General deduction formula

1. TAXATION 2021
presented by Masibulele Phesa CA(SA), RA
General Deduction formula
Prescribed textbook: Notes on South African Income Tax

2. LECTURE OUTCOMES
Understand General deduction formula
Understand case law applicable
Understand and apply disallowed expenditure
formula

3. Taxable Income Framework
We are here

4. General information about
allowable deductions
Taxable income is the amount remaining after deducting expenses by
a virtue of General Deduction formula , s11(a).
All expenses will only be allowed for deduction under this section ,
unless it is generally deductible under any section in the Act.
S11(a) must be read with s23 that contains prohibition on deductions
(negative test).
The person is only allowed the deductions if he/she is carrying on a
trade. (ss1(1).

5. Carrying on of a trade
According to section 1 trade includes :
 Profession
 Trade
 Business
 Employment
 Calling
 Occupation
 Venture
 Letting of a property
 Use of/grant permission to use a patent or any design, trade mark, copyright or any property of a
similar nature.
 In case: Burgess v CIR  it was stated that trade has a very wide meaning – it was determined that trade has a
wide meaning.
 Carrying on is not defined on the ACT, s 11 requires that a person carries a trade.
If a taxpayer is carrying on a trade, his
motive to carry business is not relevant.
The definition is not necessarily
exhaustive, the term trade was intended
to embrace every profitability activity.

6. Carrying on of a trade
 There are specific features of specific trade that has to be looked
when determining the carrying on of a trade.
  For example:
 Continuity of activities
 Long term objectives of trade to generate a profit
 Active steps taken?
 (Interpretation Note No 33 (Issue 5) provides some
direction)
 Possible to be “carrying on trade” even if you do not have the
objective to make a profit or deliberately sets out to make a loss
 Passive ≠ not “carrying on a trade”

7. Pre-paid expenditure and losses s11A
Expenditure is usually deductible after the trade has commenced, however the taxpayer
incurs expenses far before the actually date of commencing a trade, such as Company
registration costs, setting up operating environment, buying assets, application for licenses,
paying of rent.
S11A allows certain deductions that were incurred before the trade , that were never
claimed.
The following requirements need to be satisfied:
A trade must be carried on
Expenditure or losses must have been incurred before trade began
Expenditure or losses must be incurred in preparation for the carrying on of that trade
Expenditure must qualify as a deduction in terms of section 11 (a) to (w) [except s 11
((x) & (D)] and s 24 J
Expenditure or losses were not previously claimed or allowed as a deduction
Deduction of pre-trade expenditure is limited to the income from the specific trade
Excess amount carried forward and deducted against the income from that trade in
future periods and not deducted from other trade income

8. Pre-trade expenditure
example
Assume the following took place within the year of assessment ending 31 December
2020.
A vacant administration building was purchased on 25 January 2020. Transfere costs
amounted to R30 000. The building was renovated as a cost of R250 000. The
renovations were completed on 1 July 2020, the same date on which the occupants
moved in and became liable for rent to the property owner.
The property owner therefore commenced with carrying on a trade on 1 July 2020.
Rental income of R50 000 and royalties (income not related to the rentals) of Rates and
taxes in respect of the building amounted to the following:
- For the period 25 January 2020 to 30 June 2020- R60 000
- In respect of the remainder of the year of assessment –R33 000
• Required: What amount will qualify for a deduction in terms of S11a?

9. General Deduction Formula s11(a)
The court stated that s 11(a) and s 23(g) must be read together when considering
whether an amount may be deducted. Port Elizabeth Electric Tramway Co Ltd v CIR
(1936 CPD).
The General Deduction Formula is broken down into the following elements:
o Expenditure and losses
o Actually incurred
o During the year of assessment
o In production of income
o Not of a capital nature
 Section 23(g) provides that no deduction is allowed for expenditure to the EXTENT
that they are not laid out for the purposes of trade
 EXTENT  means expenses can be apportioned between trade and non-trade
expenditure

10. Expenditure and losses
 Expenditure is defined as the voluntary spending of funds; disbursements or
consumption (i.e. amount of money spent)
 Losses are not defined by the Act, the court also have not defined the word
“losses” Joffe & Co Ltd v CIR (1946 AD), the court stated that the word may
have several meanings.
 The word appeared to mean losses of floating capital employed in trade that
produces an income- Port Elizabeth Electrical Tramways (1936 CPD)
 Obligation or liability and expenditure are not synonyms- CSARS v Labat
(2011 SCA).
• An employee responsible for the bank account of the company
falsified payments and transferred R20 000 to his bank account
• Implication: Company suffers losses of R20 000

11. Actually Incurred
 The words ‘actually incurred’ rather than 'necessarily incurred.
 The word meaning is widens the field of deductible expenditure.
 There must be unconditional legal liability before an amount is “actually
incurred.
 The word limits certain deductions:
 Provisions for expenditure or losses that are uncertain
 Expenditure or losses that may arise in the future
 Expenditure or losses that are no more than expected
 s23H may limit certain deductions

12. During the year of assessment
The expenditure can not be carried forward to a subsequent year of
assessment or carried back to a previous year of assessment. This rule
is subject to s23H provisions.

