment)
• Provided the employee was still in the employment of the
Company.
• This is an uncertain future event, and the expenditure can
only be actually incurred on this future date.

Principle:
• If a payment is contingent upon the happening of an
uncertain future event, the expense and corresponding
liability can only be actually incurred once the
conditions are met.
Actually incurred –

Edgars Stores

Facts:
• Leased premises to conduct its business.
• There was a basic monthly rental and an annual rental based on
turnover.
• Taxpayer estimated variable rent and claimed it as a deduction.

Issue:
• Is the estimated amount actually incurred?
Actually Incurred –

Edgars Stores

Judgement:
• The obligation to pay turnover rental is contingent until the
turnover is determined and cannot be deducted until
determined.

Principle:
• An expense can only be deducted once there is an
unconditional legal obligation to pay the expense.
Actually incurred –
Golden
Dumps (Pty) Ltd

Facts:
• Taxpayer and former employee were involved in a 4-year
dispute over the delivery of shares promised by the
taxpayer.
• The taxpayer claimed the cost of the shares as a
deduction.
Issue:
• When was the expenditure actually incurred?
Actually Incurred –
Golden
Dumps (Pty) Ltd

Judgement:
• Only when the claim is upheld by the court will a liability
arise.
• Where the outcome of a dispute is undetermined, it cannot
be said that a liability has been actually incurred.
Principle:
• Where an obligation to pay an amount is in dispute, the
expense can only be actually incurred when the dispute
is settled with regards to the obligation and the amount
thereof.
 unquantified
Actually considerations (purchase
Incurred – price)
Unquantified
amounts: deemed not to be incurred
Acquisition
assets (s
until they become
24M) quantifiable
Actually Incurred – disposal or acquisition of equity shares (s
24N)

 Scope:
 Disposal of equity share in a company; and
 More than 25% of the selling price becomes due and payable after the end of
the year of assessment of the seller; and
 the selling price is based on the future profits of that company; and
 value of equity shares for which this section apply during the year exceeds
25% of the total value of equity shares in that company, and
 Buyer and seller are not connected persons after the sale, and
 Buyer must return the equity shares should he fails to pay any amount due,
and
 The instrument concerned is not a listed instrument payable on demand.
Actually Incurred – disposal or acquisition of equity shares (s
24N)

 Implications:
 The quantified or quantifiable amount
 That is not due and payable during that year:
 Is deemed not have accrued to the sell, and
 Is deemed not have been incurred by the buyer
 When becomes due and payable in subsequent yea:
 Is deemed to have accrued to the seller, and
 Is deemed to have been incurred by the buyer.
 Is defined as:

• Overtime pay, bonus or commission

• Travel allowance or advance paid
• Leave pay
• A night shift allowance
Variable • A standby allowance.
Remunerations • Any amount of remuneration as defined
in section 1 of the 4th schedule, other
- s 7B than bonus, that is determined based
on the work performance of the
employee.

Implications:

• Deducted or taxed when actually paid.

General Deduction Formula –
During the year of
Assessment

Not defined in the Income Tax Act

Court Case laws are used to interpret its
meaning
One court case:
• Sub-Nigel Ltd
During the Year of Assessment–
Sub-Nigel

Facts:
• Company paid insurance premiums on a loss of profits
insurance policy.
• The insurance policy will only pay out in the future, if certain
events took place.

Issue:
• Are the insurance premiums deductible even if the income
from those claims was not received in the same year?
During the year of assessment –
Sub-
Nigiel
Judgement:
• Premium were incurred to ensure income was earned in the
case certain events happened.
• The fact that no income had actually been produced was
irrelevant.
• The expense was laid out for the purpose of providing
income and should be deducted in the year incurred.

Principle:
• An expense must be deducted in the year of assessment
that it is incurred, even if it will only produce income in
future years.
• An expense has to be claimed in the year that it is incurred .
It cannot be claimed in later years.
General Deduction Formula –
In the production
of income
What is income ? Gross Income Less Exempt Income

Not defined in the Income Tax Act

Court Case laws are used to interpret its meaning

Four court cases:

• Port Elizabeth Tramway
• Joffe and Co
• BP South Africa
• Mobile Telephone Networks Holding (Pty) Ltd
In the production of income –
PE
Electric Tramway

Facts:
• Same as discussed under Expenditure and
Losses element.

Issue:
• Same as discussed under Expenditure and
Losses element
In the production of income –

PE Electric Tramway
Judgement:
• Taxpayer’s business to employ drivers.
• It is expected that liabilities to compensate the employees
will be incurred.
• Compensation paid is deductible and legal costs are not
deductible.