13. The expenditure is restricted only to the production of income
S23(f) may restrict the deductions
In a case between Port Elizabeth Electric Tramway Co Ltd v CIR (1936 CPD) A
driver of one of their cars was involved in accident and as a result he suffered
injuries and eventually died. The company was compelled to pay compensation
to the deceased’s dependent-.
Two questions were asked:
I.What action gave rise to the expenditure?
II.Is the action closely connected?
The expenditure was considered to be closely connected with each other
and was therefore allowed as a deduction.
In the production of income

14. In the production of income
Joffey & Co (Pty) Ltd v CIR (1946 AD)- The company carried on business as engineers
in reinforced concrete. The company secured a contract to do reinforced concrete work
on building in Durban. The concrete hood build by the company collapsed and a
workman employed by the contractor was killed. Action was brought by the dependants,
which established that the company had been negligent in the performance of its work
and it was required to pay damages to the dependants and litigation costs.
Are damages deductible?
1.Principle: Expenditure arose out of negligence of the taxpayer and
2.The taxpayer was unable to show that such negligence was a necessary concomitant
of their trading operations. This was avoidable expenditure.
The expenditure was not deductible in terms of s 11(a).

15. In the production of income
 Sub-Nigel v CIR:
– For expenditure to be deductible it is not necessary that
expenditure produce income in the year it was incurred
– The income may be earned only in future years, as long as the
expenditure was incurred to earn that income
 CSARS v MTN:
– The portion of any expenditure relating to dividend income
should be disallowed and the remainder relating to the income-
producing activities should be allowed
– A reasonable apportionment method must be used as a
yardstick on which apportionment should be based

16. Not of capital nature
 The facts of each case has to be considered and purpose of the expenditure to determine whether
the expenditure is capital in nature or non-capital.
 The following cases distinguishes the test based on courts judgements:
– New State Areas Ltd v CIR
– Rand Mines (Mining & Services) Ltd v CIR
– BPSA (Pty) Ltd v CIR
 New State Areas Ltd v CIR- Taxpayer was a gold mining company. It was required by the local
authority to install water-borne sewerage and to link up with the authority’s system. The system
was constructed partly on the company’s property and partly on the land outside the company’s
property. The system was installed at the cost of the authority but the company was required to
make certain payments in instalments. After the final instalments the sewer connectors inside the
company will become the property of the company and the ones outside belong to the authority.
 Are installment's deductible?
Principle
 Cost of performing income-earning operations  NOT capital in nature  therefore deductible
 Cost of establishing or improving income-earning structure  capital in nature  therefore NOT
deductible

17. Not of capital Nature
 Rand Mines (Mining & Services) Ltd:
 The expenditure in this case was held to be capital in nature
because it was a cost expended to acquire or create an income-
earning structure
 Distinguish this from expenditure incurred to “work” the income-
earning structure (which will be revenue in nature  deductible)
 BPSA: Where no new capital asset for the enduring benefit of the
taxpayer has been created the expenditure  tends to assume
more of a revenue nature

18. Prohibition of deductions s23H:Prepaid
expenditure
This section provides exception by limiting the deduction to the
following cases:
 Expenditure must be allowable in terms of s11(a) (general deduction
formula); 11(c) (legal fees); s11(d) (repairs); s11A (qualifying pre-
trade expenditure and losses); s11(w) (premiums for key-man
policies)
 Expenditure must be for service or goods or benefits that will be
enjoyed beyond the year of assessment
S23 H does not apply on the following exceptions:
• If goods or services or benefits are going to be enjoyed within 6
months after the end of the year of assessment (proviso (aa)) or
• Any expenditure that is required by legislation
• Ignore proviso (cc)

19. Prohibition of deductions s23H:Prepaid
expenditure
 If taxpayer can show during the year of assessment that:
 The goods will not be received or
 Services will not be rendered to them or
 Benefits will not be enjoyed
 Then taxpayer can deduct the expenditure to the extent that they
have been actually paid by the taxpayer

20. S23 Prohibitions of deductions
The following sections prohibits the deductions of expenditure:
 Sections:
– s23(a) – private maintenance expenditure
– s23(b) – domestic or private expenditure
– s23(c) – recoverable expenditure
– s23(d) – interest, penalties and taxes
– s23(e) – provisions and reserves
– s23(f) – expenditure incurred to produce exempt income
– s23(g) – non-trade expenditure