Principle:
• What is the purpose of the expense ?
• How closely connected is that expense to the
production of income ?
In the production of income –

Joffe & Co

Facts:
• Same as discussed under Expenditure and
Losses element.

Issue:
• Same as discussed under Expenditure and
Losses element
In the production of income –

Joffe & Co
Judgement:
• Negligent actions were not deemed necessary part of an
engineering trade and were not incurred for the purpose of
earning profits.

Principle:
• If something is not an inevitable concomitant of the
business operations it is not deductible.
• Negligence resulted in the roof collapsing and thus not an
inevitable part of trade.
In the production of income –

BP South Africa
Facts:
• Paid royalties to BP Worldwide for the use of BP
trademark.
• Royalties are based on a rate per litre sold

Issue:
• Are royalties payments incurred in the production of
income?
In the production of income –

BP South Africa
Judgement:
• Expenditure was incurred to procure the taxpayer use of the
intellectual property of the parent company for a specified
period of time.
• The expenditure is revenue in nature.

Principle:
• Recurring payments for maintaining income earning
operations are deductible.
• Royalty payments are of revenue in nature and deductible if
the intellectual property is used in the production of income.
In the production of income –
Mobile Telephone
Networks
Facts:
• Incurred audit fees for the company as a whole.
• Auditors spent 94% auditing interest income and 6% auditing exempt
dividend income.
• Also incurred training costs (training on the new accounting system)
relating to the staff employed in the interest income section.

Issue:
• Whether full audit fees are deductible?
• Whether training fees were necessary part of trade?
In the production of income –
Mobile Telephone
Network
Judgement:
• Only 94% of audit fees were incurred in the production of income.
• Training fees are necessary part of trade as it allows the taxpayer to
trade effectively.

Principle:
• Audit fees are necessary part of trade and therefore, incurred in
the production of income. Where audit fees relates to both income
and exempt income, they should b apportioned by using a
reasonable apportionment method.
• Training fees are necessary to trade effectively, and it will not
be capital in nature and will be allowed as a deduction.
General Deduction Formula –
Not of a capital in
nature.

Not defined in the Income Tax Act

Court Case laws are used to interpret its
meaning
Three court cases:
• New State Areas Ltd
• Rand Mines
• BP South Africa
Not of capital in nature –
New State
Areas Ltd
Facts:
• Required to install sewerage system on its premises as well
as land outside
• The system was installed at the cost of the local
municipality
• The taxpayer repaid the municipality in monthly
Issue:
installments.
• Whether any of these monthly installments are capital in
nature?
Not of Capital in Nature –
New State
Areas Ltd
Judgement:
• Instalments are capital in nature as they relates to acquisition of an
asset that remains the property of the company.
• Instalments relating to the system outside the property of the
company relates to right of use of such system by the company and
therefor, deductible.

Principle:
• Cost of establishing/improving /adding income earning structure
(Fixed Capital) is capital in nature and therefore not deductible.
• Cost of performing income-earning operations (floating capital ) is
revenue in nature and therefore, deductible.
Not of capital in nature –

Rand Mines

Facts:
• Acquired a contract to manage a mine under
the same group of companies.

Issue:
• Whether the acquisition costs are capital in
nature?
Not of Capital in Nature –

Rand Mines

Judgement:
• The management contract did not generate income in
itself, yet created the opportunity to generate income.
• The cost is therefore related to the income earning
structure and capital in nature.

Principle:
• Expenditure incurred to obtain an income earning
right or structure will be capital in nature.
Not of capital in nature –

BP South Africa

Facts:
• Made an upfront payment to lease premises for
20 years.

Issue:
• Whether the sum rental payment is capital in
nature?
Not of Capital in Nature –

BP South Africa

Judgement:
• This was not rental expense.
• This is capital in nature as it is creating
enduring benefits.

Principle:
• Expenditure that creates enduring benefits
is capital in nature.
 General Deduction Formula –

Purpose of Trade
 A wider interpretation should be given to trade (Burgess Case).
 Trade is defined as (s 1 of the Income Tax Act):
 Every profession, trade, business, employment, calling, occupation or venture, including the letting of any property and
the use of or the grant of permission to use any patent or any trademark or any copyright or other similar properties.
 The definition is not exhaustive and embrace every profitable activity
 Trade involves taking a risk with a hope of making a profit
 Activities concerned should be examined as whole to determine whether a taxpayer is carrying on a trade
 Does not necessary require continuity and profit motive.
 Does not include all activities that produce income – Examples, watching over existing investments.
 SARS practice – may allow deduction of interest incurred limited to the interest income
 SARS practice – may allow deduction incurred from the letting of single residential property or residential
properties but limited to rental income.
Thank you