21. S23 Prohibitions of deductions
The following sections prohibits the deductions of expenditure:
 Sections:
– s23(a) – private maintenance expenditure
 s23(b) – domestic or private expenditure
 s23(c) – recoverable expenditure
 s23(d) – interest, penalties and taxes
 s23(e) – provisions and reserves
 s23(f) – expenditure incurred to produce exempt income
 s23(g) – non-trade expenditure
 s23(h) – notional interest
 s23(i) – deductions claimed against any retirement fund lump sum benefits and retirement fund lump sum
withdrawal benefits
 s23(l) – restraint of trade
 s23(m) – expenditure relating to employment or an office
 s23(n) – government grants
 s23(o) – unlawful activities
 s23(q) – expenditure incurred in the production of foreign dividends
 s23(r) – premiums in respect of insurance policies against illness, injury, disability, unemployment or death
of that person

22. Private maintenance s 23(a)
These includes the costs incurred in the maintenance of the tax payer,
his family or establishment, are not allowed as deduction.
Domestic or private expenditure s 23 B and (m)
- Domestic or private expenditures are not allowed (include rent, cost
to repair, or expenditure in connection to any private home) are
prohibited by this section.
- Only a part of the private home being occupied for trade purposes is
allowed:
 Specifically equipped for purposes of trade AND
 Regularly and exclusively used for trade AND
 The employee’s duties are mainly performed in their home office

23. Recoverable expenditure s 23 ©
This section prohibits the deduction of that is recoverable under any contract of
insurance, guarantee, security, or indemnity.
 Interest, penalties and taxes s 23(d)
– tax imposed by the Income Tax Act
– interest and penalties imposed by any other Act imposed by the Commissioner
(e.g. VAT Act)
 Provisions and reserves s23(e)
 income carried to any reserve fund or capitalised in any way.
 Expenditure incurred to produce exempt income S23(f)  expenditure incurred in
respect of any amounts that are not included in the term ‘income’ as defined in s 1
will not qualify as a deduction.
 S23(g)  prohibits the deduction of any moneys to the extent to which such moneys
were not laid out or expended for the purposes of trade (negative test of the general
deduction formula)
 s23(h)  notional interest  interest that could’ve been earned on capital applied in
trade  no deduction
 S23(i) & (k)  not covered in Tax 2A

24. Recoverable expenditure s 23 ©
 s23(l)  expenditure in respect of restraint of trade not allowed to be deducted 
except those allowable in terms of s11(cA)
 s23(m) – Expenditure relating to employment or an office
 Prohibits the deduction any expenditure, loss or allowance relating to employment
 Prohibition does not apply to an agent or representative whose remuneration is made
mainly (>50%) from commission based on sales or turnover
 s23(m) does not affect the deduction of the following:
– Contributions to any retirement fund- s11F
– Legal cost - s11(c)
– Wear and tear –s11(e)
– Bad debts – s11(i)
– Provision for doubtful debts – s11(j)
– Qualifying rent, repairs or any expenditure in connection with domestic premises
 provided not prohibited by section 23(b

25. Recoverable expenditure s 23 ©
 s23(n)  deduction or allowance for an asset or expenditure to the EXTENT that an amount was
provided by government grant that is exempt  not deductible
 s23(o)  expenditure in respect of unlawful activities  not deductible  example bribes, traffic
fines
 S23(p)  not covered in Tax 2A
 s23(q)  expenditure to earn foreign dividends  not deductible
 s23(r)  premium paid for insurance policy which covers a person against illness, injury,
disability, unemployment or death of that person – not deductible. The proceeds of such policies
are exempt from tax.
SECTION 23(B) PROHIBITION AGAINST DOUBLE DEDUCTIONS
 Expenditure cannot be deducted more than once if it qualifies for a deduction under multiple
sections
 Section 11(a) may not be used if a deduction or allowance is granted under another section
(Specific deductions take precedence over the general deduction formula)
 Section 11(a) may also not be used to claim the balance of the expenditure  if expenditure is
limited under a certain section

26. Specific Transactions
 Advertising
 If connected to advertising existing business  deductible
 If results in an asset  capital in nature  not deductible
 Intellectual property (patents, trademarks, etc.)
 Expenses to register or acquire IP  capital in nature  not deductible (unless dealer)
 Damages and compensation
 Inevitable concomitant  closely related to income-earning operation  deductible
 Not concomitant  not closely related to income-earning operation  not deductible
 Education and continuing education
 Not capital in nature  closely related to the income-earning operations
 Goodwill
 Capital in nature  not deductible
 Interest: On loans raised to acquire shares
 Not deductible  incurred to acquire shares which produces exempt income

27. Specific Transactions
 Losses – sale of debts
 Part of income-earning operations  deductible
 Part of selling a business  capital in nature  not deductible
 Loss : Embezzlement of cash
 If money stolen by managing director or owner of business 
not deductible
 If money stolen by an employee or subordinate  deductible 
related to the income-earning operations  risk that money may
be stolen by them

28. QUESTION TIME
“... Taxes grow without rain.” Jewish Proverb